January 10, 2025 • 47 mins
Shiloh Bates talks to Chris Gilbert, the Head CLO Banker at Natixis. Natixis a leading underwriter of broadly syndicated and middle market CLOs. It was also the first bank to issue a reinvesting CLO after the financial crisis. Chris helped Shiloh with the book he published on CLO investing in 2023, CLO Investing with an Emphasis on CLO Equity and BB Notes.
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Episode Transcript
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(00:05):
Hi, I'm Shiloh Bates and welcometo the CLO Investor Podcast.
CLO stands for CollateralizedLoan obligations,
which are securities backed by poolsof leveraged loans. In this podcast,
we discuss current newsand the CLO industry,
and I interview key market players.
We're closing out what I thinkwas a very good year for CLOs.
(00:29):
There was 200 billion ofnew issues CLOs created,
which was an annualrecord. On top of that,
290 billion of CLO securitieswere refinanced or extended.
In terms of CLO returns,the Palmer Square,
broadly syndicated BB index was up 22%,
(00:50):
and the FLat Rock CLO equityindex was up 11% through the first
nine months of 2024.
The full year results will be availablein about 60 days as that data comes from
public filings not yet available.
Today I'm speaking with Chris Gilbert,the head CLO banker at Natixis.
(01:10):
His firm is a leading underwriter ofbroadly syndicated and middle market CLOs.
Natixis was the first bank to issuea reinvesting CLO after the financial
crisis. The CLO's underwriter, or banker,
brings a CLO to life by arrangingthe CLO's financing and mediating the
negotiations between all theinvestors in a CLO from AAA
(01:35):
to equity. After the closing date,
the underwriter earns a fee andgoing forward, it's the CLO manager,
a different party, that workson the CLO's loan portfolio.
Chris generously helped me with the bookI published on CLO investing in 2023.
If you're enjoying the podcast, pleaseremember to share, like and follow.
(01:58):
And now my conversationwith Chris Gilbert.
Chris, thanks for coming on the podcast.
Shiloh, thanks so much for having me.
So where are you talking to me from today?
I'm in New York City.
Okay.
So why don't you give our listeners alittle summary of your background and how
(02:21):
you ended up in the CLO banking business?
Absolutely, and if you'll indulgeme, I'll start at the beginning.
I was telling somebodyelse this the other day,
and it's interesting howit all came together.
So I started my career in 1990and my first job I had was
working for a consulting firm and ourprimary customer was the Resolution Trust
(02:41):
Corporation, which a lot of peopletoday don't even know what that is.
And it was a government institutionthat was absurdly temporary.
It existed from 1989 to 1996 and it wasset up to resolve insolvent savings and
loans. There was a savings and loancrisis that happened in the eighties,
generally due to a real estate bubble.
(03:02):
And our job was to go in and look atthese failed savings and loans and try and
triage what had happened, what had gonewrong, and there's litigation around it.
And we would support the Resolution TrustCorporation in thinking about what had
happened.
And it was a fascinating lens tolearn about the role of credit,
lending, and financialinstitutions in America,
the way they all came togetherand what could go wrong.
(03:24):
And I think that's given me an interestingoutlook into what has become my
career in CLOs. After that, I workedat Goldman Sachs for a number of years.
I had roles both in credit andtechnology investment banking where I saw
another rise and fall where I was therefor what people call the dotcom bubble
and saw some of my clientsgo from being, really,
(03:45):
the bell of the ball and on the coverof every hot business technology
magazine to all but insolvent ina period of two or three years.
And of course technology has risen again,
and I left there and endedup at what is now Natixis.
I've been here for 19years now, going on 20,
and I've been focused on CLOsfor pretty much that whole time.
(04:07):
And CLOs are obviously collateralizedloan obligations and their financial
structures that have beencreated to allow people to invest
in corporate loans and in different riskprofiles, and it's been quite a ride.
So what's something interesting you findabout the CLO business in comparison to
maybe some of the otherjobs you've had in the past?
(04:28):
Sure. Part of it is the community.
Some of the other jobs in the past haveeither been focused on looking backwards
or focused on short trade. CLOs,
it's very much a tight communitywhere there are probably a few
thousand people that regularlylook at CLOs as investments,
as creating the structures, as being partof managing them, and investing them.
(04:52):
There are probably four CLO conferencesin the year that are broadly attended.
I've seen you at many of them and Iknow you know many of these people.
And year after year you see the samepeople. We understand the trades,
we understand theparticipants in the community,
and it's really a situation wherepeople have gotten so deep in
understanding the risk, the structures,
(05:13):
and the trades and howit all fits together.
So you mentioned CLO conferences.
So one of the biggest ones is Opal thattakes place in Southern California.
That was a few weeks ago. Whatwas the vibe at that conference?
It was extremely positive. People werethere, they were coming off of a year,
and we'll talk about it later, I thinkof really record levels of activity.
(05:35):
It was curious because some people weretalking about they were wishing for a
bit of a pause and a break just for theirpersonal lives so they could see their
families given the frenetic level ofactivity and nobody saw it on the horizon.
I think investors had cash thatthey were looking to deploy.
I think managers had had somesuccess in refi-ing and resetting
(05:56):
their deals,
which means that they may have resetthe prices that they pay on their
liabilities to investors tomore attractive levels for them
given the buoyantatmosphere in the market.
And people are looking forward topositive momentum and good levels.
Going into 2025.
At Opal, how do you spend the two days?
(06:17):
Are you with managers tryingto sell CLO securities,
or going to panels, or onpanels? How do you do it?
I did speak on a panel. I loved it.
There was a panel on middlemarket loans that was, I think,
well attended and well regarded.
So I always enjoy speaking before agroup of people about a subject where
(06:38):
there's so many informedpeople in the room.
But most of the time I spend ina small curtain off part of the
room with no windows. And as a banker,my role, we're an intermediary.
We're not a principal to trades.I don't manage the loans,
I don't own the paper. Ihelp put the trades together.
So we spend timesintroducing and or updating
(07:00):
conversations between CLO managers,the people that invest in the loans,
and CLO investors. We'llbroker the conversations.
We'll sit in the room if there'ssomething that I can contribute,
or if I see a bridge in the conversationwhere I can help add value, I will.
But most of the time I'm listeningand I'm putting people together.
I also have side meetings whereI try to arrange new business.
(07:23):
I'll talk to a manager or somebody whomay want to sponsor a CLO in the equity
to taking the most risky pieceto drive the creation of a new
transaction.
And there I might have a one-on-one withthem to see what their future plans are
and if I can be helpful to them inconnecting them with other parties in the
market to create a new trade.
(07:44):
So one of the things I maybe neglectedto ask you early on in our conversation
is, so you're the head ofCLO banking at Natixis.
I think a lot of people outside of CLOsmay not be familiar with Natixis as a
bank.
So why does Natixis have thisoutsized presence in CLOs in the
US?
I think there's a few reasons. One ishistory. This business has been in place,
(08:05):
I said I'd been there for 19 years, thebusiness has been going for 21 years,
so I missed the first two years of it.
But we've been focused and dedicatedto the space for a long time.
When the industry was in itsinfancy, we were an early joiner.
I think that momentum has helped us.
We went into the Great Financial Crisiswith over $9 billion in exposure of
(08:25):
lending to people who areinvolved in the CLO space,
and where some other bankspulled out of the market,
they may have aggressively collapsedfacilities and push people out of
positions. Natixis did not do that.
So we emerged from the GreatFinancial Crisis with, I think,
one of maybe two banks with areputation that was relatively pristine
(08:46):
for supporting our clientsthrough the very absolute worst of
times.
And that credibility carried over andit allowed us to become an important
player in 2011 when we did our firstpost-crisis trade and then 12 and 13 and
14. And it's continued. We'vebenefited from those relationships,
(09:06):
and as we did, we grewexperience on the team.
We developed expertise andstructuring and placement.
We built a big salesforce around the product,
and success begat success.And we've continued to today,
where it's been a greatbusiness for the bank.
Do you think that one of your competitiveadvantages versus peers then is just
the warehouse facility thatyou're willing to put in place?
(09:29):
Is it that the terms that you offer thereare considered to be pretty friendly
to investors like myself?
Yes, but. And so much in our market,there's a lot of nuance there.
The terms we offer on their faceare probably pretty comparable to a
lot of our competitors.
I think the thing that distinguishesourselves is the reliability in
(09:51):
how we interpret the terms. So withinthese warehouses, within these facilities,
when there's a market disruption, callit Great Financial Crisis, call it COVID,
call it the Energy Crisis of 2015.
Sometimes the banks that are providingthe warehouse facility, the lender,
may take a somewhat aggressivestance with their borrowers,
(10:12):
and their risk departments may clamp down,
and suddenly the credit youthought you had may not be there.
I think the experience that Natixis hashad through so many cycles in so many
years,
we've gained great confidence in thisproduct and these structures to the
very highest levels of ourmanagement. Natixis is a French bank.
(10:33):
Our headquarters is in Paris.
I don't know that the Parisians are anexpert in the United States financial
markets,
but they are an expert in how CLOshave played out through cycles.
So for example, when COVID happened,
the market shut downfor a period of months.
Natixis was the first arrangerto arrange a reinvesting CLO,
(10:54):
and we priced it in April of 2020 whenother people were pulling away from the
market, we were leaning into themarket. It's one of our core areas,
it's an area we focus on. It's oneof the pillars of our business.
Is Natixis a bank thattakes the AAAs and AAs of
the CLOs that you're selling? Dothey have a big appetite there?
(11:14):
Again, it depends. So that's probablymy answer to all the questions.
But there are banks that havea demand for AAAs in their
Treasury unit. They useit as a cash substitute.
They might be deposit takers in theus and they like the floating rate
product with virtually no creditrisk implied by the AAA rating.
(11:37):
Natixis is not a deposittaker in the United States.
We're not a deposit taker inFrance. Our parent, BPCE Group,
is one of the biggestdeposit takers in France,
but we don't use AAA CLOsas a Treasury function.
My business does has a limitto take AAAs of CLOs as
part of our business to supportour transactions and advance
(11:59):
deals, but we don't have thenatural Treasury demand for that.
We do see that, in a lot of US banks,
a lot of Japanese banks,
increasingly Japanese banks have immensedemand for this product as a cash
substitute. We use it differently,
more as a component of my business.
(12:20):
So a lot of the business that we'vedone together has been in middle market
CLOs, which is, as you know,
a niche in the larger total US CLO market.
It's a little bit over 10% of themarket and it's growing pretty rapidly.
What do you see as the key driversof the growth in middle market CLOs?
I think it's a few things,
but I think the primary thingis the growth of middle market.
(12:43):
So one of my little sayings I liketo say is "capital follows capital".
And there's been immense growth inthe deployment of capital to private
credit lenders, middle marketlenders in the United States.
It's businesses that they've beenaround since the late nineties.
But in the past five to eight years,
the rate of growth has been astronomical.It's been spurred by I think, one,
(13:07):
the success of the asset class indelivering returns to limited partners.
People like state pension funds,like sovereign wealth funds,
like endowments, they'reinvesting in middle market credit,
private credit as an asset class.So as those investments grow,
the people in those businesses that aremaking middle market loans to middle
(13:28):
market companies, they've got more moneythat they're investing. As they do,
they need to borrow more tosupport their businesses.
They tend to operate their businessesat what we call a two times leverage
position. Meaning that if theyinvest in $300 million of loans,
they take a hundred million dollars fromtheir investors that those pensions and
endowments and sovereignwealth funds I mentioned,
(13:49):
and they take 200 million in borrowings.
That could be from me as a bankor my competitors as banks, or,
as the deal progresses, as their platformgrows more and more, the CLO market,
they'll borrow money from there. Andthat will be what spurs their growth.
So as they've grown, we grow in lockstep.
So for next year,
as you guys start to consider whichmandates that you want to work on,
(14:13):
how do you guys screen out which middlemarket managers or broadly syndicated
managers are going to be ones that youwant to work with and that you're going
to want to bring to market?
Absolutely. This is a thing wespend a lot of time thinking about.
I tell people I get two to three callsa week from a manager that says, "Hey,
I want to do a middle market CLO withyou". And of course we love that,
(14:34):
we love to hear that,
but then we need to spend sometime understanding their business,
and some people just aren't ready.So we need to understand, one,
is the debt market ready for them?Do they understand this manager,
this platform? Two,
does this manager have the operationalcapabilities to handle a CLO?
There are plenty of really smart lendersout there that I think are really good
(14:55):
at middle market lending,
but there's a level ofcomplexity to middle market CLOs.
There's detailed interaction with therating agencies to help the rating
agencies understand the portfolioand the loans they have.
There are detailed interactions withthe trustees to provide extremely
rigorous monthly reporting on each andevery one of the collateral loans across
(15:15):
20 plus dimensions like industries,spread, maturity, callability,
all sorts of featuresthat the CLO measures,
and constraints to make sure that thecredit risk is properly protected,
and they need to be able todeliver a diverse portfolio.
We like to say that you should have45 or more loans in the portfolio,
and ideally 60 plus. And as that goes,
(15:39):
some platforms just don't have that.
They might have a great trackrecord of doing 20 loans per fund.
That could be a good credit strategy.It's not a good CLO strategy.
So we try and look across these dimensionsand find the people that check all
the boxes. And we also like toliaise with people like you,
to understand what are your viewson the manager, and their strategy,
and how would you look at theinvestments in that stack?
(16:02):
Because if the smart investorsare ready to show up,
then that's a good connection.If you're wary of a platform,
then we need to know that.
Are you seeing a lot of middle marketCLOs with only 60 loans in them?
It seems to me like maybe 150 is maybemore like the average number there.
Are you seeing numbersless than that or...?
We do see numbers less than that,and I don't know want to say a lot,
(16:23):
but there are a few factors that drivethe number of loans in a middle market
CLO. One is how new theplatform is. Newer platforms,
they'll be a little bit more concentrated,or maybe a lot more concentrated.
Two is strategy.
Some managers like to spreadtheir investments out across a lot
of obligor's borrowers to avoidrisk of a concentrated loss.
(16:46):
Others may like what theycall a "conviction investment strategy" where they
want to be really sure on a smallernumber of investments instead of spreading
it across a wide number.
And another factor that can dictatethe number of loans in a CLO,
which is a little more complicated foran investor to see, you may see it,
but other investors maynot get to this level,
(17:07):
is the type of capital that supports it.
And by that I mean we talkedearlier about pensions, endowments,
sovereign wealth funds supporting a CLO,
being the equity or risk money behind it.
Some platforms have set themselves upto allow all their loans to be spread
across all of theirvehicles, all of their CLOs,
(17:27):
all of their investors. Andthere you'll see, generally,
a larger number of loans.
Some platforms are more setup to put loans in as they're
originated. So there's whatwe call a vintage effect,
where a CLO will be more concentrated inloans that are originated in a certain
period of time. Perhapsif the CLO ramped in 2023,
(17:48):
there'll be a lot of 2023-eraoriginated loans and they won't
have the ability to trade across theirvehicles to spread them out and increase
the number of loans. So short answer,not a lot with that low number,
but not zero.
So one of the things thathas been interesting this year is that the financing
rate, let's just talk about AAA becauseit's easier, but middle market CLOs,
(18:13):
the AAA is more expensive. And, not onlyis it more expensive, but it's shorter.
It's a four year reinvestment periodinstead of a five year reinvestment period
for broadly syndicated. Sothat favors the AAA buyer.
And then the two big otherstructural features are,
you get more junior capital supportingyou if you're a middle market AAA.
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And the final one is afterthe reinvestment period ends,
really middle market CLOs are really doneinvesting, but for broadly syndicated,
there's some flexibility to keep theparty going, at least for a while.
So the middle market CLOAAA is more expensive and we're talking about the basis
between that and broadly syndicatedat different times over the last,
(18:54):
call it five years or so,
I would think of the basis normalizedas somewhere between 50 and 70 basis
points. Does that jivewith your experience?
Yes, historically that has been the level.
We've seen a recent reduction of that.
So what do you see today'slevel as, 30 bps? Or.
25 To 30. Indeed, it's much tighter.
(19:16):
So that is, I think,
one of the things that's really beenbeneficial to middle market CLOs this year
because our financing cost is downcompared to where it was historically.
And although the middlemarket AAA is more expensive,
the 25 or 30 bps you'retalking about, well,
the loans in the middle markethave probably 125 bips or more of
(19:37):
incremental spread. So for the equity,
that ends up being apretty compelling story.
So what do you think has driven thisfavorable change in the basis over the
year?
I think there are a fewthings. One is liquidity.
I think that people have historicallysaid that middle market loans trade
at a premium because they're lessliquid than BSL loans and the aaas,
(19:59):
and by that I mean theydon't trade us often.
So if it's difficult to trade your loans,
people will charge ahigher liquidity premium,
and hence a higher financing cost.That liquidity premium I think has,
and should have, reduced.
If you look back threeto five and more years,
middle market CLOs represented eight to10% of the market generally year on year
(20:21):
end. BSL CLOs represented90 to 92% of the market.
In 2023,
middle market CLOs jumped up immensely.
They represented 23% of the market.
That percent came down alittle bit in 2024 to 14%.
But if you look at new issueCLOs, so the creation of new CLOs,
(20:42):
middle market were 19% of the market.So almost a fifth of the market.
BSL CLOs did have a lift because some ofthe old deals were repricing themselves
in the current environment.
So as middle market CLOs grow tobecome a larger percent of the market,
that liquidity premium shouldgo down. There's more bonds,
they should trade more often, if it'sa natural function of their growth.
(21:02):
I think a second reason, I'll come upwith three, is as the market's grown,
more investors haveonboarded the asset class.
People have to pay attention to it,
and people have had a hard timegetting the bonds they want,
what we call allocations,the ability to buy BSL CLOs,
and some of them have added middlemarket to their stable to fill their
investment quotas. And the third issimple, a little bit, what I call math.
(21:25):
People say, gee, 50 to 75 is the level,
but instead of talking about basis points,
we should talk aboutpercent of credit spread.
So credit spreads have tightened.Last year we would pay around
2.3%, 230 basis pointsover the risk free rate.
The SOFR rate for AAAs.
Nowadays it's probably 150 basispoints. So it's significantly in.
(21:49):
So instead of measuring that50 to 75 in an absolute number,
the 50 to 75 is a percent of 2.3% versus
25 to 30 is a percent of 1.5%. Thataccounts for some of the difference.
It's a portion of the creditspread, not an absolute number,
if that makes sense.
So do you think that that basiscan continue to tighten or do
(22:12):
you think people think25 or 30 bps is fair?
So first of all, I'm terribleat projecting things,
but I'll tell you my projection here.
For a long time whenit was 75 basis points,
the people investingin it said it was fair,
but it tightened to 50 and they were sadbecause they thought 75 should be the
number and then it tightened to 40.
And they were sad because theysaid 50 should be the number.
So it keeps tightening and I don'tsee why it shouldn't continue to.
(22:36):
The market always surprises me,
but there's no fundamental reasonthe liquidity is increasing.
I think people are understandingthe value proposition.
Investors have onboarded the asset classand they've onboarded the managers,
and, as you said, the fundamentals,the mechanics, the shorter life,
the absence of reinvestment,post reinvestment period,
those speak to tighter spreadsin a theoretical sense.
(22:58):
And I sometimes get stuck in theoretical.
There's no absolute barrier whyit shouldn't flip the other way.
Maybe they'll someday trade ata discount to BSL. I don't know.
Okay.
So that was the difference between broadlysyndicated and middle market in terms
of pricing. But the other differenceis that we've been talking about,
so one is just what's theloan to value through the AAA?
(23:19):
And I think the middle market, it'saround 55%, for broadly syndicated,
I think it's roughly 65%.
Is there any chance that themiddle market leverage moves
closer to broadly syndicated over time?
Or are we working with rating agencyconstraints there, or how do you see that?
And maybe the same question,too, for the reinvestment period,
(23:41):
could we get an extra year outof the deal in the middle market?
I'll answer the reinvestment periodfirst because that's the easy one.
We absolutely can go to five years andI'd say 20 to 25% of the market this year
has gone to five years.So there's no barrier.
It's not a rating agency constraint,it's a market convention.
It may continue to gravitate towardfive years. There's no real barrier.
(24:02):
Unfortunately,
I've seen those only in the trades wherethe manager takes the equity and the
double B unfortunately. So Ithink those are deals where, yeah,
third parties weren't involved.
I think that's right. Butas market convention grows,
as the increasing comfort comes towardthat, hopefully we'll show you some,
and then you'll get somelonger trades we'll see.
(24:23):
And on the advance rate,or the credit support,
so there are two drivers there.One is market convention.
I think when we look atthe rating agency models,
when we model out a middle market CLO,
and we model out a broadlysyndicated CLO often, but not always,
there's a lot more cushion in middlemarket CLOs than there are on broadly
(24:44):
syndicated CLOs for rating stresses.By which I mean, all things equal,
you could have a higher advance rate,
you could have a moreaggressive structure,
and still get the same ratingsunder the rating agency criteria,
for many, but not all, middlemarket CLOs. Broadly syndicated,
w don't usually see as much cushion,although occasionally there are some.
However,
(25:05):
investors historically have demandedthose lower advanced rates that
higher credit support.
So market convention is often drivingthe structure rather than finding the
edge of where a ratings will come out.
So there's room for it tomove. If that did leave,
I think middle market CLOs wouldstill have a lower advance rate.
(25:25):
Broadly syndicated., they tendto have slightly higher ratings.
We could talk about why thatis on the collateral pool.
And they tend to have more diverse namesbecause of some reasons we've talked
about.
So broadly syndicated deals would probablyalways have a little higher advance
rate, but I don't know howmuch higher it would go.
And I think market convention willprobably keep it around where it is today.
(25:48):
So for an investor like me, as you know,
I can buy in the primary marketwhen CLOs are being created,
and I can also buy them in the secondarymarket if we think that's where the
better risk adjusted returns are.
And my understanding of your businessis that sometimes selling equity in the
primary, the arbitrage, which is thenatural profitability of the deals,
(26:09):
is really strong, and you get a lotof buyers to show up for the primary.
And then what's not strong, I thinkyou guys know it's not strong,
and you understand when people arehunting around in the secondary instead,
how would you characterizethe current market?
Is it a primary buyer market or arethere better deals in the secondary
realizing secondary mightnot be your primary focus?
(26:31):
Sure.
Right now we're seeing a more robustprimary market across the board than we
have in a while.
It feels like the activebuyers of primary equity are
increasingly active. It toughto find loans at good prices.
We see just as the CLOmarket has been buoyed,
the collateral market has been buoyed,
but we are seeing natural formationof CLOs with third party equity right
(26:55):
now. I don't want to say it's beenthe best time I've seen in my career,
but it's active and solid and open.
It was kind of the bestarbitrage you've seen in 2021
when LIBOR floors on the loans wasstill in the money and we could
get pretty good debt prints or when wasthe easiest time to sell CLOs or is it
always a little challenging?
(27:16):
It's never easy. I have to tell mybosses how hard it is so they pay me.
If it ever gets easy,what am I doing here?
It's tough for me to pickthe right spot. And honestly,
it would never be a year. It's goingto be a month because what you want,
the ideal time and the best CLO we everdid was probably one where you price the
CLO. So the creation of a new CLO,
there are three key periodsthat people might think about.
(27:38):
One is the marketing period,
where we'll go out to investors andwe'll usually start with a AAA investor
because it's the biggest classand the most bonds to sell it.
We'll agree on a price level, afinancing rate, and once that's set,
we'll go out to the rest of thecapital stack, the mezzanine,
if there is equity to be sold,
they probably need to be in place firstbecause the one generating the impetus
(28:00):
for the trade.
And then we'll probably spend fivedays or so talking to the mezzanine
investors, the double A's,the single a's the triple Bs.
And if we sell them the double B's,we'll agree on a price very quickly.
And then we'll have a date, whichwill be a very specific day,
when we price the CLO. At that point,
we will write trade ticketsto all the new investors.
We know where all the bonds are going,and we'll agree on a closing date,
(28:24):
which will probably be about fiveweeks out. So on that pricing date,
the CLO may not own its whole portfolio.
In some few cases it might not ownany loans. At most it'll own 60,
70% of the loans it'll buy. So the bestdeal will be when you price the CLO,
and then the market tanks thenext day, and it goes down,
(28:44):
and you can buy those loans cheap,
and the CLO will take all the money itgot from the bonds and it'll buy a lot
more loans because it can buy them morecheaply. So it's not a year, it's a day,
it's a week, it's a month,
where you have that mechanic and that'llbe the best vintage and you can't see
it coming. There's anelement of luck there,
and the equity buyer who bought it willbe really happy. And in some sense,
(29:06):
a lot of equity investors will, it'salmost like dollar cost averaging,
where you go in and you buy multiple dealsacross multiple timeframes and one of
those will be your bonanza wherethe market does exactly that.
So refi and reset activity hasobviously been very elevated recently,
and one of the reasons to own CLOequity today is that as the CLO begins
(29:28):
its life with a on-call period wherethe AAA to double B rates are what they
are. And you can't really tinker withthe CLO if you're the equity investor,
but once the non-call period rolls off,
you can refinance tranches orportions of the CLO at lower rates,
you can extend the life of the CLO.
I've been saying that instead of resetbecause it makes a lot more sense to
people. Chris (29:50):
That's what it is. Shiloh:
So I think for an investor in CLO equity,I would look at a portfolio and say,
okay, when's the non-callperiod coming off on the CLO?
And is the CLO's financingin the money to do something?
So that really just means, for example,
is the AAA more expensive todaythan it would be if the non-call
(30:12):
period rolled off today? Soit's like a hypothetical calc,
and from what I've seen,
there can be material upsideand refis and resets because,
I think how people view themarket, and this is funny,
but the fair market value of CLO equitydoesn't trade or really isn't valued
with a lot of optionality or expectationthat this favorable thing's going to
(30:32):
happen. You do it and then you getcredit for it, and until you do it,
then nobody cares, which is funny.So at any rate, refis and resets,
very valuable to CLO equity, andthere've been a lot of 'em this year.
Could you just maybe walk through, forour listeners, the process of a reset?
We know when the non-callperiods coming up,
(30:53):
it's a bank like yours that putstogether the extension or refinancing.
What are the nuts and bolts of doing this?
Absolutely, and you're absolutely right.
One of the amazing things aboutCLO equity is the value of the
optionality in that you have the control,
you have the control of the timing todo it, not to do it. It's interesting,
when I started my career,the first 10, 12 years of it,
(31:15):
there was no such thing as a reset andthey've become common in the market over
the past eight or so years, and theybring incredible value to the equity,
and I think it was enterprising equityinvestors that figured this out and it's
now become a feature of the market.So the process, which you asked about:
So it'll be the equity, someonejust like yourself who has control,
(31:36):
majority of the equity, typically,that will make a direction.
They'll come out and they'll say,okay, we are going to call this debt.
We're going to take the old debt,we're going to get rid of it,
and we're going to issue new debt.They'll come to a bank like myself to say,
okay, Chris, Natixis, we'dlike to remarket our debt.
I have the Shiloh Bates CLO 2017.
(31:56):
Obviously there are no CLOs named afteryou. It's hypothetical. But this CLO,
we look at the debt prices and it's waytoo high. I look at the current market,
I can do better. I would likeyou to go out to investors,
I'd like you to replaceit. So the first step is,
we have to file somethingcalled a cleansing notice.
That is something thatgets rid of concerns about
(32:18):
securities laws where we might be talkingto people about inside information.
That cleansing noticetells the market, "Hey,
I'm thinking about doing somethingwith this deal. I might call it,
I might refi it, I mightreset it, I might collapse it.
I don't know what I'lldo, but it's in play".
So that lets us start to talkto investors. At that point,
we'll make a plan with the equity,we'll look at the portfolio,
we'll look at where we see themarket. We'll make a recommendation.
(32:40):
Should we do a refi, whichdoesn't extend the deal?
It doesn't change fundamental terms ofthe deal. Or do we want to do a reset,
where we open up the wholedeal? We may extend it,
we may change the advance rate,we may change specific terms,
but it can be a fundamental change. Atthat point. Once we've made the decision,
we'll typically start with a AAAinvestor. We'll go out to find, initially,
(33:01):
the existing holders ofthe debt. We'll ask them,
do you want to roll your position?
We see you have a hundred milliondollars investment in this deal,
$20 million investment in thisdeal. We're looking at a reset.
We're going to extend it by twoyears, three years, whatever it is.
You get the first look. Here'sthe price we think is appropriate.
If they decline, we'll go out tonew investors. If they accept,
(33:23):
they get the paper,
so long as they're willing to transactat the terms of the equity and the
arranger myself agree to. After that,
we proceed down the capital stack tothe mezzanine debt. We agree to prices,
first talking to the rollingdebt, the existing investors,
then going to new ones.Once the prices are agreed,
just like we talked about before,we'll have a pricing date.
We'll agree to a closing date.
(33:43):
There it might be shorter than thefive weeks we spoke about earlier.
Maybe it's three weeks out. Andthen once that closing date happens,
the old bonds will be extinguished andnew bonds will be issued to the new
investors.
And then presumably the CLO hasanother two year non-call period.
So that's two years where the debtinvestors will be protected and earn their
spread.
That's right. Shiloh (34:03):
Okay. So is this a lot of work? Chris:
It is a lot of work. It's an immenseamount of work, especially for my team.
My team,
we coordinate the new structuringconversations with the radiant agencies,
conversations with the law firmsthat write all the documents,
conversations with the trustees that holdthe collateral for the loan and handle
the monthly reporting,
(34:23):
conversations with the collateralmanager who do the investings,
conversations with the equity. We'reat the center of a web of investors,
service providers, attorneysthat run this process.
I like to joke and say that resets arethe worst of all worlds for banks because
the work is probably often more than anew issue transaction and the fees are
less. So it makes me sad,
(34:44):
but I think it's virtuous forthe market because it keeps the
equity engaged and evolved, and if itmakes their investment prospects better,
it can build the market for all of us.
So let me ask you this.
Let's say I own a CLO and thenon-call period is coming up,
and the AAA rate on theexisting CLO is 10 bps wider
(35:06):
than current market. To do a refinancing,
should I think of that as whenthe no-call period rolls off,
is it something where a bunch ofthings need to come together and
hopefully a refi will happen?
Or is it that the non-call period'sup, market spreads are tighter,
and we're doing something?
(35:27):
One is on the economic side, onequestion is on the economic side,
we will do something called a paybackanalysis where you cited 10 bps and that's
a nice savings, but there are coststo do in refi. It's not costless.
You're going to pay therating agencies a fee.
You're going to pay the lawyers a bunchof fees because they got to draft a lot
of documents, and you'regoing to pay me a fee.
(35:48):
So there's a fixed cost to doing this.
We'll spend some time ilooking atwhat the interest savings will be,
and we'll see how it compares to thefixed costs. And a rule of thumb we use,
and listen, there'sexceptions to every rule,
but a rule of thumb we use is if thatpayback is longer than six months,
maybe you think about it,maybe you wait, maybe you go,
if it's inside of six months,
it seems a lot more attractive andyou probably do go and execute.
(36:11):
So that's a big factor in doing this.
If you have a portfolio thathas had difficult performance,
that could influenceyour decision as well.
The market spreads mightbe 10 basis points tighter,
but if you have a deal that hasperformed worse than the market,
then that 10 basis pointsmay not fully accrue to you.
So there'll be an analysis of theportfolio and the performance of the
(36:32):
transaction itself.
But even if a CLO has underperformed,there's still an analysis to do.
My point is, the refiand reset opportunity.
It's not for the honor roll of CLOs,
it's for almost all CLOs thathave performed reasonably well.
That's how I think about it.
I think that's right, absolutely.
(36:54):
And you talked about a 10 basis pointdifferential, which is not a lot.
So that one might be cuspy.
You might want to look at thebest performing ones today.
The different deals coming offtheir on-call might be a full point
inside of where they were done,and if it's that much difference,
performance is almost irrelevant.
So you have to look at the degreeof tightening in the market and the
(37:16):
improvement of the financing costsversus the portfolio. But today,
I think any deal, regardless ofperformance, should be a candidate.
Okay, because I sawduring the COVID period,
I was very familiar with twodeals where they missed payments,
so there were excess defaults in theportfolio. There were excess triple Cs.
So instead of paying the equity,
(37:36):
the cashflow was used to eitherdelever the CLO or buy more loans,
buy more loans, actuallydelivers the CLO as well.
And one of the things that surprised mewas that for those underperformers in
2021, we were able to come backand do refinancing. So again,
it doesn't need to be the best performingCLO for us to start having these
conversations.
That's exactly right, andwe've done some of those.
(37:57):
Those might be a better refinancingcandidate than a reset candidate.
People may not want toput money in for longer,
and you might just refinancethe AAA and AA bonds,
which are the biggestpart of the cap stack,
that the double BS might be a harderconversation in those situations.
Yeah, so the concept there is ifyou're extending the life of the CLO,
it needs to have a certainamount of equity in it.
(38:17):
And if you've had a lot of loan defaults,
either you're going to haveto cough up more equity,
or maybe you could issuea next note or something.
Maybe there's another partial solutionby issuing additional debt in the deal.
But the CLO market has been doing reallywell. The CLO issuance has been strong.
CLO returns have been good for this year.
(38:38):
Do you see anything on the horizon thatcould change the direction the market's
going or what key risk would you focus on?
That was a lot of the conversationof the Opal Conference.
We spoke about where do people see acatalyst for a change, and honestly,
I'm not a great forecaster,
but I don't see an obvious catalystfor change within the CLO market.
(38:59):
Investors seem robust.
People have told us they have cash todeploy and are looking to buy new deals.
Our managers are telling us that thecredit in their portfolios is reasonably
good.
So barring some sort ofexogenous macro event,
I don't know what changes it.
And I half whimsically say I don'teven know what that would be.
(39:20):
It's not just CLOs. We'veseen almost all assets rally.
We've seen equities rally,we've seen Bitcoin rally,
we've seen investmentgrade and high yield rally.
We've seen the governmentin France falling. We see martial law in South Korea.
We see turbulence, multiple wars,and the market just goes up.
So I don't know what changes it for CLOsand I don't know what changes it for
(39:40):
the market broadly. It seems asource of strength and I think CLOs,
if there were to be achange, I still like CLOs,
we are secured by firstlien corporate loans,
which are the first out if thereare signs in corporate trouble,
and if you're buying AAAs, you'rethe first out on the first out,
top of the heap of everything and theequity, you're subordinated to CLO debt,
(40:01):
but you are secured by firstlien loans in corporate America,
diversified pool.
So it seems like the type of structurethat's weathered other storms and makes
intuitive sense. I don'tsee a catalyst for change,
but I'm always surprisedby things in the world.
The other thing I wanted to just hit iswith the Trump administration coming in
(40:21):
January, it seems to me likewhat's going to be the effect?
So I think probably moredeficit spending, maybe tariffs,
the result of which it's going to behigher for longer on rates. People ask me,
well, what about for the underlyingloans? I don't think really,
the loans in CLOs start theirlives with a 50% loan value,
(40:43):
so the marginal tinkerings of politiciansin Washington really shouldn't
affect our business too much. That'smy take. Is that how you see it or...?
More or less? Yes. My expert isn'tmacro, but I think that's right.
I think we have two advantages.
One is CLOs are floating rate productssecured by floating rate underliers,
so we shouldn't be overly exposedinterest rate risk as such.
(41:05):
I know that people do worryabout interest coverage from an
elevated basis.
So rates are SOFR since we are afloating rate product. But as you say,
our loans are made at a relativelyconservative advance rate,
and as the expectation of higherrates comes into the market,
we are seeing purchases ofcompanies happen at lower multiples,
(41:28):
which means that the financing happensat a consistent advance rate or
loan-to-value ratio,
then it's less leverage on thecompanies in a better interest coverage
position on new loans that are madein an environment with higher rate
expectations.
So I'm hopeful we're in a good spot andit seems like there's a lot of reasons
why our market alignsitself to adjust to economic
(41:51):
changes.
Great. Well, Chris, thanks somuch for coming on the podcast.
I really enjoyed our conversation.
Shiloh, thank you so much for havingme. I was really thrilled to be here,
and I appreciate the opportunity.
The content here is for informationalpurposes only and should not be taken as
(42:12):
legal, business, tax,or investment advice,
or be used to evaluate anyinvestment or security.
This podcast is not directed at anyinvestment or potential investors in any
Flat Rock Global Fund. Definition Section
AUM refers to assets under management.
LMT or liability managementtransactions are an out of
(42:33):
court modification of a company's debt.
Layering refers to placing additionaldebt with a priority above the first lien
term loan. The securedovernight financing rate, SOFR,
is a broad measure of the costof borrowing cash overnight,
collateralized by treasury securities.The global financial crisis, GFC,
was a period of extreme stress in globalfinancial markets and banking systems
(42:58):
between mid 2007 and early 2009.
Credit ratings are opinions aboutcredit risk for long-term issues or
instruments.
The ratings lie on a spectrum rangingfrom the highest credit quality on one end
to default or junk on the other. AAAA is the highest credit quality.
A C or D, depending on theagency issuing the rating,
(43:19):
is the lowest or junk quality.
Leveraged loans are corporate loans tocompanies that are not rated investment
grade. Broadly syndicated loans,BSL, are underwritten by banks,
rated by nationally recognized statisticalratings organizations and often
traded by market participants.
Middle market loans are usuallyunderwritten by several lenders with the
(43:41):
intention of holding theinvestment through its maturity.
Spread is the percentage difference incurrent yields of various classes of
fixed income securities versus treasurybonds or another benchmark bond
measure. A reset is a refinancingand extension of a CLO investment.
EBITDA is earnings beforeinterest, taxes, depreciation,
(44:02):
and amortization.
An add back would attempt to adjustEBITDA for non-recurring items.
ETFs are exchange traded funds. LIBOR,
the London Interbank OfferRate was replaced by SOFR on
June 30th, 2024.
Deliver means reducing theamount of debt financing.
High yield bonds are corporate borrowingsrated below investment grade that are
(44:27):
usually fixed rate
An unsecured default refers tomissing a contractual interest or
principle payment.
Debt has contractual interestprinciple and interest payments,
whereas equity representsownership in a company.
Senior secured corporateloans are borrowings from a company that are backed by
collateral.
(44:48):
Junior debt ranks behind seniorsecured debt in its payment priority.
Collateral pool refers to the sum ofcollateral pledge to a lender to support
its repayment.
A mon-call period refers to the timein which a debt instrument cannot be
optionally repaid.
A floating rate investment has an interestrate that varies with an underlying
(45:09):
floating rate index.General Disclaimer Section
References to interest rate movesare based on Bloomberg data.
Any mentions of specific companies arefor reference purposes only and are not
meant to describe theinvestment merits of,
or potential or actualportfolio changes related to,
securities of those companiesunless otherwise noted.
(45:32):
All discussions are based on USmarkets and US monetary and fiscal
policies.
Market forecasts and projections arebased on current market conditions
and are subject to change without notice.
Projections should not beconsidered a guarantee.
The views and opinions expressed by theFlat Rock Global speaker are those of
(45:52):
the speaker as of the dateof the broadcast and do not necessarily represent the
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Any such views are subject to changeat any time based upon market or other
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and Flat Rock Global disclaims anyresponsibility to update such views.
This material is not intended to berelied upon as a forecast, research,
(46:14):
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(46:38):
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Additional information about this podcast,
along with an edited transcript may beobtained by visiting FlatRockGlobal.com
Hi, I'm Shiloh Bates and welcometo the CLO Investor Podcast.
CLO stands for CollateralizedLoan obligations,
which are securities backed by poolsof leveraged loans. In this podcast,
we discuss current newsand the CLO industry,
and I interview key market players.
We're closing out what I thinkwas a very good year for CLOs.
(00:29):
There was 200 billion ofnew issues CLOs created,
which was an annualrecord. On top of that,
290 billion of CLO securitieswere refinanced or extended.
In terms of CLO returns,the Palmer Square,
broadly syndicated BB index was up 22%,
(00:50):
and the FLat Rock CLO equityindex was up 11% through the first
nine months of 2024.
The full year results will be availablein about 60 days as that data comes from
public filings not yet available.
Today I'm speaking with Chris Gilbert,the head CLO banker at Natixis.
(01:10):
His firm is a leading underwriter ofbroadly syndicated and middle market CLOs.
Natixis was the first bank to issuea reinvesting CLO after the financial
crisis. The CLO's underwriter, or banker,
brings a CLO to life by arrangingthe CLO's financing and mediating the
negotiations between all theinvestors in a CLO from AAA
(01:35):
to equity. After the closing date,
the underwriter earns a fee andgoing forward, it's the CLO manager,
a different party, that workson the CLO's loan portfolio.
Chris generously helped me with the bookI published on CLO investing in 2023.
If you're enjoying the podcast, pleaseremember to share, like and follow.
(01:58):
And now my conversationwith Chris Gilbert.
Chris, thanks for coming on the podcast.
Shiloh, thanks so much for having me.
So where are you talking to me from today?
I'm in New York City.
Okay.
So why don't you give our listeners alittle summary of your background and how
(02:21):
you ended up in the CLO banking business?
Absolutely, and if you'll indulgeme, I'll start at the beginning.
I was telling somebodyelse this the other day,
and it's interesting howit all came together.
So I started my career in 1990and my first job I had was
working for a consulting firm and ourprimary customer was the Resolution Trust
(02:41):
Corporation, which a lot of peopletoday don't even know what that is.
And it was a government institutionthat was absurdly temporary.
It existed from 1989 to 1996 and it wasset up to resolve insolvent savings and
loans. There was a savings and loancrisis that happened in the eighties,
generally due to a real estate bubble.
(03:02):
And our job was to go in and look atthese failed savings and loans and try and
triage what had happened, what had gonewrong, and there's litigation around it.
And we would support the Resolution TrustCorporation in thinking about what had
happened.
And it was a fascinating lens tolearn about the role of credit,
lending, and financialinstitutions in America,
the way they all came togetherand what could go wrong.
(03:24):
And I think that's given me an interestingoutlook into what has become my
career in CLOs. After that, I workedat Goldman Sachs for a number of years.
I had roles both in credit andtechnology investment banking where I saw
another rise and fall where I was therefor what people call the dotcom bubble
and saw some of my clientsgo from being, really,
(03:45):
the bell of the ball and on the coverof every hot business technology
magazine to all but insolvent ina period of two or three years.
And of course technology has risen again,
and I left there and endedup at what is now Natixis.
I've been here for 19years now, going on 20,
and I've been focused on CLOsfor pretty much that whole time.
(04:07):
And CLOs are obviously collateralizedloan obligations and their financial
structures that have beencreated to allow people to invest
in corporate loans and in different riskprofiles, and it's been quite a ride.
So what's something interesting you findabout the CLO business in comparison to
maybe some of the otherjobs you've had in the past?
(04:28):
Sure. Part of it is the community.
Some of the other jobs in the past haveeither been focused on looking backwards
or focused on short trade. CLOs,
it's very much a tight communitywhere there are probably a few
thousand people that regularlylook at CLOs as investments,
as creating the structures, as being partof managing them, and investing them.
(04:52):
There are probably four CLO conferencesin the year that are broadly attended.
I've seen you at many of them and Iknow you know many of these people.
And year after year you see the samepeople. We understand the trades,
we understand theparticipants in the community,
and it's really a situation wherepeople have gotten so deep in
understanding the risk, the structures,
(05:13):
and the trades and howit all fits together.
So you mentioned CLO conferences.
So one of the biggest ones is Opal thattakes place in Southern California.
That was a few weeks ago. Whatwas the vibe at that conference?
It was extremely positive. People werethere, they were coming off of a year,
and we'll talk about it later, I thinkof really record levels of activity.
(05:35):
It was curious because some people weretalking about they were wishing for a
bit of a pause and a break just for theirpersonal lives so they could see their
families given the frenetic level ofactivity and nobody saw it on the horizon.
I think investors had cash thatthey were looking to deploy.
I think managers had had somesuccess in refi-ing and resetting
(05:56):
their deals,
which means that they may have resetthe prices that they pay on their
liabilities to investors tomore attractive levels for them
given the buoyantatmosphere in the market.
And people are looking forward topositive momentum and good levels.
Going into 2025.
At Opal, how do you spend the two days?
(06:17):
Are you with managers tryingto sell CLO securities,
or going to panels, or onpanels? How do you do it?
I did speak on a panel. I loved it.
There was a panel on middlemarket loans that was, I think,
well attended and well regarded.
So I always enjoy speaking before agroup of people about a subject where
(06:38):
there's so many informedpeople in the room.
But most of the time I spend ina small curtain off part of the
room with no windows. And as a banker,my role, we're an intermediary.
We're not a principal to trades.I don't manage the loans,
I don't own the paper. Ihelp put the trades together.
So we spend timesintroducing and or updating
(07:00):
conversations between CLO managers,the people that invest in the loans,
and CLO investors. We'llbroker the conversations.
We'll sit in the room if there'ssomething that I can contribute,
or if I see a bridge in the conversationwhere I can help add value, I will.
But most of the time I'm listeningand I'm putting people together.
I also have side meetings whereI try to arrange new business.
(07:23):
I'll talk to a manager or somebody whomay want to sponsor a CLO in the equity
to taking the most risky pieceto drive the creation of a new
transaction.
And there I might have a one-on-one withthem to see what their future plans are
and if I can be helpful to them inconnecting them with other parties in the
market to create a new trade.
(07:44):
So one of the things I maybe neglectedto ask you early on in our conversation
is, so you're the head ofCLO banking at Natixis.
I think a lot of people outside of CLOsmay not be familiar with Natixis as a
bank.
So why does Natixis have thisoutsized presence in CLOs in the
US?
I think there's a few reasons. One ishistory. This business has been in place,
(08:05):
I said I'd been there for 19 years, thebusiness has been going for 21 years,
so I missed the first two years of it.
But we've been focused and dedicatedto the space for a long time.
When the industry was in itsinfancy, we were an early joiner.
I think that momentum has helped us.
We went into the Great Financial Crisiswith over $9 billion in exposure of
(08:25):
lending to people who areinvolved in the CLO space,
and where some other bankspulled out of the market,
they may have aggressively collapsedfacilities and push people out of
positions. Natixis did not do that.
So we emerged from the GreatFinancial Crisis with, I think,
one of maybe two banks with areputation that was relatively pristine
(08:46):
for supporting our clientsthrough the very absolute worst of
times.
And that credibility carried over andit allowed us to become an important
player in 2011 when we did our firstpost-crisis trade and then 12 and 13 and
14. And it's continued. We'vebenefited from those relationships,
(09:06):
and as we did, we grewexperience on the team.
We developed expertise andstructuring and placement.
We built a big salesforce around the product,
and success begat success.And we've continued to today,
where it's been a greatbusiness for the bank.
Do you think that one of your competitiveadvantages versus peers then is just
the warehouse facility thatyou're willing to put in place?
(09:29):
Is it that the terms that you offer thereare considered to be pretty friendly
to investors like myself?
Yes, but. And so much in our market,there's a lot of nuance there.
The terms we offer on their faceare probably pretty comparable to a
lot of our competitors.
I think the thing that distinguishesourselves is the reliability in
(09:51):
how we interpret the terms. So withinthese warehouses, within these facilities,
when there's a market disruption, callit Great Financial Crisis, call it COVID,
call it the Energy Crisis of 2015.
Sometimes the banks that are providingthe warehouse facility, the lender,
may take a somewhat aggressivestance with their borrowers,
(10:12):
and their risk departments may clamp down,
and suddenly the credit youthought you had may not be there.
I think the experience that Natixis hashad through so many cycles in so many
years,
we've gained great confidence in thisproduct and these structures to the
very highest levels of ourmanagement. Natixis is a French bank.
(10:33):
Our headquarters is in Paris.
I don't know that the Parisians are anexpert in the United States financial
markets,
but they are an expert in how CLOshave played out through cycles.
So for example, when COVID happened,
the market shut downfor a period of months.
Natixis was the first arrangerto arrange a reinvesting CLO,
(10:54):
and we priced it in April of 2020 whenother people were pulling away from the
market, we were leaning into themarket. It's one of our core areas,
it's an area we focus on. It's oneof the pillars of our business.
Is Natixis a bank thattakes the AAAs and AAs of
the CLOs that you're selling? Dothey have a big appetite there?
(11:14):
Again, it depends. So that's probablymy answer to all the questions.
But there are banks that havea demand for AAAs in their
Treasury unit. They useit as a cash substitute.
They might be deposit takers in theus and they like the floating rate
product with virtually no creditrisk implied by the AAA rating.
(11:37):
Natixis is not a deposittaker in the United States.
We're not a deposit taker inFrance. Our parent, BPCE Group,
is one of the biggestdeposit takers in France,
but we don't use AAA CLOsas a Treasury function.
My business does has a limitto take AAAs of CLOs as
part of our business to supportour transactions and advance
(11:59):
deals, but we don't have thenatural Treasury demand for that.
We do see that, in a lot of US banks,
a lot of Japanese banks,
increasingly Japanese banks have immensedemand for this product as a cash
substitute. We use it differently,
more as a component of my business.
(12:20):
So a lot of the business that we'vedone together has been in middle market
CLOs, which is, as you know,
a niche in the larger total US CLO market.
It's a little bit over 10% of themarket and it's growing pretty rapidly.
What do you see as the key driversof the growth in middle market CLOs?
I think it's a few things,
but I think the primary thingis the growth of middle market.
(12:43):
So one of my little sayings I liketo say is "capital follows capital".
And there's been immense growth inthe deployment of capital to private
credit lenders, middle marketlenders in the United States.
It's businesses that they've beenaround since the late nineties.
But in the past five to eight years,
the rate of growth has been astronomical.It's been spurred by I think, one,
(13:07):
the success of the asset class indelivering returns to limited partners.
People like state pension funds,like sovereign wealth funds,
like endowments, they'reinvesting in middle market credit,
private credit as an asset class.So as those investments grow,
the people in those businesses that aremaking middle market loans to middle
(13:28):
market companies, they've got more moneythat they're investing. As they do,
they need to borrow more tosupport their businesses.
They tend to operate their businessesat what we call a two times leverage
position. Meaning that if theyinvest in $300 million of loans,
they take a hundred million dollars fromtheir investors that those pensions and
endowments and sovereignwealth funds I mentioned,
(13:49):
and they take 200 million in borrowings.
That could be from me as a bankor my competitors as banks, or,
as the deal progresses, as their platformgrows more and more, the CLO market,
they'll borrow money from there. Andthat will be what spurs their growth.
So as they've grown, we grow in lockstep.
So for next year,
as you guys start to consider whichmandates that you want to work on,
(14:13):
how do you guys screen out which middlemarket managers or broadly syndicated
managers are going to be ones that youwant to work with and that you're going
to want to bring to market?
Absolutely. This is a thing wespend a lot of time thinking about.
I tell people I get two to three callsa week from a manager that says, "Hey,
I want to do a middle market CLO withyou". And of course we love that,
(14:34):
we love to hear that,
but then we need to spend sometime understanding their business,
and some people just aren't ready.So we need to understand, one,
is the debt market ready for them?Do they understand this manager,
this platform? Two,
does this manager have the operationalcapabilities to handle a CLO?
There are plenty of really smart lendersout there that I think are really good
(14:55):
at middle market lending,
but there's a level ofcomplexity to middle market CLOs.
There's detailed interaction with therating agencies to help the rating
agencies understand the portfolioand the loans they have.
There are detailed interactions withthe trustees to provide extremely
rigorous monthly reporting on each andevery one of the collateral loans across
(15:15):
20 plus dimensions like industries,spread, maturity, callability,
all sorts of featuresthat the CLO measures,
and constraints to make sure that thecredit risk is properly protected,
and they need to be able todeliver a diverse portfolio.
We like to say that you should have45 or more loans in the portfolio,
and ideally 60 plus. And as that goes,
(15:39):
some platforms just don't have that.
They might have a great trackrecord of doing 20 loans per fund.
That could be a good credit strategy.It's not a good CLO strategy.
So we try and look across these dimensionsand find the people that check all
the boxes. And we also like toliaise with people like you,
to understand what are your viewson the manager, and their strategy,
and how would you look at theinvestments in that stack?
(16:02):
Because if the smart investorsare ready to show up,
then that's a good connection.If you're wary of a platform,
then we need to know that.
Are you seeing a lot of middle marketCLOs with only 60 loans in them?
It seems to me like maybe 150 is maybemore like the average number there.
Are you seeing numbersless than that or...?
We do see numbers less than that,and I don't know want to say a lot,
(16:23):
but there are a few factors that drivethe number of loans in a middle market
CLO. One is how new theplatform is. Newer platforms,
they'll be a little bit more concentrated,or maybe a lot more concentrated.
Two is strategy.
Some managers like to spreadtheir investments out across a lot
of obligor's borrowers to avoidrisk of a concentrated loss.
(16:46):
Others may like what theycall a "conviction investment strategy" where they
want to be really sure on a smallernumber of investments instead of spreading
it across a wide number.
And another factor that can dictatethe number of loans in a CLO,
which is a little more complicated foran investor to see, you may see it,
but other investors maynot get to this level,
(17:07):
is the type of capital that supports it.
And by that I mean we talkedearlier about pensions, endowments,
sovereign wealth funds supporting a CLO,
being the equity or risk money behind it.
Some platforms have set themselves upto allow all their loans to be spread
across all of theirvehicles, all of their CLOs,
(17:27):
all of their investors. Andthere you'll see, generally,
a larger number of loans.
Some platforms are more setup to put loans in as they're
originated. So there's whatwe call a vintage effect,
where a CLO will be more concentrated inloans that are originated in a certain
period of time. Perhapsif the CLO ramped in 2023,
(17:48):
there'll be a lot of 2023-eraoriginated loans and they won't
have the ability to trade across theirvehicles to spread them out and increase
the number of loans. So short answer,not a lot with that low number,
but not zero.
So one of the things thathas been interesting this year is that the financing
rate, let's just talk about AAA becauseit's easier, but middle market CLOs,
(18:13):
the AAA is more expensive. And, not onlyis it more expensive, but it's shorter.
It's a four year reinvestment periodinstead of a five year reinvestment period
for broadly syndicated. Sothat favors the AAA buyer.
And then the two big otherstructural features are,
you get more junior capital supportingyou if you're a middle market AAA.
(18:33):
And the final one is afterthe reinvestment period ends,
really middle market CLOs are really doneinvesting, but for broadly syndicated,
there's some flexibility to keep theparty going, at least for a while.
So the middle market CLOAAA is more expensive and we're talking about the basis
between that and broadly syndicatedat different times over the last,
(18:54):
call it five years or so,
I would think of the basis normalizedas somewhere between 50 and 70 basis
points. Does that jivewith your experience?
Yes, historically that has been the level.
We've seen a recent reduction of that.
So what do you see today'slevel as, 30 bps? Or.
25 To 30. Indeed, it's much tighter.
(19:16):
So that is, I think,
one of the things that's really beenbeneficial to middle market CLOs this year
because our financing cost is downcompared to where it was historically.
And although the middlemarket AAA is more expensive,
the 25 or 30 bps you'retalking about, well,
the loans in the middle markethave probably 125 bips or more of
(19:37):
incremental spread. So for the equity,
that ends up being apretty compelling story.
So what do you think has driven thisfavorable change in the basis over the
year?
I think there are a fewthings. One is liquidity.
I think that people have historicallysaid that middle market loans trade
at a premium because they're lessliquid than BSL loans and the aaas,
(19:59):
and by that I mean theydon't trade us often.
So if it's difficult to trade your loans,
people will charge ahigher liquidity premium,
and hence a higher financing cost.That liquidity premium I think has,
and should have, reduced.
If you look back threeto five and more years,
middle market CLOs represented eight to10% of the market generally year on year
(20:21):
end. BSL CLOs represented90 to 92% of the market.
In 2023,
middle market CLOs jumped up immensely.
They represented 23% of the market.
That percent came down alittle bit in 2024 to 14%.
But if you look at new issueCLOs, so the creation of new CLOs,
(20:42):
middle market were 19% of the market.So almost a fifth of the market.
BSL CLOs did have a lift because some ofthe old deals were repricing themselves
in the current environment.
So as middle market CLOs grow tobecome a larger percent of the market,
that liquidity premium shouldgo down. There's more bonds,
they should trade more often, if it'sa natural function of their growth.
(21:02):
I think a second reason, I'll come upwith three, is as the market's grown,
more investors haveonboarded the asset class.
People have to pay attention to it,
and people have had a hard timegetting the bonds they want,
what we call allocations,the ability to buy BSL CLOs,
and some of them have added middlemarket to their stable to fill their
investment quotas. And the third issimple, a little bit, what I call math.
(21:25):
People say, gee, 50 to 75 is the level,
but instead of talking about basis points,
we should talk aboutpercent of credit spread.
So credit spreads have tightened.Last year we would pay around
2.3%, 230 basis pointsover the risk free rate.
The SOFR rate for AAAs.
Nowadays it's probably 150 basispoints. So it's significantly in.
(21:49):
So instead of measuring that50 to 75 in an absolute number,
the 50 to 75 is a percent of 2.3% versus
25 to 30 is a percent of 1.5%. Thataccounts for some of the difference.
It's a portion of the creditspread, not an absolute number,
if that makes sense.
So do you think that that basiscan continue to tighten or do
(22:12):
you think people think25 or 30 bps is fair?
So first of all, I'm terribleat projecting things,
but I'll tell you my projection here.
For a long time whenit was 75 basis points,
the people investingin it said it was fair,
but it tightened to 50 and they were sadbecause they thought 75 should be the
number and then it tightened to 40.
And they were sad because theysaid 50 should be the number.
So it keeps tightening and I don'tsee why it shouldn't continue to.
(22:36):
The market always surprises me,
but there's no fundamental reasonthe liquidity is increasing.
I think people are understandingthe value proposition.
Investors have onboarded the asset classand they've onboarded the managers,
and, as you said, the fundamentals,the mechanics, the shorter life,
the absence of reinvestment,post reinvestment period,
those speak to tighter spreadsin a theoretical sense.
(22:58):
And I sometimes get stuck in theoretical.
There's no absolute barrier whyit shouldn't flip the other way.
Maybe they'll someday trade ata discount to BSL. I don't know.
Okay.
So that was the difference between broadlysyndicated and middle market in terms
of pricing. But the other differenceis that we've been talking about,
so one is just what's theloan to value through the AAA?
(23:19):
And I think the middle market, it'saround 55%, for broadly syndicated,
I think it's roughly 65%.
Is there any chance that themiddle market leverage moves
closer to broadly syndicated over time?
Or are we working with rating agencyconstraints there, or how do you see that?
And maybe the same question,too, for the reinvestment period,
(23:41):
could we get an extra year outof the deal in the middle market?
I'll answer the reinvestment periodfirst because that's the easy one.
We absolutely can go to five years andI'd say 20 to 25% of the market this year
has gone to five years.So there's no barrier.
It's not a rating agency constraint,it's a market convention.
It may continue to gravitate towardfive years. There's no real barrier.
(24:02):
Unfortunately,
I've seen those only in the trades wherethe manager takes the equity and the
double B unfortunately. So Ithink those are deals where, yeah,
third parties weren't involved.
I think that's right. Butas market convention grows,
as the increasing comfort comes towardthat, hopefully we'll show you some,
and then you'll get somelonger trades we'll see.
(24:23):
And on the advance rate,or the credit support,
so there are two drivers there.One is market convention.
I think when we look atthe rating agency models,
when we model out a middle market CLO,
and we model out a broadlysyndicated CLO often, but not always,
there's a lot more cushion in middlemarket CLOs than there are on broadly
(24:44):
syndicated CLOs for rating stresses.By which I mean, all things equal,
you could have a higher advance rate,
you could have a moreaggressive structure,
and still get the same ratingsunder the rating agency criteria,
for many, but not all, middlemarket CLOs. Broadly syndicated,
w don't usually see as much cushion,although occasionally there are some.
However,
(25:05):
investors historically have demandedthose lower advanced rates that
higher credit support.
So market convention is often drivingthe structure rather than finding the
edge of where a ratings will come out.
So there's room for it tomove. If that did leave,
I think middle market CLOs wouldstill have a lower advance rate.
(25:25):
Broadly syndicated., they tendto have slightly higher ratings.
We could talk about why thatis on the collateral pool.
And they tend to have more diverse namesbecause of some reasons we've talked
about.
So broadly syndicated deals would probablyalways have a little higher advance
rate, but I don't know howmuch higher it would go.
And I think market convention willprobably keep it around where it is today.
(25:48):
So for an investor like me, as you know,
I can buy in the primary marketwhen CLOs are being created,
and I can also buy them in the secondarymarket if we think that's where the
better risk adjusted returns are.
And my understanding of your businessis that sometimes selling equity in the
primary, the arbitrage, which is thenatural profitability of the deals,
(26:09):
is really strong, and you get a lotof buyers to show up for the primary.
And then what's not strong, I thinkyou guys know it's not strong,
and you understand when people arehunting around in the secondary instead,
how would you characterizethe current market?
Is it a primary buyer market or arethere better deals in the secondary
realizing secondary mightnot be your primary focus?
(26:31):
Sure.
Right now we're seeing a more robustprimary market across the board than we
have in a while.
It feels like the activebuyers of primary equity are
increasingly active. It toughto find loans at good prices.
We see just as the CLOmarket has been buoyed,
the collateral market has been buoyed,
but we are seeing natural formationof CLOs with third party equity right
(26:55):
now. I don't want to say it's beenthe best time I've seen in my career,
but it's active and solid and open.
It was kind of the bestarbitrage you've seen in 2021
when LIBOR floors on the loans wasstill in the money and we could
get pretty good debt prints or when wasthe easiest time to sell CLOs or is it
always a little challenging?
(27:16):
It's never easy. I have to tell mybosses how hard it is so they pay me.
If it ever gets easy,what am I doing here?
It's tough for me to pickthe right spot. And honestly,
it would never be a year. It's goingto be a month because what you want,
the ideal time and the best CLO we everdid was probably one where you price the
CLO. So the creation of a new CLO,
there are three key periodsthat people might think about.
(27:38):
One is the marketing period,
where we'll go out to investors andwe'll usually start with a AAA investor
because it's the biggest classand the most bonds to sell it.
We'll agree on a price level, afinancing rate, and once that's set,
we'll go out to the rest of thecapital stack, the mezzanine,
if there is equity to be sold,
they probably need to be in place firstbecause the one generating the impetus
(28:00):
for the trade.
And then we'll probably spend fivedays or so talking to the mezzanine
investors, the double A's,the single a's the triple Bs.
And if we sell them the double B's,we'll agree on a price very quickly.
And then we'll have a date, whichwill be a very specific day,
when we price the CLO. At that point,
we will write trade ticketsto all the new investors.
We know where all the bonds are going,and we'll agree on a closing date,
(28:24):
which will probably be about fiveweeks out. So on that pricing date,
the CLO may not own its whole portfolio.
In some few cases it might not ownany loans. At most it'll own 60,
70% of the loans it'll buy. So the bestdeal will be when you price the CLO,
and then the market tanks thenext day, and it goes down,
(28:44):
and you can buy those loans cheap,
and the CLO will take all the money itgot from the bonds and it'll buy a lot
more loans because it can buy them morecheaply. So it's not a year, it's a day,
it's a week, it's a month,
where you have that mechanic and that'llbe the best vintage and you can't see
it coming. There's anelement of luck there,
and the equity buyer who bought it willbe really happy. And in some sense,
(29:06):
a lot of equity investors will, it'salmost like dollar cost averaging,
where you go in and you buy multiple dealsacross multiple timeframes and one of
those will be your bonanza wherethe market does exactly that.
So refi and reset activity hasobviously been very elevated recently,
and one of the reasons to own CLOequity today is that as the CLO begins
(29:28):
its life with a on-call period wherethe AAA to double B rates are what they
are. And you can't really tinker withthe CLO if you're the equity investor,
but once the non-call period rolls off,
you can refinance tranches orportions of the CLO at lower rates,
you can extend the life of the CLO.
I've been saying that instead of resetbecause it makes a lot more sense to
people. Chris (29:50):
That's what it is. Shiloh:
So I think for an investor in CLO equity,I would look at a portfolio and say,
okay, when's the non-callperiod coming off on the CLO?
And is the CLO's financingin the money to do something?
So that really just means, for example,
is the AAA more expensive todaythan it would be if the non-call
(30:12):
period rolled off today? Soit's like a hypothetical calc,
and from what I've seen,
there can be material upsideand refis and resets because,
I think how people view themarket, and this is funny,
but the fair market value of CLO equitydoesn't trade or really isn't valued
with a lot of optionality or expectationthat this favorable thing's going to
(30:32):
happen. You do it and then you getcredit for it, and until you do it,
then nobody cares, which is funny.So at any rate, refis and resets,
very valuable to CLO equity, andthere've been a lot of 'em this year.
Could you just maybe walk through, forour listeners, the process of a reset?
We know when the non-callperiods coming up,
(30:53):
it's a bank like yours that putstogether the extension or refinancing.
What are the nuts and bolts of doing this?
Absolutely, and you're absolutely right.
One of the amazing things aboutCLO equity is the value of the
optionality in that you have the control,
you have the control of the timing todo it, not to do it. It's interesting,
when I started my career,the first 10, 12 years of it,
(31:15):
there was no such thing as a reset andthey've become common in the market over
the past eight or so years, and theybring incredible value to the equity,
and I think it was enterprising equityinvestors that figured this out and it's
now become a feature of the market.So the process, which you asked about:
So it'll be the equity, someonejust like yourself who has control,
(31:36):
majority of the equity, typically,that will make a direction.
They'll come out and they'll say,okay, we are going to call this debt.
We're going to take the old debt,we're going to get rid of it,
and we're going to issue new debt.They'll come to a bank like myself to say,
okay, Chris, Natixis, we'dlike to remarket our debt.
I have the Shiloh Bates CLO 2017.
(31:56):
Obviously there are no CLOs named afteryou. It's hypothetical. But this CLO,
we look at the debt prices and it's waytoo high. I look at the current market,
I can do better. I would likeyou to go out to investors,
I'd like you to replaceit. So the first step is,
we have to file somethingcalled a cleansing notice.
That is something thatgets rid of concerns about
(32:18):
securities laws where we might be talkingto people about inside information.
That cleansing noticetells the market, "Hey,
I'm thinking about doing somethingwith this deal. I might call it,
I might refi it, I mightreset it, I might collapse it.
I don't know what I'lldo, but it's in play".
So that lets us start to talkto investors. At that point,
we'll make a plan with the equity,we'll look at the portfolio,
we'll look at where we see themarket. We'll make a recommendation.
(32:40):
Should we do a refi, whichdoesn't extend the deal?
It doesn't change fundamental terms ofthe deal. Or do we want to do a reset,
where we open up the wholedeal? We may extend it,
we may change the advance rate,we may change specific terms,
but it can be a fundamental change. Atthat point. Once we've made the decision,
we'll typically start with a AAAinvestor. We'll go out to find, initially,
(33:01):
the existing holders ofthe debt. We'll ask them,
do you want to roll your position?
We see you have a hundred milliondollars investment in this deal,
$20 million investment in thisdeal. We're looking at a reset.
We're going to extend it by twoyears, three years, whatever it is.
You get the first look. Here'sthe price we think is appropriate.
If they decline, we'll go out tonew investors. If they accept,
(33:23):
they get the paper,
so long as they're willing to transactat the terms of the equity and the
arranger myself agree to. After that,
we proceed down the capital stack tothe mezzanine debt. We agree to prices,
first talking to the rollingdebt, the existing investors,
then going to new ones.Once the prices are agreed,
just like we talked about before,we'll have a pricing date.
We'll agree to a closing date.
(33:43):
There it might be shorter than thefive weeks we spoke about earlier.
Maybe it's three weeks out. Andthen once that closing date happens,
the old bonds will be extinguished andnew bonds will be issued to the new
investors.
And then presumably the CLO hasanother two year non-call period.
So that's two years where the debtinvestors will be protected and earn their
spread.
That's right. Shiloh (34:03):
Okay. So is this a lot of work? Chris:
It is a lot of work. It's an immenseamount of work, especially for my team.
My team,
we coordinate the new structuringconversations with the radiant agencies,
conversations with the law firmsthat write all the documents,
conversations with the trustees that holdthe collateral for the loan and handle
the monthly reporting,
(34:23):
conversations with the collateralmanager who do the investings,
conversations with the equity. We'reat the center of a web of investors,
service providers, attorneysthat run this process.
I like to joke and say that resets arethe worst of all worlds for banks because
the work is probably often more than anew issue transaction and the fees are
less. So it makes me sad,
(34:44):
but I think it's virtuous forthe market because it keeps the
equity engaged and evolved, and if itmakes their investment prospects better,
it can build the market for all of us.
So let me ask you this.
Let's say I own a CLO and thenon-call period is coming up,
and the AAA rate on theexisting CLO is 10 bps wider
(35:06):
than current market. To do a refinancing,
should I think of that as whenthe no-call period rolls off,
is it something where a bunch ofthings need to come together and
hopefully a refi will happen?
Or is it that the non-call period'sup, market spreads are tighter,
and we're doing something?
(35:27):
One is on the economic side, onequestion is on the economic side,
we will do something called a paybackanalysis where you cited 10 bps and that's
a nice savings, but there are coststo do in refi. It's not costless.
You're going to pay therating agencies a fee.
You're going to pay the lawyers a bunchof fees because they got to draft a lot
of documents, and you'regoing to pay me a fee.
(35:48):
So there's a fixed cost to doing this.
We'll spend some time ilooking atwhat the interest savings will be,
and we'll see how it compares to thefixed costs. And a rule of thumb we use,
and listen, there'sexceptions to every rule,
but a rule of thumb we use is if thatpayback is longer than six months,
maybe you think about it,maybe you wait, maybe you go,
if it's inside of six months,
it seems a lot more attractive andyou probably do go and execute.
(36:11):
So that's a big factor in doing this.
If you have a portfolio thathas had difficult performance,
that could influenceyour decision as well.
The market spreads mightbe 10 basis points tighter,
but if you have a deal that hasperformed worse than the market,
then that 10 basis pointsmay not fully accrue to you.
So there'll be an analysis of theportfolio and the performance of the
(36:32):
transaction itself.
But even if a CLO has underperformed,there's still an analysis to do.
My point is, the refiand reset opportunity.
It's not for the honor roll of CLOs,
it's for almost all CLOs thathave performed reasonably well.
That's how I think about it.
I think that's right, absolutely.
(36:54):
And you talked about a 10 basis pointdifferential, which is not a lot.
So that one might be cuspy.
You might want to look at thebest performing ones today.
The different deals coming offtheir on-call might be a full point
inside of where they were done,and if it's that much difference,
performance is almost irrelevant.
So you have to look at the degreeof tightening in the market and the
(37:16):
improvement of the financing costsversus the portfolio. But today,
I think any deal, regardless ofperformance, should be a candidate.
Okay, because I sawduring the COVID period,
I was very familiar with twodeals where they missed payments,
so there were excess defaults in theportfolio. There were excess triple Cs.
So instead of paying the equity,
(37:36):
the cashflow was used to eitherdelever the CLO or buy more loans,
buy more loans, actuallydelivers the CLO as well.
And one of the things that surprised mewas that for those underperformers in
2021, we were able to come backand do refinancing. So again,
it doesn't need to be the best performingCLO for us to start having these
conversations.
That's exactly right, andwe've done some of those.
(37:57):
Those might be a better refinancingcandidate than a reset candidate.
People may not want toput money in for longer,
and you might just refinancethe AAA and AA bonds,
which are the biggestpart of the cap stack,
that the double BS might be a harderconversation in those situations.
Yeah, so the concept there is ifyou're extending the life of the CLO,
it needs to have a certainamount of equity in it.
(38:17):
And if you've had a lot of loan defaults,
either you're going to haveto cough up more equity,
or maybe you could issuea next note or something.
Maybe there's another partial solutionby issuing additional debt in the deal.
But the CLO market has been doing reallywell. The CLO issuance has been strong.
CLO returns have been good for this year.
(38:38):
Do you see anything on the horizon thatcould change the direction the market's
going or what key risk would you focus on?
That was a lot of the conversationof the Opal Conference.
We spoke about where do people see acatalyst for a change, and honestly,
I'm not a great forecaster,
but I don't see an obvious catalystfor change within the CLO market.
(38:59):
Investors seem robust.
People have told us they have cash todeploy and are looking to buy new deals.
Our managers are telling us that thecredit in their portfolios is reasonably
good.
So barring some sort ofexogenous macro event,
I don't know what changes it.
And I half whimsically say I don'teven know what that would be.
(39:20):
It's not just CLOs. We'veseen almost all assets rally.
We've seen equities rally,we've seen Bitcoin rally,
we've seen investmentgrade and high yield rally.
We've seen the governmentin France falling. We see martial law in South Korea.
We see turbulence, multiple wars,and the market just goes up.
So I don't know what changes it for CLOsand I don't know what changes it for
(39:40):
the market broadly. It seems asource of strength and I think CLOs,
if there were to be achange, I still like CLOs,
we are secured by firstlien corporate loans,
which are the first out if thereare signs in corporate trouble,
and if you're buying AAAs, you'rethe first out on the first out,
top of the heap of everything and theequity, you're subordinated to CLO debt,
(40:01):
but you are secured by firstlien loans in corporate America,
diversified pool.
So it seems like the type of structurethat's weathered other storms and makes
intuitive sense. I don'tsee a catalyst for change,
but I'm always surprisedby things in the world.
The other thing I wanted to just hit iswith the Trump administration coming in
(40:21):
January, it seems to me likewhat's going to be the effect?
So I think probably moredeficit spending, maybe tariffs,
the result of which it's going to behigher for longer on rates. People ask me,
well, what about for the underlyingloans? I don't think really,
the loans in CLOs start theirlives with a 50% loan value,
(40:43):
so the marginal tinkerings of politiciansin Washington really shouldn't
affect our business too much. That'smy take. Is that how you see it or...?
More or less? Yes. My expert isn'tmacro, but I think that's right.
I think we have two advantages.
One is CLOs are floating rate productssecured by floating rate underliers,
so we shouldn't be overly exposedinterest rate risk as such.
(41:05):
I know that people do worryabout interest coverage from an
elevated basis.
So rates are SOFR since we are afloating rate product. But as you say,
our loans are made at a relativelyconservative advance rate,
and as the expectation of higherrates comes into the market,
we are seeing purchases ofcompanies happen at lower multiples,
(41:28):
which means that the financing happensat a consistent advance rate or
loan-to-value ratio,
then it's less leverage on thecompanies in a better interest coverage
position on new loans that are madein an environment with higher rate
expectations.
So I'm hopeful we're in a good spot andit seems like there's a lot of reasons
why our market alignsitself to adjust to economic
(41:51):
changes.
Great. Well, Chris, thanks somuch for coming on the podcast.
I really enjoyed our conversation.
Shiloh, thank you so much for havingme. I was really thrilled to be here,
and I appreciate the opportunity.
The content here is for informationalpurposes only and should not be taken as
(42:12):
legal, business, tax,or investment advice,
or be used to evaluate anyinvestment or security.
This podcast is not directed at anyinvestment or potential investors in any
Flat Rock Global Fund. Definition Section
AUM refers to assets under management.
LMT or liability managementtransactions are an out of
(42:33):
court modification of a company's debt.
Layering refers to placing additionaldebt with a priority above the first lien
term loan. The securedovernight financing rate, SOFR,
is a broad measure of the costof borrowing cash overnight,
collateralized by treasury securities.The global financial crisis, GFC,
was a period of extreme stress in globalfinancial markets and banking systems
(42:58):
between mid 2007 and early 2009.
Credit ratings are opinions aboutcredit risk for long-term issues or
instruments.
The ratings lie on a spectrum rangingfrom the highest credit quality on one end
to default or junk on the other. AAAA is the highest credit quality.
A C or D, depending on theagency issuing the rating,
(43:19):
is the lowest or junk quality.
Leveraged loans are corporate loans tocompanies that are not rated investment
grade. Broadly syndicated loans,BSL, are underwritten by banks,
rated by nationally recognized statisticalratings organizations and often
traded by market participants.
Middle market loans are usuallyunderwritten by several lenders with the
(43:41):
intention of holding theinvestment through its maturity.
Spread is the percentage difference incurrent yields of various classes of
fixed income securities versus treasurybonds or another benchmark bond
measure. A reset is a refinancingand extension of a CLO investment.
EBITDA is earnings beforeinterest, taxes, depreciation,
(44:02):
and amortization.
An add back would attempt to adjustEBITDA for non-recurring items.
ETFs are exchange traded funds. LIBOR,
the London Interbank OfferRate was replaced by SOFR on
June 30th, 2024.
Deliver means reducing theamount of debt financing.
High yield bonds are corporate borrowingsrated below investment grade that are
(44:27):
usually fixed rate
An unsecured default refers tomissing a contractual interest or
principle payment.
Debt has contractual interestprinciple and interest payments,
whereas equity representsownership in a company.
Senior secured corporateloans are borrowings from a company that are backed by
collateral.
(44:48):
Junior debt ranks behind seniorsecured debt in its payment priority.
Collateral pool refers to the sum ofcollateral pledge to a lender to support
its repayment.
A mon-call period refers to the timein which a debt instrument cannot be
optionally repaid.
A floating rate investment has an interestrate that varies with an underlying
(45:09):
floating rate index.General Disclaimer Section
References to interest rate movesare based on Bloomberg data.
Any mentions of specific companies arefor reference purposes only and are not
meant to describe theinvestment merits of,
or potential or actualportfolio changes related to,
securities of those companiesunless otherwise noted.
(45:32):
All discussions are based on USmarkets and US monetary and fiscal
policies.
Market forecasts and projections arebased on current market conditions
and are subject to change without notice.
Projections should not beconsidered a guarantee.
The views and opinions expressed by theFlat Rock Global speaker are those of
(45:52):
the speaker as of the dateof the broadcast and do not necessarily represent the
views of the firm as a whole.
Any such views are subject to changeat any time based upon market or other
conditions,
and Flat Rock Global disclaims anyresponsibility to update such views.
This material is not intended to berelied upon as a forecast, research,
(46:14):
or investment advice. It isnot a recommendation, offer,
or solicitation to buy or sellany securities or to adopt any
investment strategy.
Neither Flat Rock Global nor the FlatRock Global speaker can be responsible
for any direct or incidental loss incurredby applying any of the information
offered.
None of the information provided shouldbe regarded as a suggestion to engage in
(46:38):
or refrain from any investment relatedcourse of action as neither Flat Rock
Global nor its affiliates are undertakingto provide impartial investment
advice, act as an impartial advisor,or give advice in a fiduciary capacity.
Additional information about this podcast,
along with an edited transcript may beobtained by visiting FlatRockGlobal.com
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