Year: 2025

Shiloh:

Hi, I’m Shiloh Bates, and welcome to the CLO Investor Podcast. CLO stands for Collateralized Loan Obligations, which are securities backed by pools of leveraged loans. In this podcast, we discuss current news in the CLO industry, and I interview key market players.
Today I’m speaking with Amir Vardi, Head of Structured Credit at UBS Asset Management. He works for one of the best regarded Broadly Syndicated Loans CLO management platforms and he also invests in CLO securities managed by third parties. We discuss multiple topics including the inefficiencies in the CLO market, CLO Debt vs. Equity, CLO modeling assumptions and economics of CLOs managed by newer market participants.
If you’re enjoying the podcast, please remember to share, like and follow. And now my conversation with Amir Vardi.
 
Shiloh:
Amir, thanks for coming on the podcast.
 
Amir Vardi:
Yeah, Shiloh, it’s a pleasure to be on. Thanks for having me.
 
Shiloh:
So, how did you end up in the CLO industry?
 
Amir Vardi:
Yeah, so my background is I’m one of the very rare people to be at one firm for my entire career. I graduated from undergrad University of Pennsylvania Business School in 2004, and my first job was at CSFB as it was called at the time. It was on the sell side. So, in sales and trading and I still have a placard on my desk which are all the people that were in my starting class. It was 100+, 100 something people. And if I look through that, maybe two or three people are still here. And so actually in prep of this podcast, I literally did that. I basically took a picture of this placard, and I fed it to AI, and I said, it has all the names on it, right? So, I said, how many of these people still work at UBS? And so, the initial response was, given the time elapsed since 2004, it’s very probable that most, if not all, of these individuals have moved on to other roles, companies, or even industries. And then it went on, despite a generic answer, it went on to suggest six names that might still be here. I was one of them, so it was right on that. And then the other five I spot checked and they were all not here. That was incorrect or a different person with the same name. So, in any case. I have been at this firm for now 21 years, started as CSFB, and became Credit Suisse. Now, it has become UBS. I’ve always been around the loans and CLO space. In 2008 is when I did that switch from the sell side to the buy side to this particular group. First, I was a research analyst for CLO bonds, picking at that time 2008, 2009, single A CLO bonds in the 60s, became a trader of CLO bonds in 2009. And then as CLO issuance came back in 2011, I remember our first deal back was [in] April 2011. I was helping on that effort. I was made a portfolio manager in 2012. And then in 2013, I picked up also the responsibility for the head of CLO capital markets. Since then, I’ve had essentially that same role, which is the dual-handed role, so both CLO issuance and CLO tranche investing.
 
Shiloh:
So, how do you see CSAM and now UBS as differentiated amongst peers and on the CLO management side?
 
Amir Vardi:
So, one thing that’s different than any of the larger players for us is that every CLO that we’ve done has been homegrown. De Novo, so we’ve never bought a CLO manager. We’ve never bought CLO contracts. So, most of the other Bigs, if you look at them, they’ve gotten to their size through acquisitions. The second thing is just the length of time that we’ve been doing this. So, this started before I started here. This started in 1997. John Popp and Andy Marshak started this business. They did three CLOs in 1998 to 1999. At that point is when CSFB acquired them and before the ink dried on that, DLJ acquired them, then Credit Suisse acquired DLJ. So, they landed at Credit Suisse in 2000 and that core team, it’s obviously grown a lot, has been here ever since 2000. So, we’re now underneath the UBS umbrella, obviously, but as far as our platform, our team, how we do business, our specialty is, it’s really been the same. CLOs is really our bread and butter. So, we have some other assets, but this is 65 % of our AUM. It was probably 90% of our assets if you look at 2007, 2008, pre-GFC, we’ve really grown it post that crisis as far as comingled funds, separate accounts and so forth. This is really at the core of what we’ve done for a [long] period of time.
 
Shiloh:
Do you spend most of your time on CLO Management or investing in CLO securities?
 
Amir Vardi:
So, I spend most of my time on the tranche investing side. The issuance side, I would call a well-oiled machine. So, we built out a team on both sides, but the structuring and issuance team related to those Madison Park CLOs is well-built out. And so, I spend, as I said, maybe 30 % of my time there and, 75 % of my time on the tranche investing side. And it’s important to note that we’ve been investing in tranches going back to that 1998 inception. So, in the older days, as you know, I’m sure, but maybe some of the listeners don’t, the 1.0 deals (the deals from before 2008) had buckets. They were still mostly loans, senior secured loans, but they had buckets for CLO tranches. So, we were investing in those CLOs into other managers’ CLO tranches. And we also had some funds that had buckets. So, it’s really post-2009-10 that we’ve built out our dedicated structured credit business. That is, funds that are exclusively investing in, we have all sorts, but it could be European investment grade, it could be US seniors, it could be equity. We have a series of CLO equity funds. But we’ve been actually investing since 1998.
 
Shiloh:
Amir, you have been in the market obviously for long time. What’s like one or two things that you find intellectually interesting about CLOs?
 
Amir Vardi:
Yeah, it’s a good question. I think it’s a dynamic market. It changes enough to keep things interesting. It evolves. The underlying loan market evolves. The structures, meaning the CLOs that sit around the loans evolve. There’re new players. Some players go away. There’s M&A. There’s consolidation. I’m a particularly data-oriented person. There’s just so much data that you can dig into and slice and dice various ways and do various types of proprietary research on how different managers are doing different things, who does what well and who has a particular style and stays in their lane and veers out of their lane. There’s just so much, it’s almost a never-ending amount of research and things that you can do within this market. I’ve anchored my career to the CLO market for over 20 years and still haven’t yet gotten bored of it. Have you Shiloh?
 
Shiloh:
Well, my career is anchored to CLO’s as well at this point. And I think one of the things I like about CLOs is I just think it’s very inefficient market. I went to grad school at the University of Chicago where they beat market efficiency into you. But, the reality is, the equity tranches I invest in are like 50 to 70 million in size and the BB tranche might be around 30 million. And these securities don’t trade a lot if you know what you are doing I think there’s high potential to outperform peers and I think there are lot of smart peers in the market, but if you got good gameplan and good research, effort. I think the potential to turn alpha is certainly there.
 
Amir Vardi:
Let me just say I totally agree with you that there’s two sides to it. On the one side, things are getting more liquid and more efficient. And on the flip side, there’s absolutely still nuance and a reason that people who are really in the weeds are close to the market and the documents and the managers can really outperform whether that’s by how you trade and maybe you can get better prices or looking for specific things in the document or picking managers in a different way. There’re so many different ways to outperform. So I’d say that there is enough inefficiency certainly AAA liquidity is extremely good AA liquidity I’d say is pretty good and equity liquidity is spotty, but it’s there you can sell your bond there is inefficiency and I totally agree with you so, your professors at University of Chicago were not wrong, but it doesn’t apply to all markets.
 
Shiloh:
Well, the beginning of my career when I was doing you know mostly direct investment in loans. I found that the reality there is that any loan to a good company made by a good firm could go bad you know there could always be some change to the business model that results in a restructuring whereas in our business we are dealing with the statistics really of the pool. So, you are CLO equity maybe assuming a 2% default rate through the entire portfolio of loans you are not betting on any loans in particular to do well or not and I found that kind of statistical analysis of the entire pool to kind of may be resonate more with how I view the world.
Amir Vardi:
Investors often ask how many line items do need to have to be diversified? And to some extent, you could buy one CLO. You could just sit there with one CLO and have 300 underlying loans. I wouldn’t stop there. My answer tends to be something like 30. If you buy 30 CLO bonds, the underlying number of issuers is around 1500, which is large. It’s almost every loan in the market, as long as it’s not 30 bonds from the same manager. 30 bonds from, say, 20 to 30 managers are going to be extremely diversified. But that starting point of even one CLO has 200, 250 plus individual companies. You’re in such a better place.
 
Shiloh:
So now there the recessionary risks in the market are up post liberation day, does UBS as a bank have an economist that has a call on what we should expect over the next year or so?
 
Amir Vardi:
At the end of the day, it’s not a driver of our credit decisions. Our credit decisions are really made at the fundamental bottom-up level company by company. Obviously, each industry has its own dynamics and the macro view there is obviously important. We might have certain out-of-favor sectors and in-favor sectors and those are based on macro views. But it’s really much, much more about the individual company, its business, who the sponsor is (that is, the owner of the company). The capital structure being put in place, the credit document, and those business factors have our macro view kind of baked in, but we don’t start with saying we are now, you know, now because of tariffs, let’s decrease our chemicals exposure across the board by 2% and, let’s increase our telecoms up by 3%. It’s really company by company analysis. So even within an industry, there’s so many differences. I mean, take like chemicals, for instance, there’s parts of chemicals where like commodity chemicals that might be very negatively impacted by oversupply by some foreign actors. And then there’s other parts, specialty chems that use that as an input. And therefore, to the extent that’s happening, their input costs just went down, but they can still sell at the same price. Their margin just went up. So, there’s literally a winner and a loser. Side by side within the same broader industry.
 
Shiloh:
Does the recent market volatility makes CLO equity or double BB’s more or less attractive to you or maybe other parts of the CLO capital stack?
 
Amir Vardi:
Yeah, I mean, equity is tough. I guess to answer we probably should see better value in debt at the moment. I think probably in particular, it’s probably the most meat on the bone in the AAA. And that’s kind of just because we tend to lag. The CLO debt tends to lag the loan market and all markets. So, you know, I’d say equity was really much more interesting than it had been, let’s say, pre-liberation day. So, at the end of 2024, end of 2025, it had been much more interesting than it had been. I’m talking about primary markets, so creating a deal, much more than it was in 2022. So, post-Russia, Ukraine invasion of 2022 and 2023. So, you were able to lock in really tight liability prices, and that has proven to be a valuable thing. But right now, the liabilities have widened and now everything’s widened, and everything’s come back in, as you said, with Trump receding from the initial tariff talks. But the CLO debt has really lagged. And then if you see a deal pricing today or tomorrow, it doesn’t mean it’s good or bad it really depends on the other side of the equation, which is we’re able to buy a bunch of assets in the 97s and 98s. But on paper, I’d say it’s hard to look at CLO equity and say, this looks great. But from a debt perspective, I think that there’s value in AAA. It just looks much more attractive relative to its alternatives, which is agency mortgages or corporate investment grade bonds, or any type of liquid ABS like credit cards, student loans, even CMBS. You’re getting better spread and yield than CMBS, which has real fundamental issues, largely tied to kind of post-COVID office, not everyone’s returned back. There’s some real stress there.
 
Shiloh:
 Well, a lot of what I’m doing, as you know, is in private credit CLO’s,  but the tariff volatility, I think, for private credit double BB’s  really was an opportunity, because spreads blew out from 650 basis points over SOFR  to more like 800 we didn’t see the tariffs as posing really a risk to the underlying bonds, but we did want to benefit from the incremental spread, so saw that as an opportunity. And then for CLO equity, the reality is, it’s down for the year. And some asset classes have come back. The S&P 500 is back to positive for the year, at least when we’re recording this. I think for an investor, who’s investing new capital today and is expecting and things that economic risks are up which I would agree with. CLO equity has lagged, and it’s one of the kinds of discounted opportunities in the market that people may want to take advantage of. So, when you say CLO equity, I think your words were maybe hard to get a conviction around it today. What kind of outcome would you expect from here if it’s not of high conviction to you.
 
Amir Vardi:
They can be negative. I mean, it’s a highly sensitive asset class to how the manager performs. So, I’d say from today, if you pick a good manager, a bad outcome should be a mid-single-digit return. So, if you made 5 to 8%, that’s probably not where you’re supposed to get on equity. Obviously, you should have upside into the high teens, and your base case is probably 12%, 13%, 14%. But I don’t see that base case being 12%, 13%, 14% today. I see at this exact point in time, you went and bought loans today and basically went and printed a CLO today where the debt is, you’re probably looking at an upside case of 12%, 14%. So that’s everything has to go well. And there are still ways to get to high teens because there’s a lot of options embedded in CLOs. So, for instance, if you look at the 2007 deals, they probably were modeled to that magic number of 12 to 14%. Things got really bad in 2008 and 2009. The 2007 vintage was a fantastic vintage. But it’s because the CLOs were able to go through 2008 and that severe sell-off in the loan market, they didn’t have to sell loans because CLOs don’t have a situation where they’re a forced seller of loans. And in fact, they were on the other side. So, there were a lot of forced liquidations by some, not by CLOs. CLOs were the beneficiary of that because if you just had to sell and you were a CLO manager and you had the guts to say I like this loan, I’m going to bid $65 for it. I’m going to bid $55 for it. And there’s a tremendous amount of value creation that took place in 2008. And then actually also as you go through 2010, so the credit markets completely froze for a few years. When they unfroze, these companies had not had the chance to extend their term loan maturities. And now they finally did. But of course, they were way wider in 2010 and 2011 than they were in 2007. So, you had these “amend and extends” and you had a massive amount of increase in the weighted average spread of your assets. Meanwhile, your liability spreads don’t change. You have the ability to take them lower, but they don’t go higher. And that might be a way to explain why equity is quite interesting today, should we have a recession. But we do sit here, Shiloh, with defaults kind of at 4% and yet loan prices, the ones you’d want to buy in a CLO are pretty close to par. So that, I think an astute manager can find some lower priced loans and maybe navigate well and add some value, but the starting point is a little bit more difficult from an equity perspective. So that’s why I say that.
 
Shiloh:
Yeah, but isn’t it one of the challenges for the market that, because a lot of money has been raised in our asset class, for the loans in particular, that when recessionary risks are up, the loan market just doesn’t trade down like it used to and those discounted loan opportunities that you want to buy maybe there are discounts but they’re not at the same discounts they would have been in the past.
 
Amir Vardi:
I do think that in the first part that you said there, people raised so much money. I think that’s part of the problem. I think that so many new players into the CLO space, if you’re going to be a new player, you have to come with a lot of cash to buy your own equity. No one’s buying a new manager’s equity, period. So many new players and so much money having been raised for equity is creating all these CLOs, but at the same time, you don’t have nearly enough new loans. And the new loan supply, 21 was a better year and since then it’s been just very, very scarce. So, the combination of not enough new loans, but a lot of new players and a lot of people trying to start CLO platforms and a lot of money being raised by existing platforms for their own equity in what we call the captive equity funds, I think, is really compressing that arb. You’re creating a lot of CLO issuance, [which] keeps the debt spreads maybe wider than they ought to be, and it’s creating a lot of demand for loans. And that’s caused a significant spread compression through repricings and spreads there are really shockingly low. I mean, low 300s, tighter than we’ve seen in a long, long time.
 
Shiloh
So, your firm, it’s been around for almost three decades. Why do you think people are giving money to newer CLO managers and taking that risk?
 
 
 
Amir Vardi:
Just to clarify your question, is it why are the people who own the company doing that? Or is it why is someone who’s unaffiliated with a company? Because it’s kind of two different answers. I can answer the first one for sure.
 
Shiloh:
Well, it was actually the latter that was my question. I mean you’re a CLO equity investor. Are you investing with first time managers? I assume not.
 
Amir Vardi:
I don’t know if anyone does. Look, why does someone do the first one and then, yeah, why does someone do the second one? I’ll ask you because I don’t know. But why does someone do it in the context of I own the manager? It’s because, yes, I don’t think that those investments on their own are particularly interesting because a new manager is going to have to pay up. Because no one knows them, so they have to pay up quite a bit on their liability costs and yet they’re going out and buying the same loans as everybody else, so, SOFR plus low 300s. So that return profile isn’t that compelling but if you do four of these deals or five of these deals and each of them is a little bit less bad than the prior one because your debt costs are getting tighter because people get to know you and you’re becoming more of what people call a liquid manager. If you get to the point of having good pricing, tier one pricing, so similar to all the top players, then you can start to attract some third-party equity with some fee discounts. And then as you go on, maybe there’s less fee discounts. And if you perform well, those fees go up. And every time you raise third party money, even with some fee discount, that’s building the value of your enterprise, of the manager. So, there’s some wild success stories. I think obvious one, I’ll say it, is Elmwood, which Elliot started and got off the ground. So, there’s a few success stories. There’s a bunch of people who are trying to chase that model and build an asset manager who specializes in CLOs, which is worth a lot. So that trade has definitely been a good one. It’s not going to work every time.
And it really depends, did you hire the right people, did they pick the right credits, etc. So, there’s a lot of people trying to do that right now. Now the second one, why do you buy deal five from a manager? I mean, probably you believe in them and probably you got enough of a manager fee discount.
 
Shiloh:
Well, at a previous firm, I did some emerging manager investing, and kind of how we thought about it back then was you could get a 15 basis point fee repaid, which, considering the leverage in the structure, might be worth a percent and a half to you in terms of incremental IRR or cash flow, but, but to your point, that doesn’t account for the fact that you know your cost of debt is going to be higher, so maybe you give all that up. But if you’re with a smaller manager, you might think, okay, these guys are going to be nimbler with the assets. Maybe they’ll get allocations of loans and trade them back to the agent on the break and make a quarter or three eighths or something like that and slowly build par that way. But the actual experience at the time was that the smaller managers just really struggled to get allocations of the loans that they wanted. And so you didn’t have that par, build, and the higher cost of debt, really weighed on returns and now that’s just not a business that we’re in.
 
Amir Vardi:
And there’s stats on that. I don’t have the exact number Shiloh, but the top, let’s say 10 managers get 80%. It’s kind of the number that comes to mind. But there’s a reason that the top managers get disproportionately more of what they want. So, if you start with the premise that a loan is well over subscribed, there’s not enough of it to go around. At the end of the syndication process, a bank could choose to just allocate pro rata. That sounds fair. Everybody gets 40 % or let’s say it’s three times over, everyone gets 33%. That is generally not how they do it. They tend to look around and say, the large managers [may] get early looks on deals. And then that gets them on their way to syndicating, let’s call it a multi-billion-dollar deal. And then at the end, if it’s widely oversubscribed, because we were helpful in and are also putting in a ticket early, we’re going to get maybe a high percent of it, someone who came in late and put in 10 million, they might get 1 million, they might get 2 million. That’s what from my vantage point I’ve seen from an allocation perspective. So, from that, yeah, I agree with you. It does tend to favor the larger players.
 
Shiloh:
Well, it doesn’t sound like either of us are investing equity dollars with new managers, but does seem like new platforms launch every couple months or so, and maybe I could see the attraction if you’re a part investor in the CLO’s manager or maybe that could make sense.
 
Amir Vardi:
Yeah, there’s so, so many and it’s always a surprise to me that someone wants to put themselves through that. There’s definitely a light at the end of the tunnel. Because everyone wants to be that Elmwood example, but maybe four out of five of them don’t get there and it is a struggle. Can I bring up one more thing about large managers which is in the context of these new, the last few years, everyone talks about liability management exercises. It was already our view – and like we’re a big manager so obviously we’re going to have this view, we’re going to talk about our book – it was our view [that] you wanted to be big. We talked about allocations. It also helps to have a big enough platform that you can afford to have, let’s say, 25 credit analysts. So, you have a very deep bench that are very focused on, let’s say, one sector. They get really, really good at that sector. They know all the companies alterin the sector, know all the CFOs and the CEOs in it. So, they get really, really good at their sectors. And that’s really what drives credit performance is, it’s really what you don’t buy, but it’s those research analysts. So, if you’re big, you can have a lot of them. You can have good ones because you have the fee revenue to pay them, etc. Allocations, size of the team. But the new thing that’s, I think probably been talked about quite a bit. But it’s just a very obvious one is the liability management exercises. And what that is, is a distressed exchange. So, in the last couple years, companies have been able to, recapitalize their debt, in some cases, do what’s called discount capture. So, reduce the balance of their debt. Other cases, maybe they’re raising new money to extend their runway. A lot of times that comes with pretty juicy economics. And, typically, any one of these types of transactions, you’ll need 51%. If you have 51% of your lenders, you can amend and do whatever you want. The documents are fairly loose, and the lawyers are very creative. The benefit of being large is if you’re trying to get to 51 % with the fewest number of counterparts to deal with, you’re going to look at your lender list, you’ll sort it by the biggest to the smallest, and you’ll pick the top five that gets you to 51%, the top X that gets you to that number. You really want to be on that list. The reason is then the byproduct of these things is there’s the “in group” and the “out group.” And there’s a very big difference in recovery; it’s funny because you see recovery rates quoted on distressed exchanges JP Morgan’s got data out that shows it’s like 65%. That’s the most recent number I just saw today. But if you think about it, no one gets 65%. That’s an average of two things. Some people are 10 to 20 points higher, and some people are getting 10 to 20 points lower. There’re not always two groups. There can be three groups, four groups, but to be big means that you’re much more likely to be in that “in group”.  And so, when things go wrong and an LME happens, it’s very challenging to be in the “in group” when you only own one or two percent of the loan.
 
Shiloh:
Okay, makes sense. So, coming back to the previous topic of CLO equity returns, I assume you were previously talking about the primary market, but I imagine that you’re investing in both primary and secondary?
 
Amir Vardi:
Yeah, definitely. We’re more so in secondary, usually.
 
Shiloh:
And that’s because presumably the return opportunity there is better?
 
 
Amir Vardi:
It depends on the time. I guess maybe it’s recency bias. In recent years, we’ve been much more involved in secondary up until recently. So, we play primary when we think there’s better value in primary. So actually, it did flip probably second half of 2024. And in the first few months of this year, we did see better value in primary. And actually, what we were doing was we were basically selling secondary. Secondary was all north of par, generically speaking. It could be par or 101, par and a half, but we were finding better price because primary is going to come at 100, at par. Better price and spread than primary. So, we were buying that and actually selling secondary and doing that rotation in order to fund those primary purchases. But prior to that, you know for pretty much all of 23 and almost all of 22, we did nearly no primary, and we were very active in the secondary. In 22, I’d say 15 % of our trading volumes were primary, so 85 % secondary. And in 23, it was even more stark, it was 98% of everything that we traded in the CLO tranche market was secondary. 2% was primary. We just saw so much better value, discount prices on the bonds, and better yield potential.
 
Shiloh:
I think, to be successful in CLO equity, you need to look at both primary and secondary for the best value, and I think a lot of our competitors just approach the market with primary only mandate.
 
Amir Vardi:
And that’s one of those inefficiencies, the “primary only” mandate, which stems from, you know, folks that need a lot of time to process. Secondary, you don’t have time, same day “bwic”, next day, at best. Primary market participants need weeks of time to put together a package to present it to their investment committee. They want to have a lot of say in what the document looks like. There’s a lot of folks that are just not set up to do secondary. Primary is cleaner. It’s an easier thing to buy. It’s cleaner. Secondary is a little bit, depending on the bond, it’s going to have a little bit more seasoning to it. So, it does keep people at bay, and it’s part of what we talked about earlier, which is part of the inefficiency. It keeps people away, and therefore there’s better value there.
 
Shiloh:
Well, in my opinion, that captive fund vehicles would be the worst way to invest in CLO equity. I mean, those are funds where investors have committed to do the next four or five deals with the manager and that manager is going to call, call the equity capital and start earning a fee on it as soon as possible. The initial profitability, or projected profitability of the CLO is not the main driver of CLO creation, and then what the end investor gets out of it is four or five CLO equity investments, exposure to a minuscule part of the market in four or five CLOs that had high loan overlap and are super correlated. I think it makes no sense.
 
 
Amir Vardi:
So basically, between captive equity and third-party equity as two kinds of distinct strategies where it seems like you’re getting the same thing, you’re buying CLO equity. I think the third-party equity side of things is better. It’s more opportunistic. You’re getting that diversity across managers. You’re getting diversity across vintages that you don’t get in captive equity because you’re just going to buy six or eight deals from one manager across one or two vintages. And they’re not ever going to buy in secondary. They’re not set up to do that. So, there’s no buying in secondary and there’s no selling; if there’s inefficiencies, sometimes you want to sell into a really strong bid. They’re just holding it for life. One thing that they have on their side will be that there’s not this feeling of two sets of fees, one at the CLO level and one at the fund level. There’s some truth to that. But I think that the third-party funds are probably more than worth their fees, I think at the end of the day, you’ll have a better net return there than you will in the captives. So, you’re more than worth the fees.
 
Shiloh:
Well having the third-party equity at a minimum will ensure that the management fee is done at a fair market rate and the same thing for the underwriter fee.
 
Amir Vardi:
That’s what I was alluding to as far as I think a sophisticated third-party investor can push the manager’s fees to what you call market level. And that moves around with the market, and it probably moves around with a particular manager and maybe through time. But those captive funds have a set discount and, ostensibly it’s X percent discount off of full fees. Well, was that manager getting full fees? Is this really a discount, as you’ve been told? So, yeah, I’m a little bit suspect in some cases. I think some are actually probably pretty attractive and a bunch of them aren’t.
 
Shiloh:
Well I think this goes back to our conversation about how inefficient our market is and how there’s a lot of players out there who are implementing their strategies, in a way that wouldn’t make sense to the two of us.
 
Amir Vardi:
And the conflicts go back to what you said, which is you’re giving the manager money in a fund and the fund doesn’t have fees and they are the decider of when to do a deal. And when they do a deal is when they start to earn fees. When that CLO closes, they’ll start to earn manager fees on the par value of the CLO’s assets. So, they’ll take 50 million from the fund. They’ll turn it into 500 million CLO. They’ll start to make, let’s call it, 40 basis points on the 500 million, what do you think that manager’s going to do? I think they’re going to print.
 
Shiloh:
So, at times you’ve seen these captive equity funds, creating CLOs with initial profitability that’s probably worse than the CLO BB note and again they do that because they want those fees.
 
Amir Vardi:
I think 2023 was a perfect example of that. I certainly would have preferred buying primary BBs. This is generic, because it’s always case by case. Primary BBs over primary equity. I would have preferred secondary BBs over either of those two things and secondary equity probably above all three of those things. But last on that list would have been primary equity, which is what captive equity is doing. It’s buying primary equity in that manager’s deals.
 
Shiloh:
For CLO equity, do you think of there as being a bid ask spread or is it that equity often just trades through BWICS or auction processes where the buyer and seller are matched up through a dealer who earns just like a small fee for their time on that transaction.
 
Amir Vardi:
I think there’s a bid-ask spread. I think it gets asked by investors into our funds, what’s the bid-ask spread? And I can kind of quote it. If you ask me on AAAs, I’d say it’s 10 cents. In equity, I’ll typically go to some offering runs and look and say, okay, bid-ask is two points, but the reality is like you’re transacting inside of that. And that’s probably true in every market, but it’s very true in this market. So, the real bid ask then is not a two-point bid ask. It’s something like, you are probably skinny it down to maybe it’s half a point. But I think I understand your question because of the inefficiency of the market, you might actually be able to flip the bid ask. In other words, you can sometimes get bids that you feel are very good and you’re selling it above theoretically like the offer side and sometimes you’re able to buy stuff at a level that you think is like below what quote the bid side is. So that yeah, I think that there is a bid ask. It’s not at all clear what that is because unlike other markets, the CLO market is a bit weird. Each of the tranches is very small. And so, it’s not like every single CLO tranche is quoted by a bunch of dealers every day. They mostly are not quoted by any dealer. And they mostly don’t trade any given day. But there’s enough things that look a lot like them that do trade every day. And so, you can get an idea. There’re daily marks. How they’re able to do that is they’re able to say, this manager’s bond that had these features traded at this DM [Discount Margin], and I’ll take that DM and apply to all other bonds that are similar in those features. So, it goes back to why is this market interesting? It’s not efficient. There’s supposed to be an answer to what’s been asked, if you’re a trader that, I think some traders are very good at being able to sort of invert that.
Shiloh:
So, you may have heard that we’re living in the golden age of private credit. So, are you managing private credit assets on your balance sheet there or investing in private credit CLOs?
 
Amir Vardi:
Is it still the golden age of private credit? Or are we passed that, I think we’re probably still in it. Yeah, it’s a gap for us. We have not ever invested in what we used to call middle market CLOs and now private credit CLOs. I think there’s a place for that. Obviously, you do it. We’ve always gotten comfort from knowing the underlying loans, so in the area that we traffic, which is the broadly syndicated CLO market, we do know 98 % of the underlying loans. We know all the managers, we’re in a lot of the same deals. There’s a decent amount of overlap. So especially when we’re investing in the BBs or in equity, we get comfort from that whereas in the middle market, I think if we were to approach it, we would be very disciplined with which managers we work with. It’s so more about the diligence of the managers. We just would not know the underlying companies. Even under NDA, you’d get the list of names and you kind of scratch your head and say, okay, I can understand what they do, but I don’t know the company. We haven’t looked at it. So, I get comfort that our research analyst team has looked at the names. So that’s kept us away from the middle market. I think it’s not nearly as much of an issue at the top of this structure. So, I think middle market CLO AAAs are safe, and you still want to be a little disciplined with managers, but you can probably have a broader lens there. The other aspect is liquidity. So, because we’re an asset manager. Most of our funds have certainly daily marks, also some different terms, but generally have the ability for the client to redeem and the tranche market on the middle market side is less liquid. It’s getting better. You tell me, I’m actually curious, but my sense it’s less liquid. So that’s kept us at bay. And that might change. I think we’re probably supposed to take another look at it, but that’s why we’re not in that space.
 
Shiloh:
So, for private credit equity and BBs, they’re going to be significantly less liquid than their BSL counterpart but if you’re talking about BBs, for example, on the one hand, less liquid and the underlying loans aren’t traded, but the positive, there is that you get 12% equity, initially in the deal, rather than the 8% you get in broadly syndicated and that initial equity matters a lot in terms of how robust, the CLO BB is to defaults on the underlying loans that initial equity is very valuable.
 
Amir Vardi:
There’s no doubt I mean, the same thing with Europe. You have better subordination, as they say, at every level and probably even more so in middle market CLOs than in European CLOs. And there’s value to that. It’s just more cushion for mistakes, more loss absorption capability. Like I said, it’s a gap for us. That’s where it’s rooted in. It’s just knowing and having that comfort of like, I really do know what I’m investing in. And with the middle market space, I think there’s some managers that are really good there. And if you’re able to source their paper. Let me ask you about this Shiloh, are you ever able to buy BB secondary, middle market deal with BB and secondary? Or is that like in April, you said it got to 800, you’re talking about primary deals done in April?
 
Shiloh:
SOFR + 800 is where things traded in the secondary so through auction processes or directly through brokered dealers who are trying to earn like maybe 50 basis points bid ask spread.
 
Amir Vardi:
There is a bid-ask spread in CLOs
 
Shiloh:
Indeed.
 
Amir Vardi:
I kind of look at it on paper and think that probably the equity could be very interesting just because the spread is so much higher, so much higher, and then your liability cost is only a little bit higher. Like, the arbitrage should be a lot higher. And yeah, you’re getting less leverage, I would think on paper, mean, on paper, looks like it’s a lot juicier of an asset and just not something we’ve participated in, but has that been your experience?
 
Shiloh:
Yeah. So, it is my experience. So if you’re sitting around and you said to yourself, Hey, should I do middle market, or should I do broadly syndicated CLO equity, and you were indifferent to the underlying assets, and you just ran your projected return case through Intex, what you find is that the middle market CLO is going to spit off a lot more cash, and that’s because the underlying loans are SOFR + 500 maybe a little shy of that. And then when you look at the CLO’s financing costs, starting with AAA, for example, the AAA in middle market CLOs is 30 bps wide to broadly syndicated. And as you go down the stack, the basis is going to be higher. But the natural profitability of the CLO, which is just, is the rated earns on its assets, less the CLOs financing cost, the CLO, the private credit CLO the middle market CLO is going to be much more profitable, and so your initial IRRs are higher. And then you talked a bit about liability management exercises. But you know, in private credit, that’s not really a thing. So private credit is one lender or a club of lenders. They’re all friendly. There’s no lender-on-lender violence. I think the docs are better, and so I think recoveries, they may not hit 70. Maybe 70 is becoming an antiquated number, but I would expect them to be much better than broadly syndicated as well. So there’s a couple of things that have worked in our favor on these investments.
 
Amir Vardi:
Can I ask one thing? So, I get all that and it sounds really good. The one thing I haven’t wrapped my head around is just how do you get out? What is the exit? So, you’re going to cash flow better and maybe it’s not that relevant but, what do you think is going to be how you get out? You’re selling it? It’s getting called? There must be some way to get out of the trade in the end.
 
Shiloh:
So, the typical middle market CLO has a reinvestment period of four years, and then after that, the CLO naturally de levers, and then over time, all the debt would be repaid and the equity would get what remains, but that’s not really what we’re hoping for. We own CLO equity in semi-permanent capital vehicles. They’re interval funds, and basically, you know when the CLO’s reinvestment period ends. Our goal would be to extend the CLO’s life or to do a refinancing. And if you find yourself in a position where you know neither of those are economical, then a lot of times, instead of just, having the CLO do a full wind down, a natural wind down, the CLO manager will just buy the loans from the CLO at fair market value. So that would be an appraised value that comes from a third party, like Standard and Poor’s or Houlihan Lokey. And so, they can value all the loans that remain, and from that, the manager can give you a calculation of your liquidation value, and they might take those loans and put them into a new CLO that’s ramping or a BDC, or some other account that they’re managing.
 
Amir Vardi:
So it’s similar in concept to a [BSL] CLO being called, but as opposed to the loans being sold in the market at fair market value, the loans are being taken back by the manager at fair market value into some other fund on their platform.
 
Shiloh:
That’s correct. So, one last question for you, Amir, when I say 2 and 70 in our business, people know exactly what that means. It means 2% defaults and 70% recoveries. Those are kind of the base case modeling assumptions that I think a lot of people use. Is that way you use around the shop, or are those numbers a little bit antiquated?
 
Amir Vardi:
Those are antiquated. I mean, I think that is probably what most people use as what they would call a base case. From an equity investor perspective, I think most people are probably running a whole bunch of other scenarios and we do that too. But from a base case perspective, for one thing, 2 and 70, 2 is below the average default number. A little bit rosy and then recoveries aren’t 70 anymore. So that’s a little bit rosy as well. So, I think the bigger issue isn’t that that’s too rosy. It’s that it’s just antiquated. I’ve been thinking about it a little bit differently. I mean, if you think of what 2 and 70 really mean, it’s a loss rate of 60 basis points. So, for the listeners, 2% of your portfolio defaults, 70 recovery means 30 % you lost on each loan. So, 2% times 30% is 60 basis points. Actual realized loss will ultimately depend and be very different based on the manager. But if you look at that historically and back it into a default recovery, that’s fine. I mean, that’s kind of one way to get to that same place. But there’s so much more that goes into the actual losses at the end of the day. All of the managers cumulative decisions of what credits to buy, the trading that they’ve done, lower priced loans that they bought or lower priced loans that they sold, what recoveries they got and add in LMEs into that, all that stuff, the reinvestment price assumption. I actually think, at the same time that you have 2 and 70, too rosy is probably aspects that are too conservative, like reinvestment price assumption. People generally just assume it’s like 99.5 [or] par and at times it is lower. And the constant prepayment rate, which is what percent of your loans repay you, the number people typically use is 20. And the reality is historically it’s actually higher than that. My bigger issue also isn’t necessarily what numbers you choose to use. It’s that whatever assumptions you make going in are not that correlated to the actual outcome at the end. There’s some research on this and we recently ran an analysis on our own deals, the Madison Park deals. We actually found it was inversely correlated. So, we took all the deals at issuance. We basically ran exactly the same assumption. So, it could be 2 and 70 and 20 and you know, weight average spread at the current [level], we did a very consistent thing. We said, let’s just run what this looked like. And then we said, what actually happened? And it was actually slightly inversely correlated. Not that I can explain why that is. The R squared was weak, but the correlation was slightly inverted, weak correlation. And it’s essentially not a great indicator of what you ultimately will get because these things are around for so long that, in time isn’t all that helpful. I do think if you were to run like 3% defaults and 50 recovery, you’ll never buy equity. We didn’t really get into it, but you know, all those options in the CLO structure, we’ve talked about extending the deals, which are called resets, refi’ing the deals. We mentioned in 2008, 2009, there’s various ways that equity can win, but you’re basically not modeling any of those things. So, I kind of get why people choose some rosy numbers because it’s sort of like compensating for all the things that are just impossible to model.
 
Shiloh:
I agree. So, the 60-basis points loss rate is probably too optimistic but we’re probably being conservative on refinancings, extensions and buying loans at discounts during recessionary periods. So, I think being too optimistic in one place and too conservative and another probably nets you out to the right place.
Well, Amir thanks so much for coming on the podcast, really enjoyed it.
 
Amir Vardi:
It was a pleasure to be on. I also just wanted to add, Shiloh, that in our little CLO market, which isn’t nearly as little as it was when we both joined it, you’ve been one of the biggest advocates of this space and educators, mass market educators through your book and your podcast. So I actually want to really thank you for that. So, thanks, Shiloh.
 
Shiloh:
It’s great to hear, appreciate it.
 
Amir Vardi:
Thank you.
 
*******
Disclosure AI:
The content here is for informational purposes only and should not be taken as legal, business tax or investment advice, or be used to evaluate any investment or security. This podcast is not directed at any investment or potential investors in any Flat Rock Global Fund.
 
Definition Section:
–       Secured overnight financing rate SOFR is a broad measure of the cost of borrowing cash overnight, collateralized by Treasury securities.
–       The global financial Crisis GFC was a period of extreme stress in the global financial markets and banking systems between mid-2007 and early 2009.
–       Credit ratings are opinions about credit risk for long term issues or instruments. The ratings lie in a spectrum ranging from the highest credit quality on one end to default or junk on the other. A AAA is the highest credit quality, a C or a D, depending on the agency, the rating is the lowest or junk quality.
–       Leveraged loans are corporate loans to companies that are not rated investment grade.
–       Broadly syndicated loans are underwritten by banks, rated by nationally recognized statistical ratings organizations, and often traded among market participants.
–       Middle market loans are usually underwritten by several lenders, with the intention of holding the instrument through its maturity.
–       Spread is the percentage difference in current yields of various classes of fixed income securities versus Treasury bonds, or another benchmark bond measure.
–       A reset is a refinancing and extension of a CLO investment period.
–       EBITDA is earnings before interest, taxes, depreciation and amortization. An add-back would attempt to adjust EBITDA for non-recurring items.
–       LIBOR, the London Interbank Offer Rate, was replaced by SOFR on June 30th, 2024.
–       Delever means reducing the amount of debt financing.
–       High yield bonds are corporate borrowings rated below investment grade that are usually fixed rate and unsecured.
–       Default refers to missing a contractual interest or principal payment.
–       Debt has contractual interest, principal and interest payments, whereas equity represents ownership in a company.
–       Senior secured corporate loans are borrowings from a company that are backed by collateral.
–       Junior debt ranks behind senior secured debt in its payment priority.
–       Collateral pool refers to the sum of collateral pledged to a lender to support its repayment.
–       A non-call period refers to the time in which a debt instrument cannot be optionally repaid.
–       A floating rate investment has an interest rate that varies with the underlying floating rate index.
–       RMBS, our residential mortgage-backed securities.
–       Loan to value is a ratio that compares the loan amount to the enterprise value of a company.
–       GLG is a firm that sets up calls between investors and industry experts.
Risks:
§  CLOs are subject to market fluctuations. Every investment has specific risks, which can significantly increase under unusual market conditions.
§  The structure and guidelines of CLOs can vary deal to deal, so factors such as leverage, portfolio testing, callability, and subordination can all influence risks associated with a particular deal.
§  Third-party risk is counterparties involved: the manager, trustees, custodians, lawyers, accountants and rating agencies.
§  There may be limited liquidity in the secondary market.
§  CLOs have average lives that are typically shorter than the stated maturity. Tranches can be called early after the non-call period has lapsed.
 
General disclaimer section:
Flat Rock may invest in CLOs managed by podcast guests. However, the views expressed in this podcast are those of the guest and do not necessarily reflect the views of Flat Rock or its affiliates. Any return projections discussed by podcast guests do not reflect Flat Rock’s views or expectations. This is not a recommendation for any action and all listeners should consider these projections as hypothetical and subject to significant risks.
References to interest rate moves are based on Bloomberg data. Any mentions of specific companies are for reference purposes only and are not meant to describe the investment merits of, or potential or actual portfolio changes related to securities of those companies, unless otherwise noted. All discussions are based on U.S. markets and U.S. monetary and fiscal policies. Market forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee. The views and opinions expressed by the Flat Rock Global Speaker are those of the speaker as of the date of the broadcast, and do not necessarily represent the views of the firm as a whole. Any such views are subject to change at any time based upon market or other conditions, and flat Rock global disclaims any responsibility to update such views. This material is not intended to be relied upon as a forecast, research or investment advice.
 
It is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Neither Flat Rock Global nor the Flat Rock Global speaker can be responsible for any direct or incidental loss incurred by applying any of the information offered. None of the information provided should be regarded as a suggestion to engage in, or refrain from any investment-related course of action, as neither Flat Rock Global nor its affiliates are undertaking to provide impartial investment advice. Act as an impartial adviser or give advice in a fiduciary capacity. Additional information about this podcast, along with an edited transcript, may be obtained by visiting flatrockglobal.com.

Shiloh:

Hi, I’m Shiloh Bates, and welcome to the CLO Investor Podcast. CLO stands for Collateralized Loan Obligations, which are securities backed by pools of leveraged loans. In this podcast, we discuss current news in the CLO industry, and I interview key market players.

Today I’m speaking with Brian Nolan, Head of European CLO structuring at PGIM. This spring I saw Brian present at the Creditflux conference in London and thought he’d be a good guest to have on to discuss European CLOs and how they’re different from US CLOs.  At Flat Rock we invest in US CLOs so this podcast was a learning experience for me.

If you’re enjoying the podcast, please remember to share, like and follow. And now my conversation with Brian Nolan.

*******

Brian Nolan:

Thanks so much for having me. It’s a pleasure.

Shiloh Bates:

So why don’t we start off with your origin story and how you ended up in the European CLO market?

Brian Nolan:

So I went to school in Ireland where I’m from and I moved to London in 2010. So my first three years is not worth speaking about because it wasn’t CLO related, but that was in Bank of Ireland and then I moved to Fitch Ratings. So my background before I joined PGIM is in rating agencies. I spent two and a half years at Fitch in the CLO team, two and a half years in S&P in the CLO team. And now I’ve been at PGIM for about seven years in the structuring team here.

Shiloh Bates:

And what’s one thing that you find interesting about CLOs?

Brian Nolan:

So, I think my original three years I was in a Corporate Banking type role and I think what some people might find interesting, but what frustrated me was the difficulty in finding information. So you spend so much of your time on various websites trying to get reports. The thing that I loved about CLOs, and this is probably a boring answer, is you have such a complete set of data that you can interpret and use and whether that’s in the rating agencies when you’re trying to stress a portfolio or when you’re structuring a portfolio on the issuer side, I just get a lot of comfort from having a lot of certainty in the numbers that we’re using.

Shiloh Bates:

Okay. So, at PGIM, is your role more structuring CLOs or are you also playing a role in the loans that go into these vehicles?

Brian Nolan:

Predominantly it’s on the structuring side. So, we’re one of the biggest CLO managers both in Europe and the US and with that comes quite frequent access to the market. So, whether it’s resets, refis or new issues. So my team is responsible for structuring the cadence of those deals and when they’re going to market and being as efficient as possible in terms of getting in and out of the market. Then when the transaction starts, we’re responsible for making sure the bank is doing a good structuring job and then a lot of the back and forth with investors on the CLO documents. So we have full-time analysts that do that. I think the thinking being that because of the volume expecting the portfolio managers to do that on top of their day job is probably stretching them too thin. So, it’s very much making sure the structures make sense for the platform and then keeping the machine consistently going.

Shiloh Bates:

Okay. So, are you working on structuring deals in the US and Europe or just Europe?

Brian Nolan:

No, I personally work just in Europe. So, we have an equivalent team in the US that would do it for our US deals and we’re in constant communication to understand the differences between the markets and usually it’s the way that the US innovates in something first and then they’re explaining it to me so that we can try and do it in Europe as well. But occasionally maybe it goes the other way.

Shiloh Bates:

As a CLO manager, how does PGIM differentiate itself?

Brian Nolan:

I’m sure most people have interesting answers to this. I think certainly the first one is quite a difference between Europe and the US. So, in Europe PGIM manages loans and bonds from the same team out of our portfolio management team. So, if you look at our CLOs versus some of our competitors here in Europe, you will see a much larger proportion of fixed rate bonds in our deals versus others. So, I think that’s probably the most obvious difference between US and others in Europe. In the US that’s less so I think up until a few years ago, Volker restricted any bonds at all going into the CLOs and I think even now most managers just have a small 5% bucket, so it’s less of a thing in the US but in Europe that’s a big distinguishing factor. I would say generally, and this applies to both sides is we’ve got a very active management style, so we have a high churn rate. We have deep resources. So, I think across the US and Europe we’ve got 35 credit analysts and 15 people on the desk between portfolio management and traders. So that is to allow us to analyze things quickly, take a view quickly, and churn the portfolio – mostly through primary. So, replacing assets that are less good relative value with the primary assets that come in. So, I think that is something we would say over and above what most people do in our DNA.

Shiloh Bates:

So how big is the European CLO market?

Brian Nolan:

I don’t have the number in front of me, but I think it’s about a quarter to a third of the size of the US market. So it’s materially smaller. I think it’s really since 2013 when 2.0s started going. I can tell you a busy year for us in Europe is maybe 9 or 10 deals in a year where our US colleagues are in the twenties and thirties number.

Shiloh Bates:

So that’d be about 300 billion or so euros I guess.

Brian Nolan :

Yes.

Shiloh Bates:

And then in Europe, are CLO securities only denominated in euros or are there other currencies that you guys are dealing with?

Brian Nolan:

The vast majority is in euros. Within the CLOs or you mean the liability structure?

Shiloh Bates:

I’ll take both.

Brian Nolan:

So within the CLOs we have a construct here in Europe called a perfect asset swap, which is a derivative that you sign with one or two banks that offer it here where it basically hedges your FX and is also linked to the underlying assets such that if the asset prepays you or if it defaults, the swap is linked to that so you don’t end up with a big mark to market payment that you need to make.

Shiloh Bates:

Interesting.

Brian Nolan:

It is, it’s quite bespoke, which makes it quite expensive. So for instance, you could have a sterling asset that pays you 500 over and the cost of the swap might be a hundred or 150 basis points of that. So the actual real term, what you’re comparing it to on the Euro side, it has to be something compelling for it to make sense for the costs that’s involved. So, I would say in Europe I suspect if you looked originally back in 2013, 2014 when the loan market was much smaller, you probably did have some of this happening as people were stretching to get diversity. As the European market has matured, I think you have a lot more options in Euro loans now that it would be a small minority of managers that still use that flexibility. On the liability side, it’s interesting because the vast majority of CLOs are issued in Euro. We actually issued the only GBP Sterling CLO, so that was back probably about seven or eight years ago now. That was just before Brexit. It was a very distinctive trade and that was called a couple of years ago, so it doesn’t exist anymore. That’s the only non-euro deals that I’m aware of up until I think there was a mid-market CLO that was done quite recently, which was GBP Sterling as well. So 99% of it will be in euros.

Shiloh Bates:

How many CLO managers do you have in Europe?

Brian Nolan:

So this is an ever-increasing number as a lot of US platforms are moving over to Europe. I think if you look at people that have actively issued a deal in the last year or two, you’re probably talking about 50 to 60 managers. If you actually look at every manager that has a deal outstanding, it’s probably more like 70 80, but a large chunk of those have not been active for a long time and I think that’s grown significantly. You probably add high single digits of managers over the last four or five years. In terms of new entrants to the market

Shiloh Bates:

Geographically, are most of the managers in London or spread around Europe?

Brian Nolan:

The vast majority will be in London. You have three or four in Dublin, in Ireland, I’m aware of a couple in Scandinavia and maybe one in Spain and then a few France maybe. But I would say probably 80% plus based in London.

Shiloh Bates:

So then talking about getting into the assets in the European CLOs and how they’re different from the US, the loans that go into CLOs often are created in leveraged buyouts. Is the continent, is Europe as friendly to private equity activity as we are here in the US?

Brian Nolan:

I think that depends on whether you’re looking at creation or other things that happen along the lines. So, I think one thing Europe has – can be seen as a positive or a negative – you have a lot of regional diversity, so you have different domiciles but different regulations and different laws. So, I don’t think anything could be as friendly as the US because obviously it’s very uniform there and very business friendly. That leads to potentially less efficiency on the LBO side, what it does potentially benefit you on the other side of things is if things go wrong, what you can see is the different regulatory regimes in Europe that are maybe not as sponsor friendly as the US would be do mean that you see things like less LME activity, you see a bit more of a relationship based interaction between sponsor and CLO managers versus a transactional one, which maybe you might see more in the US. That’s very much looking for the positives. I mean up until the last few years when LMEs started to come through in the US I think in Europe there was a lot of frustration with how long things took and the various hoops you had to jump through in various jurisdictions.

Shiloh Bates:

So in a European CLO, is it easy to come up with enough underlying loans so that you have the diversity that the CLO requires?

Brian Nolan:

Ultimately I think that is becoming more difficult as the years go by and more managers come to the market. So LBO activity in Europe, since the interest rate spikes in ’22 has really slowed down, whereas issuance on the CLO side has not really. So, you’re definitely seeing significant demand for loans where the supply is not necessarily coming through on LBOs. So I think you definitely can struggle to do it in a fast way and I think a good example of this is maybe print and sprint transactions. So I think these happen quite frequently in the US and I know obviously the most about our platform versus our US colleagues and how easy it can be for them to do a print and sprint transaction. Whereas in Europe, while there have been some done, and we did one, our original deal in the 2.0 era was a print and sprint, it definitely is more difficult to get that many assets very quickly.

Shiloh Bates:

So the print and sprint in case people don’t know is just a CLO is forming without really any assets in a warehouse or a very small warehouse if there is one and the CLOs come into life and all the assets are just being bought in the secondary market.

Brian Nolan:

Yes, in a very short period of time. Whereas I think the typical warehousing period here in Europe is you generally ramp up those assets over a three-to-six-month period before you issue the CLO. And to your point around diversity, I guess this is one key difference between the markets, so defining what’s an acceptable level of diversity is quite different between the European and the US markets. So I think your typical US transaction is going to have somewhere between 250 to 350 individual obligors, whereas a European deal is probably half of that. And I think that’s a function of the smaller market and I would say that diversity amount has increased in Europe over time. If you go back to when the market opened in 2013, it would not be uncommon to see less than a hundred obligors in a portfolio, whereas now it’s probably around the 150 number.

Shiloh Bates:

Does that tie to your earlier comment about putting bonds in your portfolios that it’s easier to get the diversity you need if you’re also looking at senior secured bonds?

Brian Nolan:

That was absolutely one of the key drivers when we originally issued our first European CLO 2.0. So I think as the loan market has matured, it’s become less necessary, but we still think that your top 10 bond ideas are going to be better than your worst 10 loan ideas. So even though it might not change the number of obligor, it should give you access to a better quality of obligor.

Shiloh Bates:

So the base rate in your market is euribor, am I pronouncing it correctly?

Brian Nolan:

Correct.

Shiloh Bates:

So the loans are floating on euribor and are they paying 300 over like in the US?

Brian Nolan:

No. Typically if you look back on the long-term averages, I would say the European market generally is at a premium to, on a spread basis. A portfolio today is probably somewhere between 340 and 380 depending on the style of the manager. Whereas I think in the US as you said, it’s closer to 300.

Shiloh Bates:

And so what accounts for that premium over the US does that reflect liquidity or potentially higher loan losses that you need to be compensated for?

Brian Nolan:

I think primarily it’s driven by CLOs. So in Europe the CLO buyer is in excess of 80% of the loan market, so we wouldn’t have the alternatives to CLOs that the US would have. And on the other side of the equation, CLO liabilities generally price at a premium to the US. So in order for the arbitrage to work, the CLOs are floored at a certain level and because they make up so much of the market that technical can sometimes put a floor on where spreads can go until liabilities come in tighter. Equally, you could argue the loan market is definitely less liquid in Europe we would still consider it a liquid market, but it wouldn’t be the same as the US. So you could also imply that there is some illiquidity premium there versus the European equivalents.

Shiloh Bates:

So then SOFR, the secured overnight financing rate is the base rate for US CLOs. So that’s roughly four and a quarter. Where’s euribor? I know that’s been coming down. Where does that sit today?

Brian Nolan:

Probably date myself here. I haven’t checked it recently. It’s somewhere in the two and a half percent area, I think

Shiloh Bates:

Two and a half. So the ECB has been cutting.

Brian Nolan:

Yeah, I don’t think went as high as you guys, but then we’ve been cutting as well.

Shiloh Bates:

So then the underlying loans geographically, is it mostly the UK, Germany, France, and maybe Spain or what’s the country mix there?

Brian Nolan:

I mean the ones you’ve named are generally the top. I would say the largest countries would probably be still below 20%. So it would have a regional diversity there, the UK, France and Germany would be the largest. Then you would have Spanish, Italian, Scandinavians as well as some more peripheral countries. So that is one thing I think a US CLO will have more obligor diversity, but a European CLO will have that regional diversity where you do have some diversity benefits from having exposure to multiple geographies.

Shiloh Bates:

So in the US I think that investors in CLO equity for example are assuming a loan loss reserve, which is a 2% default rate and a 70 cent recovery rate. In prior podcasts I’ve talked about that being maybe a little bit antiquated or a little bit too beneficial for the CLO equity investor. How do those compare to what’s happened in Europe and what investors should expect maybe going forward?

Brian Nolan :

See, I think the one thing we always say in relation to this is that A CLO is an actively managed portfolio. So when we look back across all of our portfolios over the last 10 years we’ve done this analysis and the vast majority of our deals actually have a positive annual trading. So when you take away the losses versus the positives, depending on certain vintages for instance, if you go out of reinvestment period just before there’s a downturn and you lose the flexibility, those vintages can be the most difficult. But I would say the headline numbers in Europe, the default rate has been materially below that over the course of the 10 year average. Obviously that will differ year to year and the recovery rate is, again, this is very idiosyncratic because you’re going to have one that’s 20 and another one that’s a hundred.

I think the average is in the 60 to 70 range across those defaults that have happened. So I think the recovery rate is 1 – Obviously as the market has gone cov-lite, there was a lot of discussion around whether recoveries were going to be later or worse than long-term averages. I don’t think there’s been enough defaults in Europe ready to get a meaningful amount of data on that, but what we have seen so far is obviously on a case by case it can be wildly different, but if you look at the average across a bigger data set, we don’t see a huge difference in the long-term average.

Shiloh Bate:

So are the assets leveraged on assets four and a half to five and a half times EBITDA with interest coverage around three times?

Brian Nolan:

That depends on whose numbers you use. If you use the company numbers, that probably sounds about right. I think it differs per industry, but I think certainly on our numbers we obviously do our own internal forecasts and look at add-backs and what ones are realistic In terms of one-offs, we would see it probably slightly ahead of that. I don’t work on the portfolio management side of the team, I wouldn’t be as close to that data as those guys would. I think your numbers sound like company projections in line with what we’re typically seeing

Shiloh Bates:

Is the reinvestment period in Europe, is it typically five years like the US?

Brian Nolan:

I would say the average is probably four and a half. And I would say five years ago it was probably four years. So it’s slowly migrating and we have seen deals that have done at five as well, but my understanding of the US market is it’s much more standard to be five in most deals.

Shiloh Bates:

And so what’s a good AAA spread over euribor if you’re issuing a deal today?

Brian Nolan:

So today I think the European market is potentially starting to distinguish between new issue and reset and also between managers. So I know you’ve seen tiering in the US market for a long time and I think it’s probably a sign of the European market maturing more that we’re starting to see that. I would say for a new issue deal today you’re probably looking at 130 or low 130s. For a reset, you’re probably looking at mid 130s and then yeah, you could see certain deals in the high 130s depending on if it’s a reset, the quality of the portfolio and the manager and things like that.

Shiloh Bates:

So the spread for European AAAs is pretty comparable to what you find in the US then

Brian Nolan:

Today, I think so, yes. I think that has diverged over time, but as of today it’s actually remarkably close.

Shiloh Bates:

So then for the equity tranche, is that much more profitable in Europe given the numbers you went through? I mean if the AAA financing cost is the same as the US but the spread is 50 to 80 bps more on the assets, that should be pretty lucrative for the equity tranche?

Brian Nolan:

Yes, so I think down the structure you probably are a little bit wider in Europe. So when you’re looking at the weighted average cost, you should be wider in Europe than you would be in the US. But we’ve done some analysis looking back since 2018 we’ve done the high-level arbitrage calculation, which is the spread on the assets minus the cost of debt times the leverage. We would typically see Europe being somewhere between, and this is proportional, not eight points higher, but about 8%. So if it’s 15% in US, the equivalent would be about 16 or 17 in Europe. So I think it’s generally looked a little bit higher. The other thing in Europe is we issue a single B tranche in almost every transaction, whereas I think that’s quite rare in the US.

Shiloh Bates:

It is, yeah,

Brian Nolan:

Which means you get more leverage, but obviously it’s more expensive leverage, but overall in Europe it’s accretive to the returns.

Shiloh Bates:

So at Flat Rock we also invest in BBs. What’s the spread over euribor for BB these days?

Brian Nolan:

So the spread, I think it’s probably in the low 600s right now. I think that can be a bit volatile per manager and I think it’s demand and supply and technicals can have a big impact on that market. If you have a lot of deals all come at the same time, that can suddenly blow out to 650, 700 pretty quickly. And equally in a very strong market it could be as tight as 500, but I think in today’s market you’re probably looking at high five hundreds, low six hundreds.

Shiloh Bates:

Then does the lack of diversity when compared to the US, does that mean that the CLO needs some additional equity capital to support the BB?

Brian Nolan:

Yes. For instance, AAA, your typical subordination in the US is somewhere between 35 and 36%. The equivalent in Europe would be more like 38 to 39%. So, you are going to have less leverage across your structure if you just go down to BBs, you will have to issue more equity in Europe. But typically what happens is they issue single Bs as well. So actually if you look for the same size deal in Europe, you would generally have a smaller equity ticket, but because you’re getting less efficient leverage, you’re going to have a more expensive leverage than you would in the us.

Shiloh Bates:

So what are the economics then of the single B?

Brian Nolan:

The single B can be volatile. So right now it’s probably high eight hundreds, low nine hundreds, DM probably at a price of 98 or 97.

Shiloh Bates:

And then once you issue the BB and the single B, how much equity is left in the deal? Is it 7% or 6% or something?

Brian Nolan:

So the enhancement on the junior note is 6.5%. So for say a 400 million transaction you could do 30 million or 31 million of equity.

Shiloh Bates:

And then is the equity in Europe, is it typically bought by third parties like a Flat Rock, or is the manager putting the CLO equity into their own funds?

Brian Nolan:

So, this has evolved considerably over the last four or five years I would say. So PGIM is now one of the minority of CLO managers that is 100% third party equity. So in our transactions, 95% is sold to third parties. I think if you look at the rest of the top 10 managers, they all have captive equity funds. So it’s effectively the managers managing that money instead of each individual deal having an individual third party. If I was to talk about percentages of the market, it’s not all published anywhere, but I think you’re probably out of the 50 managers that are currently active, you’re probably talking somewhere between five and 10 of them are third party equity guys. The rest would be captive fund guys and I would say five, six years ago that was probably closer to 60/40.

Shiloh Bates:

So then are people investing in Euro CLO securities? I mean these are investors that their assets are in euros as well, or do you think people are like myself, I’m a US dollar funder if you will, so people give me their US dollars, they want to return in dollars. Are you seeing people like me come across the pond looking at European CLOs and just maybe taking the currency risk or trying to hedge it? Or are these more European asset managers who already fund in euros and the risk return of CLO equity or BBs or up the stack?

Brian Nolan:

See, I would say certainly on the equity tranche, if look at our equity investors, you’re pretty close to 50/50 I would say between the US and Europe. So we do have a lot of US investors that relative value between the US and the European market at any given time and any hedging that they’re doing is happening away from the CLO. So I don’t see what that looks like, but presumably they are hedging it somehow. And I think similar to the US, I mean when you go into the debt of the structure, certainly on the AAA level, a large portion is coming out of Asia, in particular Japan, but you would have some US banks there as well.

Shiloh Bates:

So the AAA through maybe single A that comes out of Japan. I mean those are banks that are buying Euro CLOs and then they have some hedging program that converts those euros back to yen at some point.

Brian Nolan:

Yes. So these are quite established buyers. They’re buying big size. So I think this happens between the bank and them, so we’re not party to exactly what it looks like, but that would all be 100% hedged on their side. I think it’s a lot easier to hedge AAAs where you know the cash flows versus equity, which can be a lot more variable.

Shiloh Bates:

Then if somebody is doing relative value, let’s just stay with equity for a second amongst the two different markets, I guess it’s easy to run your scenarios through Intex and presumably the US CLO equity tranche and a European would spit out different projected IRRs. Would in general that potential investor, would they see the European collateral pool as a more safe and stable one?

Brian Nolan:

I think that’s changed over time. I would say historically US pools were always viewed as lower risk and more diversified and better quality, especially with the LME activity we’re seeing in the US. I think a lot of people are starting to question that. Additionally, I mean certainly the course of this year, I was just at the global ABS conference in Barcelona where we met a lot of international investors and there’s definitely a tone of people that were historically all in on US maybe thinking that diversity away from the US is maybe the thing to do right now. So I think that historically it’s always been viewed the US is the superior market and you don’t get many European investors that don’t do US, but you get a lot of US investors that don’t do Europe. But I think there may be a bit of a change given the recent macro events.

Shiloh Bates:

So, if somebody were to begin investing in European CLO securities, my understanding of the market is that it’s pretty clubby. Whereas in the US CLO market, it’s a lot of people with sharp elbows I think and relationships matter, but the economics of trades is really the key driver. Is it possible, I guess people are doing it, but you see a lot of investors come over there and have success in navigating a market that’s more relationship based?

Brian Nolan:

I think so, and I think you probably distinguish at this point between taking majority equity and being involved in the warehouse versus when the deal is brought to market and maybe a minority is sold at that point. I think the relationship aspect in Europe is huge in terms of deciding to do a transaction together and being involved right from the warehouse stage through to the CLO. Where it gets maybe a bit more transactional is if you want to sell some equity at the time of your CLO pricing, I think runs will be sent out to everyone and everyone will put their bids in. That will be a lot more transactional. So I haven’t been involved in the US market to know if that follows the same dynamics, but I think in Europe, and I think this is what most people do, it’s you go to some of these conferences and all of the managers are there, and if you sit down with a manager and you express an interest in getting involved in equity, I think most of them will go out of their way to help educate and get anyone up the curve and explain to them how things work.

And you probably do that with multiple managers, so you don’t have a single guy, but I don’t think it’s a difficult club to penetrate, especially if most European managers will have a US affiliate and if there’s a relationship existing on that side of things, it obviously makes things a lot more easy as well. But I think it’s a fairly open community and I think the problem certainly from an equity perspective is the amount of captive funds that are in the European market means that with those funds, minority equity is the only piece that’s sold and that is usually sold in the transactional way on the day of pricing, whereas the 95% third party guys is still very relationship based.

Shiloh Bates:

In the US we have around 100 active managers, and I think if you’re willing to invest in one of their warehouses, be that equity and participate in the takeout, I think it’s probably not too hard to find many who will take you up on that.

Brian Nolan:

I would say that historically was the case in Europe you had a big pipeline and the successful managers generally had, and this is a European perspective, quite a lot of warehouses, but you might have three or four open at a given time, which is probably about a year’s worth of issuance. So, getting in the pipeline was generally a year in advance. I would say with the amount of new entrance to the European market as well as the amount of secondary or in minority equity that’s available at primary from the retention fund type vehicles, we’ve seen that lower down a bit because I think there’s more supply than there used to be, and I don’t think the equity base has materially increased. So, I think it used to be, as you describe in Europe as well, probably less so in the last couple of years.

Shiloh Bates:

So one of the big changes to the US market over the last two or three years is just the rise of ETFs, the exchange traded funds, where lots of retail investors now own CLO securities. Is that something that is beginning in Europe?

Brian Nolan:

I think it’s beginning. So I think we’ve got three or four that have launched in the last year or so. None of them to the scale of what we’ve seen in the US yet. I’m not an expert on the regulations behind it, but my high-level understanding is the retail investor is a lot harder to access in Europe, whereas in the US you can go onto your personal trading app and access a bunch of these things. In Europe to get it to show up on your list, you’ve got to qualify as a certain type of investor, which means going out of your way to answer some questions and get signed off. So I think the barriers to investing are a bit higher in Europe, but I think if you look at generally how things go, if it works in the US with a lag effect, it’s likely to come to Europe as well. We’re just a little bit behind you guys.

Shiloh Bates:

Are there any other big differences between European and US CLOs that we haven’t covered?

Brian Nolan:

One thing that is present in European CLOs that is probably viewed as a negative in US CLOs is maybe the ESG elements. So, in European CLOs it’s become fairly standard to have an exclusion list in your CLOs and you’ve got a lot of European managers and a lot of this is coming from the European investor base that is very ESG focused.

Shiloh Bates:

ESG is the inclusion of environmental, social and governance factors in investment decisions.

Brian Nolan:

And a lot of managers are doing a lot of ESG work on their non-CLO funds. So you’ll see a lot of managers including us, will put additional ESG information in their reports as well as having quite a conclusive ESG exclusion list.

Shiloh Bates:

Okay, so ESG exclusion would, so we’re talking about dirty coal and what other industries can be excluded or would be commonly excluded?

Brian Nolan:

You can have stuff like gambling, tobacco, alcohol, anything. This can differ a lot between transactions, but I think in a typical European transaction you probably have somewhere between 20 and 30 exclusions and it would be a lot of the energy ones, a lot to do with weapons and ammunition, anything that someone somewhere has thought that that could be viewed as an ESG point. So you probably have, I’m not an expert on US documentation, I think there are some exclusions that go into US documents, but I think they existed for a long time. I would say that it’s significantly more comprehensive in European transactions.

Shiloh Bates:

In the US I hear very little talk of ESG and I think it’s partially because of the difficulty in quantifying the criteria. Any other key differences, Brian?

Brian Nolan:

Maybe the risk retention as well. So obviously historically this was present in the US as well, but I don’t know how long ago, seven, eight years ago, it was repelled in the US so it’s not a thing anymore unless you have a manager that wants to do it for accessing European investors. But obviously every deal in Europe is risk retention compliant, which is a 5% co-investment in the vehicle by the sponsor or the originator, which in the vast majority of circumstances is the manager or a manager entity. Or you can have some people use a third party originator where I think it’s a skin in the game thing. So to qualify, you basically have to take underlying risk on the assets that are going into the CLO. So I think you, depending on who you talk to, I mean I think a lot of European managers would say it’s not needed, but from an investor perspective, I think it’s probably only a good thing if the manager is required to put skin in the game as well.

You have two ways of solving for this, which is either a vertical retention where you take 5% of every tranche or you take it horizontal, which is you take 5% of the transaction size in the equity tranche. So I think historically we call them captive funds, but most of them in Europe started out as retention funds where managers would go out and raise enough capital to do the next seven, eight deals and be the retention provider. I think that’s evolved a little bit in Europe that people are doing it over and above just for retention purposes. But I think that’s a key difference. And again, this is maybe a European perspective, but I think when the manager has a requirement to put 5% of the capital into the structure, it does maybe raise the barrier of entry in Europe from a manager perspective. And also I guess over time this may be compresses, but I think historically European management fees have been higher than the US and I think generally what we’ve always said is that capital requirement is potentially part of that as well, that in order for it to be economic for the manager to put 5% into every transaction, it does have that impact in terms of the hurdle rate on the fee side.

So I think that the retention is quite a big difference and it probably has a couple of knock-on effects.

Shiloh Bates:

So European risk retention is something I come across quite a bit just because in our US CLOs there is not the requirement, at least for broadly syndicated, there is not the requirement for the manager to own the 5% vertical strip or half the equity roughly. But when you’re selling CLO securities, there’s a lot of investors in Europe who if you want to market the CLOs, AAA or whatever to them, the CLO needs to be risk retention compliant. So even if you’re not bound to those rules in the US, the manager or some affiliated vehicle needs to buy the CLO securities so that you can gather up European investors if you want to go that route.

Brian Nolan:

Yeah, I think you’ll know better than me, but anecdotally, I think someone told me it’s somewhere around the 1 in 10 transactions is risk retention compliance in the US. So yeah, obviously that’s 100% in Europe

Shiloh Bates:

I do a lot of middle market CLOs and those are actually still on the European standard. So there’s still the risk retention capital is required here in the US.

Brian Nolan:

As an investor, do you see that as a positive, negative or neutral

Shiloh Bates:

If a manager, let’s say they own a 5% vertical strip, do I really care? Not that much. I mean imagine, so 65% of what they are committing to is AAA. They’re comfortable owning the AAA in their own deal. It’s not a huge vote of confidence for me. And then 5% of the equity and the other more junior securities, I think it’s helpful. I mean I would take it if offered. I think for a lot of CLO management platforms, they do a lot of deals and to put up 5% of the capital on each one, I think that’s really quite a burden on their platform. I think probably the ultimate alignment is we’ve been in some deals where the CLO equity is also going into the personal PAs, the personal accounts of the CLO managers so directly in, and that is I think a very strong alignment.

Let’s say a manager hasn’t invested in any of the CLO securities that I’m in. So what’s the alignment? Well, I think it’s still pretty strong because 1 – there’s an incentive fee that could be material for the manager if they really perform. 2 – CLO management is a competitive business and if a CLO manager doesn’t do a great job with the assets, then they’re going to struggle to find new investors. So I don’t think there’s a risk that there’s some orphan CLO at the manager where they didn’t invest in it and don’t prioritize it like the others. I just don’t see that as a risk.

Brian Nolan:

No, I think a lot of CLO managers would agree with you on that one. Certainly from the capital requirements of building a large platform point of view.

Shiloh Bates:

How easy is it to get allocations of new loans in Europe?

Brian Nolan:

Relationships still play a key part. I mean a typical loan that comes to market that is well liked by CLOs can be quite easily six to seven times oversubscribed. So the relationships do become a big part of it. And obviously, yeah, the bigger you are, the more important you are to the bank. Typically that would lead to better allocations. So you could say that maybe the managers that don’t have those relationships are potentially taking all the stuff that the other guys don’t want. But I think even as one of the biggest managers, while we might get an oversized allocation, we still on a deal like that, it’s not like you’re getting anywhere close to a hundred percent fill. So if you look at the amount of managers across the market and the amount of assets in their deals, I think it’s probably gotten a little better than it used to be in terms of new managers getting allocation and all the different term loans. My time from banking, all I know is A and B where A was amortizing and B was a bullet. And that’s actually one difference I think actually with US and Europe that I didn’t cover is the US deals will generally have a small amortization in them, the underlying loans, whereas Europe is very much bullet.

Shiloh Bates:

So you don’t have the 1% amortization, it’s just 0 amortization and

Brian Nolan:

Exactly

Shiloh Bates:

You’re due the principle at the end.

Brian Nolan:

Speaking to our US guys. Obviously when a CLO goes post reinvestment period, it becomes a bit more restrictive on what you can reinvest and the documents are very prescriptive in terms of the source of the funds and what you can do with that. So I know having that amortization coming in on 250 loans makes things significantly more complicated in the US to reinvest post reinvestment period. So that’s something that we’ve become more aware of as we have our monthly meetings and we talk about what’s the workload in each of the teams and they’re spending a lot of time on figuring out reinvestment and we’re going, what are they doing until we found out what the reason was. So that’s an interesting quirk. I dunno why that is the case, but yeah, Europe bullet loans don’t have any amortization.

Shiloh Bates:

One thing you mentioned was that the management fees are higher in Europe in the US for broadly syndicated. I would say 40 basis points is probably a fair fee, and then the incentive is 20 over 12. The 12 has to be earned in cash, so it takes a while for that to be paid to the manager. Obviously they have to earn it. What’s the average fee across the pond?

Brian Nolan:

I would say up until maybe the last couple of years, if I look back on ours, the incentive would be the same, but the headline number would be 50 instead of 40. I would say in the last couple of years it’s maybe begun to compress a little bit, so maybe into the mid forties, but long-term average has always been higher than the US and I think obviously we’ve got quite a big manager in both markets, so we can see that over time. But I don’t know if the US is compressing in the same way that Europe is right now. But up until two years ago, we didn’t really have any struggles getting 50 basis points on every deal. I would say that’s maybe more of a hot topic at the moment than it historically has been.

Shiloh Bates:

Great. Well why don’t we leave it at that. Brian, thanks so much for coming on the podcast. Really enjoyed our conversation.

Brian Nolan:

Thanks for inviting me. I had a lot of fun.

*******

Disclosure AI:

The content here is for informational purposes only and should not be taken as legal, business tax or investment advice, or be used to evaluate any investment or security. This podcast is not directed at any investment or potential investors in any Flat Rock Global Fund.

Definition Section:

• Secured overnight financing rate SOFR is a broad measure of the cost of borrowing cash overnight, collateralized by Treasury securities.

•  

• The global financial Crisis GFC was a period of extreme stress in the global financial markets and banking systems between mid-2007 and early 2009.

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• Credit ratings are opinions about credit risk for long term issues or instruments. The ratings lie in a spectrum ranging from the highest credit quality on one end to default or junk on the other. A AAA is the highest credit quality, a C or a D, depending on the agency, the rating is the lowest or junk quality.

•  

• Leveraged loans are corporate loans to companies that are not rated investment grade.

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• Broadly syndicated loans are underwritten by banks, rated by nationally recognized statistical ratings organizations, and often traded among market participants.

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• Middle market loans are usually underwritten by several lenders, with the intention of holding the instrument through its maturity.

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• Spread is the percentage difference in current yields of various classes of fixed income securities versus Treasury bonds, or another benchmark bond measure.

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• A reset is a refinancing and extension of a CLO investment period.

•  

• EBITDA is earnings before interest, taxes, depreciation and amortization. An add-back would attempt to adjust EBITDA for non-recurring items.

• LIBOR, the London Interbank Offer Rate, was replaced by SOFR on June 30th, 2024.

•  

• Delever means reducing the amount of debt financing.

•  

• High yield bonds are corporate borrowings rated below investment grade that are usually fixed rate and unsecured.

•  

• Default refers to missing a contractual interest or principal payment.

•  

• Debt has contractual interest, principal and interest payments, whereas equity represents ownership in a company.

•  

• Senior secured corporate loans are borrowings from a company that are backed by collateral.

• Junior debt ranks behind senior secured debt in its payment priority.

• Collateral pool refers to the sum of collateral pledged to a lender to support its repayment.

• A non-call period refers to the time in which a debt instrument cannot be optionally repaid.

• A floating rate investment has an interest rate that varies with the underlying floating rate index.

• RMBS are residential mortgage-backed securities.

• Loan to value is a ratio that compares the loan amount to the enterprise value of a company.

• GLG is a firm that sets up calls between investors and industry experts.

• A Risk Retention Fund is a third-party fund raised by CLO managers to comply with the CLO Risk Retention Rules.

• The US CLO Risk Retention Rule was introduced in 2014 under the Dodd-Frank Wall Street Reform and Consumer Protection Act requiring CLO managers to retain not less than 5% of the credit risk associated with each of their CLOs. In 2018, the US risk retention requirement reversed for BSL CLO managers after being successfully challenged in court.

• LME stands for Liability Management Exercises which are strategies often used by sponsors or select lenders to restructure debt obligations of distressed companies in order to avoid traditional default proceedings.

General disclaimer section:

Flat Rock may invest in CLOs managed by podcast guests. However, the views expressed in this podcast are those of the guest and do not necessarily reflect the views of Flat Rock or its affiliates. Any return projections discussed by podcast guests do not reflect Flat Rock’s views or expectations. This is not a recommendation for any action and all listeners should consider these projections as hypothetical and subject to significant risks.

References to interest rate moves are based on Bloomberg data. Any mentions of specific companies are for reference purposes only and are not meant to describe the investment merits of, or potential or actual portfolio changes related to securities of those companies, unless otherwise noted. All discussions are based on U.S. markets and U.S. monetary and fiscal policies. Market forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee. The views and opinions expressed by the Flat Rock Global Speaker are those of the speaker as of the date of the broadcast, and do not necessarily represent the views of the firm as a whole. Any such views are subject to change at any time based upon market or other conditions, and flat Rock global disclaims any responsibility to update such views. This material is not intended to be relied upon as a forecast, research or investment advice.

It is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Neither Flat Rock Global nor the Flat Rock Global speaker can be responsible for any direct or incidental loss incurred by applying any of the information offered. None of the information provided should be regarded as a suggestion to engage in, or refrain from any investment-related course of action, as neither Flat Rock Global nor its affiliates are undertaking to provide impartial investment advice. Act as an impartial adviser or give advice in a fiduciary capacity. Additional information about this podcast, along with an edited transcript, may be obtained by visiting flatrockglobal.com.