Month: February 2025

Shiloh Bates:

Hi, I am 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 am speaking with Mike Comparato of Benefit Street Partners to discuss commercial real estate, CRE, CLOs. Mike and I worked together at Benefit Street before I joined Flat Rock seven years ago. At Flat Rock, we invest in CLOs backed by corporate loans, where private equity firms are buying companies and looking to add leverage to the returns they seek. In CRE CLOs, the underlying real estate properties are going through some type of upgrade or transition. I thought Mike would be an ideal guest to shed light on another variety of CLOs that exist in the market. In full disclosure, my firm is also an investor in Benefit Street’s CLOs, corporate CLOs, that is. If you’re enjoying the podcast, please remember to share like and follow. And now my conversation with Mike Comparato. Mike, thanks so much for coming on the podcast.

Mike Comparato:

Thanks for having me, Shiloh.

Shiloh Bates:

Mike, why don’t we start off with your background and how you ended up being a CRE CLO manager?

Mike Comparato:

Sure. So I’ve been in and around commercial real estate, literally, since birth. I was very blessed and privileged to be born into a development family that started in 1946. So my grandfather and great- grandfather actually started our family development company after he returned from World War II. I was on construction sites at three years old. They built shopping centers, office buildings, apartment buildings, condominiums, kind of everything. I’ve always really had commercial real estate in my blood. Professionally, I’ve been in the business for 30 years, roughly, and have been at Benefit Street for about the past 10, and we’re one of the most active middle market commercial real estate lenders in the space. We say middle market, that’s typically focusing on 25- to 100 million-dollar whole loans, occasionally, underwrite and close stuff smaller than that. Occasionally underwrite stuff bigger than that. But generally speaking, that’s where we compete. We finance all asset classes, but have a real focus on multi-family. So a lot of what we do is in the multi-family sector, probably 75 to 80% of what we do is in the multi-family sector.

Shiloh Bates:

How many CRE CLOs do you guys manage today?

Mike Comparato:

Outstanding CRE CLOs, I’m going to guess, around a half a dozen. We’ve probably issued 13 or 14 over the years. Some of them have been called, some of them just aren’t outstanding anymore. I think we consider ourselves one of the larger, more active issuers within the CRE space on that front.

Shiloh Bates:

So Mike, when I tell the story of corporate loan CLOs, I like to start by just going into detail on the assets you can find in the CLO. What are kind of the key characteristics? So why don’t you do that for CRE CLOs to start?

Mike Comparato:

So it’s all obviously commercial real estate. Generally speaking, it is senior mortgages within commercial real estate. We’re not seeing any sort of subordinate debt or mezzanine pieces that have made their way into the CRE CLO trust at this point. And it’s usually all shorter duration, floating rate, typically transitional commercial real estate assets or some sort of value-add commercial real estate assets. We are seeing a few instances now where there’s some more stabilized product coming into the space, just because people are of the belief, right or wrong, that interest rates could be lower in future years. So they don’t want to lock in long-term fixed-rate debt today. So we are starting to see a little bit more stabilized product in the CLO structure. But I would say, generally speaking, there’s almost always some component of value-add or upside in most of the loans that find their way into a CRE CLO.

Shiloh Bates:

So how many loans would you find in a CRE CLO?

Mike Comparato:

I would say it probably ranges from a minimum of 15, upwards of maybe 50 or 60 appears to be the max. It’s very much a middle market vehicle. It doesn’t really work well in the rating agency model to have 100-, 200-, 300 million-dollar loans. It’s really built for diversification and granularity, and so it naturally gravitates towards middle market lenders. I would say the typical deal size is usually around 800 million, minimal, to about 1.2 billion. Again, not to say that there aren’t CLOs smaller than that, and there’s been a handful that are larger than that, but generally speaking, you’re kind of seeing that 800 million to 1.2 billion range for an individual issuer.

Shiloh Bates:

So, was it the CLO size is 800 million plus or the loans are 800 million plus and you’re putting pieces of them into the CRE CLOs?

Mike Comparato:

Well, the CLO is 800 million plus.

Shiloh Bates:

Oh, I see. Okay.

Mike Comparato:

We’ll aggregate individual loans. You’ll close 40 individual loans ranging from 20, 30, 60 million each, and they aggregate up to that 800 million. We’re actually closing the loan, putting it on our balance sheet.

We’re typically using some sort of warehouse financing to bridge that to the CLO execution. But then we pool all of those closed loans together and issue the CLO and we retain the bottom part of that capital stack.

Shiloh Bates:

So, in corporate loan CLOs, the underlying loans usually have a loan to value of about 50%. What’s the loan to value in a CRE CLO?

Mike Comparato:

So again, most of the loans that find themselves in the CRE CLOs have some component of transition or some component of value-add. So there’s really two LTVs, loan to values. One is the as-is current loan to value, and then one is the as-stabilized loan to value after the completion of the business plan, whatever that business plan may be. So it deviates depending on how deep or heavy the business plan is. But I would say, generally speaking, we’re seeing as-is LTVs in the 70, 65, 70, 75% range on individual loans and the as-stabilized loan to values in the 50 to 60% range on an as-stabilized basis.

Shiloh Bates:

Is SOFR, the secured overnight financing rate, is that the underlying floating rate benchmark in your market?

Mike Comparato:

Yes. Everything is priced over SOFR.

Shiloh Bates:

And then what’s the typical spread for the underlying loans in these portfolios?

Mike Comparato:

The market’s gotten very tight. Again, we’re back to the tights. We saw that peak valuations in Q4 ‘21, Q1 ‘22, actually, probably, inside of those levels in the whole loan origination side of things. A middle of the fairway multifamily loan today could price at, probably, SOFR 250 to 300 over. Hospitality is probably SOFR 375 to 450. Industrial is probably going to price closer to multi-family. Retail is probably going to price somewhere in between multi-family and hospitality, and then office is a disaster unto itself. We haven’t seen a whole lot of office, transitional office loans, get done. We actually wrote our first office loan about six months ago, maybe eight months ago. It’s the first one we’ve written in probably three years. That was SOFR 1000. And that loan’s already been repaid in full. We’ve only done one office loan. We haven’t seen a bunch of it out there. Your guess on pricing is probably as good as mine.

Shiloh Bates:

Oh, so the performance of these loans must be pretty good if that’s the rates, if those are the rates, where they’re borrowing today?

Mike Comparato:

Yeah, I mean, I think you’re comparing to the corporate world. It’s a little bit apples and oranges. You’re dealing in commercial real estate with a physical asset. I’m sitting in New York, in our office. I’m looking across the street at a building that was probably built in 1910. It’s still being used. It’s still there. There’s still tenants and they’re paying rent. So it’s got just a risk profile that I think the market thinks is a little bit different than a corporate CLO. That’s why we think they price where they do. I wouldn’t say that it’s

necessarily the actual performance at the asset level as much as it could be just the asset itself and its potential performance per se.

Shiloh Bates:

So in the corporate loan CLOs that I usually invest in, they finance themselves by issuing debt rated AAA at the top down to double-B at the bottom, and then there’s roughly like 8 to 12% equity. Is that a similar, is that similar to the capital structures used by CRE CLOs?

Mike Comparato:

It’s very close. I would say three, four years ago you were selling triple-A through triple-B minus, and you were retaining everything sub investment grade and below. And that was usually the thickness of that equity piece. And sub-investment grade was around 20%. With the increase in rates and the subsequent backup in cap rates, we’ve seen that shrink a little bit, and I would say we’re closer now to the corporate world where the bottom or the equity piece is probably closer to 13, 14, 15% than the 20% it was three or four years ago.

Shiloh Bates:

And what’s a good AAA financing rate for your CLOs?

Mike Comparato:

I think we’re seeing AAAs get done right now around 145, 140 in that general area.

Shiloh Bates:

Okay. So 140 basis points is maybe 30 basis points wide to a broadly syndicated loan, CLO, AAA and maybe 10 bps tight to where middle market CLO AAAs have been printing?

Mike Comparato:

Yeah, we usually trade a little bit wide of that market. It’s a meaningfully less liquid market. The real estate side of things has meaningfully less participants, meaningfully less liquidity. So, I think there’s a premium in our AAAs, and I’m guessing in all of the bonds all the way down the stack, that’s just a liquidity premium, if nothing else.

Shiloh Bates:

Is the illiquidity premium, is that just a function of you need to understand property level specifics for some of these CLOs given that there aren’t as diversified as maybe a corporate loan CLO?

Mike Comparato:

I’m not sure. I think it’s a size thing more than anything else. I’m by no means a corporate CLO expert. We do have corporate experts at BSP, obviously. I think we run one of the largest CLO businesses in the corporate world, but it’s not my expertise. I just think it’s a size thing more than anything else.

Shiloh Bates:

In the CLOs that I invest in, the real protections for the debt investors are that if there’s too many downgraded loans, if there’s too many triple-C rated loans or defaults, then instead of the CLO making

its equity distributions, that cash is retained in the CLO for the benefit of the debt holders. Do CRE CLOs have… is that kind of the similar structure there?

Mike Comparato:

Yeah, it’ll be the same. So if you trigger certain covenants, IC, OC test interest coverage and just have LTV issues, defaults, et cetera, distributions would get shut off and everything goes to hyper am, top of the capital stack.

Shiloh Bates:

So hyper am, or hyper amortization, just means that all the cash flows received from the CLO are being used to repay the top part of the CLOs financing?

Mike Comparato:

Correct.

Shiloh Bates:

Okay. So for these CRE CLOs, it’s the case that the equity owner is really just the originator of the loans and that equity just comes from a fund that you guys are investing out of, but I don’t think that there’s, well, are there third party investors who come into these CRE CLOs in the equity tranche, or is it always retained by the manager like yourself?

Mike Comparato:

So I would say, largely, the loans are originated by the issuer. There are a few shops that will acquire loans and then issue a CRE CLO, and then generally speaking, the issuer is retaining the bottom. There’s been a few instances. I mean it’s very, very few and far between where the equity goes somewhere else, but generally speaking, it’s an origination liability structure that’s used by originators, and then retained, the bottom retained, by that originator/issuer.

Shiloh Bates:

So if you guys use these as a financing trade, I guess the other alternative is to just borrow from a bank. So you have a portfolio of these loans, and the other way would be to just go to a JPMorgan or Wells Fargo, for example. How do you guys think about whether or not you should do a securitization or just go to a money center bank?

Mike Comparato:

That’s option one. Alternative is money center bank. Option two is selling an A note and just keeping a B or keeping a Mez piece that creates the same structure as well. And then lastly would be the CRE CLO. Economics obviously pay a very big part in that decision, but I think we gravitate towards the CRE CLO for its non-economic benefits to us as issuer. It’s non-recourse. It’s non-mark to market. It’s match term funded. Those are things that we don’t typically get at banks. So if the economics are equal, the non- economic drivers are going to push you to CRE CLO execution. If the economics are better in CRE CLO, that’s a very easy decision. You just ask the question, how much worse can the economics be? Or, said, differently, what’s the cost you’re willing to pay to have non-recourse, non-mark to market, match term funded liability structure? And that’s kind of the only decision that we make with respect to staying at a warehouse facility or issuing a new transaction.

Shiloh Bates:

One of the trends we’ve seen for corporate CLOs is that there just hasn’t been a lot of M & A and LBO activity that’s really creating these loans. And as a result, the CLO total AUM has been somewhat stagnant here over the last few years. Is there a lot of creation of the underlying loans in CRE CLO such that the industry is growing? What’s the trend there?

Mike Comparato:

There was a fairly meaningful pause in ’23 and ’24. We have stayed very active on the origination front. We just made some good macro decisions at the peak of the market that let us have a pretty clean balance sheet and let us play offense when a lot of the market was playing defense. So we actually had our second-best origination year in the history of the platform last year, and we issued a CLO at the end of last year. I’m sure we’re going to have probably a few in 2025, but the overall industry has been very, very slow. We have seen a wave that came out of the gates at the beginning of the year. I want to say three deals, maybe four, got priced in the first three or four weeks of the year, which is probably close to the equivalent of everything that got done last year. We’re seeing things pick up again on an industry, broad industry standard. We never slowed down. There is a massive, massive demand for credit, and the historical providers of credit, banks, mortgage REITs, etc., are largely on the sidelines. They’ve got a lot of defaulted and/or delinquent loans, or imminently defaulted or delinquent loans, and they’re really hoarding cash. They know that they’ve got to solve problems. And so the last thing on their mind right now is putting new risk on. It’s really getting through the legacy stuff that was originated a few years back.

Shiloh Bates:

In your business, do you generate alpha on the assets by being in the right sectors, so being in industrial versus not in office, or is it more the property-specific calls that you make that result in strong performance?

Mike Comparato:

Can I say all of the above? If there was one formula that was just, if you do this right, you’ll be successful. I wish there was that easy button to hit somewhere. We haven’t found it yet. Certainly hindsight being 2020, avoiding office was probably one of the best calls we ever made. So yes, avoiding that industry overall ended up being an excellent, excellent decision. I think we’re of the view, generally, that if you get the macro right, you’re going to be okay, generally, in this business. If you’re lending on newer-vintage, higher-quality assets in good, liquid markets, you’re probably going to be okay. I think where the market went very wrong, and we called this very publicly at the peak of the market, and again, Q4 of ’21, Q1 of ’22, is any asset with the word multi-family in it was just being valued at a three- and-a-half cap or a four cap or a two cap.

There’s no cap rate tiering between a 2020, brand new vintage, class A asset in Miami, incredibly liquid market, and a 1974 vintage, B minus asset in Chattanooga, Tennessee. Not that there’s anything wrong with Chattanooga, Tennessee, but it’s meaningfully less liquid than Miami is as an overall market. That was just an incredibly unhealthy dynamic that was going on, and again, what typically happens in bull markets. I mean, you get raging bull markets, valuations get thrown out the window, and you just value everything silly. And that’s what we saw. We called that at the peak of the market. We proactively said, if those are our choices and the market is going to value those things the same, we think there’s a multi- family correction coming. We want to lend on nicer, newer assets and big liquid markets. And so we proactively stopped lending on 1970s- and 1980s-vintage multifamily and stayed in bigger, more liquid markets on nicer, newer assets. So I think just those two macro decisions alone let us stay in the driver’s seat and play offense for calendar year 2023 and 2024. I think we’ve got enough really good real estate guys that just know how to underwrite the sticks and bricks. I don’t want to say that’s the easy part, but that’s pretty straightforward. So we kind of view this as get the macro right and just don’t make the silly unforced errors, and you’re probably going to be right more often than you’re not.

Shiloh Bates:

So, the loans in corporate CLOs are created in leveraged buyouts, so private equity firms buying a company, and they’re putting up around 50% of the purchase price. Who are the owners of the properties in CRE CLOs?

Mike Comparato:

Again, reminder that CRE CLO is really built for middle market. So, you don’t see, typically, the Simons, the Vornados, the Blackstones, the Brookfields. You don’t typically see those names as sponsors in CRE CLOs. You’re going to have a more of a middle market borrower profile. I would say that profile is really one of three things. You’ve got the middle market institutional borrower, a fund or a series of funds that has a few billion of AUM, but they’re actively in the middle market. You’ve got the high net worth family office that either is only a development family or partially does development as a part of the family office operation. And then lastly is the traditional GP LP syndicated equity structure where if there’s a 10 or 20 million equity requirement in a deal, a GP will bring in 5% of that stack and they’ll go syndicate the 95 friends, family, country club, etc.

Shiloh Bates:

Then what’s the difference between a CRE CLO and a CMBS, commercial mortgage-backed security?

Mike Comparato:

CMBS is typically 5- and 10-year fixed rate loans with meaningful call protection, usually yield maintenance or defeasance until the last 90 days before maturity where CRE CLO historically has been a short-duration, floating-rate instrument with a lot of flexibility, really intended more for non-stabilized assets where CMBS is really built for stabilized transactions.

Shiloh Bates:

So then for investors who want to get exposure to the kinds of loans in your CRE CLOs or that your platform underwrites in general, how would a retail investor go about doing that?

Mike Comparato:

I don’t think there’s really a direct means for a retail investor to invest directly into a CLO. One of the vehicles that we run is our publicly traded mortgage REIT, ticker symbol is FBRT, an active issuer. So an indirect way to invest in one of our CRE CLOs would just be through stock ownership. It’s not, obviously, a direct investment into just the assets in that vehicle. It would just be into the mortgage REIT that holds the CRE CLO equity. So indirect, not perfect, but I don’t think there really is a means to get into these things as an individual investor.

Shiloh Bates:

Got it. And is there anything interesting or topical about CRE CLOs that we haven’t covered in our chat here?

Mike Comparato:

I think we covered most of it from 10,000 feet. You asked all the right questions and certainly the salient ones. I think we covered a lot of it.

Shiloh Bates:

Great. Well, Mike, thanks so much for coming on the podcast.

Mike Comparato:

Yeah, enjoyed the time and appreciate the invite.

Disclosure:

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

AUM refers to assets under management.

LMT, or liability management transactions, are an out of court modification of a company’s debt.

Layering refers to placing additional debt with a priority above the first lien term loan.

The 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 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 on 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 D, depending on the agency issuing the rating, is the lowest or junk quality.

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

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

Middle market loans are usually underwritten by several lenders with the intention of holding the investment 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.

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

ETFs are exchange traded funds.

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 principle payment. Debt has contractual interest principle 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 pledge 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 an underlying floating rate index.

In the context of CRE CLOs, a senior mortgage refers to a loan that is secured by a lien on commercial real estate and has priority over other types of debt.

Illiquidity premium refers to the additional return that investors demand for holding an asset that is not easily tradeable or liquid.

Defeasance is often used in commercial real estate loans to allow the borrower to sell or refinance the property without paying off the loan early.

General Disclaimer Section

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 US markets and US 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 advisor, or give advice in a fiduciary capacity. Additional information about this podcast, along with an edited transcript may be obtained by visiting FlatRockGlobal.com.