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00:00We are seeing it. CDS spreads are starting to widen, credit spreads creeping ever so slightly
00:04higher, though they are well behaved. Is this a market that is starting to push back on the
00:09amount of spending we're seeing from these hyperscalers? And is it warranted? Should
00:13there be pushback? Well, thanks, Danny, and great as always to be with you. I'd say you put it a
00:21little bit differently. Rather than pushing back, the market is just being a little more selective.
00:25There's a lot to choose from in the digital infra lending space from very, very high quality
00:32lending opportunities to some of the hyperscalers to some of the below investment grade chip financed
00:38type of issues. So there's a lot to do there. There's a lot to sift through. There is a lot
00:44of risk, but there's a lot of opportunity. On balance, we see this widening as more of an
00:49opportunity because you're able to deploy into this space in high single digits, seven,
00:54eight, nine percent yields in some of these opportunities, sometimes for a very strong
00:59investment grade type of quality. So if anything, we'd see it as more of an opportunity. But yes,
01:05there's a lot that needs to get financed. There's a lot of lending that has to happen. And we're
01:10really only in the early innings of this whole wave of financing and digital infraspace.
01:15Well, are you seeing a lot of dispersion differences between various asset managers because of the
01:21way this is all developing? Yeah, I think what you're seeing is the need to be able to deploy
01:28in size. These are very large lending opportunities. You're talking about building data centers that
01:35need 10, 20, 25 billion dollars of debt to build them out. And then you need chips that need to
01:42get
01:43financed to go into the data centers. I mean, this is a very significant, really unlike anything we've seen
01:49in our careers. And so where you can really add additional value as an asset manager is to be
01:55able to speak for multi-billion dollar pieces of these financings. And that's naturally something
02:00that only a handful of asset managers can do. So that really is leading to that dispersion that
02:07you mentioned, Mike, between asset managers. And PIMCO is certainly one of those that are able
02:11to do so with different landmark projects like Oracle's Michigan campus. How do you think about,
02:16though, how you manage AI concentration risks as you see this opportunity and want to participate
02:22more in these jumbo size deals? No, it's a great question, Danny. And yes, this has been a real
02:27focus for us. And we have deployed a lot of capital into this space. But Dan Iveson, our group CIO,
02:33has
02:33been laser focused on this concentration risk. And it's really two things. It's the underlying credit
02:39risk that you're taking. And in many cases, it's very different. In some cases, you're very close
02:44to your single A, double A, even triple A rated hyperscaler in terms of the structure of the
02:50lease that you have. In some cases, you're further away. So you're taking more credit risk the further
02:54away you are from that hyperscaler. So that's one thing is what really is the credit risk that
02:59you're taking. The other is the concentration risk that you mentioned. I mean, the beauty of AI is that
03:06it's disrupting technology and it's generating a lot of excitement through that disruption.
03:10Of course, the downside risk is that it's disrupting through its technology. And so
03:15you could see a lot of disruption risk down the road. So you don't want to have too much
03:21risk in any one project or in the whole complex. So that's something that we're very much keeping
03:26an eye on. It's a great opportunity, but you want to be moderate and measured in how you deploy into
03:30it
03:31and always with a keen eye to the credit underwriting and making sure that you're not taking sneaky credit
03:37risks that are embedded somehow in the structure of what you're doing.
03:41Christian, I know that this is something you noted, that as more investors are looking to lend
03:45into this space, that you're already starting to see underwriting get more relaxed. Where are you
03:49seeing that? Where are you seeing undue risk being taken?
03:52Yeah, you're seeing it in a couple of different ways. And so it'll be things like when you're doing
03:58a data center financing, by how much is that data center insured? You're generally not insuring 100%
04:04of the value of the data center, but you're insuring some significant portion of the data center
04:08that gives, ultimately, that gives the lender protection. Or things like in chip financing.
04:15These are very detailed elements, but you really have to get into the granularity of these things
04:19in chip financing. Do you have the right on day one when you lend the money out to go in
04:25and inspect
04:26that the chips are actually there and they're actually working? When you're lending against an
04:30Nvidia chip, that's a rapidly depreciating asset. You want to make sure that it's there,
04:34that it's working, that it's getting taken care of, these types of things. So this is not
04:38your grandfather's Oldsmobile. This is not just general IG credit risk. It's very granular. It
04:44really takes going through the documents and the structure with a fine-tooth comb. We think that
04:49when you do it right, it's some of the best risk-adjusted rewards out there in credit and in fixed
04:55income in general right now. Of course, if you do it wrong, you're taking a lot of credit risk
04:59that you may not be getting paid for. Are you able to set up hedges for all of these risks
05:03that
05:03you're talking about? I know in Michigan, you had a very unusual one that Dan put in place,
05:08matching the lease to the contract. Yeah, there's a lot of different ways that you can mitigate the
05:14risk. I mean, ultimately, you are ultimately taking some credit risk. You're taking the credit risk of
05:20the hyperscaler that you're ultimately lending to. So you are taking a bet on AI. You're taking a bet on
05:26this technology cycle. It's one we think, though, that is quite reasonable. If you look at the
05:32hyperscalers, they still have very, very low debt to enterprise value. If you look at a Google or a
05:40Microsoft or even a Meta, you're talking about just gross debt, not even giving them credit for
05:45the cash that they have on balance sheet, gross debt that is in the low single digits, maybe mid-single
05:50digits of total enterprise value. So you've got a lot of equity cushion there. Now, when you're
05:57doing data center financing, of course, you're lending to the data center rather than directly
06:01to the hyperscaler. And so you do have to structure that in a way that you're very close to the
06:06hyperscaler. But ultimately, we think that this is really good risk-adjusted reward.
06:10Christian, I wonder when you sort of look out on a longer term time horizon, when you look at the
06:15attractiveness of this, what are sort of the level of these big data center financings you think
06:20PIMCO is going to undertake? Is there a certain percentage, for example, of your portfolio you
06:24think that might start to gear more towards this AI ecosystem? Well, it's going to matter by
06:32portfolio. And some strategies are going to have very little exposure. They're not really designed
06:36to take this kind of type of credit risk. And others are going to be designed to take a lot
06:39more.
06:40So it's really going to depend on the strategy and the client and what have you. If you look right
06:44now, the hyperscalers are only about, call it five ish percent of the investment grade corporate bond
06:51index. We see that going to 10% of the index and maybe a little bit more than that. So
06:56I'd say in
06:57those strategies that are directly focused on these types of risks, yeah, you'll probably see
07:02around 10, maybe as much as 15% of portfolios in these. But that'll be at the upper end. Again,
07:09because there is so much, first of all, there's a lot of other things to do in the world. There's
07:13a lot
07:13of other ways to lend into this CapEx cycle. There's the utilities, there's transmission,
07:19there's energy, etc. So there are a lot of different opportunities out there, but also because you
07:24are ultimately taking disruption risk and you want to scale that accordingly. Speaking of other
07:30opportunities out there, the federal government is selling a lot of paper these days and we're going
07:35to get the refunding announcement on Wednesday. Is there a crowding out going on? And I'm wondering,
07:41when you look at the term premium for basically across the curve, they've all been going up
07:47for the last 12 to 18 months. And I wonder how much of that is federal borrowing versus what's
07:52going on in the oil markets and the Middle East and what the competition is from AI and other private
08:00credit. Yeah, thanks for that, Mike. I mean, I think if you listen to some of the interviews that
08:06that Rich Clarida, former vice chair of the Fed and our chief economic advisor has had with you,
08:12with Bloomberg and with others, you know, he's spoken about this really well, where it's more
08:16of the latter. It's more of the competition for all of the financing opportunities that are out there
08:22in the economy right now. We are in a CapEx wave like we haven't seen in decades, in generations.
08:29This CapEx wave on the one hand leads to higher growth, but on the other hand, you know, really
08:34needs financing. And so the government is competing ultimately with all of this private sector
08:39financing that has to happen because there is all of this private sector financing, because there is
08:45projections of higher economic growth, of higher productivity that raises the neutral real rate
08:54of interest that raises real interest rates, which pushes borrowing rates for everybody higher across
09:00the board. You know, on the one hand is a challenge for governments. It's a challenge for some borrowers.
09:06But on the other hand, it's a great opportunity for investors who are lending into this broader CapEx cycle.
09:11It's pushing up returns in fixed income across the board. And now you're seeing yields in diversified income
09:18strategies of call it seven, seven and a half percent without taking undue credit risk. It really is
09:24a really interesting opportunity set right now. But ultimately, there is this crowding. Ultimately,
09:28there is a demand for financing across the board, public sector, private sector. Ultimately, it's
09:34healthy. It's driving growth higher. It's driving productivity higher. But it does mean a crowding
09:40out in financing sectors. And it comes after the shakeout, as we started this conversation talking
09:45about, Christian, where there has been differentiation between different managers. I remember when we spoke
09:50earlier this year around March, when we were really in the thick of it of concerns about what people
09:55were selling, what those managers were doing. You said, look, I don't like what loans are being sold
10:00right now. It's not great. It's not good opportunities for us. What about now? Are there still stresses that
10:05are present and selling into this market that you think does present a good opportunity?
10:10Yeah, I mean, you're starting to see opportunities in repriced traded leveraged loans. So in the below
10:18investment grade, so below investment grade, there's the high yield bond market and there's the traded
10:22leveraged loan market. And that traded leveraged loan market has a lot of different things that are
10:27driving yields higher. But right now, if you look at single B leveraged loans, you're getting eight and a half,
10:33nine, nine and a half percent yields on a pretty resilient and diversified profile of liquid. And
10:40that's really important of liquid opportunities. And that's much higher. That's a few percent higher
10:46than what you would have gotten a few years ago. Now, what's going on there is in part,
10:51it's competition from and the turmoil that's going on in direct lending. So the volatility that you're
10:56seeing in direct lending is creating contagion into these traded bank loans. In part, it's because of the
11:03concerns around software. So there's a lot of that market is loans from software companies. So what's
11:09going to happen with all that disruption? And what is it going to do to the credit quality of some
11:13of
11:13those software issuers? In part, it's just the general what we just talked about. It's a general
11:18rise in yields across the board. But you pull it all together and you get a pretty diversified opportunity
11:23set in this below investment grade space without having to go into the deeply illiquid part of the
11:28market, which is private credit direct lending. So yes, we'd say we are starting to see opportunity now.
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