September 2, 2025 • 44 mins
Melissa Brady, Senior Director at Alvarez & Marsal, joins The CLO Investor podcast to discuss the performance of private credit loans, why some credit managers may have different marks than others, and other trends in private credit.
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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 leverage loans. In this podcast,
we discuss current newsand the CLO industry,
and I interview key market players.Today I'm speaking with Melissa Brady,
Senior Director at Alvarez& Marsal Valuation Services.
(00:29):
She leads a team that valuesprivate credit loans for CLOs, BDCs,
and interval funds.
She also publishes the Alvarez& Marsal Private Credit Update,
a quarterly publication that I'd highlyrecommend. We discuss multiple topics,
including the performanceof private credit loans,
why some credit managers may havedifferent marks than others for the same
(00:50):
underlying loan and othertrends in private credit.
I've also settled on a newpodcast closing question,
which is how would you describe ACLO in the last than 30 seconds?
And I'll answer to at the end of thepodcast. If you're enjoying the podcast,
please remember to share like and follow.And now my conversation with Melissa
(01:10):
Brady.
Melissa,
thanks so much for coming on the podcast.
Pleasure. Thank you for having me.
Why don't you tell our listeners howyou ended up at Alvarez & Marsal?
Sure. So, I started hereabout five years ago.
I started my career doing private creditabout 20 years ago during the great
(01:32):
financial crisis.
That's when I really pivoted and startedat Houilhan Lokey for a little bit,
was there for seven years and then withRSM and then came here in 2020 during
COVID was just really looking for agreater platform with great resources,
and that's what Alvarez & Marsal hasprovided for me here. So, it's been great.
(01:52):
We have such a wide diverse set of clientbase with all kinds of different size
AUMs and all kinds ofdifferent strategies. So,
it's been a really nice learning curve.
So, your primary role is valuation ofprivate credit loans, is that correct?
That's correct. So, within theportfolio valuation group, my niche,
(02:13):
my key focus is on private credit.
I do a number of private equityclients as well. Our group,
we focus on real estate funds,venture capital, private equity funds,
credit funds. So, we see the entire gamut.
My niche just because I enjoy it so muchand I've continued to enjoy it for all
these years, has reallybeen in private credit.
(02:34):
It's something I have seen evolveand change so much over the years,
and it's an asset class thatI truly enjoy working on. So,
we certainly have the bandwidth and thevolume of works to keep me happy and
busy here. So, it's been going well.
Good to hear.
So what's the general process forvaluation of a private credit loan?
(02:56):
So, we really want to get a goodunderstanding of the underlying business.
When we look at private credit, we'relooking at so many different variables.
Who's the sponsor? Is this a sponsorbacked loan or non-sponsored backed?
What's the strength of thecashflow? What sector it is,
the fundamentals of the business andunderstanding the business model to see,
hey, what's really the challengesto future cashflow? So,
(03:19):
when we look at private credit, I'mpersonally looking at first the size.
I'm looking at the concentrationor lack of concentration in cash
flows. I'm looking at who the sponsor is,
what's the liquidity condition of thebusiness to get a really good flow and
also understanding, okay, isthe pricing of that loan today?
(03:41):
Is that really representative of themarket? So, it's really EBITDA size,
how it's priced, cashflow, strength,
and all of those other qualitativefactors that you really want to get a good
handle on the credit fundamentals.
So, how does what's happening inthe broadly syndicated loan market,
how does that information makeits way into your valuations,
(04:02):
if at all?
So,
me and my small team here are responsiblefor the private credit updates that we
do, and we're looking atbroadly syndicated loans,
primary market and the secondary market.
We're looking at our internal data.
We understand that frankly the broadlysyndicated loan is going to have
different technicals and differenttechnicals to the private credit space.
(04:26):
And So,we understand that. So,
just because a broadly syndicatedmarket is moving in a certain direction,
it doesn't mean that the private creditspace is going to also move one-to-one
the way the BSL market is moving.
But we certainly look at the BSL marketto understand the debt markets further,
but we're also looking at datain addition to the deal flow
(04:47):
that we see internally with the dealvolume that we have and the private credit
research and analysis that we're doinginternally to get a more comprehensive
view of the debt markets.
And so that private creditresearch that I do every quarter,
the reason why we do it so early andwe release it so early is because a
key trend that we're seeing with ourclient base is they want valuations done
(05:10):
early. They actually want to be finalor done a few days after quarter end.
So, we release that research pretty earlyon in the process because most of our
clients really get aheadstart on valuations well before the quarter end even
starts.
So,
is the flow of information then that theunderwriter of the private credit loan
or the owner,
(05:31):
they probably pass you financials assoon as they get them and then you start
working on updating a valuation and thatmay be done. Is it a quarterly basis?
Is that what most ofyour clients are taking?
Yes.
And so those are the marks that gointo a BDCs schedule of investments at
quarter end or to an intervalfunds NAV or their financials as
(05:53):
well?
That's correct. And someclients want to a range,
some clients want a point estimate.It all depends on the fund's,
valuation policy andprocedures on their end.
But we would say majoritydo want to see a range.
The majority want to see a range.
How big would the range generallybe for a private credit loan?
(06:13):
What percentage of par?
We don't want to see it morethan two points ideally,
but sometimes it will be wider than that,
especially when we deal with distresseddebt valuation and just the nature
of leverage. As you know, Shiloh,it's a double-edged sword. So,
with these highly leverageddistressed credits,
the rate is certainly going to be alot wider. But for performing credits,
(06:36):
it can range two to three points.
So, you tell the owner of the loan, Hey,
your loan might be worth anywherefrom 97 cents on the dollar to par.
And then it's up to them to decide wherethey think they should be in the range.
Yeah,
and I would say a lot of them do go withthe midpoint because they don't want to
have to deal with the extraquestions by the auditors. Not all,
(07:00):
it depends on their valuationpolicy and procedures,
but a lot of them do go with the midpoint.Not necessarily every client does,
but I would say the majority.
Is the majority of your clients,
are they taking quarterly marks fromyou or are they doing it less frequently
to maybe save a little bit of money?
They take it quarterly. Forthe private equity clients,
(07:23):
that might be quarterly.That might be annually.
But I would say for themajority of the credit funds,
the BDCs that we have as ourclient base, it would be quarterly.
Got it. so,
one of the things that's been in the newsrecently is that there may be a number
of different investors with the sameloan and then they're disclosing their
quarterly mark to the world through aBDCs schedule of investments or private
(07:46):
credits equivalent.
And oftentimes thevaluation is different. So,
for par loans, it doesn't really matterthat much. One manager might say, Hey,
loan X is worth 99 cents. Another managermight have the same amount of par.
Probably not a huge difference, butas you get in, as loans have issues,
the difference between where differentmanagers are marking the same loan can
(08:10):
vary quite a bit.
Absolutely. That's been going on foras long as I've been doing this work.
Why is that?
I think the first key reason behindthat is maybe difference in information
- in information rights. So it'sinformation rights for sure.
That's a key driver there. Also,
it's just certain asset managershave different views and
(08:34):
that's where it is challengingwhen the mark differentials can be
pretty significant.
You see that quite a bit with theones that are non-accrual basis,
the more distressed credits havingsuch a wide disparity in marks.
And we deal with certain assetmanagers that are way more
conservative and certain assetmanagers that frankly are way more
(08:57):
optimistic and a little bitmore aggressive on their marks.
And that's just the realityof the world that we're in.
When you value a loan, presumablyeverybody gets the same price or,
well, I guess some people take arange, so maybe that's not true,
or how do you guys do it?
So when we have, let's say the sameexact credit for three different funds,
(09:19):
we have to be mindful that we onlycan use the information that was given
to us from that particular client.We can't cross use information.
Clearly we have the knowledge,
but what's actually appliedin the valuation schedules has to be the information
that we've been given fromthat particular client.
Even though we may know and have moreinformation from the other funds,
(09:41):
we try to be consistent. Absolutely,we do our best in that. So,
there is going to be differences ininformation and access to information and
information rights eventhough they're co-lenders.
So, when a loan is maybe on non-accrual,
when you're marking it for anumber of different investors,
some investors think maybe the loan'sreally money good and the company
(10:02):
will be bought by year end.
And so that would argue for a much highermark and then other investors in the
same loan just have a more don't knowthat or don't believe that taking a more
pessimistic view and thereforeget a lower mark for the same
security essentially.
Certainly that is thecase. You've seen that. So,
we have certain situations where I thinkone of the key trends that we're seeing
(10:25):
right now is clearly we knowM&A's weak and slow right now.
So, you see where a lot of the sponsorswant to go and do a pure exit through
M&A and they go to the M&A markets,they try to get [an] investment banker,
the bids come in [they're]very disappointed with the bids that have come in.
And so they just drop the whole saleprocess and they do a dividend recap and
(10:48):
we've seen quite a bit of that.
They're just not going to take a lowervaluation, especially when we look at,
I'm sure you know this,
the 2021 vintages when valuationswere so high when capital
raising was at the alltime high with fundraising,
and then you also had the debtmarkets with rates near zero. So,
we saw a lot of these2021 vintages frankly,
(11:10):
that they were just overpaid. Thesewere very frothy, high multiples.
They levered them up becausecapital was so cheap.
And so we're seeing a lot ofthe 2021 vintages seeing more
challenges today. So,
you're seeing those havingsome restructuring events or recapitalizations of
those credits.
But I would also argue we've hadhigher rates for longer for so long,
(11:34):
and I would predict recoveriesin this space to come
down for the creditsthat have not done well.
Do you guys publish a stat?
Do you guys have a defaultrate or non-accrual rate for the loans that you guys
do valuation work for?
We definitely have that datapoint. We don't publish it,
but we certainly keep track ofthat information internally.
(11:57):
It's something actuallywe're thinking about.
Maybe if we do publish in the future,
we are seeing non-accruals creep up.
We do expect non-accrualsto continue to creep up,
especially for these certain vintagesand for credits that have frankly been
over levered from the start.
Did Liberation day play a negativerole in terms of the performance
(12:19):
of the businesses that you guysvalue? Or is it too early to say?
There's always this lag on when eventshappen and how that will impact the
market and how we see the data.Because there's always lagging data.
We all know that the markethates instability and
non-transparency and uncertainty.It's the worst thing for the market.
(12:41):
So clearly we did see a bit ofchallenges where the fundamentals of the
credit, it did get a little rocky.
The issuers remember are alsogetting impacted if they can't close
certain contracts, for example,
because people want to beon a wait-and-see mode.
We have seen margins get erodeda bit in this inflationary
(13:03):
market,
and we have seen growth take a littlebit of pressure given the tariff supply
chain issues and whatnot.
But I think it's safe to say that alot of the loans are doing just fine,
especially the ones that didn't getoverlevered have ample liquidity.
Those are doing okay.But overall, I say yeah,
(13:23):
we've seen inflation takeits toll and growth is there.
It's just not as robust asit used to be. Who knows?
I can't predict the future and Ican always be wrong at this stuff,
but we've seen growth taper down. We'veseen margin take a little bit of hit,
but like I said, every credit and everysituation's going to be very different.
Some credits are just going to have thebandwidth and the ability to withstand
(13:46):
more stress than other credits.
Is there any industry that standsout to you as being more at risk
versus others in your dataset?
If the industry canface fierce competition
from AI, that's somethingwe've already seen. So,
here's a classic example whereyou have this great technology
(14:11):
that provides tutoringservices to K to 12,
and your contract is with these publicschool districts and you've done really
well all this time,
and all of a sudden you have thesecompeting technologies that can provide
tutoring for little or no cost. So,
you can see how we've seen thosecompanies unfortunately not
(14:34):
do well with very lowrecovery when they can't sell
the technology at auction,
there's no value to the IP and yourbusiness just went away. It hurts.
But we've seen a few examples ofthat. Also, another in healthcare,
we're seeing where sponsors want to gointo the dermatology business and they
(14:55):
bought a bunch of dermatologyclinics and as you know,
the consumer is cuttingdown their spending.
And so this dermatology spacewhere they bought a whole
bunch of these clinicsacross the country, well,
you've got high fixed costs andcustomers are buckling down on their
(15:15):
spend.
And so we're seeing that type of businessmodel take a little bit of a hit as
well as growth in margins have eroded.
In healthcare, have you seenwages increase faster than
reimbursement rates?
Yeah. I'm going to focus a littlebit on a segment of healthcare,
more the vet space,the veterinarian space.
We've seen a lot of these strategiesof roll up add-on where you buy
(15:40):
these vet clinics andyou expand and you grow.
Everyone loves to spend money ontheir pets. Even in a downturn,
they'll spend money in a recessionbecause everyone loves their pets.
And so we've seen that businesssegment have such incredible
margins and cashflow strength.So, not surprising what happens,
you got this tremendous amount ofcompetition entering that space. So,
(16:04):
we've seen some of these vetborrowers struggle a little bit as
competition has come sofierce that there's growth pressure and margin pressure
now that they haven't seen before.Especially if you maybe did a bit,
a few add-ons of targetcompanies that were a mistake
can have a real big impact onyour cashflow strength. So,
(16:25):
we're seeing a few of these vetclinic space take a bit of a hit.
A hit in the sense that they're atrisk for default or that financial
performance is down?
Performance is down.
They were bought for extremelyfrothy multiples in 2021 or 2022.
They were highly levered.
(16:46):
And what's going on is they have to PIK
100% of a certain tranche.
And if you have to PIKthe full tranche loan,
that always is going to give mepause. So, it's not one or two,
it's actually I've seen three or fourof these that they're all struggling.
Do you have a sense for ifthe stress in private credit,
(17:08):
do you think it's similar to thebroadly syndicated loan market?
Broadly syndicated, bythe way, the default rate,
if you include distressedexchanges, which you should,
it's around 4%. I'm assumingthat for private credit,
what you're seeing isa much smaller number.
Yesah, and the reason for that isbecause you continue to get support from
(17:29):
sponsors and other co-lenders.So, with the private credit space,
you just have more support.
You have liquidity support coming infrom the sponsor doing equity cures,
you have co-lenders coming inwilling to put in more money. So,
that pushes the defaultjust down the road.
So that's why we're just seeing solittle defaults in private credits.
You just have ample dry powder,
(17:51):
ample resources to continuesupporting the credit.
So sometimes default really isn't thekey metric because for private credit,
and this is true forbroadly syndicated as well,
but one person's default is anotherperson's kick the can down the road.
The private equity sponsorcan always put in more money.
The lenders can always agree to defertheir interest or principal and avoid a
(18:13):
default. If you're an investor in CLOs,you care about the ultimate recovery.
So, kicking the can might bea decent solution for now,
but sooner or later the loaneither repays you or it doesn't.
No, that's a great point, Shiloh,
because we clearly see lenderswilling to shut down, amortization,
willing to PIK part of theinterest or some of the interest or
(18:35):
have PIK periods of time where theyallow PIK for certain duration of time.
So,
another key trend that we're seeing iscertainly a lot more PIK to provide more
liquidity as rates are still high.
So, then in terms of defaults,staying on that for a few minutes,
your expectation is for this year,
so for 2025 defaults willbe elevated over last year
(18:59):
and their primary driver is the2021 vintage where blenders were
maybe a little too aggressive. Do yousee anything that would stop the trend?
That's right.
I think maybe for the next 12-18months we work through these more
challenging credits, especiallythese certain vintages.
I do think that you're going tosee the have and the have-nots.
(19:23):
You have certain asset managers that aregoing to do well and their portfolio is
going to do just fine,
and you're going to see others thatfrankly did not have that same discipline.
You can see it now, just look atwhich BDCs have the most non-accruals.
There's a wide differenceby asset managers and how they're dealing with their
non-accruals. And so yes, you got tosee how things work through the system.
(19:46):
The deals that are getting done arecertainly, these are the better deals.
And also it's interestingeveryone's wondering, well,
hoping and praying that the M&A marketsstart to open up in 2026 so that
sponsors can finally realizetheir investments and return
capital to their investors.
It's been a challenging time forsponsors because they want to be able
(20:10):
to close these funds and the life cycleof these funds have gotten longer and
longer. So, like I mentionedearlier, not surprising,
we're seeing a trend in dividend recaps.
A big trend is also continuationvehicles where LPs want out. So,
a continuation vehicleis a way to also get out.
For the continuation vehicle, is a privateequity firm launched a fund with a,
(20:34):
let's call it a fiveyear reinvestment period.
They're expected to return capitalto investors as they sell these
businesses.
And either the bids aren'tthere to get the initial
investors a healthy returnor the more favorable way
to look at it would be the privateequity firm still sees upside in their
(20:56):
investment, and so they don't want tosell it to another private equity firm.
They put it into a continuation vehiclewhere they have the same asset but
presumably owned by adifferent investor base.
When a loan's going intoa continuation vehicle,
does that have any significancefor you guys in your valuations?
Yes. So,
a big trend that we're seeing arethese valuation opinion work when those
(21:19):
continuation vehicles are created. So,
we come in and we provide valuationopinion to ensure that the investors
who want out and the investors who wantto remain in are all treated fairly.
So, that's been a pretty big trend,absolutely in the valuation space.
So, in that case, you'redoing the same work,
but the end product for you guysis a valuation opinion that's
(21:43):
disseminated to the market or given toparticular investors saying that the
pricing,
the valuation of the loan going from oneset of investors to another is done on
an arms length basis that it's fair.
That's right.
And so it does require a few morehurdles on our end because of the
risk. So, we have to go to this committee,ensure that everyone's on board. So,
(22:04):
there's a lot more in the processgiven the higher risk. So,
there's more involved when we do thesevaluation opinions versus just mark to
market on a quarterly basis.
Are you seeing loans structuredwith PIK upfront or does all the
PIK come when a business stumbles?
We're seeing both actually.Believe it or not,
(22:24):
we are seeing PIK upfront as well.
But the caveat there is I wouldsay the deals that are getting done
today are the better deals becausethey're really being picked
through. So we still have a verymuch a supply demand imbalance.
There's a lot of demand for the paper,
very little supply givenM&A is still quiet. So,
(22:45):
the competition is absolutely fierce. So,
we've seen in 2025, anumber of new issuances at,
SOFR plus 450, SOFR plus 475. So,
we're seeing these new loans gettingdone at under 500 basis points spreads
because of the high competition.
(23:05):
So, at another time,
those would've been loans under in netSOFR plus six or something like that.
Yeah, throughout 2024 we saw not all,
but a lot of the SOFRplus S plus 6% or higher,
those certainly gotrepriced. And as you know,
the sheer volume of repricing in2024 and the first half of 2025 has
been tremendous. So, majority ofloans right now are S plus five.
(23:28):
So in terms of the documentationof the private credit loan,
does it matter to you in terms of yourevaluation, if there's a covenant,
if there's more than onecovenant or if it's cov lite,
does that factor into your evaluation?
It does, and especially ifsomething is done with a,
this is a recurring revenueloan, it's still EBITDA negative,
(23:52):
it's still burning cash. Wewant to understand, okay,
what's the pricing on that?If it's S plus four 50,
we're going to take a little bit of pausethere because usually we want to see
those loans be priced a littlebit higher, like 550, 575.
We're seeing some of these covenantsgive them a lot of extra cushion when
they're being amended to give somebreathing room for the underlying credit.
(24:13):
But at the end of the day,
we're still seeing quite a bitof allowable add-backs to EBITA.
How EBITDA is defined, so personally,
I look at real EBITDA and adjust theEBITDA for the covenant compliance
certificate,
knowing that a lot of times thetotal add-backs can be 30% or
higher. If it's over 30%add-backs on the EBITDA. Clearly,
(24:35):
I want to understand how muchof that is truly non-recurring,
how much of that is potentially recurringin nature and should be not included
in the adjusted number. So,
really getting a good handle ofwhat's real EBITDA here because
we can certainly see leveragemultiples being under-reported
(24:56):
just due to EBITDA alone.
And that's something Idefinitely take a close look at.
Well,
how often is it that you and the clienthave significantly different EBITDA
numbers that you're using for valuation?
It's more if we have significantdifferences in valuation.
It does happen on occasion,
(25:17):
and that's where we just want tohave a follow-up conversation.
It might certainly be, Hey,
we missed some key informationwe didn't know about.
It's more about educating each other,making sure we're on the same page.
Typically, we want to be on the same page.
We want to be able to communicateeffectively to the client, our logic,
(25:38):
our reasoning,
our expertise in how we got tothe fundamentals of the valuation,
and typically we get to apoint where we all can agree.
And what if you guys arestruggling to get to that point?
I imagine it happens rarely.
It does happen. We don't like to see it,
but it does happen and wehave to remain independent.
We have to remain independent and feelgood with the work product that we're
(26:01):
delivering. And if we can't stand byit, we're not going to stand by it.
So there will be times when yes,
we disagree and themark just has to change.
In your business - Areyou seeing a lot of,
is it that business is booming becausethere's a lot of new private credit
asset managers out there and newfunds to work for is business booming
(26:24):
because private credit's growing?
Yes. So, we're seeing our clients grow,
continue to do new originations.
Even in this highly competitive market.
We're also seeing ourclients launch new funds,
and so that's keeping us busy as well.
And we're seeing private credit growin other spaces like real estate
(26:45):
infrastructure funds.
There's a lot of demand for structuredproduct valuations for those types of
funds that another teamworks on next to me. So yes,
things are going well.
Good to hear. What do you see as someof the challenges in your day to day?
I think the biggest challenge is inthis particular client base is people
(27:07):
really want things ASAP. So,
you have a very tight timecrunch to turn things around,
and it's a client base that's highlydemanding. They want what they want. So,
it's the ability to have theresources and the technology
to be able to turn. As youknow, these funds are massive.
(27:27):
We have clients as largest 2 trillionin assets under management. So,
it's the ability to use technology andthe resources to be able to continue to
fundamental robust work product,
but also be able to turn the volumegiven it's on a quarterly basis
and there's a number of credits andnumber of investments that need to be
(27:48):
covered each quarter. That'sthe biggest challenge.
Do your clients usually share with youthe initial financial model from the
private equity sponsor?
Correct. They do.
And then they do their own type ofstress testing on that original forecast.
And how often do you think is the sponsor,
the private equity firm'sinvestment case realized?
(28:09):
No one meets their budget.No one meets their budget.
And I keep on telling my staff,don't worry if they miss the budget,
who can budget? Well, it's sucha hard challenging thing to do.
And so I'm not so concernedabout if they miss their budget.
I'm more concerned about seeing thefundamental trends. So if they're growing,
(28:31):
but maybe not growing as fastas the sponsor predicted,
especially when you havea lot of equity cushion,
I'm not worried about that at all.
When you guys providemarks for your clients,
should the person who views the mark,
the end investor in the fundthat your client manages,
(28:51):
should they think of thatas a realizable price?
If their fund closed up and sold allof its loans that they should get your
prices more or less from that exercise?Or how should they think about it?
That's a great question,
and I see that struggle withthe definition of the deal team
really fixated on investment value and our
(29:15):
team focused on fair value, andthe definitions are very different.
So, the fair values we're providingis really okay. It really is.
The basis is on the codificationcode out there for GAAP,
but it's based on exit value. So,
what you would get not underany duress, arm's length,
willing participants,
(29:36):
participants with the same level ofinformation as of that valuation date.
The challenge comes in orthe deal teams that well
hold on,
but we're going to hold onto it forfour years and we're expecting to do
X, Y, Z in the next fouryears and realize a much,
much higher valuation. Well, that's great,
(29:57):
but that's investment value that you'reexpecting to realize four years from
today. So sometimes it'sreminding the deal team on, Hey,
what is the principles behind fairvalue? And listen, we can be wrong,
absolutely. But what we try todo is when there is an exit,
I always ask, okay, what did you getfor the investment for the security?
(30:19):
Because I want to know, well, if itwas different from our last valuation,
why was that the case?
And there might be buyer-specificreasons that we can't
incorporate in our fair value definition.
The assumptions need to be based ona market participant basis and has to
strip out a buyer specific synergy orbuyer specific reasons for that purchase.
(30:43):
Well,
one of the things I've noticed in termsof comparable company analysis that
similar to what you guysare doing, I imagine,
is just that you have one borrower thatyou're looking at and you're adjusting
EBITDA and you're saying, okay, theprivate equity firm paid, I don't know,
8x EBITDA for this company onthe adjusted EBITDA number.
(31:04):
And then you want to comparethat to comps in the market,
but then people don't adjustthe EBITDA of the comps.
And so if you don't adjustthe EBITDA of the comps,
what you're going to see is a setthat's trading at 15 times or 12 times,
and then you say, look, well,I've got all this equity cushion,
but what you've done,it's not apples to apples.
(31:26):
Oh, absolutely. Absolutely.Have to be apples to apples.
And you do see some deal teamsbeing more savvy and understanding
valuation better than others. Likeyou said, Shiloh, we look at, alright,
what was the buy in multiple?
What was the last trade ofthat underlying business?
What's happened to the market?
But what's also happened to thecompany over time to refinance and
(31:49):
readjust the multiple?As you know, years ago,
what PE firms were doing werebasically, they looked at,
let's say a group of comps and theytook the street median or mean,
and they applied a 30% discountand that was their multiple.
So we've certainly moved far andaway from that over the years.
But the whole idea is let'shave a better starting point,
(32:12):
a better transaction pointthat you can say, Hey,
this company that is privatelyheld just got bought for
8x. To completely disregard that,
especially if you're looking atit a year out or two years out,
is I don't think conformingwith the ICPA standards on best
practices and how you deal with valuation.
(32:33):
So, could you tell us a little bit aboutyour quarterly publication that you do
that's your middle market update?
Sure. So each quarter we releaseour private credit update.
We're looking at a lot ofdifferent data and resources.
We're looking at primarytrade, secondary indices,
looking at a lot of ourresearch internally,
looking at the deal flowthat we have internally,
(32:56):
and other research and data that we have.
We use a lot of goodinformation from PitchBook, LCD,
and I've got a small team here,
and I run that team where we puttogether a report and we try to
add a lot of color and discussion.
I know we have our competitors dothe same thing each quarter as well,
but we like to differentiate ourselvesa little bit by adding a lot more
(33:19):
discussion rather than just chartsand graphs to get the reader a
little bit better understandingof what's happening in the market.
And we do that quarterly.
I think it's important because youwant to get a very good in depth,
deep knowledge of what's happening in themarkets. I release that internally and
externally every quarter,
(33:40):
and that's some of the key basis on howwe're looking at private credit for that
quarter in addition to what we dofor that specific credit in those
schedules, that's uniqueto that credit. So,
this is to give everyone a good update,
be aware of maybe what'sthe key trends going on,
how are deals gettingpriced right now and why?
(34:04):
And getting a little bit morecolor. I mentioned before,
we're starting to see deals now gettingpriced at S plus 450 S plus 475. So,
if we're seeing a dealprice at S plus 525 with
reasonable equity cushion,reasonable leverage ratios,
reasonable interest coverage,that's a performing credit.
We don't need to worry about that,
(34:24):
especially if it can be repriced inthe market at a much lower spread.
So is your publication availableto anybody in the market,
or do they need to be a client?
Yes.
Okay. So, they can find iton your website presumably?
I have it on my LinkedIn profile.
I will try to find a way to publish iton our website. I have not done that yet,
(34:44):
but I tend to distributethat on my LinkedIn profile.
Are there any trends in the middlemarket that we haven't discussed today?
I think the asset class is growing.
You see these relationships withbanks. Banks want to get involved,
but they can't get involveddirectly in private credit.
So they're partnering up with privatecredit funds to provide more capital.
(35:07):
We're seeing more interest in theretail side, which interesting.
So you're getting more moneyfrom the retail investors.
We're seeing more interest by insurancecompanies seeing the asset class grow in
other areas such as asset-basedfinancing and even stuff like
student loans.
So I think McKenzie published areport a couple months ago predicting
(35:30):
this asset class to reach 30trillion at one point for the US.
Who knows?
But it's certainly grown so muchsince I got involved back in 2007
for sure. And it's evolved so much andit's changed so much over the years.
Good stuff. So I launchedthis podcast last year.
I listened to a lot of podcasts myselfand some of my favorite hosts- they
(35:53):
closed their podcast by asking somethingkind that somebody has done for
you, or recommend three books.
And what I've decided I'mgoing to go with going forward,
we'll see how it works. And thismay be a little bit unfair to you,
but I think my closingquestion is going to be,
when somebody asks you what a CLO is,
and you have 30 seconds toanswer, what would you say?
(36:17):
And again, I know you're not a CLOday-to-day professional, but what we do,
you're also in our market.
And my husband is Andrew Brady,who was a CLO manager for years.
So I'll piggyback off his knowledge andwhat I've picked through his brain over
the years. So collateralizedloan obligations,
think of it as a big gorilla of number of
(36:39):
loans that are put togetherin a big basket and
you bifurcate or split it upbased on the quality of that
particular tranches. SoAAA, BB and all that,
all the way down to the equity class.
And you get a different returnbased on your risk profile.
So if it blows up,
(37:00):
the AAA gets their money firstfollowed by the next tranche in the
structure. So that's how I look at CLOs.I don't know if that's right or not,
but it's definitely the big playerin private credit space for sure,
because they gobble up so manyof these credits. Absolutely.
So they're a big factor. So Shiloh,
how would you define or describe a CLO?
(37:23):
What I would say is the easiest wayto think about a CLO is that it's a
diversified pool of senior secured loans,
and it finances itself by issuingdebt sold in portions, AAA,
as you said, down to BB, and then there'sequity investors in the pool of loans,
and they effectively own the pool.
And so you could think of aCLO just as a simplified bank,
(37:45):
the banks in one business line only,
and that's lending and it lendsat a higher rate than it borrows,
and that generates profitabilityfor the CLOs equity investors,
and hopefully it also results in highquality debt investments for the people
who lend the CLO.
Great.
Melissa, thanks so much for comingon the podcast. I really enjoyed it.
Thank you, Shiloh. It was a pleasure.
(38:12):
The
content
here
is
for
informational
purposes
only
and
should
not
be
taken
as
legal,
business
tax
or
investment
advice,
or
be
used
to
evaluate
any
investment
or
security.
This
podcast
is
not
directed
at
any
investment
or
potential
investors
in
any
Flat
Rock
Global
Fund.
Definition
Section:
-
Secured
overnight
financing
rate
SOFR
is
a
broad
measure
of
the
cost
of
borrowing
cash
overnight,
collateralized
by
Treasury
securities.
-
The
global
financial
Crisis
GFC
was
a
period
of
extreme
stress
in
the
global
financial
markets
and
banking
systems
between
mid-2007
and
early
2009.
-
Credit
ratings
are
opinions
about
credit
risk
for
long
term
issues
or
instruments.
The
ratings
lie
in
a
spectrum
ranging
from
the
highest
credit
quality
on
one
end
to
default
or
junk
on
the
other.
A
AAA
is
the
highest
credit
quality,
a
C
or
a
D,
depending
on
the
agency,
the
rating
is
the
lowest
or
junk
quality.
-
Leveraged
loans
are
corporate
loans
to
companies
that
are
not
rated
investment
grade.
-
Broadly
syndicated
loans
are
underwritten
by
banks,
rated
by
nationally
recognized
statistical
ratings
organizations,
and
often
traded
among
market
participants.
-
Middle
market
loans
are
usually
underwritten
by
several
lenders,
with
the
intention
of
holding
the
instrument
through
its
maturity
.-
Spread
is
the
percentage
difference
in
current
yields
of
various
classes
of
fixed
income
securities
versus
Treasury
bonds,
or
another
benchmark
bond
measure.
-
A
reset
is
a
refinancing
and
extension
of
a
CLO
investment
period.
-
EBITDA
is
earnings
before
interest,
taxes,
depreciation
and
amortization.
An
add-back
would
attempt
to
adjust
EBITDA
for
non-recurring
items
.-
LIBOR,
the
London
Interbank
Offer
Rate,
was
replaced
by
SOFR
on
June
30th,
2024.
-
Delever
means
reducing
the
amount
of
debt
financing.-
High
yield
bonds
are
corporate
borrowings
rated
below
investment
grade
that
are
usually
fixed
rate
and
unsecured.
-
Default
refers
to
missing
a
contractual
interest
or
principal
payment.-
Debt
has
contractual
interest,
principal
and
interest
payments,
whereas
equity
represents
ownership
in
a
company.
-
Senior
secured
corporate
loans
are
borrowings
from
a
company
that
are
backed
by
collateral.
-
Junior
debt
ranks
behind
senior
secured
debt
in
its
payment
priority.-
Collateral
pool
refers
to
the
sum
of
collateral
pledged
to
a
lender
to
support
its
repayment.
-
A
non-call
period
refers
to
the
time
in
which
a
debt
instrument
cannot
be
optionally
repaid.
-
A
floating
rate
investment
has
an
interest
rate
that
varies
with
the
underlying
floating
rate
index.
-
RMBS,
our
residential
mortgage-backed
securities.
-
Loan
to
value
is
a
ratio
that
compares
the
loan
amount
to
the
enterprise
value
of
a
company.
-
GLG
is
a
firm
that
sets
up
calls
between
investors
and
industry
experts.-
Payment
In
Kind,
or
PIK,
refers
to
a
type
of
loan
or
financial
instrument
where
interest
or
dividends
are
paid
in
a
form
other
than
cash,
such
as
additional
debt
or
equity,
rather
than
in
cash-
A
covenant
refers
to
a
legally
binding
promise,
or
lender
protection,
written
into
a
loan
agreement.
-
Net
Asset
Value
(NAV)
-
The
value
of
a
fund's
assets
minus
its
liabilities,
typically
used
to
determine
the
per-share
value
of
an
interval
fund
or
investment
vehicle.
-
Dividend
Recapitalization
(Dividend
Recap)
-
A
refinancing
strategy
where
a
company
borrows
to
pay
a
dividend
to
its
shareholders,
often
used
by
private
equity
sponsors.-
Continuation
Vehicle
-
A
fund
structure
that
allows
investors
to
roll
their
interest
in
an
existing
portfolio
company
into
a
new
vehicle,
while
offering
liquidity
to
those
who
want
to
exit.
-
Equity
Cure
-
A
provision
that
allows
private
equity
sponsors
to
inject
equity
into
a
company
to
fix
a
financial
covenant
breach.
Risks:
CLOs
are
subject
to
market
fluctuations.
Every
investment
has
specific
risks,
which
can
significantly
increase
under
unusual
market
conditions.
The
structure
and
guidelines
of
CLOs
can
vary
deal
to
deal,
so
factors
such
as
leverage,
portfolio
testing,
callability,
and
subordination
can
all
influence
risks
associated
with
a
particular
deal.
Third-party
risk
is
counterparties
involved:
the
manager,
trustees,
custodians,
lawyers,
accountants
and
rating
agencies.
There
may
be
limited
liquidity
in
the
secondary
market.
CLOs
have
average
lives
that
are
typically
shorter
than
the
stated
maturity.
Tranches
can
be
called
early
after
the
non-call
period
has
lapsed.
General
disclaimer
section:
Flat
Rock
may
invest
in
CLOs
managed
by
podcast
guests.
However,
the
views
expressed
in
this
podcast
are
those
of
the
guest
and
do
not
necessarily
reflect
the
views
of
Flat
Rock
or
its
affiliates.
Any
return
projections
discussed
by
podcast
guests
do
not
reflect
Flat
Rock's
views
or
expectations.
This
is
not
a
recommendation
for
any
action
and
all
listeners
should
consider
these
projections
as
hypothetical
and
subject
to
significant
risks.References
to
interest
rate
moves
are
based
on
Bloomberg
data.
Any
mentions
of
specific
companies
are
for
reference
purposes
only
and
are
not
meant
to
describe
the
investment
merits
of,
or
potential
or
actual
portfolio
changes
related
to
securities
of
those
companies,
unless
otherwise
noted.
All
discussions
are
based
on
U.S.
markets
and
U.S.
monetary
and
fiscal
policies.
Market
forecasts
and
projections
are
based
on
current
market
conditions
and
are
subject
to
change
without
notice.
Projections
should
not
be
considered
a
guarantee.
The
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and
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expressed
by
the
Flat
Rock
Global
Speaker
are
those
of
the
speaker
as
of
the
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of
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and
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of
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as
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whole.
Any
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based
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and
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Rock
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This
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a
forecast,
research
or
investment
advice.
It
is
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a
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or
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or
to
adopt
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flatrockglobal.com.
Hi, I'm Shiloh Bates and welcometo the CLO Investor Podcast.
CLO stands for CollateralizedLoan obligations,
which are securities backed by poolsof leverage loans. In this podcast,
we discuss current newsand the CLO industry,
and I interview key market players.Today I'm speaking with Melissa Brady,
Senior Director at Alvarez& Marsal Valuation Services.
(00:29):
She leads a team that valuesprivate credit loans for CLOs, BDCs,
and interval funds.
She also publishes the Alvarez& Marsal Private Credit Update,
a quarterly publication that I'd highlyrecommend. We discuss multiple topics,
including the performanceof private credit loans,
why some credit managers may havedifferent marks than others for the same
(00:50):
underlying loan and othertrends in private credit.
I've also settled on a newpodcast closing question,
which is how would you describe ACLO in the last than 30 seconds?
And I'll answer to at the end of thepodcast. If you're enjoying the podcast,
please remember to share like and follow.And now my conversation with Melissa
(01:10):
Brady.
Melissa,
thanks so much for coming on the podcast.
Pleasure. Thank you for having me.
Why don't you tell our listeners howyou ended up at Alvarez & Marsal?
Sure. So, I started hereabout five years ago.
I started my career doing private creditabout 20 years ago during the great
(01:32):
financial crisis.
That's when I really pivoted and startedat Houilhan Lokey for a little bit,
was there for seven years and then withRSM and then came here in 2020 during
COVID was just really looking for agreater platform with great resources,
and that's what Alvarez & Marsal hasprovided for me here. So, it's been great.
(01:52):
We have such a wide diverse set of clientbase with all kinds of different size
AUMs and all kinds ofdifferent strategies. So,
it's been a really nice learning curve.
So, your primary role is valuation ofprivate credit loans, is that correct?
That's correct. So, within theportfolio valuation group, my niche,
(02:13):
my key focus is on private credit.
I do a number of private equityclients as well. Our group,
we focus on real estate funds,venture capital, private equity funds,
credit funds. So, we see the entire gamut.
My niche just because I enjoy it so muchand I've continued to enjoy it for all
these years, has reallybeen in private credit.
(02:34):
It's something I have seen evolveand change so much over the years,
and it's an asset class thatI truly enjoy working on. So,
we certainly have the bandwidth and thevolume of works to keep me happy and
busy here. So, it's been going well.
Good to hear.
So what's the general process forvaluation of a private credit loan?
(02:56):
So, we really want to get a goodunderstanding of the underlying business.
When we look at private credit, we'relooking at so many different variables.
Who's the sponsor? Is this a sponsorbacked loan or non-sponsored backed?
What's the strength of thecashflow? What sector it is,
the fundamentals of the business andunderstanding the business model to see,
hey, what's really the challengesto future cashflow? So,
(03:19):
when we look at private credit, I'mpersonally looking at first the size.
I'm looking at the concentrationor lack of concentration in cash
flows. I'm looking at who the sponsor is,
what's the liquidity condition of thebusiness to get a really good flow and
also understanding, okay, isthe pricing of that loan today?
(03:41):
Is that really representative of themarket? So, it's really EBITDA size,
how it's priced, cashflow, strength,
and all of those other qualitativefactors that you really want to get a good
handle on the credit fundamentals.
So, how does what's happening inthe broadly syndicated loan market,
how does that information makeits way into your valuations,
(04:02):
if at all?
So,
me and my small team here are responsiblefor the private credit updates that we
do, and we're looking atbroadly syndicated loans,
primary market and the secondary market.
We're looking at our internal data.
We understand that frankly the broadlysyndicated loan is going to have
different technicals and differenttechnicals to the private credit space.
(04:26):
And So,we understand that. So,
just because a broadly syndicatedmarket is moving in a certain direction,
it doesn't mean that the private creditspace is going to also move one-to-one
the way the BSL market is moving.
But we certainly look at the BSL marketto understand the debt markets further,
but we're also looking at datain addition to the deal flow
(04:47):
that we see internally with the dealvolume that we have and the private credit
research and analysis that we're doinginternally to get a more comprehensive
view of the debt markets.
And so that private creditresearch that I do every quarter,
the reason why we do it so early andwe release it so early is because a
key trend that we're seeing with ourclient base is they want valuations done
(05:10):
early. They actually want to be finalor done a few days after quarter end.
So, we release that research pretty earlyon in the process because most of our
clients really get aheadstart on valuations well before the quarter end even
starts.
So,
is the flow of information then that theunderwriter of the private credit loan
or the owner,
(05:31):
they probably pass you financials assoon as they get them and then you start
working on updating a valuation and thatmay be done. Is it a quarterly basis?
Is that what most ofyour clients are taking?
Yes.
And so those are the marks that gointo a BDCs schedule of investments at
quarter end or to an intervalfunds NAV or their financials as
(05:53):
well?
That's correct. And someclients want to a range,
some clients want a point estimate.It all depends on the fund's,
valuation policy andprocedures on their end.
But we would say majoritydo want to see a range.
The majority want to see a range.
How big would the range generallybe for a private credit loan?
(06:13):
What percentage of par?
We don't want to see it morethan two points ideally,
but sometimes it will be wider than that,
especially when we deal with distresseddebt valuation and just the nature
of leverage. As you know, Shiloh,it's a double-edged sword. So,
with these highly leverageddistressed credits,
the rate is certainly going to be alot wider. But for performing credits,
(06:36):
it can range two to three points.
So, you tell the owner of the loan, Hey,
your loan might be worth anywherefrom 97 cents on the dollar to par.
And then it's up to them to decide wherethey think they should be in the range.
Yeah,
and I would say a lot of them do go withthe midpoint because they don't want to
have to deal with the extraquestions by the auditors. Not all,
(07:00):
it depends on their valuationpolicy and procedures,
but a lot of them do go with the midpoint.Not necessarily every client does,
but I would say the majority.
Is the majority of your clients,
are they taking quarterly marks fromyou or are they doing it less frequently
to maybe save a little bit of money?
They take it quarterly. Forthe private equity clients,
(07:23):
that might be quarterly.That might be annually.
But I would say for themajority of the credit funds,
the BDCs that we have as ourclient base, it would be quarterly.
Got it. so,
one of the things that's been in the newsrecently is that there may be a number
of different investors with the sameloan and then they're disclosing their
quarterly mark to the world through aBDCs schedule of investments or private
(07:46):
credits equivalent.
And oftentimes thevaluation is different. So,
for par loans, it doesn't really matterthat much. One manager might say, Hey,
loan X is worth 99 cents. Another managermight have the same amount of par.
Probably not a huge difference, butas you get in, as loans have issues,
the difference between where differentmanagers are marking the same loan can
(08:10):
vary quite a bit.
Absolutely. That's been going on foras long as I've been doing this work.
Why is that?
I think the first key reason behindthat is maybe difference in information
- in information rights. So it'sinformation rights for sure.
That's a key driver there. Also,
it's just certain asset managershave different views and
(08:34):
that's where it is challengingwhen the mark differentials can be
pretty significant.
You see that quite a bit with theones that are non-accrual basis,
the more distressed credits havingsuch a wide disparity in marks.
And we deal with certain assetmanagers that are way more
conservative and certain assetmanagers that frankly are way more
(08:57):
optimistic and a little bitmore aggressive on their marks.
And that's just the realityof the world that we're in.
When you value a loan, presumablyeverybody gets the same price or,
well, I guess some people take arange, so maybe that's not true,
or how do you guys do it?
So when we have, let's say the sameexact credit for three different funds,
(09:19):
we have to be mindful that we onlycan use the information that was given
to us from that particular client.We can't cross use information.
Clearly we have the knowledge,
but what's actually appliedin the valuation schedules has to be the information
that we've been given fromthat particular client.
Even though we may know and have moreinformation from the other funds,
(09:41):
we try to be consistent. Absolutely,we do our best in that. So,
there is going to be differences ininformation and access to information and
information rights eventhough they're co-lenders.
So, when a loan is maybe on non-accrual,
when you're marking it for anumber of different investors,
some investors think maybe the loan'sreally money good and the company
(10:02):
will be bought by year end.
And so that would argue for a much highermark and then other investors in the
same loan just have a more don't knowthat or don't believe that taking a more
pessimistic view and thereforeget a lower mark for the same
security essentially.
Certainly that is thecase. You've seen that. So,
we have certain situations where I thinkone of the key trends that we're seeing
(10:25):
right now is clearly we knowM&A's weak and slow right now.
So, you see where a lot of the sponsorswant to go and do a pure exit through
M&A and they go to the M&A markets,they try to get [an] investment banker,
the bids come in [they're]very disappointed with the bids that have come in.
And so they just drop the whole saleprocess and they do a dividend recap and
(10:48):
we've seen quite a bit of that.
They're just not going to take a lowervaluation, especially when we look at,
I'm sure you know this,
the 2021 vintages when valuationswere so high when capital
raising was at the alltime high with fundraising,
and then you also had the debtmarkets with rates near zero. So,
we saw a lot of these2021 vintages frankly,
(11:10):
that they were just overpaid. Thesewere very frothy, high multiples.
They levered them up becausecapital was so cheap.
And so we're seeing a lot ofthe 2021 vintages seeing more
challenges today. So,
you're seeing those havingsome restructuring events or recapitalizations of
those credits.
But I would also argue we've hadhigher rates for longer for so long,
(11:34):
and I would predict recoveriesin this space to come
down for the creditsthat have not done well.
Do you guys publish a stat?
Do you guys have a defaultrate or non-accrual rate for the loans that you guys
do valuation work for?
We definitely have that datapoint. We don't publish it,
but we certainly keep track ofthat information internally.
(11:57):
It's something actuallywe're thinking about.
Maybe if we do publish in the future,
we are seeing non-accruals creep up.
We do expect non-accrualsto continue to creep up,
especially for these certain vintagesand for credits that have frankly been
over levered from the start.
Did Liberation day play a negativerole in terms of the performance
(12:19):
of the businesses that you guysvalue? Or is it too early to say?
There's always this lag on when eventshappen and how that will impact the
market and how we see the data.Because there's always lagging data.
We all know that the markethates instability and
non-transparency and uncertainty.It's the worst thing for the market.
(12:41):
So clearly we did see a bit ofchallenges where the fundamentals of the
credit, it did get a little rocky.
The issuers remember are alsogetting impacted if they can't close
certain contracts, for example,
because people want to beon a wait-and-see mode.
We have seen margins get erodeda bit in this inflationary
(13:03):
market,
and we have seen growth take a littlebit of pressure given the tariff supply
chain issues and whatnot.
But I think it's safe to say that alot of the loans are doing just fine,
especially the ones that didn't getoverlevered have ample liquidity.
Those are doing okay.But overall, I say yeah,
(13:23):
we've seen inflation takeits toll and growth is there.
It's just not as robust asit used to be. Who knows?
I can't predict the future and Ican always be wrong at this stuff,
but we've seen growth taper down. We'veseen margin take a little bit of hit,
but like I said, every credit and everysituation's going to be very different.
Some credits are just going to have thebandwidth and the ability to withstand
(13:46):
more stress than other credits.
Is there any industry that standsout to you as being more at risk
versus others in your dataset?
If the industry canface fierce competition
from AI, that's somethingwe've already seen. So,
here's a classic example whereyou have this great technology
(14:11):
that provides tutoringservices to K to 12,
and your contract is with these publicschool districts and you've done really
well all this time,
and all of a sudden you have thesecompeting technologies that can provide
tutoring for little or no cost. So,
you can see how we've seen thosecompanies unfortunately not
(14:34):
do well with very lowrecovery when they can't sell
the technology at auction,
there's no value to the IP and yourbusiness just went away. It hurts.
But we've seen a few examples ofthat. Also, another in healthcare,
we're seeing where sponsors want to gointo the dermatology business and they
(14:55):
bought a bunch of dermatologyclinics and as you know,
the consumer is cuttingdown their spending.
And so this dermatology spacewhere they bought a whole
bunch of these clinicsacross the country, well,
you've got high fixed costs andcustomers are buckling down on their
(15:15):
spend.
And so we're seeing that type of businessmodel take a little bit of a hit as
well as growth in margins have eroded.
In healthcare, have you seenwages increase faster than
reimbursement rates?
Yeah. I'm going to focus a littlebit on a segment of healthcare,
more the vet space,the veterinarian space.
We've seen a lot of these strategiesof roll up add-on where you buy
(15:40):
these vet clinics andyou expand and you grow.
Everyone loves to spend money ontheir pets. Even in a downturn,
they'll spend money in a recessionbecause everyone loves their pets.
And so we've seen that businesssegment have such incredible
margins and cashflow strength.So, not surprising what happens,
you got this tremendous amount ofcompetition entering that space. So,
(16:04):
we've seen some of these vetborrowers struggle a little bit as
competition has come sofierce that there's growth pressure and margin pressure
now that they haven't seen before.Especially if you maybe did a bit,
a few add-ons of targetcompanies that were a mistake
can have a real big impact onyour cashflow strength. So,
(16:25):
we're seeing a few of these vetclinic space take a bit of a hit.
A hit in the sense that they're atrisk for default or that financial
performance is down?
Performance is down.
They were bought for extremelyfrothy multiples in 2021 or 2022.
They were highly levered.
(16:46):
And what's going on is they have to PIK
100% of a certain tranche.
And if you have to PIKthe full tranche loan,
that always is going to give mepause. So, it's not one or two,
it's actually I've seen three or fourof these that they're all struggling.
Do you have a sense for ifthe stress in private credit,
(17:08):
do you think it's similar to thebroadly syndicated loan market?
Broadly syndicated, bythe way, the default rate,
if you include distressedexchanges, which you should,
it's around 4%. I'm assumingthat for private credit,
what you're seeing isa much smaller number.
Yesah, and the reason for that isbecause you continue to get support from
(17:29):
sponsors and other co-lenders.So, with the private credit space,
you just have more support.
You have liquidity support coming infrom the sponsor doing equity cures,
you have co-lenders coming inwilling to put in more money. So,
that pushes the defaultjust down the road.
So that's why we're just seeing solittle defaults in private credits.
You just have ample dry powder,
(17:51):
ample resources to continuesupporting the credit.
So sometimes default really isn't thekey metric because for private credit,
and this is true forbroadly syndicated as well,
but one person's default is anotherperson's kick the can down the road.
The private equity sponsorcan always put in more money.
The lenders can always agree to defertheir interest or principal and avoid a
(18:13):
default. If you're an investor in CLOs,you care about the ultimate recovery.
So, kicking the can might bea decent solution for now,
but sooner or later the loaneither repays you or it doesn't.
No, that's a great point, Shiloh,
because we clearly see lenderswilling to shut down, amortization,
willing to PIK part of theinterest or some of the interest or
(18:35):
have PIK periods of time where theyallow PIK for certain duration of time.
So,
another key trend that we're seeing iscertainly a lot more PIK to provide more
liquidity as rates are still high.
So, then in terms of defaults,staying on that for a few minutes,
your expectation is for this year,
so for 2025 defaults willbe elevated over last year
(18:59):
and their primary driver is the2021 vintage where blenders were
maybe a little too aggressive. Do yousee anything that would stop the trend?
That's right.
I think maybe for the next 12-18months we work through these more
challenging credits, especiallythese certain vintages.
I do think that you're going tosee the have and the have-nots.
(19:23):
You have certain asset managers that aregoing to do well and their portfolio is
going to do just fine,
and you're going to see others thatfrankly did not have that same discipline.
You can see it now, just look atwhich BDCs have the most non-accruals.
There's a wide differenceby asset managers and how they're dealing with their
non-accruals. And so yes, you got tosee how things work through the system.
(19:46):
The deals that are getting done arecertainly, these are the better deals.
And also it's interestingeveryone's wondering, well,
hoping and praying that the M&A marketsstart to open up in 2026 so that
sponsors can finally realizetheir investments and return
capital to their investors.
It's been a challenging time forsponsors because they want to be able
(20:10):
to close these funds and the life cycleof these funds have gotten longer and
longer. So, like I mentionedearlier, not surprising,
we're seeing a trend in dividend recaps.
A big trend is also continuationvehicles where LPs want out. So,
a continuation vehicleis a way to also get out.
For the continuation vehicle, is a privateequity firm launched a fund with a,
(20:34):
let's call it a fiveyear reinvestment period.
They're expected to return capitalto investors as they sell these
businesses.
And either the bids aren'tthere to get the initial
investors a healthy returnor the more favorable way
to look at it would be the privateequity firm still sees upside in their
(20:56):
investment, and so they don't want tosell it to another private equity firm.
They put it into a continuation vehiclewhere they have the same asset but
presumably owned by adifferent investor base.
When a loan's going intoa continuation vehicle,
does that have any significancefor you guys in your valuations?
Yes. So,
a big trend that we're seeing arethese valuation opinion work when those
(21:19):
continuation vehicles are created. So,
we come in and we provide valuationopinion to ensure that the investors
who want out and the investors who wantto remain in are all treated fairly.
So, that's been a pretty big trend,absolutely in the valuation space.
So, in that case, you'redoing the same work,
but the end product for you guysis a valuation opinion that's
(21:43):
disseminated to the market or given toparticular investors saying that the
pricing,
the valuation of the loan going from oneset of investors to another is done on
an arms length basis that it's fair.
That's right.
And so it does require a few morehurdles on our end because of the
risk. So, we have to go to this committee,ensure that everyone's on board. So,
(22:04):
there's a lot more in the processgiven the higher risk. So,
there's more involved when we do thesevaluation opinions versus just mark to
market on a quarterly basis.
Are you seeing loans structuredwith PIK upfront or does all the
PIK come when a business stumbles?
We're seeing both actually.Believe it or not,
(22:24):
we are seeing PIK upfront as well.
But the caveat there is I wouldsay the deals that are getting done
today are the better deals becausethey're really being picked
through. So we still have a verymuch a supply demand imbalance.
There's a lot of demand for the paper,
very little supply givenM&A is still quiet. So,
(22:45):
the competition is absolutely fierce. So,
we've seen in 2025, anumber of new issuances at,
SOFR plus 450, SOFR plus 475. So,
we're seeing these new loans gettingdone at under 500 basis points spreads
because of the high competition.
(23:05):
So, at another time,
those would've been loans under in netSOFR plus six or something like that.
Yeah, throughout 2024 we saw not all,
but a lot of the SOFRplus S plus 6% or higher,
those certainly gotrepriced. And as you know,
the sheer volume of repricing in2024 and the first half of 2025 has
been tremendous. So, majority ofloans right now are S plus five.
(23:28):
So in terms of the documentationof the private credit loan,
does it matter to you in terms of yourevaluation, if there's a covenant,
if there's more than onecovenant or if it's cov lite,
does that factor into your evaluation?
It does, and especially ifsomething is done with a,
this is a recurring revenueloan, it's still EBITDA negative,
(23:52):
it's still burning cash. Wewant to understand, okay,
what's the pricing on that?If it's S plus four 50,
we're going to take a little bit of pausethere because usually we want to see
those loans be priced a littlebit higher, like 550, 575.
We're seeing some of these covenantsgive them a lot of extra cushion when
they're being amended to give somebreathing room for the underlying credit.
(24:13):
But at the end of the day,
we're still seeing quite a bitof allowable add-backs to EBITA.
How EBITDA is defined, so personally,
I look at real EBITDA and adjust theEBITDA for the covenant compliance
certificate,
knowing that a lot of times thetotal add-backs can be 30% or
higher. If it's over 30%add-backs on the EBITDA. Clearly,
(24:35):
I want to understand how muchof that is truly non-recurring,
how much of that is potentially recurringin nature and should be not included
in the adjusted number. So,
really getting a good handle ofwhat's real EBITDA here because
we can certainly see leveragemultiples being under-reported
(24:56):
just due to EBITDA alone.
And that's something Idefinitely take a close look at.
Well,
how often is it that you and the clienthave significantly different EBITDA
numbers that you're using for valuation?
It's more if we have significantdifferences in valuation.
It does happen on occasion,
(25:17):
and that's where we just want tohave a follow-up conversation.
It might certainly be, Hey,
we missed some key informationwe didn't know about.
It's more about educating each other,making sure we're on the same page.
Typically, we want to be on the same page.
We want to be able to communicateeffectively to the client, our logic,
(25:38):
our reasoning,
our expertise in how we got tothe fundamentals of the valuation,
and typically we get to apoint where we all can agree.
And what if you guys arestruggling to get to that point?
I imagine it happens rarely.
It does happen. We don't like to see it,
but it does happen and wehave to remain independent.
We have to remain independent and feelgood with the work product that we're
(26:01):
delivering. And if we can't stand byit, we're not going to stand by it.
So there will be times when yes,
we disagree and themark just has to change.
In your business - Areyou seeing a lot of,
is it that business is booming becausethere's a lot of new private credit
asset managers out there and newfunds to work for is business booming
(26:24):
because private credit's growing?
Yes. So, we're seeing our clients grow,
continue to do new originations.
Even in this highly competitive market.
We're also seeing ourclients launch new funds,
and so that's keeping us busy as well.
And we're seeing private credit growin other spaces like real estate
(26:45):
infrastructure funds.
There's a lot of demand for structuredproduct valuations for those types of
funds that another teamworks on next to me. So yes,
things are going well.
Good to hear. What do you see as someof the challenges in your day to day?
I think the biggest challenge is inthis particular client base is people
(27:07):
really want things ASAP. So,
you have a very tight timecrunch to turn things around,
and it's a client base that's highlydemanding. They want what they want. So,
it's the ability to have theresources and the technology
to be able to turn. As youknow, these funds are massive.
(27:27):
We have clients as largest 2 trillionin assets under management. So,
it's the ability to use technology andthe resources to be able to continue to
fundamental robust work product,
but also be able to turn the volumegiven it's on a quarterly basis
and there's a number of credits andnumber of investments that need to be
(27:48):
covered each quarter. That'sthe biggest challenge.
Do your clients usually share with youthe initial financial model from the
private equity sponsor?
Correct. They do.
And then they do their own type ofstress testing on that original forecast.
And how often do you think is the sponsor,
the private equity firm'sinvestment case realized?
(28:09):
No one meets their budget.No one meets their budget.
And I keep on telling my staff,don't worry if they miss the budget,
who can budget? Well, it's sucha hard challenging thing to do.
And so I'm not so concernedabout if they miss their budget.
I'm more concerned about seeing thefundamental trends. So if they're growing,
(28:31):
but maybe not growing as fastas the sponsor predicted,
especially when you havea lot of equity cushion,
I'm not worried about that at all.
When you guys providemarks for your clients,
should the person who views the mark,
the end investor in the fundthat your client manages,
(28:51):
should they think of thatas a realizable price?
If their fund closed up and sold allof its loans that they should get your
prices more or less from that exercise?Or how should they think about it?
That's a great question,
and I see that struggle withthe definition of the deal team
really fixated on investment value and our
(29:15):
team focused on fair value, andthe definitions are very different.
So, the fair values we're providingis really okay. It really is.
The basis is on the codificationcode out there for GAAP,
but it's based on exit value. So,
what you would get not underany duress, arm's length,
willing participants,
(29:36):
participants with the same level ofinformation as of that valuation date.
The challenge comes in orthe deal teams that well
hold on,
but we're going to hold onto it forfour years and we're expecting to do
X, Y, Z in the next fouryears and realize a much,
much higher valuation. Well, that's great,
(29:57):
but that's investment value that you'reexpecting to realize four years from
today. So sometimes it'sreminding the deal team on, Hey,
what is the principles behind fairvalue? And listen, we can be wrong,
absolutely. But what we try todo is when there is an exit,
I always ask, okay, what did you getfor the investment for the security?
(30:19):
Because I want to know, well, if itwas different from our last valuation,
why was that the case?
And there might be buyer-specificreasons that we can't
incorporate in our fair value definition.
The assumptions need to be based ona market participant basis and has to
strip out a buyer specific synergy orbuyer specific reasons for that purchase.
(30:43):
Well,
one of the things I've noticed in termsof comparable company analysis that
similar to what you guysare doing, I imagine,
is just that you have one borrower thatyou're looking at and you're adjusting
EBITDA and you're saying, okay, theprivate equity firm paid, I don't know,
8x EBITDA for this company onthe adjusted EBITDA number.
(31:04):
And then you want to comparethat to comps in the market,
but then people don't adjustthe EBITDA of the comps.
And so if you don't adjustthe EBITDA of the comps,
what you're going to see is a setthat's trading at 15 times or 12 times,
and then you say, look, well,I've got all this equity cushion,
but what you've done,it's not apples to apples.
(31:26):
Oh, absolutely. Absolutely.Have to be apples to apples.
And you do see some deal teamsbeing more savvy and understanding
valuation better than others. Likeyou said, Shiloh, we look at, alright,
what was the buy in multiple?
What was the last trade ofthat underlying business?
What's happened to the market?
But what's also happened to thecompany over time to refinance and
(31:49):
readjust the multiple?As you know, years ago,
what PE firms were doing werebasically, they looked at,
let's say a group of comps and theytook the street median or mean,
and they applied a 30% discountand that was their multiple.
So we've certainly moved far andaway from that over the years.
But the whole idea is let'shave a better starting point,
(32:12):
a better transaction pointthat you can say, Hey,
this company that is privatelyheld just got bought for
8x. To completely disregard that,
especially if you're looking atit a year out or two years out,
is I don't think conformingwith the ICPA standards on best
practices and how you deal with valuation.
(32:33):
So, could you tell us a little bit aboutyour quarterly publication that you do
that's your middle market update?
Sure. So each quarter we releaseour private credit update.
We're looking at a lot ofdifferent data and resources.
We're looking at primarytrade, secondary indices,
looking at a lot of ourresearch internally,
looking at the deal flowthat we have internally,
(32:56):
and other research and data that we have.
We use a lot of goodinformation from PitchBook, LCD,
and I've got a small team here,
and I run that team where we puttogether a report and we try to
add a lot of color and discussion.
I know we have our competitors dothe same thing each quarter as well,
but we like to differentiate ourselvesa little bit by adding a lot more
(33:19):
discussion rather than just chartsand graphs to get the reader a
little bit better understandingof what's happening in the market.
And we do that quarterly.
I think it's important because youwant to get a very good in depth,
deep knowledge of what's happening in themarkets. I release that internally and
externally every quarter,
(33:40):
and that's some of the key basis on howwe're looking at private credit for that
quarter in addition to what we dofor that specific credit in those
schedules, that's uniqueto that credit. So,
this is to give everyone a good update,
be aware of maybe what'sthe key trends going on,
how are deals gettingpriced right now and why?
(34:04):
And getting a little bit morecolor. I mentioned before,
we're starting to see deals now gettingpriced at S plus 450 S plus 475. So,
if we're seeing a dealprice at S plus 525 with
reasonable equity cushion,reasonable leverage ratios,
reasonable interest coverage,that's a performing credit.
We don't need to worry about that,
(34:24):
especially if it can be repriced inthe market at a much lower spread.
So is your publication availableto anybody in the market,
or do they need to be a client?
Yes.
Okay. So, they can find iton your website presumably?
I have it on my LinkedIn profile.
I will try to find a way to publish iton our website. I have not done that yet,
(34:44):
but I tend to distributethat on my LinkedIn profile.
Are there any trends in the middlemarket that we haven't discussed today?
I think the asset class is growing.
You see these relationships withbanks. Banks want to get involved,
but they can't get involveddirectly in private credit.
So they're partnering up with privatecredit funds to provide more capital.
(35:07):
We're seeing more interest in theretail side, which interesting.
So you're getting more moneyfrom the retail investors.
We're seeing more interest by insurancecompanies seeing the asset class grow in
other areas such as asset-basedfinancing and even stuff like
student loans.
So I think McKenzie published areport a couple months ago predicting
(35:30):
this asset class to reach 30trillion at one point for the US.
Who knows?
But it's certainly grown so muchsince I got involved back in 2007
for sure. And it's evolved so much andit's changed so much over the years.
Good stuff. So I launchedthis podcast last year.
I listened to a lot of podcasts myselfand some of my favorite hosts- they
(35:53):
closed their podcast by asking somethingkind that somebody has done for
you, or recommend three books.
And what I've decided I'mgoing to go with going forward,
we'll see how it works. And thismay be a little bit unfair to you,
but I think my closingquestion is going to be,
when somebody asks you what a CLO is,
and you have 30 seconds toanswer, what would you say?
(36:17):
And again, I know you're not a CLOday-to-day professional, but what we do,
you're also in our market.
And my husband is Andrew Brady,who was a CLO manager for years.
So I'll piggyback off his knowledge andwhat I've picked through his brain over
the years. So collateralizedloan obligations,
think of it as a big gorilla of number of
(36:39):
loans that are put togetherin a big basket and
you bifurcate or split it upbased on the quality of that
particular tranches. SoAAA, BB and all that,
all the way down to the equity class.
And you get a different returnbased on your risk profile.
So if it blows up,
(37:00):
the AAA gets their money firstfollowed by the next tranche in the
structure. So that's how I look at CLOs.I don't know if that's right or not,
but it's definitely the big playerin private credit space for sure,
because they gobble up so manyof these credits. Absolutely.
So they're a big factor. So Shiloh,
how would you define or describe a CLO?
(37:23):
What I would say is the easiest wayto think about a CLO is that it's a
diversified pool of senior secured loans,
and it finances itself by issuingdebt sold in portions, AAA,
as you said, down to BB, and then there'sequity investors in the pool of loans,
and they effectively own the pool.
And so you could think of aCLO just as a simplified bank,
(37:45):
the banks in one business line only,
and that's lending and it lendsat a higher rate than it borrows,
and that generates profitabilityfor the CLOs equity investors,
and hopefully it also results in highquality debt investments for the people
who lend the CLO.
Great.
Melissa, thanks so much for comingon the podcast. I really enjoyed it.
Thank you, Shiloh. It was a pleasure.
(38:12):
The
content
here
is
for
informational
purposes
only
and
should
not
be
taken
as
legal,
business
tax
or
investment
advice,
or
be
used
to
evaluate
any
investment
or
security.
This
podcast
is
not
directed
at
any
investment
or
potential
investors
in
any
Flat
Rock
Global
Fund.
Definition
Section:
-
Secured
overnight
financing
rate
SOFR
is
a
broad
measure
of
the
cost
of
borrowing
cash
overnight,
collateralized
by
Treasury
securities.
-
The
global
financial
Crisis
GFC
was
a
period
of
extreme
stress
in
the
global
financial
markets
and
banking
systems
between
mid-2007
and
early
2009.
-
Credit
ratings
are
opinions
about
credit
risk
for
long
term
issues
or
instruments.
The
ratings
lie
in
a
spectrum
ranging
from
the
highest
credit
quality
on
one
end
to
default
or
junk
on
the
other.
A
AAA
is
the
highest
credit
quality,
a
C
or
a
D,
depending
on
the
agency,
the
rating
is
the
lowest
or
junk
quality.
-
Leveraged
loans
are
corporate
loans
to
companies
that
are
not
rated
investment
grade.
-
Broadly
syndicated
loans
are
underwritten
by
banks,
rated
by
nationally
recognized
statistical
ratings
organizations,
and
often
traded
among
market
participants.
-
Middle
market
loans
are
usually
underwritten
by
several
lenders,
with
the
intention
of
holding
the
instrument
through
its
maturity
.-
Spread
is
the
percentage
difference
in
current
yields
of
various
classes
of
fixed
income
securities
versus
Treasury
bonds,
or
another
benchmark
bond
measure.
-
A
reset
is
a
refinancing
and
extension
of
a
CLO
investment
period.
-
EBITDA
is
earnings
before
interest,
taxes,
depreciation
and
amortization.
An
add-back
would
attempt
to
adjust
EBITDA
for
non-recurring
items
.-
LIBOR,
the
London
Interbank
Offer
Rate,
was
replaced
by
SOFR
on
June
30th,
2024.
-
Delever
means
reducing
the
amount
of
debt
financing.-
High
yield
bonds
are
corporate
borrowings
rated
below
investment
grade
that
are
usually
fixed
rate
and
unsecured.
-
Default
refers
to
missing
a
contractual
interest
or
principal
payment.-
Debt
has
contractual
interest,
principal
and
interest
payments,
whereas
equity
represents
ownership
in
a
company.
-
Senior
secured
corporate
loans
are
borrowings
from
a
company
that
are
backed
by
collateral.
-
Junior
debt
ranks
behind
senior
secured
debt
in
its
payment
priority.-
Collateral
pool
refers
to
the
sum
of
collateral
pledged
to
a
lender
to
support
its
repayment.
-
A
non-call
period
refers
to
the
time
in
which
a
debt
instrument
cannot
be
optionally
repaid.
-
A
floating
rate
investment
has
an
interest
rate
that
varies
with
the
underlying
floating
rate
index.
-
RMBS,
our
residential
mortgage-backed
securities.
-
Loan
to
value
is
a
ratio
that
compares
the
loan
amount
to
the
enterprise
value
of
a
company.
-
GLG
is
a
firm
that
sets
up
calls
between
investors
and
industry
experts.-
Payment
In
Kind,
or
PIK,
refers
to
a
type
of
loan
or
financial
instrument
where
interest
or
dividends
are
paid
in
a
form
other
than
cash,
such
as
additional
debt
or
equity,
rather
than
in
cash-
A
covenant
refers
to
a
legally
binding
promise,
or
lender
protection,
written
into
a
loan
agreement.
-
Net
Asset
Value
(NAV)
-
The
value
of
a
fund's
assets
minus
its
liabilities,
typically
used
to
determine
the
per-share
value
of
an
interval
fund
or
investment
vehicle.
-
Dividend
Recapitalization
(Dividend
Recap)
-
A
refinancing
strategy
where
a
company
borrows
to
pay
a
dividend
to
its
shareholders,
often
used
by
private
equity
sponsors.-
Continuation
Vehicle
-
A
fund
structure
that
allows
investors
to
roll
their
interest
in
an
existing
portfolio
company
into
a
new
vehicle,
while
offering
liquidity
to
those
who
want
to
exit.
-
Equity
Cure
-
A
provision
that
allows
private
equity
sponsors
to
inject
equity
into
a
company
to
fix
a
financial
covenant
breach.
Risks:
CLOs
are
subject
to
market
fluctuations.
Every
investment
has
specific
risks,
which
can
significantly
increase
under
unusual
market
conditions.
The
structure
and
guidelines
of
CLOs
can
vary
deal
to
deal,
so
factors
such
as
leverage,
portfolio
testing,
callability,
and
subordination
can
all
influence
risks
associated
with
a
particular
deal.
Third-party
risk
is
counterparties
involved:
the
manager,
trustees,
custodians,
lawyers,
accountants
and
rating
agencies.
There
may
be
limited
liquidity
in
the
secondary
market.
CLOs
have
average
lives
that
are
typically
shorter
than
the
stated
maturity.
Tranches
can
be
called
early
after
the
non-call
period
has
lapsed.
General
disclaimer
section:
Flat
Rock
may
invest
in
CLOs
managed
by
podcast
guests.
However,
the
views
expressed
in
this
podcast
are
those
of
the
guest
and
do
not
necessarily
reflect
the
views
of
Flat
Rock
or
its
affiliates.
Any
return
projections
discussed
by
podcast
guests
do
not
reflect
Flat
Rock's
views
or
expectations.
This
is
not
a
recommendation
for
any
action
and
all
listeners
should
consider
these
projections
as
hypothetical
and
subject
to
significant
risks.References
to
interest
rate
moves
are
based
on
Bloomberg
data.
Any
mentions
of
specific
companies
are
for
reference
purposes
only
and
are
not
meant
to
describe
the
investment
merits
of,
or
potential
or
actual
portfolio
changes
related
to
securities
of
those
companies,
unless
otherwise
noted.
All
discussions
are
based
on
U.S.
markets
and
U.S.
monetary
and
fiscal
policies.
Market
forecasts
and
projections
are
based
on
current
market
conditions
and
are
subject
to
change
without
notice.
Projections
should
not
be
considered
a
guarantee.
The
views
and
opinions
expressed
by
the
Flat
Rock
Global
Speaker
are
those
of
the
speaker
as
of
the
date
of
the
broadcast,
and
do
not
necessarily
represent
the
views
of
the
firm
as
a
whole.
Any
such
views
are
subject
to
change
at
any
time
based
upon
market
or
other
conditions,
and
flat
Rock
global
disclaims
any
responsibility
to
update
such
views.
This
material
is
not
intended
to
be
relied
upon
as
a
forecast,
research
or
investment
advice.
It
is
not
a
recommendation,
offer
or
solicitation
to
buy
or
sell
any
securities
or
to
adopt
any
investment
strategy.
Neither
Flat
Rock
Global
nor
the
Flat
Rock
Global
speaker
can
be
responsible
for
any
direct
or
incidental
loss
incurred
by
applying
any
of
the
information
offered.
None
of
the
information
provided
should
be
regarded
as
a
suggestion
to
engage
in,
or
refrain
from
any
investment-related
course
of
action,
as
neither
Flat
Rock
Global
nor
its
affiliates
are
undertaking
to
provide
impartial
investment
advice.
Act
as
an
impartial
adviser
or
give
advice
in
a
fiduciary
capacity.
Additional
information
about
this
podcast,
along
with
an
edited
transcript,
may
be
obtained
by
visiting
flatrockglobal.com.
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