#24, Alex Navin, Managing Director, Performance Trust Capital Partners, LLC

Alex Navin, Managing Director, Performance Trust Capital Partners, LLC, joins The CLO Investor podcast to discuss the year for CLO equity on multiple fronts: leveraged loan defaults, spread compressions, potential Fed Rate cuts, and the growth in CLO debt EFTs. 

Episode Transcript

(00:06):
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 newsin the CLO industry and I interview key market players.
Today, I am speaking with Alex Navin,

(00:27):
Managing Director and CLOTrader at Performance Trust.
Alex and his firm are specialistsin trading CLO equity tranches.
We discuss what's become a challengingyear for CLO equity on multiple fronts,
elevated defaults,
spread compression on the CLOs assetsthat's outpaced declines in CLO

(00:48):
financing rates, and at the same time,
CLO equity market required ratesof return are still quite wide. .
That has resulted in CLOequity trading at discounts,
while other markets like theS&P 500 hit all time highs.
We discuss the potential for Fed Ratecuts to improve the outlook for CLO equity
as well as growth in CLO debt ETFs leadingto more favorable CLO financing costs
and higher CLO equity distributions.If you're enjoying the podcast,
please remember toshare, like, and follow.
And now my conversation with Alex Navin.

(01:10):
Alex, thanks so much forcoming on the podcast.
Hey Shiloh, thank youso much for having me.
So why don't you start off by telling ourlisteners how you ended up being a CLO
trader.
I guess it's really interesting. I wasactually a mechanical engineer in school,
and I think that generally as the WallStreet firms are doing some recruiting,
they found themselves looking at folkswith engineering and math backgrounds,
particularly as it came to someof the more complex products. So,

(01:33):
I ended up finding myself in the Citirotational program for sales and trading,
and the first desk that Iended up on was for CMBS.
So CMBS is the commercialmortgage backed securities.
Yeah, thanks for jumpingin with the acronyms.
We'll probably have a bunch of acronymsas we go through the conversation today,
and hopefully we can break them down.
And then the second rotation that itdid through that program was on the CLO

(01:56):
trading desk, so that was the quicktransition into that part of the career.
Okay, and how long have you been in CLOs?
So, basically in the CLOmarket for the last 15 years,
and the city program was pretty amazingbecause it obviously gave me opportunity
to find that part of the trading marketthat I felt most comfortable in or where
I felt like I had something to add interms of an edge or a market that really

(02:20):
started to appeal to me. And,of course, after 15 years,
I think that I consider myself incrediblylucky that I still love what I do and
the market still finds its way to bringinteresting challenges and interesting
areas for growth.
And I think the CLO market's one ofthose things where we've seen it now,
I think the market's finallytopped $1 trillion in size,
and that's basically tripledin size from when I started,

(02:42):
and probably even biggerfrom when you started.
And I think that that growth isa demonstration of the product.
At the end of the day,
I'm pretty much a true believerin the quality of the product,
and I think that it's justbeen a really amazing,
really interesting asset class.
So how long have you beenat Performance Trust?
Well,
why don't I go back a little bit becauseI think that the path to Performance
Trust was interestingenough to talk about.

(03:03):
I started at Citi and I was there onthe trading desk for a better part of a
decade.
I ended up in London for a couple ofyears trading the European CLO book as
well. But I spent a littlebit of time on the buy side,
an asset manager called Blue Bay,that was during [the] COVID crisis.
And on the follow of that,
one of my friends at the time and mycurrent business partner now, Jared Gogek,
he actually brought me a very interestingidea based on a couple of insights

(03:25):
that he found during the COVID marketsell off and all the complexity that came
with that.
But the really first big insight was thatwe should start our own broker dealer,
and we should go out on our own and tryto do something independent. This came
from a couple of observationsthat he made during COVID,
which is one - that the dealer communityhad largely moved away from providing

(03:46):
liquidity for CLO equity tranches.That was for a couple of reasons.
One - that it was a lot more capitalefficient for the broker-dealers to focus
on trading debt.
Two - it's a lot easier for them to doit because it's a lot easier to run CLO
debt than it is to run CLO equity. So,
what he saw was there was a real needfor us to basically fill a gap in the

(04:07):
marketplace, which is a couple of things.Jared's strong suit was relationships.
And I think that he has an amazing abilityto connect clients with one another
and give that type of high-touch clientexperience that I think most people
in the CLO market were starting to missas the market started to grow a lot
bigger. And if you called a big bank,
maybe you were getting a junior analystor a junior salesperson who's doing

(04:30):
their best, but they don'tknow the answers right away,
and they have to get you on thephone with somebody else. And two,
I think that you would have thembeing oftentimes very distracted,
especially during COVID where there areso many bonds trading on any given day,
you don't get that high-touch customerservice that you would've come to expect
from when the market,
when it was a lot smaller and a littlebit more boutiquey 10 years ago.
So we had this need, I think,

(04:50):
to fill a gap in client service and makingsure that clients felt like they were
really being taken care of. And thentwo, there was my area of expertise,
which is essentially providing accuratepricing, deep insights into structure,
modeling of equity cash flows,
and helping clients navigate a marketwhere pricing is uncertain. There's not a
lot of visibility, perhaps there'sa perception of illiquidity. So,

(05:12):
this combination of being able to giveclients the level of service that I think
that they deserve, and I thinkthat they're all looking for,
plus the ability to give them reallyaccurate pricing insights and pricing
guidance, was this, I think ,
gap in the marketplace that Jaredidentified and brought to me.
And we ultimately ended up forming ourteam and starting a broker-dealer called
Crosspoint that ultimately gotmerged into Performance Trust. Well,

(05:33):
Performance Trust found our teamand the little pod that we'd built,
and ultimately brought us onand added us to their platform.
So, is it just CLOequity that you're doing,
or do you guys ever tradein BBs or up the stack?
Yeah, we'll trade allacross the stack. So,
just because we have focus on CLO equitydoesn't mean that we don't spend time
on other parts of the capitalstructure. I think the business model,

(05:55):
the focus on equity, again,
came from our identificationof this need in the market,
but as you look through differentmarket cycles and different market
participants,
there are folks who certainly on ourclient list who trade the whole cap stack.
So,
if they are investing in equity andthey're investing equally in AAAs for some
of the other funds that they might manage,
then it's quite natural for them to cometo us and for them to use our access to

(06:20):
the markets and alsoour insights and again,
our relationships to trade anyparticular part of the capital structure.
It just so happens to bethat we have, I think,
a competitive advantage on equity.And equally,
I think that some of the dealers have acompetitive advantage on, for example,
trading AAAs. If you're one of thereally large money-center banks,
you are going to have access to reallycheap capital, really cheap financing,

(06:43):
and you're going to have simply morebalance sheet resources in order to have
whatever it is, $100million, $200 million,
$500 million of AAAs on your book thatyou're willing to make 2-way markets on.
We're not in that position. That's notour competitive advantage. And listen,
I think that the market benefitsfrom having those players there,
and we're certainly happythat those folks exist.
So when you guys are trading equity,

(07:04):
how often are the trades directlywith an asset manager versus
the bids wanted in competition orauction processes that are common in the
market?
So the bid wanted, we have thisacronym, BWIC - Bids Wanted In Comp.
It's a really big part of the market now,
and I think that there's areally good reason for it,

(07:24):
and I can just walk through themechanism for a minute and I think it's,
for most people,
the easiest way to think about it isessentially throwing something on an
auction like eBay. And you want to getas many people to bid on it as possible.
And ultimately you'regoing to have, ideally,
one buyer who is more motivated thanall the others that are out there.
And the only way to maybe identifythat one buyer who's got the highest

(07:45):
motivation or the highest convictionto buy that bond is to put it out in
competition and haveeverybody bidding on it. So,
this is a mechanism that'sbecome incredibly popular.
I would say that at least half or maybethree quarters of the volume for the CLO
market now is being done on this auctionmechanism. I think that as the market
grows, we're starting to have somegrowing pains with that mechanism.

(08:07):
And I think that those growing painshave been felt most acutely over really
just [the] last couple of months,especially as it relates to CLO equity.
And we can talk aboutthat a little bit more,
but one problem with having theseauctions out there is that if there are so
many of them that it feelsa bit cumbersome to run all the bonds that are coming
to market or coming to auction, then youtend to get less people focused on it.

(08:27):
So, if you're looking forthat one motivated buyer,
but there's a hundred auctions out there,
well clearly they can be a little bitmore selective about what they're actually
going to try to buy. So,
now we have this situation where thereare so many auctions that are occurring
at any given time that some of the focusis starting to be lost on who's going
to be actually providingliquidity for those auctions.
When somebody like us decides whothey're going to bid with in the auction

(08:51):
processes. So, we bid with anInvestment Bank or we bid with a Bank,
and then one of the servicesyou offer in advance of that is
you put out price talk. So can youtalk about how that process works?
Yeah, definitely. So we takepride in our price talk.
I think that one of the things that wedo is really unique is that we put out
exact dollar price talk on CLO equity,

(09:14):
and that was a calling card thatI created back in Crosspoint.
And I think that there's, again,I've talked about this for a minute,
but there's thisperception of illiquidity,
or there's this perception that CLOequity is harder to value than other
tranches. And I think thatthere's a lot to that. Of course,
I think that there's reasonswhy it can be harder to model,
there's reasons why it can be harderto analyze and why the price might seem

(09:34):
harder to determine. But,
one of the things that we think isreally valuable to the market is to give
people the views that we have aboutwhere some of these things should trade.
And I think that thedetermination of those prices,
it's not necessarily rocket science,but there is a ton that goes into it,
and there's a ton of both art and sciencethat I think goes into determining

(09:55):
those prices.
And I'm not sure if you want me to goa little bit into methodology or how we
look at it.
Yeah, I think that'd bereally interesting. I mean,
one of the reasons I may havementioned this to you before,
that I wanted to have you on a podcast,
is that we find your price talkto be very accurate. So yeah,
I would love to hearmore about how you do it.
Yeah, sure. There's no simple answer,but I'll go through two different,

(10:16):
I suppose,
angles of attack on this question whilewe're on a podcasts - getting one of my
favorite podcasts that's outthere is How I Built This,
which is this podcast whereGuy Raz interviews founders who've built companies,
and I think the one theme that theyalways have is everybody feels like they
have a bit of a component of luck thatwent into the way that they built their
business. I think that my componentof luck was cutting my teeth at Citi,

(10:37):
and I talked brieflyabout my career there,
but I think one of the big takeaways isthat throughout the 2010s and into even
current day, Citi was one ofthe biggest issuers of CLOs,
and the consequences ofthat are severalfold. One:
a lot of the investorsdemand, or ask nicely,
or ask because they don't have accuratepricing services from third party marks,

(10:58):
they ask Citi for marks on all the equitythat they've purchased from Citi. So,
as an analyst and as an associategoing through my early years at Citi,
one of my roles and responsibilities wasproviding month-end marks for all these
equity tranches.
And so every single month I would haveto put a valuation on anywhere from 200
to 500 individual CUSIPs.And so, I would have to,

(11:19):
let's call it luck orlet's call it lack of luck,
but I would have to clear up my weekendsonce a month in order to sit down and
price out 200 to 500 equityCUSIPs. And, in the early days,
that wasn't really that trivial.
I think that the softwareis getting a lot better,
and this is going to be the secondpart of my conversation here,
which is that the software has improveddramatically. But, back in the day,

(11:40):
there was a lot of running these thingsmanually and double checking the cash
flows and making sure that thecollateral was pulling in properly,
everything was updated.So, it was a lot of hard work.
And I think that there's no wayto shortcut that hard work. So,
I'm calling it luck,
but my luck was starting in a placethat gave me the opportunity to do that
work. So, as I projected that forward,

(12:01):
one of the things that I had to dowas get faster at valuing all of these
CLO equity securities and coming upwith different methodologies in order to
help triangulate prices very quickly.
And I think that that basicallypulled forward to today gave me this,
let's call it competitive advantage inthe fact that I've probably run more CLO
equity tranches than the vast majorityof people in the market just because of

(12:23):
the fact that I was sat in that unenviablerole of running bonds every single
month. So that's theluck that goes into it,
and I think that there's just no realway to shortcut that kind of hard work.
But as we pull forward into today,
I think that the softwareis advanced dramatically,
and I think that now we have a lot oftools at our disposal that we probably
didn't in the prior generation.So, we'll talk briefly about Intex.

(12:44):
Intex is the dominant cashflowmodeling software that is used
in not only the CLO market, but alsoother structured credit markets,
mortgage market, consumer, ABS,etc., (asset backed securities).
But what Intex has now is a little bitof more advanced cash flow modeling,
and now there's wrappers on top ofIntex. So there's new software providers.

(13:06):
The one that we use is called Valitana,
and I'll give a shout out to thembecause they're relatively new in the
marketplace, but they've developed apiece of software which I think is really,
really incredible and enables us toshortcut a lot of the analysis that
again,
used to be done a little bit by hand.And now we have the ability to do a lot of
automated runs and a lot of the automatedanalysis that we might not have been

(13:27):
able to do back in theday. Where back in the day,
I was essentially doing[the analysis] by hand. So,
what we've been able to do is we'vebeen able to take a lot of the different
inputs that we get from all the datasources we have available to us now,
a lot of loan market data, and thenagain modeling of the cash flows.
And we've developed a bunch of differentscenarios that are dynamic in nature.
So, when I'm looking at CLOequity, I'm looking at probably,

(13:50):
just because I'm a human,I'm not a robot yet,
I'm looking at probably 5 to 10 scenarios.
I know there are certain people in themarketplace who take pride in the fact
that they have 50 or a hundredscenarios that they look at.
I think that maybe that's a bit dilutivein terms of your ability to digest that
type of output. So,
what I try to look at is 5 to 10 scenariosthat I think are most illustrative

(14:11):
of both reality andfuture possible scenarios.
When you buy CLO equity inthe primary from a bank,
one of the services that you mentionedwas that once a month they'll provide you
a mark, they'll tell youwhat indicative price for it,
but a lot of times, in my experience,
the secondary CLO market istrading wider or at lower

(14:33):
prices than the primary market. So,
if you buy CLO equity in the primary andthen have a trader like yourself market
to secondary levels a month later,
you might find a pretty significantdepreciation in what you bought. So,
how do you think about that dynamic?
That's a good question. Basically,
I think what you're illustrating isthere are two types of buyers for CLO

(14:56):
equity. There is broad strokes.
There are going to be funds who buythird party equity and then broad strokes
that are going to be funds whoonly buy captive equity. So,
what I mean by that is,
the manager will buy their own equityin primary or they'll come to the new
issue market with an equitycheck already in hand. So,
I think if you are a manager andyou're taking your own equity check,

(15:17):
that's not to say that the price ofthe equity and primary doesn't matter,
but in a way it's not beingdetermined by market forces.
I think you're creating thisdeal to create a fee stream and
ultimately, the price of CLO equity willbe determined by the secondary market
at some point in the future. But,
it's not the reason these things arebeing created. The reason that they're

(15:38):
being created is to take advantage of anarbitrage between the asset spread and
the liability spread to generatecashflow to the equity. But ultimately,
if you're the CLO managerretaining your own equity,
you're more concerned aboutboth assets under management,
growing the size of your funds, and thefee stream that's also being created.
So, again,
this determination of what is theprice at primary for a deal like that.

(16:00):
The price at primary might not reallybe that important or determined by
market forces. Now,
if you are somebody else who hasthe ability to buy equity in primary
from any manager of your own choosing,
of course you're going tocare about what the price is.
And I think that determining the pricein those types of CLO equity sale
processes during the primary isgoing to be really important.

(16:22):
And I think you're going to find thatthose deals where there's a bit of price
discovery or syndication where the equityis getting sold to multiple investors
is going to align more closely withwhat the secondary market price is
than a deal where it doesn't gothrough a price discovery process.
When I started investing in CLO equity,
one of my biggest surprises was justthat if you're working with one bank,

(16:46):
you can buy CLO equity in the primaryand they'll send you a bunch of modeling
runs with projected IRRsin the mid-teens area and
they're assuming a low default rate anda good loan recovery rate and favorable
reinvestments.
And there's 10 of these variablesthat determine the CLO equity return.
Every variable is skewed tothe most favorable way. So,

(17:11):
it shakes out mid-teens again, call it.
And then if you asked a trader at thesame bank on the same day what their
targeted IRR would be forthe same exact security,
they'd call it 9% or 10%. Andthey'd take all those variables,
all the 10 variables,
and they'd skew them on the conservativeside and that's what they'd be

(17:31):
willing to pay. So I just thoughtthat was a pretty comical dynamic.
There is a joke that goesamongst CLO investors,
it's if you don't see a yield of 12-14%,you need to change your scenarios.
So, you mentioned youhad a bunch of scenarios,
but do you have one inparticular that rises above all

(17:51):
else like a 2% default rateand a 70 cent recovery,
which I think is probably the most common?
So, I mentioned the software.
I think that the models now are all abit dynamic and I think that creates
something that's a bit moreinteresting. 2% CDR with a 70 recovery,
so a 2% default rate.
The CDR is the constant default rate.
Yeah,
so 2% default rate per year and a 70%recovery rate upon default is probably

(18:15):
not the right way to look at it.
It's the standard runs for how you wouldlook at CLO debt, but with CLO debt,
it doesn't really matter that much.
You could dial that default rate up to5% or you could dial that recovery rate
down to 50% and you're even still goingto get the same, essentially cash flows.
So your debt tranches are all going tolook the same no matter how you run those
scenarios. But for equity, it'sgoing to make quite a big difference.

(18:36):
CLO equity, generally, if youhave a $400 million CLO deal,
the equity tranche is going to be 10%of the deal, so it'll be $40 million.
And this gives us what we refer to inthe marketplace as 10 times leverage.
So, if you have 1% of your CLOgo bad and one credit goes bad,
and that credit happensto be 1% of the deal,

(18:56):
while it's 1% of your $400 million deal,
it ends up being 10% ofyour CLO equity tranche. So,
you have this 10 times leveragedeffect for all of these assumptions.
One of the cool things aboutthe software that we have now,
and it's something that we hadto do manually back in the day,
is we can take the marketdata that we already know,
which is where loans aretrading, loan prices,

(19:17):
and we can use that to essentiallyproject forward what our default rate
or expected default rate is going to be.
So you're going to have different CLOswith different collateral quality.
You might have a CLO that has 5%trading below some type of price
that you might determine to be distressed.
And I think those pricelevels vary over time.
But right now I think that everybodywould say if you're trading below 70,

(19:41):
which is, again the recovery thatyou might assume in a basic scenario,
if you have 5% of yourportfolio trading below 70,
then you're pretty muchgoing to anticipate that 5% of your portfolio is going
to default at some point,
or at least that's what theloan market is telling you. So,
this now is one of the biggestinputs to running CLO equity,
is you can actually use the marketdata that we already have, loan prices.

(20:02):
You can plug that into themodel to determine what your default rate forward is
going to be. So, if I'm runningtwo CLOs under the same,
let's call it automated scenario whereone CLO has 2% below 70 and one CLO
has 5% below 70. For the first one,
I'm going to be running essentially a2% default rate, and for the second one,
I'm going to be running a 5% default rate.
And what that does is it does a riskadjustment. So, I'm still, again,

(20:25):
the joke is solving for 12 to 14% IRR,
but with one deal I'm defaulting a lotmore of the collateral and with the other
deal, I'm defaulting a lot less.
So that's one of the ways that some ofthis automation of the software allows us
to take market data into make a dynamic model.
So,
the idea there is that maybe it's a2% default rate on the loans overall,

(20:45):
but those are really for par loans.
And if a loan is alreadytraded into the 80s or 70s,
then you need to make anadjustment there. Obviously,
that's accredited higher risk,
and I would assume that a loan tradingat 70 would just, by your modeling,
default at some point and recover 70.That's how you would think about it.
Yeah, that's definitelyone way to think about it.

(21:07):
These are things that I like to changeover market scenarios and over different
cycles as well,
which is why one of the things thatI try to do is I always try to have a
scenario that I maintain relativelyconstant over the last, let's call it,
two years or three years.
So I can go back and look at somethinghow I ran it two years ago without having
changed the assumptionsor the model too much.

(21:27):
And then I can create anotherscenario now that might more
accurately represent what my viewof the world is going forward.
And I think what you were sayingthere was if a loan is trading at 70,
it is distressed and itis likely to default.
Is it likely to recover 70 or is itlikely to recover something less,
like 50 or is it likelyto recover something more,
like 80? Obviously that's notsomething that we can know.

(21:49):
That's something that even distressedtraders who are trading these loans,
they don't know.
But clearly there's this assumption thatthere's market efficiency and that the
prices of these loans are telling marketparticipants something about what that
anticipated recovery is.
But where I'm going with this isessentially that's something that can be
stressed and that is something thatI actually like to stress often,
which is ultimate recovery.

(22:10):
And I think that we've seen recoveriesdrifting lower as liability management
exercises are becoming more popular.
I think that you've probably talked aboutthese with other guests in the past.
I have. Those are the out of courtrestructurings that lenders are doing now.
Yeah, certainly.
And I think that there's going to bevariable recovery on some of these loans.
So, that loan might be trading at 70;

(22:31):
one lender might get 80 recovery andone lender might get a 50 recovery.
So these are things that can be stressedand these are things that I do like to
stress in my models in order to determinethe sensitivity really to that type of
input.
So, let's say somebody participatingin BWICs recently that you've been
involved with, they're buying equity.
What's the targeted IRR theyshould expect in your opinion?

(22:54):
So, the CLO market, especiallyequity has had a bit of a tough year.
And I think maybe we can just goback and talk a little bit about why,
and maybe that helps frame someof this conversation now. But,
I looked at the lev'd (leveraged) loanindex, the Morningstar Lev Loan index,
which is pretty widely trackedindex of where levered loan prices,
but also the underlying features of theloans. So, if I looked 12 months ago,

(23:17):
in August of 2024,
the average spread on the loansin that index was around 350.
If we go to January of this year, theaverage spread on those loans was 340.
And, if you go all the way to today, theaverage spread on those loans is 325.
So all things equal, again,
the loan index is trading roughlyin the high-90s dollars price,

(23:38):
but you've lost 25 basis pointsof spread on the universe in
general.And, these are what refer to as assets.
These are the assets that go into CLOsthat generate the return that CLO equity
investors expect to receive.
And the other side of theequation hasn't really moved.
So AAAs right now are roughly SOFR plus

(23:59):
130-135.
They had a brief moment of glory inJanuary this year where they're trading
inside of 120,
but if you rewind to the same timeframeas what I was quoting on the lev loan
index of August of last year,
generally CLO AAAs werestill SOFR plus 130-135.
So ,you have this equation,there's inputs and outputs,

(24:19):
and so the input into CLO is the spreadfrom loans, the spread from the assets,
it was 350 going in andnow it's 325 going in. And,
what's going out is your130-135 on CLO AAAs. So,
basically you have less money coming inand the same amount of money going out
and it's 10 times levered.So,
the way that this works is if you have25 basis points less spread on your

(24:39):
portfolio,
that works out to about 2.5 points lessequity payment that you're getting as an
equity holder right now. And,it's not just for one year,
it's for every year you'reprojecting going forward. So,
if you have a CLO equity tranche thathas five year reinvestment period and two
or three years of amortization,
you're getting two and a half points lesscashflow this year and for every year

(25:01):
out to seven years. Take a present valueof that, it's roughly 10 to 12 points.
So if you started this year or you started12 months ago with an equity tranche
that traded at 75, for example,75 cents on the dollar,
you've lost 12 points presentvalue of future cashflow. So,
your equity should trade at 63 if youwere wanted to keep the same IRR. So,

(25:22):
if you were running this thing at 15%IRR a year ago and you're running it at
15% IRR today,
you have lost 12 points ofanticipated cashflow and spread.
Now, there's been a bitof a mitigating factor,
which is that you've already receiveda bunch of cashflow in that period of
time,
so you've probably received 12 to 15points of cashflow ideally through that

(25:43):
period of time. And so, net-net,
your IRR from a year agoto today should be zero.
And I think that broadly that's whatpeople are looking at right now is saying,
well, I've been taking all this risk inCLO equity, but over the last 12 months,
my return has been closeto zero, or maybe flat,
or maybe phenomenally higherin certain situations,
or maybe a decent amount lower in othersituations. So, as we look at that,

(26:04):
let's call it the problem,
the problem is that that's not somethingthat's going to reverse. This is not a
scenario where, oh,
prices have come down andtherefore now the value is better.
This is just a math problem.
There is less money comingin and going to investors.
So there isn't really a case forthe prices to return to a higher

(26:24):
level unless you have the opportunityfor CLO managers to add spread
or to build par. Add spread, meaning buyloans with wider spread or build par,
meaning buying loanswith lower dollar prices,
or you have a world where CLO AAAsend up going a lot tighter. So,
you have to have pretty rose coloredglasses in order to see why CLO equity at

(26:44):
this stage has corrected to a pointwhere everything is going to be different
there where it was 12 monthsago. I think in general,
my view is that the worstof it is probably done,
but that doesn't really change the factthat we have less cash flows as equity
investors right now.
Okay, but in this math problem,
we have CLOs today are buyingthree quarters or so of

(27:07):
leveraged loans out there, and if theCLO equity isn't making good money,
then this is like a closed system,
then the CLO financing costs have tocome down to make it profitable for the
equity going forward or loan spreads,
there won't be demand for loansand loan spreads move wider. But,
there isn't a long run setup wherethe equity is putting in at-risk

(27:30):
dollars and not making a healthy return.
I agree with that,
and I think that maybe I have a couplequestions for you in terms of where the
fundraising landscape looks like forthird party investing versus dedicated
manager fund investing,
because I think as much as I agreewith you that this should be a
self-correcting mechanism in the sensethat if equity returns don't look good,
then people will notcreate CLO equity anymore.

(27:52):
But do you see something different interms of, in the private credit space,
where you have maybe more rationalityin terms of creation of these
vehicles because you just won't do itif the arbitrage doesn't make sense or
it's a bit more opportunistic in termsof the assets they're able to source
versus the liabilities thatthey're pricing in CLOs?
Maybe they have different fundingmechanisms other than just the CLO market?

(28:14):
Well, one of the real attractions ofprivate credit CLOs is just the natural
profitability is greater.
So you might pick up 175 BPSin spread on the total loan
portfolio, comparing privatecredit to broadly syndicated.
But at the AAA, for example, whichis the biggest financing cost,
the delta there isprobably today 25-30 BPS.

(28:38):
So, just the private credit,
just the cash flows you get from the CLOsis going to be much higher. But coming
back, so the problem for,
and I guess you're asking aboutprivate credit highlights ,
that it's more of a broadly syndicatedCLO equity math problem. But,
if borrowers are refinancing tighter,
how I would've thought ofthat in the past is that okay,

(29:01):
so that's negative for CLO equitycash flows, but at the same time,
the economy is presumably doing wellat a market where loans are repricing
tighter, the capital markets are open.
I should expect lessdefauls than my base case.
But would you say that's true today or no?
That's interesting because this maybepulls to a bigger question about the

(29:22):
U.S. economy as a wholeand the idea of how healthy
are capital markets in general.
And I think if you look ateven just equity indices,
maybe the S&P 500,
all the money is being generated by theMag 7 and Artificial Intelligence and
all the various plays that come withthat - infrastructure, energy, etc. But,

(29:44):
if you look at a broader index likemaybe the Russell with small caps,
I think you're seeing a lot of thesecompanies treading water to some extent.
They're certainly not growing as fastand inflation is still here to some
extent. So,
I think it's a question of are thesecompanies growing fast enough to keep pace
with inflation and therefore, are theirstock prices going to be going up?
Are they going to be mostly flat? Andthe reason I bring this up is that a lot

(30:07):
of these smaller borrowers are maybe muchmore representative of what you'd get
in the Russell Index from astock equivalency standpoint than what you would get
in the S&P 500 from aMag 7 standpoint. So,
you have this universe wherecapital markets are wide open.
There's still this maybe hangover of aton of liquidity that came from COVID and

(30:29):
all of the programs that both were fiscaland monetary in terms of money that
came into the system. So, yeah,
there's the ability for a lot of theseborrowers to refinance at much cheaper
rates.
And of course the growth of the CLOmarket is one of the reasons why a lot of
these borrowers are able to get suchamazing, cheap financing. And again,
from a fundamental standpoint,
I think this is amazing. I think thatthis is the ability for the US capital

(30:51):
markets to be incredibly efficient andto allocate money to folks who are trying
to grow the economy and folks who areemploying Americans. And, let's call it,
the problem at this stage is that it'snot going to be a tide that lifts all
boats.
And I think you're going to have differentsectors where there's going to be
problems.
And I think that the first thing thatwe saw when there was a little bit of a

(31:11):
tariff tantrum today,
everybody was going through their CLOportfolios and trying to decide which
sectors are going to beexposed. Is it agriculture?
Is it going to be theequipment? Manufacturing?
Where is it that there's going toactually be economic sensitivities?
Because in general, financingcosts are cheap and money is cheap,
and it feels like it's really easy torefinance your loans tighter and tighter

(31:32):
and tighter.
But I don't think that's going tosolve the problems for everybody in the
universe. And I don't think we'regoing to have this 0% default rate.
I think that in general, if you look12 months ago and 12 months forward,
you're probably closerto 4 or 5% defaults,
including LMEs because you're going tohave credits that are still running into
growth problems.
Well, it's one of the keyissues because people,

(31:55):
I think look at CLO equity as potentiallyan alternative to the S&P 500 or to
other equity exposures.
And the reality is the S&Pp500 is driven by seven stocks.
So, in our asset class,
we care about the health of everyloan. And if a loan does really well,
well that's not great either. Theyjust refinance out of your market,

(32:17):
so you have to care about everybody.
And the economy hasbecome a little bit of a,
it's not this rising tide lifting allboats. Some companies are doing really,
really well.
Yeah, CLO equity is for sure atrade for Goldilocks scenarios,
and if the market is toohot or doing too well,
you're going to get thisnegative convexity effect with so much loan repricing.
We've just seen thatover the last 12 months.

(32:39):
But there's certainly times when you'reable to clip this steady arbitrage and
you're able to have this advantage whereyou're getting tons of cash flows that
you can reinvest that makes CLO equityan incredibly attractive asset class.
It's not every year. Youwouldn't ever expect it to be,
you think you'd expect pricesto go up, prices to go down,
but this last year hasobviously been challenging.
But this doesn't mean that theasset class doesn't make sense.

(32:59):
But in your, back tothe math problem again,
so if you lost 25 BPS on your assetsand you don't have any cost savings,
CLO financing rates are the same. Thisis year over year, August to August,
and we're recording this August 22nd,by the way. So then, going forward,
should somebody assume that we'll lose25 BPS on the assets again and not have

(33:20):
tighter CLO or better CLO financing rates?
Well, I wish I had a crystal ball,
but here's a couple of things that I'mthinking about as we're heading into the
fall here and as we're heading intothe potential for maybe a rate cut,
which obviously PresidentTrump's pushing for pretty hard.
I think that there's this real possibilitythat if and when rate cuts come,
the floating rate assets and CLOs floatagainst three months SOFR and so do the

(33:42):
liabilities.
So we have both liabilities and theassets floating against three months SOFR.
And three months SOFR, forall intents and purposes,
is going to track prettyclosely with fed funds.
So if we have some interest rate cuts,
you're basically going to have prettydirect impact on the interest income for
both CLO assets, loans, andliability, CLO tranches. So,
I think if you are maybe an insurancecompany or maybe just an asset manager,

(34:05):
a mutual fund,
or maybe you're buying the loan mutualfund because you like floating rate
assets, which certainly makes sensein an inflationary environment,
you like to have some floating rate assetsthat are going to protect you to some
extent against inflation. And in the fallyou have that floating rate come down
and start to float down.
Maybe you're going to start to rethinkabout buying that floating rate loan at

(34:27):
SOFR plus 250.
And I think maybe you're going to thinkabout allocating towards fixed rate
assets that aren't going to behaving that compression and income,
especially if you're alonger term investor.
If you are an endowment or a mutualfund or you have the ability to take
duration risk and you're happy with10 year, 20 or 30 year duration risk.

(34:48):
You might be more inclined to gobuy something that's not floating
than something that'sfixed. So, that's one,
let's call it potential mitigant ofcontinued spread compression on the
loan side.
Well, again,
so if I'm losing 25 BPS on theassets and not saving anything
on the CLO financing costs, isn't ittrue that the CLO begins its life,

(35:11):
it goes two years, it getsthrough the non-call period,
and let's say CLO financingrates haven't declined.
Isn't it the case that still we coulddo in the money refinancing if we're not
looking to extend the life of the deal,
if we do a refinancing the CLO AAA andall the debt securities will be shorter,
CLO debt investors like short CLOsand we'll give you a lower rate there.

(35:36):
So, isn't that an option versus thismath problem that you've described?
Yeah, it is.
And these options that CLO equityhave are at times incredibly valuable.
And I think that the one that you'retalking about right now is let's fast
forward two years in the future.The whole deal is a bit shorter.
What you would expect thereis a bit of a term curve. So,

(35:57):
that means that if you're buying abrand new CLO AAA for a primary deal,
you might have a seven or eightyear weighted average life. But,
if you're buying a refinancingAAA or refinanced AAA,
you might have something like a threeto five year weighted average life for
your AAA.
And because you have a shorter number ofcash flows or shorted effective spread
duration, you would theoreticallybuy that at a tighter spread. So,

(36:20):
I think that we see that a littlebit right now in [the] secondary,
I think that primaryspreads are generally 130,
but if you were to buy secondaryAAAs, you're probably paying, well,
you are almost certainly payinga premium dollar price. So,
it was a question of exactly whereyour spread is, but all things equal,
I think that you're buying shorter AAAsanywhere from 10 to 25 basis points

(36:41):
tighter than you're buyinglonger AAAa. So yeah,
you have that ability to refinance,
but it's going to be incredibly sensitiveto what's happening at the market in
any given time. Post this, let's callit tariff tantrum that we had this year,
this mini tariff tantrum, thatterm curve was pretty flat,
short AAAs and long AAAs weretrading at the same spread. So,
I think that some of the most skilledCLO equity investors understand that this

(37:04):
market dynamic can occur at differenttimes and will know when to pull the
trigger on different options. So, shouldI pull the trigger on a refinancing?
Should I pull the trigger on a reset,
which basically takes your whole dealand makes it like a brand new deal again
with a five year reinvestment period. Or,
in the option that I think somepeople are actually taking right now,

(37:25):
you're just going to collapse thedeal, you're going to call it,
you're going to sell all the loans tothe market and you're going to get your
money back. And I think that that optionthat people are starting to pull the
trigger on right now makes a lot ofsense when the arbitrage is bad and loan
prices are high.
Yeah. But when loansare repricing tighter,
so the loan owner is goingto make do with less income.

(37:45):
But isn't that from the perspectiveof somebody investing in CLO equity,
isn't it that the total market returnand leverage finance is going down?
So, in the equity, yeah, I'm losing somecash flows, but so is everybody else.
So, is the loan investor,presumably the bond market,
somebody investing in high yield bondsis suffering from high yield spreads

(38:09):
coming in. So, it's not that everybodyin the debt market is losing,
but you don't have to take it on the chinin terms of the price of the security
that you own in equity because,
and maybe this will tie to maybea question on SOFR coming down,
but there's a lot ofmoney in our asset class,
and I think the money has come in becausethe asset class has offered favorable

(38:29):
risk-adjusted returns. And it seemslike we're giving some of that up at the
moment. We're coming backto the math problem again,
when a loan reprices fromSOFR plus 350 to 325,
the loan probably still trades atpar. So, you are losing income,
but the price is thesame. So, for CLO equity,
how I think it should work is that yes,
I am losing income when loansreprice tighter; however,

(38:53):
the overall market rate ofreturn is tighter for all asset classes and the value
of what I own should hold up.
I think actually what's happeningthough is that's not the case.
People are looking atCLO equity and saying,
I want a 15% return regardlessof how many of these loans have
repriced tighter. So, thatresults in a negative move.

(39:15):
Yeah, and certainly,
I mean to talk a little bit about thatcall mechanism that I was mentioning,
I think we are already seeing that callmechanism be used because you're having
these vehicles that simplyare no longer efficient.
If you have a vehicle that maybe it'son the really bad side of all the loan
repricing and the loanindex might be at 325,
but say this CLO happened to owntons of really, really clean credits,

(39:37):
good on the manager, of course, pat themon the back for choosing good credits.
But,
the problem with that is now maybe theirportfolio actually has a 290 spread,
290 weighted average spread.
And if you have a portfolio thathas a 290 weighted average spread,
you're simply not going to generate enoughincome for the CLO equity investor to
get the cash flows that they need to takethe risk that they want to get the 15%

(39:57):
IRR that they want.So again,
your CLO equity investorwho's sophisticated and can look at the portfolio and
understand, hey, all theseloans are really clean,
I'll probably get betterthan bid side execution.
When I liquidate this portfolio,
I might get an extra three or four orfive points above what I currently think
my equity tranchesmarked at or the NAV is.

(40:19):
Now it's just a good timeto just get my money back.
I'll take my money back and I'll takeadvantage of this strong loan market and
I'll put it somewhere else.
Maybe I'll put it in debt becausedebt is actually pretty cheap.
BB tranches are probablypretty cheap, all things equal.
I think there's plentyof investors who say,
BBs offer really compelling relativevalue compared to equity as a result.
But if I come into this year with areturn expectation for CLO equity of

(40:43):
again,
just let's call it 15% and loansare repricing tighter on me,
would I have expected or should I expectthat in August offered rates of return
across leveraged finance have come down.
Should I still expectto be making the 15%?
Why isn't the market rate ofreturn 13% or some other number?

(41:04):
So, this part of the market, thisis where it becomes non-linear,
and this is where it becomes a scenarioof investors get to determine what the
market price is in the secondarymarket in a competitive environment.
And I think right now that's certainlywhat we're seeing is that CLO equity
investors in third party who are willingto participate in the secondary and
provide bids when tranchesare available for sale,

(41:26):
I think they are taking thetime right now to say, Hey,
market prices are not reflectiveof the 15% that I want to earn,
or 12% to 15% that I want to earn at themarket prices where they were trading
two months ago or threemonths ago. So now,
I want to buy these equity tranchesat, call it 5 points, 6 points,
7 points lower than where theywere trading in June or July.

(41:46):
And if I can buy them there, I want to.
And there's plenty of peoplewho want to buy CLO equity 5, 6,
7 points lower than where they'retrading in July because you do get that,
now advantage of, okay, maybe yourcash flows are a little bit lower,
but you've adjusted for that in terms ofyour purchase price and now you're able
to purchase something at a lower priceand self-correct to that IRR that you're
trying to achieve.
The other part of the mathproblem that we've talked about,

(42:09):
which I find fascinating by the way,
because it's really just with thissimple math, it sums up the whole year,
but there's been a lot of money raisedin these ETFs for CLO securities,
AAA and down. So,
why aren't CLO financing ratesmoving down as quickly as the
loan financing rates?
Great question.

(42:29):
I can barely keep up with the pace ofgrowth of some of these CLO AAA ETFs.
I do think that it's great that retailinvestors finally have the ability to get
access to this asset class. And again,
with CLO AAAs trading at 135 now,
it's such a compelling security to buyfor almost any type of investor that's
out there.
You're obviously getting far better thanyou would ever get in a money market
fund or a savings account.So, as an individual investor,

(42:52):
I do think that it's amazing that theynow have access to this asset class.
As much as they have grown, I thinkwe're in the tens of billions.
I think we're probably 40, 50, 60billion in terms of AUM and CLO AAA ETFs.
It's still a pretty small sizecompared to the size of the market. So,
I think I quoted earlier, CLOs in general,
roughly $1 trillion in size.The AAA tranche is around 60%.

(43:14):
So you have 600 billionof CLO AAAs outstanding.
That means that the dominantinvestor base is not these ETFs.
They're still pretty small inthe grand scheme of things,
and so they're not going to determinewhere AAA is priced or don't price.
And this asset class hasreally been dominated by banks.
And it's obviously an incrediblyattractive asset class for banks as

(43:35):
well. They're floating rates, so youget to have a lower portfolio duration,
the AAA rating, plus thehigh amount of subordination,
plus the fact that there's basically been,
I think the number is 0% losseson CLOs going back 20 years. So,
if you have a bank portfolio that wantsto take really low capital charges and
get really attractive interest income,

(43:56):
I don't really think there's thatmany better assets than CLO AAAs.
That being said, if you're a big bank,whether it's U.S. or foreign, Japanese,
other big players as well,
you have a significantamount of pricing power and
negotiating power. I think that if youcome in to take the entire tranche,
$350 million AAA tranche,

(44:18):
you are doing that with a view thatyou are going to box out any other
investor and not have tocompete on price. And so,
I think that that's one of thedynamics that's kept AAAs very cheap,
is that there is perhaps lesscompetition during the syndication
process for some of these deals thanyou would get in any other fixed

(44:40):
income asset class where you run areally competitive sale process and it's
multiple times oversubscribed andthere's investors clamoring all over each
other to gain access to the collateral,
etc. I think we do have a uniquedynamic here that keeps AAAs a bit wide.
So, with the Fed potentially cuttinghere maybe once or twice this year,
is the expectation,
is that going to be positiveor negative for CLO equity?

(45:05):
I talked a little bit already aboutthe fact that floating rate assets may
become a little bit less attractive ifyou are losing some of that interest
income.
And you might have investors pivot fromfloating to fixed in that particular
scenario. But, there's anotherway to look at this as well,
which is that I think in a world whereyou have easier money from the Fed,

(45:26):
you have rate cuts coming in,
I think we're going to startto see capital markets go a bit gangbusters again.
And I think that some of that'salready starting to occur.
We're seeing the resurgence of SPACs,Special Purpose Acquisition Companies.
There's some of these vehicles that areblank check companies that essentially
can do whatever, but investorsthrow money at them anyway,
not knowing exactly what itis that they're going to do.

(45:46):
We're seeing the resurgent in crypto.We're seeing these crypto treasury
companies, like MicroStrategy,
and tons of retail investorsthrowing money that way.
So that's essentially what happenedpost-COVID, 2021, we had easy money,
we had helicopter money.
You had a lot of retail investorsstarting to chase those returns.
But it's not just retail,it's institutional as well. You have folks saying,
okay, well now my discount rate's lower.

(46:08):
I want to go further out the riskspectrum. I want to take more risk.
I want to allocate towardsother things. And so,
all of a sudden this can bereally incrementally good for the CLO market because
you would have a big resurgencein capital markets activity.
What I mean by that is mergersand acquisitions, LBOs,
new companies coming public.When you have that resurgence,

(46:28):
that could be the source of collateralthat the CLO market has been dying
for, for a long time. And I think thatif you have that dynamic come to the
market where you have a real trueboom in capital markets activity and
you have new collateralcoming to the market,
then all of a sudden you don't have thisdynamic of CLOs competing all over each

(46:50):
other to buy the samecollateral again and again,
tighter and tighter inrefinancings and resets,
and you have de-novo collateral comingto market where you can actually take
advantage of wider spreads. So, I thinkthat that's the optimistic case here,
which is that rate cuts could drive aboom in capital markets and could drive
M&A, in which case you have a bitof a Goldilocks scenario, again,
which I was talking about for CLO equity,which is loan prices will stay high,

(47:12):
there will be more collateral to buy,
and your arbitrage will berelatively constant in that world.
It's possible for CLO AAAs to come inbecause you'll have more people trying to
buy the widest spread AAA asset that youcan and you'll have a better arbitrage.
What do you think?
Well,
I think it's definitely true that if wetook our cashflow modeling and we left
SOFR where it is today, whichis roughly four and a quarter,

(47:34):
CLO equity would be more profitable ifthat's the only variable that you moved.
But I think the secondorder effects, in my view,
are going to be veryfavorable for CLO equity. So,
the lower base rate willmean less bankruptcies,
less restructurings, lessinterest burden on companies.
I think that'll be favorable.

(47:54):
And then my thoughts on just themarket rate of return is that,
let's say again hypothetically, if CLOequity is doing some mid-teen return,
as the base rate comes in,
that mid-teen return should look allthe more compelling to folks. So,
I think both of those factors couldresult in CLO equity trading up.

(48:15):
Do you also see a potential forsome type of downside in the next,
maybe it's not 12 months,
but maybe it's 24 months because it'sbeen a long time since we've had a credit
cycle.
So, that's a good question.And I think though that again,
as you're running defaults in yourmodeling, and we're doing the same here,
we are looking at the trading pricesof loans and factoring into our default

(48:38):
rate, anything that'sshowing stress now. So,
I think that really captures therisk on the year look forward. But,
at the end of the day,
these loans were initiallymade with a 50% loan to value.
Private equity firm owns a company.If the loan's not paying off at par,
presumably the private equity firm isgetting totally wiped on their investment.

(49:02):
Where senior secured recoverieshave been in the mid 60s area,
so there's still a recovery, a decentone, even in a default. So, yeah,
there's downside risk, but it'salso across our three funds,
it's basically exposure to first lienassets and we consider these assets to
be all-weather.So, they can certainly underperform.

(49:24):
We've talked about CLOequity doing that this year,
but when first lien loansare underperforming,
then you probably have somepretty substantial problems in any other asset class
that you might've favored aswell. That's how I think about it.
And then one thing I shouldpoint out in this conversation,
CLO equity returns have been what theyare, so that's a little disappointing.
But for BBs, which wealso manage at Flat Rock,

(49:47):
actually pretty much everything thatwe've talked about really isn't an issue
for the BB. So,
I pulled up the Palmer Square has anindex that tracks the return for BBs.
It's up 6% and change this year. So,
if default rates are elevated,it's not enough to impair BB.
If the loans are repricing tighter,it's less income for the CLO equity,

(50:09):
but the BB's still getting paidits interest presumably. So,
investors in that part of the CLOcapital structure are doing quite well,
and I think that's actuallytrue as you go up the stack,
which we don't manage the other portions.
Yeah, I think BBs are really prettycompelling value proposition here,
just in general. I think that if you'relooking at the primary market for BSL,

(50:31):
you're getting anywhere betweenSOFR plus five and SOFR plus six,
but if you're looking at some of thestuff that you guys invest in at Flat Rock
in the private credit space, you'regoing to get even wider than that.
And SOFR right now is still around 4%.
So your all-in yield is alreadyat that double digits level,
and you don't have to make any rosyassumptions in terms of your modeling like

(50:52):
you might have to do for CLO equity.So, you're getting true fixed income,
10 to 12% yield by simply buying theBB tranche and not having to be too
creative about the accounting.
Alex, my new closingquestion for the podcast is,
what's a CLO if you only have30 seconds to give the answer?
Sure. The CLO in 30 seconds. Ultimately,

(51:13):
A CLO is a financing facility and it'sa financing facility for levered loans.
Couple different markets, boththe private credit market,
what we used to call the middle market,but also the broadly syndicated market,
which is much bigger. And, whatit provides is the ability to,
this vehicle will finance allthese credits in an incredibly
diversified way by creating an arbitrage.

(51:34):
So the assets inside the facility willgenerate a higher amount of interest
income, then you're going tohave to pay on the liabilities.
And what that creates is a structurewhere you have advantages for
every single part of the investor.
Both you have subordinationfor the senior making,
the senior really attractive investmentfor folks who are risk averse.

(51:55):
And then you have really attractive riskadjusted returns for investors in the
junior tranches, both the junior ratedtranches as well as the equity tranche,
which really takes advantage of thisarbitrage and this diversified financing
facility.
Thanks, Alex. Really appreciate it.
And Shiloh,
I wanted to thank you very much forobviously having me on the podcast,
and thank you for your time. And I justremember when I started in the market,

(52:15):
there were so few resources for folks toget out there and learn about CLOs and
get up to speed.
It always felt like things were behindpaywalls or behind bank research desks,
so really grateful for you to be doinga podcast like this and putting some
education out into the marketfor everybody to receive.
Great. Thanks, Alex. I reallyenjoyed our conversation.

(52:39):
The content here is for informationalpurposes only and should not be taken as
legal business tax or investmentadvice or be used to evaluate any
investment or security.
This podcast is not directed at anyinvestment or potential investors in any
flat rock global fund definition section.
Payment in kind or pick refers to a typeof loan or financial instrument where

(53:01):
interest or dividends are paidin a form other than cash,
such as additional debt orequity rather than in cash.
A covenant refers to a legally bindingpromise or lender protection written into
a loan agreement securedovernight financing rate.
SOFR is a broad measure of thecost of borrowing cash overnight,
collateralized by treasury securities.The global financial crisis,

(53:24):
GFC was a period of extreme stress inthe global financial markets and banking
systems between mid 2007 and early 2009.
Credit ratings are opinions aboutcredit risk for long-term issues or
instruments. The ratings lie in aspectrum ranging from the highest credit
quality on one end todefault or junk on the other.

(53:45):
A AAA is the highestcredit quality AC or a D.
Depending on the agency, the ratingis the lowest or junk quality.
Leveraged loans are corporate loans tocompanies that are not rated investment
grade broadly. Syndicated loansare underwritten by banks,
rated by nationally recognized statisticalratings organizations and often

(54:05):
traded among market participants.
Middle market loans are usuallyunderwritten by several lenders with the
intention of holding theinstrument 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 refinancing andextension of A CLO investment.

(54:27):
EBITDA is earnings before interest,taxes, depreciation, and amortization.
An add-back would attempt to adjustEBITDA for non-recurring items. Libor,
the London Interbank offerrate was replaced by F on
June 30th, 2024. Dele means reducingthe amount of debt financing.
High yield bonds are corporate borrowingsrated below investment grade that are

(54:49):
usually fixed rate and unsecureddefault refers to missing a contractual
interest or principal 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.
Junior debt ranks behind seniorsecured debt in its payment priority.

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Collateral pool refers to the sum ofcollateral pledge to a lender to support
its repayment.
A on-call refers to the time in whicha debt instrument cannot be optionally
repaid.
A floating rate investment has an interestrate that varies with the underlying
floating rate. S are residentialmortgage backed securities.

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Loan to value is a ratio that comparesthe loan amount to the enterprise value
of a company. LG is a firm that setsup calls between investors and industry
experts.
A risk retention fund is a third partyfund raised by CLO managers to comply
with the CLO risk retention rules.
The US LO risk retention rule wasintroduced in 2014 under the Dodd-Frank

(55:53):
Wall Street Reform and ConsumerProtection Act requiring CLO managers to
retain not less than 5% of the creditrisk associated with each of their CLOs.
In 2018,
the US risk retention requirementreversed for managers after being
successfully challenged in court.
E stands for liabilitymanagement exercises,

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which are strategies often used bysponsors or select lenders to restructure
debt obligations of distressed companiesin order to avoid traditional default
proceedings. Flatrock may investin CLOs managed by podcast guests.
However, the views expressed in thispodcast are those of the guest and do not
necessarily reflect the views ofFlatrock or its affiliates. Any return

(56:38):
projections discussed by podcast guestsdo not reflect flat rock's views or
expectations. This is not arecommendation for any action,
and all listeners should consider theseprojections as hypothetical and subject
to significant risks.
References to interest rate movesare based on Bloomberg data.
Any mentions of specific companies arefor reference purposes only and are not

(57:02):
meant to describe the investment meritsof or potential or actual portfolio
changes related to securities of thosecompanies unless otherwise noted.
All discussions are based on US marketsand 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.

(57:25):
The views and opinions expressed by theFlat Rock Global speaker are those of
the speaker as of the dateof the broadcast and do not necessarily represent the
view of the firm as a whole. Any suchviews are subject to change at any time
based upon market or other conditions.
And Flatrock Global Disclaims anyresponsibility to update such views.
This material is not intended to berelied upon as a forecast, research,

(57:47):
or investment advice.
It is not a recommendation offer orsolicitation to buy or sell any 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

(58:10):
or refrain from any investmentrelated course of action,
as neither Flatrock Global norits affiliates are undertaking.
To provide impartial investment advice,
act as an impartial advisor or giveadvice in a fiduciary capacity.
Additional information about this podcastalong with an edited transcript may be
obtained by visiting flatrock global.com.