May 15, 2024 • 37 mins
In the third episode of The CLO Investor, Flat Rock Global CIO Shiloh Bates talks to Scotia Bank's David Williams, a prominent CLO (collateralized loan obligation) banker. Shiloh and David discuss CLO issuance, refis and resets, profitability, and opportunities and challenges in today's CLO Market.
Mark as Played
Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
(00:02):
- Hi, I'm Shiloh Bates
and welcome to the CLO Investor podcast.
CLO stands for collateralizedloan obligations,
which are securities backedby pools of leverage loans.
In this podcast, we discusscurrent news in the CLO
industry, and I interviewkey market players.
(00:23):
Today I'll be joinedby David Williams, one
of our industry's prominent CLO bankers.
A CLO banker, sometimesreferred to as ACL O.
Arranger is the person responsible
for bringing a CLO to life.
That includes arranging allof the financing for the CLO
and mediating thenegotiations between the CLOs.
(00:45):
Many constituents A CLO bankerearns a fee when the CLO is
created and that usually endstheir involvement in the CLO.
Some of the topics for today'spodcast include strong CLO
issuance, refis resets, CLO, profitability
and opportunities andchallenges in the CLO market.
(01:07):
Now let's get started. David,welcome to the podcast.
- Really appreciate theopportunity to speak to you.
- I know we've known eachother for over a decade now,
but why don't you take a few minutes
and just give our listeners anoverview of your background.
- I've been in the structure credit space
for just under 20 years.
(01:27):
I recently joined Scotiabankactually almost coming up on my
one year anniversary in May of last year.
Before that I was at Natixis and Natixis.
I was running the credit group
and also global syndication
for structured creditwithin Natixis that included
(01:48):
CLOs, both middle marketand broadly syndicated
and that financing business.
- Okay, and what does a head
of syndicate do in a CLO business?
- Well, before I was the head of syndicate
and I was actually doingmore of the day to day
where I was basically theintermediary between sales
and banking and I help liaise
(02:08):
between the manager
and the banking team to helpget CLOs basically up and down
and priced and source interest up
and down the capital structurefor the deals to be able
to get best execution for our managers
so we can get repeat transactions
- Note in CLO jargon, CLOnotes, CLO liabilities
(02:29):
and the CLO stack allreferred to the same thing.
These are the multiple securitiesthat are issued by the CLO
to finance itself.
- So is that a littlebit like herding cats?
- There's a lot of herding cats
and you have to make bothsides happy at all times.
So investors and managers,it's a delicate balance
and not always the easiest,
(02:50):
but I find that if you can be successful
and you can find that mediumthere, hopefully that leads
to a successful repeat business
and you wanna come outwhere everybody is happy,
not too happy because
that means you did something poorly on
one side or the other.
So you want everyone to bemoderately happy I think.
(03:12):
- So now you're at Scotia
and there's a lot ofCLO bankers out there.
So how do you guysdifferentiate your platform?
- I think that we were able
to be quite successful at my former shop.
That being said, SCO is reallygiving us a lot of tools here
to build out the franchise the way
that we collectively see howto build a successful business.
(03:36):
At the end of the day,I think you need a bank
that has the appropriate risk tolerance
and by risk tolerance we arepar lenders to PAR lenders.
So I don't think we'redoing anything abnormal,
but you certainly need tohave a balance sheet, you need
to have the capital froma personnel perspective,
from a distribution perspective,
(03:58):
and you also need abank that is going to be
supportive in good and bad times
and very relationship oriented.
And since I've gotten here a year ago,
Scotia has not only beensupportive from a balance sheet
perspective and helping usgiving the tools and risk
and really developingthe credit franchise,
(04:19):
but also from a personnel
and to make sure that wemitigate all execution risks
and that we are bringingthe right deals to market
and giving our new risk groupnot new risk group to Scotia,
but the risk group with regards
to structure credit comfort there.
We do things a littlebit differently at Scotia
(04:40):
and some other banks arecertainly I think following suit
or taking this business model.
But back to your core question,I think that there are a lot
of CLO arrangers out there.
I think that we're goingto differentiate ourselves
with being involved both inthe private debt middle market
side of the landscape
and also on the broadly syndicated side
(05:00):
and basically come
with creative solutions from a financing
perspective to our clients.
And I think that's hugely important.
- So what I've seen, especiallyon the middle market side is
that the banks that have themost success are really also
the banks that like tolend against the loans.
So before the CLOs formed,
often a CLO warehouse is putin place to acquire loans.
(05:24):
If a bank actually wants
to provide the leverage in awarehouse, that's very useful
for the CLO formation.
And if the bank doesn't likethat risk for whatever reason,
then it's hard to be at the top
of the middle market league tables.
- I think that that's a great point.
Fortunately I think Scotiahas a great DNA with regards
to lending and lendingto the right partners.
(05:45):
And I think picking thosepartners are hugely important.
You really need to eat yourown cooking in the sense
that you are living with these loans prior
to a full CLO coming to fruition
and you need a bank thatis going to be supportive
with lower diversity with regards
to funding those assets priorto having enough diversity
(06:08):
to go into ACL O.
So there needs to be a real comfort
with the underlying assets
but also the platforms across the board
and you have to make sure
that you are banking the right partners
and you're aligned inall of your interests.
- So the CLO industry is really off
to a really strong start this year.
So in terms of new issu ends,
(06:30):
we've seen about 60 billion already
as we're talking here at the end of April
and 50 billion of refi
and reset, reset being justan extension of the life
of the CLO, what do youthink the key drivers
of all the CLO business is today?
- I think that the CLOs havebeen around for I guess upwards
of 20 years now
(06:50):
and really taking the life of its own,
I would say since the mid-teens
and as CLO creation happens,there are different markets
and liabilities areissued at different times,
assets are aggregated at different times.
We're seeing a massive waveof refinancings right now
and a lot of that isfrom legacy transactions
(07:14):
that either have come outof reinvestment period
and that are amortizingthat are paying down.
And sometimes that is
because they have veryattractive costs of debt
and liabilities right now,
but at some point in time the manager
and the equity wants to extend that
and doesn't wanna lose the assets.
And then on the other side you have deals
(07:35):
that were done at calledthe last 12, 18, 24 months
where the liabilities in theCLO debt was at much wider
levels and you're seeing an opportunity
to really decrease your cost of funds
and decreasing your cost offunds will ultimately lead to,
and these are activelymanaged portfolios as long
as you avoid significantdefaults in the portfolio,
(07:58):
that should all be accretiveto your equity investors.
So we're seeing a huge way
of refinancings from both legacydeals that we're coming out
of reinvesting period,
and then also more recent deals
with higher liability costson top of the new issue wave.
- So we've seen the cost
of the AAA come downsubstantially over the last year.
(08:20):
What do you think's driving that?
Is it just the banks were onstrike for the last two years
and now with economic conditionsimproving, their appetite
for the top of the CLO stack has come back
or you're talking to these banks,
so why don't you giveus some insight there?
- I think it's a mix. I thinkmost recently we've certainly
seen a handful of the USbanks who are the largest
(08:43):
and Japan is the close second.
And if you actually mixthe two, the Japanese
and the US banks are thelargest buyers of triple acls.
But we're also seeing newinvestors come into this space
from different, and it's notjust geographic locations,
it's different types of investors.
It's asset managersand insurance companies
and pension funds thathistorically may not have been
(09:05):
comfortable with the three letter acronym
because it's been alsoso longly associated
with the CDO world.
I think that that's worn offafter 14 years now finally,
and we're also seeing a lot
of a BS investors I think justrealize on a relative value
basis, CLOs has historicallypriced substantially wide to
(09:26):
that of the A BS market.
And these are certainlyfloating rate products.
Floating area products in highrate environments should be
attractive to more investors
and you're not lockedinto the same rate risk
securitization can be usedin many different ways,
but at the end of the day, CLOs are pools
of corporate credit both on theprivate credit middle market
(09:48):
side to the broadly syndicated world.
So small, medium, large, mega types
of corporates on the underlying.
And these CLOs have proved
to be resilient over the years
and it's now a 20 plus year market
where you can actually lookat data all the way from
equity to aaas.
(10:09):
And I think that the performance
as an asset class has been quite strong.
And investors globally, whetherit's banks, hedge funds,
asset managers, pensionfunds are recognizing this.
And while some have been inthe product since day one,
there's a handful ofinvestors that you know,
we're a little bit slow to get comfortable
(10:30):
with the CLO world.
That certainly changed.
It doesn't hurt that it isa floating rate product.
Floating rate products
and higher interest rate environments are
certainly attractive.
That being said, higherinterest rate environments
historically have also led
to higher default in very environments.
(10:50):
This doesn't seem tobe the case as of now.
We'll see how that plays out.
But at the end of the day,
these structures have justproved quite resilient
and given the floating rate nature,
it is an extremelyattractive return versus some
of the other asset classes
that we've seen on a relative value basis.
A lot of crossover fromtraditional flow EBS investors
(11:12):
that are now looking at the CLO world
because of that performance history.
- And as you talk to theinvestors in the top part
of the stacks, banks
and insurance companies,obviously the CLOs cost
of debt has been declining,
but is that a trend that you would expect
to continue throughout the year
or is there some type ofspread over SOFR where beyond
(11:34):
that it's hard to push?
- It's hard to say thatthere's a concrete level.
We are probably, or Ishouldn't say probably,
but we're roughly 25 bips.
If you look at the libor,
so R adjusted spreads about 25 bips wide
of the absolute tights where we got.
So there likely is room torun versus historical spreads,
(11:59):
but they always look at thisasset class as a relative value
where they're seeing elsewhere
and I think that they're every handle.
So right now, let's say PSLaaas for top tiers at one 50,
when I say handle, they say that's a five
to get to the four.
There is some psychologicalbarriers to investors.
(12:20):
So if you're able to break that,
usually more deals follow
and it's the next shoe to drop so to say.
And I think it's alwayshard to push to get
to those absolute tights
and I don't know if we shouldbe in those absolute tights
because there are macroeconomic considerations
that we all need to take into account now
(12:40):
and there always were,
but more so now we are ina higher rate environment
and historically a higherrate environments have led
to more stress portfolio.
So there are concerns,
but the performance has been pretty decent
and at the end of the day,CLOs have continued to be wide
of other fixed income products.
So we will
(13:01):
and we continue to see demandat these tighter levels.
- Well, from the perspectiveof a CLO equity investor,
I'm definitely gonnacheer you on in looking
for lower handles on thetriple-A cost in terms
of stories of higher
for longer on rates seems like every month
or so we have to reset our expectations
(13:23):
and fed cuts continue to get pushed out.
How does that affect either the AAA rate
or your business in general?
Just the trend for hire for longer here,
- It really goes to how wepick our credit managers
and who we're working with.
At the end of the day, theseare actively managed goals.
(13:43):
If we had a crystal ball, wesaid that everything was going
to be where it was today
and not have any significantstress on the portfolios at
these rate environments,
I think everybodywould've called us crazy.
We understand that there areproblems within every portfolio
at the same time it goes to a question on
(14:05):
how rapid these increaseswill potentially get
or are we gonna see substantial decreases
From a lending perspective, it seems to be
for us a pretty attractive entry point,
but there's always portfolioconsiderations I think
with higher rate environmentsthat you have to be thoughtful
and maybe not go all inat once, so to speak.
(14:28):
- So one of the trends we'veseen in the market over the
last two years is that fornewly issued CLOs, a lot
of times the equity is being bought
by the manager themselves inan internal fund rather than
going out to a third partyequity investor like us.
And the reason is that new issue,
the initial profitabilityexpectation of CLOs, we call
(14:51):
that the ARB has been reallypoor over the last two years,
but in spite of the poor arb,
I guess managers take the deals anyways
and I guess we'll see how thosereturns work out for them.
Is the arbitrage improving herein April of 24 with the cost
of CLOs financing coming in?
- ARB is is hard.
(15:11):
There are situations
where the ARB might notnecessarily look attractive
to all CLO investors,
but there's opportunitiesthat present itself
that may still make the equity attractive
where you can maybe aggregate a portfolio
that it might still be lowerspread on the asset side,
but lower dollar price.
(15:32):
So it can be a pull to par trade
- Note.
A pull to par CLO investmentis one in which the initial
loans are bought at discounts to par.
The CLO equity investor expects
to benefit from both thecash flows of the CLO as well
as price appreciationon the underlying loans.
- Some equity investorsdo take a strong view
(15:54):
that they are able
to potentially resetthese transactions at post
and on-call period after one or two years.
I think liabilities certainlytightening help vr, I think
that dealers, not to speak our own book,
but we are getting compressedon fees substantially
(16:14):
that doesn't hurt VR at allwhen you have lower costs,
maybe lawyers have had tocompress their fees as well.
I think the costs
for the overall structurehave ultimately gotten
more efficient.
So all these factors withthe cost of CLO creation
with tighter liabilitiesto enhance the overall R.
(16:35):
Over the past few months we'vedefinitely seen more loan
creation, but the competitivenesson the asset side seems
to be quite fierce
and spreads have compressedto a good amount.
So we'll see what thatultimately does for the yard.
But I think you need tobe ready from an arranger
and from an equity perspective
to act when there's any hiccupin the market and be decisive
(16:59):
because even a 25
or a 50 basis point sell offin loans creates opportunity
with a levered vehicle.
And if you're able tolock in attractive aaas
or have a structure that isready to go in short order,
those tend to create the best arbitrage
opportunities on the CLO side.
- What we found interestingover the last two years really
(17:21):
was I think the initial R
before middle market deals inthe primary was attractive.
So we were active there
and then we also saw prettyinteresting opportunities in
secondary CLO LO equity,which had sold off quite a bit
for broadly syndicatedCLOs in the primary.
I thought that was a littlebit of a tougher trade.
The initial returns therewould've probably projected
(17:44):
to be maybe double digits to your point,
you could invest in A CLO like that
and if you're able todo the CLO refinancing
or extension in a year
or two, then all
of a sudden the profitabilityexpectation would increase
substantially, but it's just hard
to put all your eggs in that basket.
So we weren't particularlyactive in those.
(18:05):
- I think that what's reallyinteresting you touched on in
the beginning is onthe middle market side,
I think these portfolios, sincethey're originated assets,
they take a long timeto aggregate the assets.
So it could take anywherefrom nine months to two years.
So right now if you have a portfolio
that has call protection
(18:26):
and you were able to sourcethat over the trailing called 12
to 18 months
and you can go securitizethose assets into a CLO at
the current middle market spread,
the ARB should work out quite well.
Whereas on the broadly syndicated side,
you're aggregating theseassets at a much faster pace,
(18:48):
mostly in secondary.
We have seen the new issuepipeline pick up historically
you've been able tobuild portfolios over a
longer period of time.
I think we've also seen a little bit
of migration away fromthe banks with the size
of the overall private debtmanagers out there eating the
dinner of some of the banks to an extent
(19:10):
and playing in what werepreviously broadly syndicated CLOs.
So I think that all takesinto account how do you make
that our work on the forward pipeline
because even with market,a lot of these portfolios,
once they get securitized
and they've been originatedfor the past 12 to 18 months,
(19:31):
there's a lot of competitionon that side too.
And maybe those, those thosespreads have compressed 50
or a hundred plus basis points.
So we're gonna need
to see further typing I thinkon the liability side on both
broadly syndicated in the middlemarket to to make sure that
that ARB is still attractive.
But I do think that historicallythe mid-teens on the
(19:53):
broadly syndicated and thehigh teens is where you needed
to be to source thatthird party equity bid.
- Are you seeing new demandfor middle market equity
or double Bs?
- Yeah, so middle market equityI think you know very well
and you've been extremelysuccessful with your fundraise
and with the way that yourplatform has evolved over time,
(20:16):
and I think you've seenvalue for a long period
of time in in that space, being able
to write a substantialminority ticket alongside the
manager is going to allow you
to source those opportunitiesin greater bulk.
A lot of these managers,they are financing traits,
so they don't always sell the equity.
(20:36):
There's nothing more importantin middle market than
alignment of interest.
So there are opportunities
where you can get majorityequity in the middle market,
but you know better than everyone.
You want that manager havinga say in the underlying loans,
controlling those loansacross all their portfolios,
making sure that there's
that a true alignmentif anything goes wrong,
(20:58):
they are originatingthese assets, making sure
that they have the riskretention structures in place
for European investors forUS compliance, et cetera.
So the barriers to entry
and being able to sourcemiddle market equity
and even double BS can be challenging
and you have to be patient,but if you are patient
and you have the rightpartners, it's proven
(21:20):
that you tell us how that'sstraight has worked out.
- So it's definitely worked out great.
But I think I would add to the barriers of
investing in middle market equity
or double BS for newer guys is that
the securities are really only available
to onshore investors.
So if you're not domic out here,it's gonna be pretty tricky
to get involved in someof these transactions.
(21:42):
- It's a hundred percent right.There is less than a handful
of managers that have seasoning vehicles
and it's very cumbersome to set that up.
- Note a seasoning facilitybuys middle market loans from
the CLO manager and holds themfor a brief period of time
before they are purchased
by the CLOA seasoning facilityenables offshore investors
(22:03):
to participate in middle market CLO equity
and BB rated notes.
- If you have onshore money like yourself,
it gives you a massivecompetitive advantage
to source these opportunities.
And there's not very many
with the deeper pockets like yourself.
And you don't want 20 equityinvestors in a middle market
(22:23):
CLO or frankly probably evenin the broadly syndicated CLO.
You wanna know who your partners are
and the ability
to have onshore money reallysets you apart I think,
from the rest of the investor base
and you'll get first looks on transactions
and that goes a long way.
- Yeah, I think we'refortunate in that setup.
So you're a banker, you'reputting the deals together,
(22:44):
once the CLO closes,you guys get paid a fee
and then from there on it'sreally the CLO manager managing
the structure and investorslike us getting our cut
of the economics, whateverwe've signed up for.
But I know you also sitat a ton of meetings
where the CO manager istalking to investors like us
and describing what theythink the credit quality
(23:07):
of the loans is going in.
I was wondering if you could just give
us some insights there.
- It's a new business for Scotia
and I think SCO has, hopefullywe've gotten comfortable
with the asset class,
but also I think the managers need to do,
and these are activelymanaged vehicles, they have
to take a proactive view
and sure they don't seem too fussed.
(23:28):
You have to always be wary at that time,
but they are evolving in theway that they think about it.
I think from time to time,industries go in and out of favor
and you need to be thoughtfulin higher rate environments.
Okay, what are those industriesthat potentially are going
to be more stressed
or what industries are going to outperform
(23:49):
or perform well inhigher rate environments?
So I think we've seen managers pivot,
not necessarily on their strategy,
but evolve in the way
that they think about certain industries.
I think for a long time technology
and software was definitelyan area that people tried
to shy away from and things can change,
but over the past handful ofyears we've seen that part
(24:10):
of the market outperformothers and not all technology
and software companies are created equal,
but a lot of them arequite substantial in size
and you can even see itin the equities market.
It significantly outperformedsome of the blue chips
that we've been accustomedto thinking are the best
and biggest companies out there.
(24:31):
And same goes for CLO managers.
I think that they've evolved
and the way that they'vethought about industries
and as actively managedportfolio managers, they've had
to give some thought onwhat these rate environments
and different environmentsin general are going
to have an impact withregards to their portfolios.
- I think the biggestevolution I've noticed from the
(24:53):
managers is just that for oil
and gas, which was 5%
of these portfolios back in 20 15, 20 16,
we're just really not seeing a lot
of these energy namesin portfolios anymore.
And the reason is thatit's just this one risk
that's unquantifiable as a result.
I think secured lenders justdo not have a lot of appetite
(25:13):
for these companies.
So you do see some doubledigit industry exposure in
technology, for example, in healthcare,
but when you delve intoit, it's literally dozens
of different business models.
So there's not one riskthat it's all correlated
to like there was in oiland gas years ago or so.
I think one other thingI'd point out is that
(25:35):
whenever we're talkingabout the risk in the loans,
what we're doing really isunique from other loan investing
in that every CLO investorI imagine that you talk to
for equity for example,is running a 2% default
rate through the portfolio.
We know, we acknowledgeupfront that not all
of the 200 loans in the CLOare gonna work out as expected.
(25:55):
And so we're budgeting to take losses
and we're still targetingwhat we think are mid-teen
or higher returns net of those loan losses
where in other vehiclespeople are investing,
they may look at a yield froma loan fund or a bond fund
and they mistake, in myopinion, in that yield
for future return.
(26:15):
And it's roughly correctas long as no loans
or bonds default.
But unfortunately that isn't the world
of high yield credit. So
- It's a great point.
I think you need to reallytake into account, you have
to change your assumptions, you have
to take into consideration
what these higher rateenvironments are gonna do
for your default assumptions.
(26:36):
Also, when the credit marketsare quite hot, you have
to look at prepayment rates as well,
and that's gonna go intothe overall economics
to your investment.
At the end of the day,if you have a portfolio
that was originated in avery attractive timeframe
and those portfolio companies
(26:57):
and those assets areperforming quite well,
there's a high likelihoodposted on-call period
that you'll get refinancedas soon as they can out
of those assets and you needto take into consideration all
of these dynamics when you're looking at
any of these investments.
- So after being in theCLO space for 20 years,
what's the one thing youfind most interesting
about our industry?
(27:18):
- I think that it's stillsomewhat of a clubby market.
It's evolving.
I think I love that we'veseen an evolution of,
call it middle market privatecredit CLOs, the receptiveness
of investors now willingto dive into that part
of the market where theynever, we were the stepchild
of the market for a long period of time
(27:39):
and just the way thatthe CLO market evolves.
You can use CLO technologyin a lot of different ways
and you're not going to your job every day
and it's the same thing in and out.
You gotta be on your toes
and you gotta really bethoughtful with regards
to who you're working with,who your partners are.
(28:01):
And it's a long game.
It's a long nine innings andthe market ebbs and flows
and in times of stresssometimes creates the
best opportunities.
And sometimes when the marketsare seemingly great, it tends
to be exceptionally slow.
You never know what you'renecessarily gonna get.
But I think working with goodpeople, having new investors,
(28:24):
new managers,
and even the evolution ofthe retail market with ETFs,
I have my aunts and unclesasking me about various CLO ETFs
and interval funds
and I think it's excitingwhen the flat rocks
of the world are able to issue
and given different products to investors
that historically have not been able
(28:45):
to enter this part of the market.
And it's certainly creating
for more interesting conversation
and makes your job interesting.
- I think it definitelyis maybe surprisingly a
relationship business.
When I started going to CLOconferences a little bit over 10
years ago, the middlemarket CLO panel was really,
if there were 10 or 15 people in the
(29:06):
audience, you'd be lucky.
And a few of those would've been people
that were just working onsomething from the last
presentation and didn't get the cue
that it was time to get up and go.
And then now the middle marketpanel is probably as busy
as the CLO equity panel.
I do think relationshipsare huge in the space,
and one of the thingsthat I like about it is
that sometimes we're buyingbonds in the secondary,
(29:29):
so the CO already exists
and you're just trying to get a price
and it's a zero sum game, sowe're sometimes buying CLOs
that way, but in the primarymarket is totally different.
It feels more like this team process
where everybody's working.
You other equity investors,everybody's pushing
for the best steel
and it's somewhat of a team effort
(29:50):
to get it over the finish line.
And so doing that with peoplethat you, I can respect,
I find that very rewarding.
- I couldn't agree with you more.
I can't remember ever working
with a single equity investor one time
or a single manager one time.
I think you're allworking to a common goal,
whether it's workingwith the investor side,
(30:12):
the manager side, collectively, I think
that we are all in this together.
We see a long-term future in this product,
and relationships are immensely important
to getting everything donein the collective success
of having a fluid marketfor the long-term.
It's important for managersto have a liquid illiquid
(30:35):
to have both buckets,especially in times of stress
to be able to play in liquidmarkets that are less liquid.
To have a view there tobe able to go anywhere
with assets just in general is helpful.
Yes, there's certain managersthat have not done as well
as others in terms ofdifferentiating the platform,
and I think that's hugely important.
(30:57):
But if you're not wellcapitalized, I think going forward
and just the CLO landscape both on BSL
and middle market, you'rein for a tough ride.
There's no reason for150 managers anymore.
- CLO management is a scale business
and either you have the capital
to do deals in favorable marketsand not favorable markets,
or you're just not gonna be relevant.
(31:17):
And if you're outta the market for a while
and you come back, then your CLOs cost
of debt's gonna be elevated
and somebody's gotta bear
that additional cost from the equity seat.
That's a manager problem.
But I think you needto be able to do three
or more deals a year with outside capital
or not to be relevant in the space
(31:38):
- Three deals a year, buttying them appropriately.
You don't wanna do adeal just to do a deal,
but you couldn't say better.
If you're not in the marketin a consistent basis,
you're not gonna get theright liability pricing if you
don't get the right liability pricing,
the equity doesn't work.
So whether it's three new issues
or if it's two new issues in a reset,
I think just having enoughtransactions to be relevant
(32:02):
to your end investor base,
that's gonna certainly justimprove the cost of financing
and the CLO execution going forward.
- Well, thanks again,David. This is really above
and beyond the call of duty.
- Thank you for having mesilo. Really appreciate it.
- The content here is forinformational purposes only
(32:23):
and should not be takenas legal business tax
or investment advice
or be used to evaluate anyinvestment or security.
This podcast is notdirected at any investors
or potential investors inany Flat Rock Global Fund
definition section.
The secured overnight financingrate software is a broad
measure of the cost ofborrowing cash overnight.
(32:46):
Collateralized by treasury securities,
leveraged loans arecorporate loans to companies
that are not ratedinvestment grade broadly.
Syndicated loans areunderwritten by banks, rated
by nationally recognizedstatistical ratings organizations
and often traded by market participants.
Middle market loans areusually underwritten
by several lenders with the intention
(33:08):
of holding the investmentthrough its maturity.
A collateralized debt obligation.
CDO is a structured financeproduct that is backed by a pool
of assets other than leveraged loans.
Securitization divides cash flows
amongst different investorsin a pool of assets.
Global financial crisis
or GFC refers to thebanking downturn in 2008
(33:29):
and 2009.
Asset backed securities aresecuritizations, usually backed
by non-first lie and loan collateral.
Par lender is a lenderfocused on buying loans
that are not in stress.
Risk retention is when the CLOmanager acquires securities
in its CLO to meetregulatory requirements.
Junior capital is financing
(33:49):
that has a lower priorityclaim in debt repayment
to a secured term loan spreadis the percentage difference
in current yields of various classes
of fixed income securitiesversus treasury bonds
or another benchmark bondmeasure yield is income returned
on investment, such
as the interest receivedfrom holding a security.
The yield is usually expressed
(34:10):
as an annual percentage ratebased on the investments cost,
current market value or face value.
The Flat Rock Global CLO equity index
and its legal disclaimers areavailable on the Flat Rock
Global website.
Amortization is the process
by which the CLO repays its financing
after the reinvestment period ends ETFR,
(34:31):
exchange traded funds.
General disclaimer section references
to interest rate moves arebased on Bloomberg data.
The credit quality offixed income securities
and a portfolio is assigned
by a nationally recognizedstatistical rating organization,
such as Standard and Pores, Moody's
or Fitch as an indication
(34:51):
of an issuer's credit worthinessratings range from triple A
highest to D lowest bonds rated Triple B
or above are consideredinvestment grade credit ratings.
Double B and below are lowerrated securities, also known
as junk bonds.
Any mentions of specific companies are
for reference purposes only
and are not meant to describethe investment merits of
(35:13):
or potential or actualportfolio changes related
to securities of those companiesunless otherwise noted.
All discussions are based onUS markets and US monetary
and fiscal policies.
Market forecasts
and projections are basedon current market conditions
and are subject to change without notice,
projections should not beconsidered a guarantee.
(35:36):
The views and opinions expressed
by the Flat Rock global speakerare 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 basedupon market or other conditions,
and Flat Rock GlobalDisclaims any responsibility
to update such views.
(35:57):
This material is notintended to be relied upon
as a forecast, research,or investment advice.
It is not a recommendationoffer or solicitation to buy
or sell any securities or toadopt any investment strategy.
Neither Flat Rock Global
nor the Flat Rock GlobalSpeaker can be responsible
for any direct or incidentalloss incurred by applying any
(36:20):
of the information offered.
None of the information
provided should be regardedas a suggestion to engage in
or refrain from any investmentrelated course of action
as neither Flat Rock Global
nor its affiliates are undertaking.
To provide impartialinvestment advice, act
as an impartial advisor
or give advice in a fiduciary capacity.
(36:41):
This broadcast is copyright2024 of Flat Rock Global LLC.
All rights reserved.
This recording may not bereproduced in whole or in part
or in any form without thepermission of Flat Rock Global.
Additional informationabout this podcast along
with an edited transcript may be obtained
by visiting flat rock global.com.
- Hi, I'm Shiloh Bates
and welcome to the CLO Investor podcast.
CLO stands for collateralizedloan obligations,
which are securities backedby pools of leverage loans.
In this podcast, we discusscurrent news in the CLO
industry, and I interviewkey market players.
(00:23):
Today I'll be joinedby David Williams, one
of our industry's prominent CLO bankers.
A CLO banker, sometimesreferred to as ACL O.
Arranger is the person responsible
for bringing a CLO to life.
That includes arranging allof the financing for the CLO
and mediating thenegotiations between the CLOs.
(00:45):
Many constituents A CLO bankerearns a fee when the CLO is
created and that usually endstheir involvement in the CLO.
Some of the topics for today'spodcast include strong CLO
issuance, refis resets, CLO, profitability
and opportunities andchallenges in the CLO market.
(01:07):
Now let's get started. David,welcome to the podcast.
- Really appreciate theopportunity to speak to you.
- I know we've known eachother for over a decade now,
but why don't you take a few minutes
and just give our listeners anoverview of your background.
- I've been in the structure credit space
for just under 20 years.
(01:27):
I recently joined Scotiabankactually almost coming up on my
one year anniversary in May of last year.
Before that I was at Natixis and Natixis.
I was running the credit group
and also global syndication
for structured creditwithin Natixis that included
(01:48):
CLOs, both middle marketand broadly syndicated
and that financing business.
- Okay, and what does a head
of syndicate do in a CLO business?
- Well, before I was the head of syndicate
and I was actually doingmore of the day to day
where I was basically theintermediary between sales
and banking and I help liaise
(02:08):
between the manager
and the banking team to helpget CLOs basically up and down
and priced and source interest up
and down the capital structurefor the deals to be able
to get best execution for our managers
so we can get repeat transactions
- Note in CLO jargon, CLOnotes, CLO liabilities
(02:29):
and the CLO stack allreferred to the same thing.
These are the multiple securitiesthat are issued by the CLO
to finance itself.
- So is that a littlebit like herding cats?
- There's a lot of herding cats
and you have to make bothsides happy at all times.
So investors and managers,it's a delicate balance
and not always the easiest,
(02:50):
but I find that if you can be successful
and you can find that mediumthere, hopefully that leads
to a successful repeat business
and you wanna come outwhere everybody is happy,
not too happy because
that means you did something poorly on
one side or the other.
So you want everyone to bemoderately happy I think.
(03:12):
- So now you're at Scotia
and there's a lot ofCLO bankers out there.
So how do you guysdifferentiate your platform?
- I think that we were able
to be quite successful at my former shop.
That being said, SCO is reallygiving us a lot of tools here
to build out the franchise the way
that we collectively see howto build a successful business.
(03:36):
At the end of the day,I think you need a bank
that has the appropriate risk tolerance
and by risk tolerance we arepar lenders to PAR lenders.
So I don't think we'redoing anything abnormal,
but you certainly need tohave a balance sheet, you need
to have the capital froma personnel perspective,
from a distribution perspective,
(03:58):
and you also need abank that is going to be
supportive in good and bad times
and very relationship oriented.
And since I've gotten here a year ago,
Scotia has not only beensupportive from a balance sheet
perspective and helping usgiving the tools and risk
and really developingthe credit franchise,
(04:19):
but also from a personnel
and to make sure that wemitigate all execution risks
and that we are bringingthe right deals to market
and giving our new risk groupnot new risk group to Scotia,
but the risk group with regards
to structure credit comfort there.
We do things a littlebit differently at Scotia
(04:40):
and some other banks arecertainly I think following suit
or taking this business model.
But back to your core question,I think that there are a lot
of CLO arrangers out there.
I think that we're goingto differentiate ourselves
with being involved both inthe private debt middle market
side of the landscape
and also on the broadly syndicated side
(05:00):
and basically come
with creative solutions from a financing
perspective to our clients.
And I think that's hugely important.
- So what I've seen, especiallyon the middle market side is
that the banks that have themost success are really also
the banks that like tolend against the loans.
So before the CLOs formed,
often a CLO warehouse is putin place to acquire loans.
(05:24):
If a bank actually wants
to provide the leverage in awarehouse, that's very useful
for the CLO formation.
And if the bank doesn't likethat risk for whatever reason,
then it's hard to be at the top
of the middle market league tables.
- I think that that's a great point.
Fortunately I think Scotiahas a great DNA with regards
to lending and lendingto the right partners.
(05:45):
And I think picking thosepartners are hugely important.
You really need to eat yourown cooking in the sense
that you are living with these loans prior
to a full CLO coming to fruition
and you need a bank thatis going to be supportive
with lower diversity with regards
to funding those assets priorto having enough diversity
(06:08):
to go into ACL O.
So there needs to be a real comfort
with the underlying assets
but also the platforms across the board
and you have to make sure
that you are banking the right partners
and you're aligned inall of your interests.
- So the CLO industry is really off
to a really strong start this year.
So in terms of new issu ends,
(06:30):
we've seen about 60 billion already
as we're talking here at the end of April
and 50 billion of refi
and reset, reset being justan extension of the life
of the CLO, what do youthink the key drivers
of all the CLO business is today?
- I think that the CLOs havebeen around for I guess upwards
of 20 years now
(06:50):
and really taking the life of its own,
I would say since the mid-teens
and as CLO creation happens,there are different markets
and liabilities areissued at different times,
assets are aggregated at different times.
We're seeing a massive waveof refinancings right now
and a lot of that isfrom legacy transactions
(07:14):
that either have come outof reinvestment period
and that are amortizingthat are paying down.
And sometimes that is
because they have veryattractive costs of debt
and liabilities right now,
but at some point in time the manager
and the equity wants to extend that
and doesn't wanna lose the assets.
And then on the other side you have deals
(07:35):
that were done at calledthe last 12, 18, 24 months
where the liabilities in theCLO debt was at much wider
levels and you're seeing an opportunity
to really decrease your cost of funds
and decreasing your cost offunds will ultimately lead to,
and these are activelymanaged portfolios as long
as you avoid significantdefaults in the portfolio,
(07:58):
that should all be accretiveto your equity investors.
So we're seeing a huge way
of refinancings from both legacydeals that we're coming out
of reinvesting period,
and then also more recent deals
with higher liability costson top of the new issue wave.
- So we've seen the cost
of the AAA come downsubstantially over the last year.
(08:20):
What do you think's driving that?
Is it just the banks were onstrike for the last two years
and now with economic conditionsimproving, their appetite
for the top of the CLO stack has come back
or you're talking to these banks,
so why don't you giveus some insight there?
- I think it's a mix. I thinkmost recently we've certainly
seen a handful of the USbanks who are the largest
(08:43):
and Japan is the close second.
And if you actually mixthe two, the Japanese
and the US banks are thelargest buyers of triple acls.
But we're also seeing newinvestors come into this space
from different, and it's notjust geographic locations,
it's different types of investors.
It's asset managersand insurance companies
and pension funds thathistorically may not have been
(09:05):
comfortable with the three letter acronym
because it's been alsoso longly associated
with the CDO world.
I think that that's worn offafter 14 years now finally,
and we're also seeing a lot
of a BS investors I think justrealize on a relative value
basis, CLOs has historicallypriced substantially wide to
(09:26):
that of the A BS market.
And these are certainlyfloating rate products.
Floating area products in highrate environments should be
attractive to more investors
and you're not lockedinto the same rate risk
securitization can be usedin many different ways,
but at the end of the day, CLOs are pools
of corporate credit both on theprivate credit middle market
(09:48):
side to the broadly syndicated world.
So small, medium, large, mega types
of corporates on the underlying.
And these CLOs have proved
to be resilient over the years
and it's now a 20 plus year market
where you can actually lookat data all the way from
equity to aaas.
(10:09):
And I think that the performance
as an asset class has been quite strong.
And investors globally, whetherit's banks, hedge funds,
asset managers, pensionfunds are recognizing this.
And while some have been inthe product since day one,
there's a handful ofinvestors that you know,
we're a little bit slow to get comfortable
(10:30):
with the CLO world.
That certainly changed.
It doesn't hurt that it isa floating rate product.
Floating rate products
and higher interest rate environments are
certainly attractive.
That being said, higherinterest rate environments
historically have also led
to higher default in very environments.
(10:50):
This doesn't seem tobe the case as of now.
We'll see how that plays out.
But at the end of the day,
these structures have justproved quite resilient
and given the floating rate nature,
it is an extremelyattractive return versus some
of the other asset classes
that we've seen on a relative value basis.
A lot of crossover fromtraditional flow EBS investors
(11:12):
that are now looking at the CLO world
because of that performance history.
- And as you talk to theinvestors in the top part
of the stacks, banks
and insurance companies,obviously the CLOs cost
of debt has been declining,
but is that a trend that you would expect
to continue throughout the year
or is there some type ofspread over SOFR where beyond
(11:34):
that it's hard to push?
- It's hard to say thatthere's a concrete level.
We are probably, or Ishouldn't say probably,
but we're roughly 25 bips.
If you look at the libor,
so R adjusted spreads about 25 bips wide
of the absolute tights where we got.
So there likely is room torun versus historical spreads,
(11:59):
but they always look at thisasset class as a relative value
where they're seeing elsewhere
and I think that they're every handle.
So right now, let's say PSLaaas for top tiers at one 50,
when I say handle, they say that's a five
to get to the four.
There is some psychologicalbarriers to investors.
(12:20):
So if you're able to break that,
usually more deals follow
and it's the next shoe to drop so to say.
And I think it's alwayshard to push to get
to those absolute tights
and I don't know if we shouldbe in those absolute tights
because there are macroeconomic considerations
that we all need to take into account now
(12:40):
and there always were,
but more so now we are ina higher rate environment
and historically a higherrate environments have led
to more stress portfolio.
So there are concerns,
but the performance has been pretty decent
and at the end of the day,CLOs have continued to be wide
of other fixed income products.
So we will
(13:01):
and we continue to see demandat these tighter levels.
- Well, from the perspectiveof a CLO equity investor,
I'm definitely gonnacheer you on in looking
for lower handles on thetriple-A cost in terms
of stories of higher
for longer on rates seems like every month
or so we have to reset our expectations
(13:23):
and fed cuts continue to get pushed out.
How does that affect either the AAA rate
or your business in general?
Just the trend for hire for longer here,
- It really goes to how wepick our credit managers
and who we're working with.
At the end of the day, theseare actively managed goals.
(13:43):
If we had a crystal ball, wesaid that everything was going
to be where it was today
and not have any significantstress on the portfolios at
these rate environments,
I think everybodywould've called us crazy.
We understand that there areproblems within every portfolio
at the same time it goes to a question on
(14:05):
how rapid these increaseswill potentially get
or are we gonna see substantial decreases
From a lending perspective, it seems to be
for us a pretty attractive entry point,
but there's always portfolioconsiderations I think
with higher rate environmentsthat you have to be thoughtful
and maybe not go all inat once, so to speak.
(14:28):
- So one of the trends we'veseen in the market over the
last two years is that fornewly issued CLOs, a lot
of times the equity is being bought
by the manager themselves inan internal fund rather than
going out to a third partyequity investor like us.
And the reason is that new issue,
the initial profitabilityexpectation of CLOs, we call
(14:51):
that the ARB has been reallypoor over the last two years,
but in spite of the poor arb,
I guess managers take the deals anyways
and I guess we'll see how thosereturns work out for them.
Is the arbitrage improving herein April of 24 with the cost
of CLOs financing coming in?
- ARB is is hard.
(15:11):
There are situations
where the ARB might notnecessarily look attractive
to all CLO investors,
but there's opportunitiesthat present itself
that may still make the equity attractive
where you can maybe aggregate a portfolio
that it might still be lowerspread on the asset side,
but lower dollar price.
(15:32):
So it can be a pull to par trade
- Note.
A pull to par CLO investmentis one in which the initial
loans are bought at discounts to par.
The CLO equity investor expects
to benefit from both thecash flows of the CLO as well
as price appreciationon the underlying loans.
- Some equity investorsdo take a strong view
(15:54):
that they are able
to potentially resetthese transactions at post
and on-call period after one or two years.
I think liabilities certainlytightening help vr, I think
that dealers, not to speak our own book,
but we are getting compressedon fees substantially
(16:14):
that doesn't hurt VR at allwhen you have lower costs,
maybe lawyers have had tocompress their fees as well.
I think the costs
for the overall structurehave ultimately gotten
more efficient.
So all these factors withthe cost of CLO creation
with tighter liabilitiesto enhance the overall R.
(16:35):
Over the past few months we'vedefinitely seen more loan
creation, but the competitivenesson the asset side seems
to be quite fierce
and spreads have compressedto a good amount.
So we'll see what thatultimately does for the yard.
But I think you need tobe ready from an arranger
and from an equity perspective
to act when there's any hiccupin the market and be decisive
(16:59):
because even a 25
or a 50 basis point sell offin loans creates opportunity
with a levered vehicle.
And if you're able tolock in attractive aaas
or have a structure that isready to go in short order,
those tend to create the best arbitrage
opportunities on the CLO side.
- What we found interestingover the last two years really
(17:21):
was I think the initial R
before middle market deals inthe primary was attractive.
So we were active there
and then we also saw prettyinteresting opportunities in
secondary CLO LO equity,which had sold off quite a bit
for broadly syndicatedCLOs in the primary.
I thought that was a littlebit of a tougher trade.
The initial returns therewould've probably projected
(17:44):
to be maybe double digits to your point,
you could invest in A CLO like that
and if you're able todo the CLO refinancing
or extension in a year
or two, then all
of a sudden the profitabilityexpectation would increase
substantially, but it's just hard
to put all your eggs in that basket.
So we weren't particularlyactive in those.
(18:05):
- I think that what's reallyinteresting you touched on in
the beginning is onthe middle market side,
I think these portfolios, sincethey're originated assets,
they take a long timeto aggregate the assets.
So it could take anywherefrom nine months to two years.
So right now if you have a portfolio
that has call protection
(18:26):
and you were able to sourcethat over the trailing called 12
to 18 months
and you can go securitizethose assets into a CLO at
the current middle market spread,
the ARB should work out quite well.
Whereas on the broadly syndicated side,
you're aggregating theseassets at a much faster pace,
(18:48):
mostly in secondary.
We have seen the new issuepipeline pick up historically
you've been able tobuild portfolios over a
longer period of time.
I think we've also seen a little bit
of migration away fromthe banks with the size
of the overall private debtmanagers out there eating the
dinner of some of the banks to an extent
(19:10):
and playing in what werepreviously broadly syndicated CLOs.
So I think that all takesinto account how do you make
that our work on the forward pipeline
because even with market,a lot of these portfolios,
once they get securitized
and they've been originatedfor the past 12 to 18 months,
(19:31):
there's a lot of competitionon that side too.
And maybe those, those thosespreads have compressed 50
or a hundred plus basis points.
So we're gonna need
to see further typing I thinkon the liability side on both
broadly syndicated in the middlemarket to to make sure that
that ARB is still attractive.
But I do think that historicallythe mid-teens on the
(19:53):
broadly syndicated and thehigh teens is where you needed
to be to source thatthird party equity bid.
- Are you seeing new demandfor middle market equity
or double Bs?
- Yeah, so middle market equityI think you know very well
and you've been extremelysuccessful with your fundraise
and with the way that yourplatform has evolved over time,
(20:16):
and I think you've seenvalue for a long period
of time in in that space, being able
to write a substantialminority ticket alongside the
manager is going to allow you
to source those opportunitiesin greater bulk.
A lot of these managers,they are financing traits,
so they don't always sell the equity.
(20:36):
There's nothing more importantin middle market than
alignment of interest.
So there are opportunities
where you can get majorityequity in the middle market,
but you know better than everyone.
You want that manager havinga say in the underlying loans,
controlling those loansacross all their portfolios,
making sure that there's
that a true alignmentif anything goes wrong,
(20:58):
they are originatingthese assets, making sure
that they have the riskretention structures in place
for European investors forUS compliance, et cetera.
So the barriers to entry
and being able to sourcemiddle market equity
and even double BS can be challenging
and you have to be patient,but if you are patient
and you have the rightpartners, it's proven
(21:20):
that you tell us how that'sstraight has worked out.
- So it's definitely worked out great.
But I think I would add to the barriers of
investing in middle market equity
or double BS for newer guys is that
the securities are really only available
to onshore investors.
So if you're not domic out here,it's gonna be pretty tricky
to get involved in someof these transactions.
(21:42):
- It's a hundred percent right.There is less than a handful
of managers that have seasoning vehicles
and it's very cumbersome to set that up.
- Note a seasoning facilitybuys middle market loans from
the CLO manager and holds themfor a brief period of time
before they are purchased
by the CLOA seasoning facilityenables offshore investors
(22:03):
to participate in middle market CLO equity
and BB rated notes.
- If you have onshore money like yourself,
it gives you a massivecompetitive advantage
to source these opportunities.
And there's not very many
with the deeper pockets like yourself.
And you don't want 20 equityinvestors in a middle market
(22:23):
CLO or frankly probably evenin the broadly syndicated CLO.
You wanna know who your partners are
and the ability
to have onshore money reallysets you apart I think,
from the rest of the investor base
and you'll get first looks on transactions
and that goes a long way.
- Yeah, I think we'refortunate in that setup.
So you're a banker, you'reputting the deals together,
(22:44):
once the CLO closes,you guys get paid a fee
and then from there on it'sreally the CLO manager managing
the structure and investorslike us getting our cut
of the economics, whateverwe've signed up for.
But I know you also sitat a ton of meetings
where the CO manager istalking to investors like us
and describing what theythink the credit quality
(23:07):
of the loans is going in.
I was wondering if you could just give
us some insights there.
- It's a new business for Scotia
and I think SCO has, hopefullywe've gotten comfortable
with the asset class,
but also I think the managers need to do,
and these are activelymanaged vehicles, they have
to take a proactive view
and sure they don't seem too fussed.
(23:28):
You have to always be wary at that time,
but they are evolving in theway that they think about it.
I think from time to time,industries go in and out of favor
and you need to be thoughtfulin higher rate environments.
Okay, what are those industriesthat potentially are going
to be more stressed
or what industries are going to outperform
(23:49):
or perform well inhigher rate environments?
So I think we've seen managers pivot,
not necessarily on their strategy,
but evolve in the way
that they think about certain industries.
I think for a long time technology
and software was definitelyan area that people tried
to shy away from and things can change,
but over the past handful ofyears we've seen that part
(24:10):
of the market outperformothers and not all technology
and software companies are created equal,
but a lot of them arequite substantial in size
and you can even see itin the equities market.
It significantly outperformedsome of the blue chips
that we've been accustomedto thinking are the best
and biggest companies out there.
(24:31):
And same goes for CLO managers.
I think that they've evolved
and the way that they'vethought about industries
and as actively managedportfolio managers, they've had
to give some thought onwhat these rate environments
and different environmentsin general are going
to have an impact withregards to their portfolios.
- I think the biggestevolution I've noticed from the
(24:53):
managers is just that for oil
and gas, which was 5%
of these portfolios back in 20 15, 20 16,
we're just really not seeing a lot
of these energy namesin portfolios anymore.
And the reason is thatit's just this one risk
that's unquantifiable as a result.
I think secured lenders justdo not have a lot of appetite
(25:13):
for these companies.
So you do see some doubledigit industry exposure in
technology, for example, in healthcare,
but when you delve intoit, it's literally dozens
of different business models.
So there's not one riskthat it's all correlated
to like there was in oiland gas years ago or so.
I think one other thingI'd point out is that
(25:35):
whenever we're talkingabout the risk in the loans,
what we're doing really isunique from other loan investing
in that every CLO investorI imagine that you talk to
for equity for example,is running a 2% default
rate through the portfolio.
We know, we acknowledgeupfront that not all
of the 200 loans in the CLOare gonna work out as expected.
(25:55):
And so we're budgeting to take losses
and we're still targetingwhat we think are mid-teen
or higher returns net of those loan losses
where in other vehiclespeople are investing,
they may look at a yield froma loan fund or a bond fund
and they mistake, in myopinion, in that yield
for future return.
(26:15):
And it's roughly correctas long as no loans
or bonds default.
But unfortunately that isn't the world
of high yield credit. So
- It's a great point.
I think you need to reallytake into account, you have
to change your assumptions, you have
to take into consideration
what these higher rateenvironments are gonna do
for your default assumptions.
(26:36):
Also, when the credit marketsare quite hot, you have
to look at prepayment rates as well,
and that's gonna go intothe overall economics
to your investment.
At the end of the day,if you have a portfolio
that was originated in avery attractive timeframe
and those portfolio companies
(26:57):
and those assets areperforming quite well,
there's a high likelihoodposted on-call period
that you'll get refinancedas soon as they can out
of those assets and you needto take into consideration all
of these dynamics when you're looking at
any of these investments.
- So after being in theCLO space for 20 years,
what's the one thing youfind most interesting
about our industry?
(27:18):
- I think that it's stillsomewhat of a clubby market.
It's evolving.
I think I love that we'veseen an evolution of,
call it middle market privatecredit CLOs, the receptiveness
of investors now willingto dive into that part
of the market where theynever, we were the stepchild
of the market for a long period of time
(27:39):
and just the way thatthe CLO market evolves.
You can use CLO technologyin a lot of different ways
and you're not going to your job every day
and it's the same thing in and out.
You gotta be on your toes
and you gotta really bethoughtful with regards
to who you're working with,who your partners are.
(28:01):
And it's a long game.
It's a long nine innings andthe market ebbs and flows
and in times of stresssometimes creates the
best opportunities.
And sometimes when the marketsare seemingly great, it tends
to be exceptionally slow.
You never know what you'renecessarily gonna get.
But I think working with goodpeople, having new investors,
(28:24):
new managers,
and even the evolution ofthe retail market with ETFs,
I have my aunts and unclesasking me about various CLO ETFs
and interval funds
and I think it's excitingwhen the flat rocks
of the world are able to issue
and given different products to investors
that historically have not been able
(28:45):
to enter this part of the market.
And it's certainly creating
for more interesting conversation
and makes your job interesting.
- I think it definitelyis maybe surprisingly a
relationship business.
When I started going to CLOconferences a little bit over 10
years ago, the middlemarket CLO panel was really,
if there were 10 or 15 people in the
(29:06):
audience, you'd be lucky.
And a few of those would've been people
that were just working onsomething from the last
presentation and didn't get the cue
that it was time to get up and go.
And then now the middle marketpanel is probably as busy
as the CLO equity panel.
I do think relationshipsare huge in the space,
and one of the thingsthat I like about it is
that sometimes we're buyingbonds in the secondary,
(29:29):
so the CO already exists
and you're just trying to get a price
and it's a zero sum game, sowe're sometimes buying CLOs
that way, but in the primarymarket is totally different.
It feels more like this team process
where everybody's working.
You other equity investors,everybody's pushing
for the best steel
and it's somewhat of a team effort
(29:50):
to get it over the finish line.
And so doing that with peoplethat you, I can respect,
I find that very rewarding.
- I couldn't agree with you more.
I can't remember ever working
with a single equity investor one time
or a single manager one time.
I think you're allworking to a common goal,
whether it's workingwith the investor side,
(30:12):
the manager side, collectively, I think
that we are all in this together.
We see a long-term future in this product,
and relationships are immensely important
to getting everything donein the collective success
of having a fluid marketfor the long-term.
It's important for managersto have a liquid illiquid
(30:35):
to have both buckets,especially in times of stress
to be able to play in liquidmarkets that are less liquid.
To have a view there tobe able to go anywhere
with assets just in general is helpful.
Yes, there's certain managersthat have not done as well
as others in terms ofdifferentiating the platform,
and I think that's hugely important.
(30:57):
But if you're not wellcapitalized, I think going forward
and just the CLO landscape both on BSL
and middle market, you'rein for a tough ride.
There's no reason for150 managers anymore.
- CLO management is a scale business
and either you have the capital
to do deals in favorable marketsand not favorable markets,
or you're just not gonna be relevant.
(31:17):
And if you're outta the market for a while
and you come back, then your CLOs cost
of debt's gonna be elevated
and somebody's gotta bear
that additional cost from the equity seat.
That's a manager problem.
But I think you needto be able to do three
or more deals a year with outside capital
or not to be relevant in the space
(31:38):
- Three deals a year, buttying them appropriately.
You don't wanna do adeal just to do a deal,
but you couldn't say better.
If you're not in the marketin a consistent basis,
you're not gonna get theright liability pricing if you
don't get the right liability pricing,
the equity doesn't work.
So whether it's three new issues
or if it's two new issues in a reset,
I think just having enoughtransactions to be relevant
(32:02):
to your end investor base,
that's gonna certainly justimprove the cost of financing
and the CLO execution going forward.
- Well, thanks again,David. This is really above
and beyond the call of duty.
- Thank you for having mesilo. Really appreciate it.
- The content here is forinformational purposes only
(32:23):
and should not be takenas legal business tax
or investment advice
or be used to evaluate anyinvestment or security.
This podcast is notdirected at any investors
or potential investors inany Flat Rock Global Fund
definition section.
The secured overnight financingrate software is a broad
measure of the cost ofborrowing cash overnight.
(32:46):
Collateralized by treasury securities,
leveraged loans arecorporate loans to companies
that are not ratedinvestment grade broadly.
Syndicated loans areunderwritten by banks, rated
by nationally recognizedstatistical ratings organizations
and often traded by market participants.
Middle market loans areusually underwritten
by several lenders with the intention
(33:08):
of holding the investmentthrough its maturity.
A collateralized debt obligation.
CDO is a structured financeproduct that is backed by a pool
of assets other than leveraged loans.
Securitization divides cash flows
amongst different investorsin a pool of assets.
Global financial crisis
or GFC refers to thebanking downturn in 2008
(33:29):
and 2009.
Asset backed securities aresecuritizations, usually backed
by non-first lie and loan collateral.
Par lender is a lenderfocused on buying loans
that are not in stress.
Risk retention is when the CLOmanager acquires securities
in its CLO to meetregulatory requirements.
Junior capital is financing
(33:49):
that has a lower priorityclaim in debt repayment
to a secured term loan spreadis the percentage difference
in current yields of various classes
of fixed income securitiesversus treasury bonds
or another benchmark bondmeasure yield is income returned
on investment, such
as the interest receivedfrom holding a security.
The yield is usually expressed
(34:10):
as an annual percentage ratebased on the investments cost,
current market value or face value.
The Flat Rock Global CLO equity index
and its legal disclaimers areavailable on the Flat Rock
Global website.
Amortization is the process
by which the CLO repays its financing
after the reinvestment period ends ETFR,
(34:31):
exchange traded funds.
General disclaimer section references
to interest rate moves arebased on Bloomberg data.
The credit quality offixed income securities
and a portfolio is assigned
by a nationally recognizedstatistical rating organization,
such as Standard and Pores, Moody's
or Fitch as an indication
(34:51):
of an issuer's credit worthinessratings range from triple A
highest to D lowest bonds rated Triple B
or above are consideredinvestment grade credit ratings.
Double B and below are lowerrated securities, also known
as junk bonds.
Any mentions of specific companies are
for reference purposes only
and are not meant to describethe investment merits of
(35:13):
or potential or actualportfolio changes related
to securities of those companiesunless otherwise noted.
All discussions are based onUS markets and US monetary
and fiscal policies.
Market forecasts
and projections are basedon current market conditions
and are subject to change without notice,
projections should not beconsidered a guarantee.
(35:36):
The views and opinions expressed
by the Flat Rock global speakerare 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 basedupon market or other conditions,
and Flat Rock GlobalDisclaims any responsibility
to update such views.
(35:57):
This material is notintended to be relied upon
as a forecast, research,or investment advice.
It is not a recommendationoffer or solicitation to buy
or sell any securities or toadopt any investment strategy.
Neither Flat Rock Global
nor the Flat Rock GlobalSpeaker can be responsible
for any direct or incidentalloss incurred by applying any
(36:20):
of the information offered.
None of the information
provided should be regardedas a suggestion to engage in
or refrain from any investmentrelated course of action
as neither Flat Rock Global
nor its affiliates are undertaking.
To provide impartialinvestment advice, act
as an impartial advisor
or give advice in a fiduciary capacity.
(36:41):
This broadcast is copyright2024 of Flat Rock Global LLC.
All rights reserved.
This recording may not bereproduced in whole or in part
or in any form without thepermission of Flat Rock Global.
Additional informationabout this podcast along
with an edited transcript may be obtained
by visiting flat rock global.com.
Popular Podcasts
Stuff You Should Know
If you've ever wanted to know about champagne, satanism, the Stonewall Uprising, chaos theory, LSD, El Nino, true crime and Rosa Parks, then look no further. Josh and Chuck have you covered.
Dateline NBC
Current and classic episodes, featuring compelling true-crime mysteries, powerful documentaries and in-depth investigations. Follow now to get the latest episodes of Dateline NBC completely free, or subscribe to Dateline Premium for ad-free listening and exclusive bonus content: DatelinePremium.com
On Purpose with Jay Shetty
I’m Jay Shetty host of On Purpose the worlds #1 Mental Health podcast and I’m so grateful you found us. I started this podcast 5 years ago to invite you into conversations and workshops that are designed to help make you happier, healthier and more healed. I believe that when you (yes you) feel seen, heard and understood you’re able to deal with relationship struggles, work challenges and life’s ups and downs with more ease and grace. I interview experts, celebrities, thought leaders and athletes so that we can grow our mindset, build better habits and uncover a side of them we’ve never seen before. New episodes every Monday and Friday. Your support means the world to me and I don’t take it for granted — click the follow button and leave a review to help us spread the love with On Purpose. I can’t wait for you to listen to your first or 500th episode!