Private Credit Loans and Trends

Shiloh Bates:

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 Melissa Brady, Senior Director at Alvarez & Marsal Valuation Services. She leads a team that values private credit loans for CLOs, BDCs and interval funds. She also publishes the Alvarez & Marsal Private Credit Update, a quarterly publication I’d highly recommend.  We discuss multiple topics including the performance of private credit loans, why some credit managers may have different marks for the same underlying loan and other trends in private credit. 

I’ve also settled on a new podcast closing question, which is “how would you describe a CLO in less than 30 seconds.”  And I’ll answer too at the end of the podcast. 

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

Shiloh Bates:

Melissa, thanks so much for coming on the podcast.

Melissa Brady:

Pleasure. Thank you for having me.

Shiloh Bates:

Why don’t you tell our listeners how you ended up at Alvarez & Marsal?

Melissa Brady:

Sure. So, I started here about five years ago. I started my career doing private credit about 20 years ago during the great financial crisis. That’s when I really pivoted and started at Houlihan Lokey for a little bit, was there for seven years and then with RSM and then came here in 2020 during COVID was just really looking for a greater platform with great resources, and that’s what Alvraez & Marsal has provided for me here. So, it’s been great. We have such a wide diverse set of client base with all kinds of different size AUMs and all kinds of different strategies. So, it’s been a really nice learning curve.

Shiloh Bates:

So, your primary role is valuation of private credit loans, is that correct?

Melissa Brady:

That’s correct. So, within the portfolio valuation group, my niche, my key focus is on private credit. I do a number of private equity clients as well. Our group, we focus on real estate funds, venture capital, private equity funds, credit funds. So, we see the entire gamut. My niche just because I enjoy it so much and I’ve continued to enjoy it for all these years, has really been in private credit. It’s something I have seen evolve and change so much over the years, and it’s an asset class that I truly enjoy working on. So, we certainly have the bandwidth and the volume of works to keep me happy and busy here. So, it’s been going well.

Shiloh Bates:

Good to hear. So what’s the general process for valuation of a private credit loan?

Melissa Brady:

So, we really want to get a good understanding of the underlying business. When we look at private credit, we’re looking at so many different variables. Who’s the sponsor? Is this a sponsor backed loan or non-sponsored backed? What’s the strength of the cashflow? What sector it is, the fundamentals of the business and understanding the business model to see, hey, what’s really the challenges to future cashflow? So, when we look at private credit, I’m personally looking at first the size. I’m looking at the concentration or lack of concentration in cash flows. I’m looking at who the sponsor is, what’s the liquidity condition of the business to get a really good flow and also understanding, okay, is the pricing of that loan today, is that really representative of the market? So, it’s really EBITDA size, how it’s priced, cashflow , strength, and all of those other qualitative factors that you really want to get a good handle on the credit fundamentals.

Shiloh Bates:

So, how does what’s happening in the broadly syndicated loan market, how does that information make its way into your valuations, if at all?

Melissa Brady:

So, me and my small team here are responsible for the private credit updates that we do, and we’re looking at broadly syndicated loans, primary market and the secondary market. We’re looking at our internal data. We understand that frankly the broadly syndicated loan is going to have different technicals and different technicals to the private credit space. And so, we understand that. So, just because a broadly syndicated market is moving in a certain direction, it doesn’t mean that the private credit space is going to also move one-to-one the way the BSL market is moving. But we certainly look at the BSL market to understand the debt markets further, but we’re also looking at data in addition to the deal flow that we see internally with the deal volume that we have and the private credit research and analysis that we’re doing internally to get a more comprehensive view of the debt markets. And so that private credit research that I do every quarter, the reason why we do it so early and we release it so early is because a key trend that we’re seeing with our client base is they want valuations done early. They actually want to be final or done a few days after quarter end. So, we release that research pretty early on in the process because most of our clients really get a headstart on valuations well before the quarter end even starts.

Shiloh Bates:

So, is the flow of information then that the underwriter of the private credit loan or the owner, they probably pass you financials as soon as they get them and then you start working on updating a valuation and that may be done. Is it a quarterly basis? Is that what most of your clients are taking?

Melissa Brady:

Yes.

Shiloh Bates:

And so those are the marks that go into a BDCs schedule of investments at quarter end or to an interval funds NAV or their financials as well?

Melissa Brady:

That’s correct. And some clients want to a range, some clients want a point estimate. It all depends on the fund’s, valuation policy and procedures on their end. But we would say majority do want to see a range.

Shiloh Bates:

The majority want to see a range. How big would the range generally be for a private credit loan? What percentage of par?

Melissa Brady:

We don’t want to see it more than two points ideally, but sometimes it will be wider than that, especially when we deal with distressed debt valuation and just the nature of leverage. As you know, Shiloh, it’s a double-edged sword. So, with these highly leveraged distressed credits, the rate is certainly going to be a lot wider. But for performing credits, it can range two to three points.

Shiloh Bates:

So, you tell the owner of the loan, Hey, your loan might be worth anywhere from 97 cents on the dollar to par. And then it’s up to them to decide where they think they should be in the range.

Melissa Brady:

Yeah, and I would say a lot of them do go with the midpoint because they don’t want to have to deal with the extra questions by the auditors. Not all, it depends on their valuation policy and procedures, but a lot of them do go with the midpoint. Not necessarily every client does, but I would say the majority.

Shiloh Bates:

Is the majority of your clients, are they taking quarterly marks from you or are they doing it less frequently to maybe save a little bit of money?

Melissa Brady:

They take it quarterly. For the private equity clients, that might be quarterly. That might be annually. But I would say for the majority of the credit funds, the BDCs that we have as our client base, it would be quarterly.

Shiloh Bates:

Got it. so, one of the things that’s been in the news recently is that there may be a number of different investors with the same loan and then they’re disclosing their quarterly mark to the world through a BDCs schedule of investments or private credits equivalent. And oftentimes the valuation is different. So for par loans, it doesn’t really matter that much. One manager might say, Hey, loan X is worth 99 cents. Another manager might have the same amount of par. Probably not a huge difference, but as you get in, as loans have issues, the difference between where different managers are marking the same loan can vary quite a bit.

Melissa Brady:

Absolutely. That’s been going on for as long as I’ve been doing this work. Why is that? I think the first key reason behind that is maybe difference in information – in information rights. So it’s information rights for sure. That’s a key driver there. Also, it’s just certain asset managers have different views and that’s where it is challenging when the mark differentials can be pretty significant. You see that quite a bit with the ones that are non-accrual basis, the more distressed credits having such a wide disparity in marks. And we deal with certain asset managers that are way more conservative and certain asset managers that frankly are way more optimistic and a little bit more aggressive on their marks. And that’s just the reality of the world that we’re in.

Shiloh Bates:

When you value a loan, presumably everybody gets the same price or, well, I guess some people take a range, so maybe that’s not true, or how do you guys do it?

Melissa Brady:

So when we have, let’s say the same exact credit for three different funds, we have to be mindful that we only can use the information that was given to us from that particular client. We can’t cross use information. Clearly we have the knowledge, but what’s actually applied in the valuation schedules has to be the information that we’ve been given from that particular client. Even though we may know and have more information from the other funds, we try to be consistent. Absolutely, we do our best in that. So, there is going to be differences in information and access to information and information rights even though they’re co-lenders.

Shiloh Bates:

So, when a loan is maybe on non-accrual, when you’re marking it for a number of different investors, some investors think maybe the loan’s really money good and the company will be bought by year end. And so that would argue for a much higher mark and then other investors in the same loan just have a more, don’t know that or don’t believe that taking a more pessimistic view and therefore get a lower mark for the same security essentially.

Melissa Brady:

Certainly that is the case. You’ve seen that. So, we have certain situations where I think one of the key trends that we’re seeing right now is clearly we know M&A’s weak and slow right now. So, you see where a lot of the sponsors want to go and do a pure exit through M&A and they go to the M&A markets, they try to get investment banker, the bids come in, they’re very disappointed with the bids that have come in. And so they just drop the whole sale process and they do a dividend recap and we’ve seen quite a bit of that. They’re just not going to take a lower valuation, especially when we look at, I’m sure you know this, the 2021 vintages when valuations were so high when capital raising was at the all time high with fundraising, and then you also had the debt markets with rates near zero. So, we saw a lot of these 2021 vintages frankly, that they were just overpaid. These were very frothy, high multiples. They levered them up because capital was so cheap. And so we’re seeing a lot of the 2021 vintages seeing more challenges today. So, you’re seeing those having some restructuring events or recapitalizations of those credits. But I would also argue we’ve had higher rates for longer for so long, and I would predict recoveries in this space to come down for the credits that have not done well.

Shiloh Bates:

Do you guys publish a stat? Do you guys have a default rate or non-accrual rate for the loans that you guys do valuation work for?

Melissa Brady:

We definitely have that data point. We don’t publish it, but we certainly keep track of that information internally. It’s something actually we’re thinking about. Maybe if we do publish in the future, we are seeing non-accruals creep up. We do expect non-accruals to continue to creep up, especially for these certain vintages and for credits that have frankly been over levered from the start.

Shiloh Bates:

Did Liberation day play a negative role in terms of the performance of the businesses that you guys value? Or is it too early to say?

Melissa Brady:

There’s always this lag on when events happen and how that will impact the market and how we see the data. Because there’s always lagging data. We all know that the market hates instability and non-transparency and uncertainty. It’s the worst thing for the market. So clearly we did see a bit of challenges where the fundamentals of the credit, it did get a little rocky. The issuers remember are also getting impacted if they can’t close certain contracts, for example, because people want to be on a wait-and-see mode. We have seen margins get eroded a bit in this inflationary market, and we have seen growth take a little bit of pressure given the tariff supply chain issues and whatnot. But I think it’s safe to say that a lot of the loans are doing just fine, especially the ones that didn’t get overlevered have ample liquidity. Those are doing okay. But overall, I say yeah, we’ve seen inflation take its toll and growth is there. It’s just not as robust as it used to be. Who knows? I can’t predict the future and I can always be wrong at this stuff, but we’ve seen growth taper down. We’ve seen margin take a little bit of hit, but like I said, every credit and every situation’s going to be very different. Some credits are just going to have the bandwidth and the ability to withstand more stress than other credits.

Shiloh Bates:

Is there any industry that stands out to you as being more at risk versus others in your dataset?

Melissa Brady:

If the industry can face fierce competition from AI, that’s something we’ve already seen. So, here’s a classic example where you have this great technology that provides tutoring services to K to 12, and your contract is with these public school districts and you’ve done really well all this time, and all of a sudden you have these competing technologies that can provide tutoring for little or no cost. So, you can see how we’ve seen those companies unfortunately not do well with very low recovery when they can’t sell the technology at auction, there’s no value to the IP and your business just went away. It hurts. But we’ve seen a few examples of that. Also, another in healthcare, we’re seeing where sponsors want to go into the dermatology business and they bought a bunch of dermatology clinics and as you know, the consumer is cutting down their spending. And so this dermatology space where they bought a whole bunch of these clinics across the country, well, you’ve got high fixed costs and customers are buckling down on their spend. And so we’re seeing that type of business model take a little bit of a hit as well as growth in margins have eroded.

Shiloh Bates:

In healthcare, have you seen wages increase faster than reimbursement rates?

Melissa Brady:

Yeah. I’m going to focus a little bit on a segment of healthcare, more the vet space, the veterinarian space. We’ve seen a lot of these strategies of roll up add-on where you buy these vet clinics and you expand and you grow. Everyone loves to spend money on their pets. Even in a downturn, they’ll spend money in a recession because everyone loves their pets. And so we’ve seen that business segment have such incredible margins and cashflow strength. So, not surprising what happens, you got this tremendous amount of competition entering that space. So, we’ve seen some of these vet borrowers struggle a little bit as competition has come so fierce that there’s growth pressure and margin pressure now that they haven’t seen before. Especially if you maybe did a bit, a few add-ons of target companies that were a mistake can have a real big impact on your cashflow strength. So, we’re seeing a few of these vet clinic space take a bit of a hit.

Shiloh Bates:

A hit in the sense that they’re at risk for default or that financial performance is down?

Melissa Brady:

Performance is down. They were bought for extremely frothy multiples in 2021 or 2022. They were highly levered. And what’s going on is they have to PIK 100% of a certain tranche. And if you have to PIK the full tranche loan, that always is going to give me pause. So, it’s not one or two, it’s actually, I’ve seen three or four of these that they’re all struggling.

Shiloh Bates:

Do you have a sense for if the stress in private credit, do you think it’s similar to the broadly syndicated loan market? In Broadly syndicated, by the way, the default rate, if you include distressed exchanges, which you should, it’s around 4%. I’m assuming that for private credit, what you’re seeing is a much smaller number.

Melissa Brady:

Yesah, and the reason for that is because you continue to get support from sponsors and other co-lenders. So, with the private credit space, you just have more support. You have liquidity support coming in from the sponsor doing equity cures, you have co-lenders coming in willing to put in more money. So, that pushes the default just down the road. So that’s why we’re just seeing so little defaults in private credits. You just have ample dry powder, ample resources to continue supporting the credit.

Shiloh Bates:

So sometimes default really isn’t the key metric because for private credit, and this is true for broadly syndicated as well, but one person’s default is another person’s kick the can down the road. The private equity sponsor can always put in more money. The lenders can always agree to defer their interest or principal and avoid a default. If you’re an investor in CLOs, you care about the ultimate recovery. So, kicking the can might be a decent solution for now, but sooner or later the loan either repays you or it doesn’t.

Melissa Brady:

No, that’s a great point, Shiloh, because we clearly see lenders willing to shut down, amortization, willing to PIK part of the interest or some of the interest or have PIK periods of time where they allow PIK for certain duration of time. So, another key trend that we’re seeing is certainly a lot more PIK to provide more liquidity as rates are still high.

Shiloh Bates:

So, then in terms of defaults, staying on that for a few minutes, your expectation is for this year, so for 2025 defaults will be elevated over last year and their primary driver is the 2021 vintage where blenders were maybe a little too aggressive. Do you see anything that would stop the trend?

Melissa Brady:

That’s right. I think maybe for the next 12-18 months we work through these more challenging credits, especially these certain vintages. I do think that you’re going to see the have and the have-nots. You have certain asset managers that are going to do well and their portfolio is going to do just fine, and you’re going to see others that frankly did not have that same discipline. You can see it now, just look at which BDCs have the most non-accruals. There’s a wide difference by asset managers and how they’re dealing with their non-accruals. And so yes, you got to see how things work through the system. The deals that are getting done are certainly, these are the better deals. And also it’s interesting everyone’s wondering, well, hoping and praying that the M&A markets start to open up in 2026 so that sponsors can finally realize their investments and return capital to their investors. It’s been a challenging time for sponsors because they want to be able to close these funds and the life cycle of these funds have gotten longer and longer. So, like I mentioned earlier, not surprising, we’re seeing a trend in dividend recaps. A big trend is also continuation vehicles where LPs want out. So, a continuation vehicle is a way to also get out.

Shiloh Bates:

For the continuation vehicle, is a private equity firm launched a fund with a, let’s call it a five year reinvestment period. They’re expected to return capital to investors as they sell these businesses. And either the bids aren’t there to get the initial investors a healthy return or the more favorable way to look at it would be the private equity firm still sees upside in their investment, and so they don’t want to sell it to another private equity firm. They put it into a continuation vehicle where they have the same asset but presumably owned by a different investor base. When a loan’s going into a continuation vehicle, does that have any significance for you guys in your valuations?

Melissa Brady:

Yes. So, a big trend that we’re seeing are these valuation opinion work when those continuation vehicles are created. So, we come in and we provide valuation opinion to ensure that the investors who want out and the investors who want to remain in are all treated fairly. So, that’s been a pretty big trend, absolutely in the valuation space.

Shiloh Bates:

So, in that case, you’re doing the same work, but the end product for you guys is a valuation opinion that’s disseminated to the market or given to particular investors saying that the pricing, the valuation of the loan going from one set of investors to another is done on an arms length basis that it’s fair.

Melissa Brady:

That’s right. And so it does require a few more hurdles on our end because of the risk. So, we have to go to this committee, ensure that everyone’s on board. So, there’s a lot more in the process given the higher risk. So, there’s more involved when we do these valuation opinions versus just mark to market on a quarterly basis.

Shiloh Bates:

Are you seeing loans structured with PIK upfront or does all the PIK come when a business stumbles?

Melissa Brady:

We’re seeing both actually. Believe it or not, we are seeing PIK upfront as well. But the caveat there is I would say the deals that are getting done today are the better deals because they’re really being picked through. So we still have a very much a supply demand imbalance. There’s a lot of demand for the paper, very little supply given M&A is still quiet. So, the competition is absolutely fierce. So, we’ve seen in 2025, a number of new issuances at, SOFR plus 450, SOFR plus 475. So, we’re seeing these new loans getting done at under 500 basis points spreads because of the high competition.

Shiloh Bates:

So, at another time, those would’ve been loans under in net SOFR plus six or something like that.

Melissa Brady:

Yeah, throughout 2024 we saw not all, but a lot of the SOFR plus S plus 6% or higher, those certainly got repriced. And as you know, the sheer volume of repricing in 2024 and the first half of 2025 has been tremendous. So, majority of loans right now are S plus five.

Shiloh Bates:

So in terms of the documentation of the private credit loan, does it matter to you in terms of your evaluation, if there’s a covenant, if there’s more than one covenant or if it’s cov-lite, does that factor into your evaluation?

Melissa Brady:

It does, and especially if something is done with a, this is a recurring revenue loan, it’s still EBITDA negative, it’s still burning cash. We want to understand, okay, what’s the pricing on that? If it’s S plus four 50, we’re going to take a little bit of pause there because usually we want to see those loans be priced a little bit higher, like 550, 575. We’re seeing some of these covenants give them a lot of extra cushion when they’re being amended to give some breathing room for the underlying credit. But at the end of the day, we’re still seeing quite a bit of allowable add-backs to EBITDA. How EBITDA is defined, so personally, I look at real EBITDA and adjust the EBITDA for the covenant compliance certificate, knowing that a lot of times the total add-backs can be 30% or higher. If it’s over 30% add-backs on the EBITDA. Clearly, I want to understand how much of that is truly non-recurring, how much of that is potentially recurring in nature and should be not included in the adjusted number. So, really getting a good handle of what’s real EBITDA here because we can certainly see leverage multiples being under-reported just due to EBITDA alone. And that’s something I definitely take a close look at.

Shiloh Bates:

Well, how often is it that you and the client have significantly different EBITDA numbers that you’re using for valuation?

Melissa Brady:

It’s more if we have significant differences in valuation. It does happen on occasion, and that’s where we just want to have a follow-up conversation. It might certainly be, Hey, we missed some key information we didn’t know about. It’s more about educating each other, making sure we’re on the same page. Typically, we want to be on the same page. We want to be able to communicate effectively to the client, our logic, our reasoning, our expertise in how we got to the fundamentals of the valuation, and typically we get to a point where we all can agree.

Shiloh Bates:

And what if you guys are struggling to get to that point? I imagine it happens rarely.

Melissa Brady:

It does happen. We don’t like to see it, but it does happen and we have to remain independent. We have to remain independent and feel good with the work product that we’re delivering. And if we can’t stand by it, we’re not going to stand by it. So there will be times when yes, we disagree and the mark just has to change

Shiloh Bates:

In your business – Are you seeing a lot of, is it that business is booming because there’s a lot of new private credit asset managers out there and new funds to work for is business booming because private credit’s growing?

Melissa Brady:

Yes. So, we’re seeing our clients grow, continue to do new originations. Even in this highly competitive market. We’re also seeing our clients launch new funds, and so that’s keeping us busy as well. And we’re seeing private credit grow in other spaces like real estate infrastructure funds. There’s a lot of demand for structured product valuations for those types of funds that another team works on next to me. So yes, things are going well.

Shiloh Bates:

Good to hear. What do you see as some of the challenges in your day to day?

Melissa Brady:

I think the biggest challenge is in this particular client base is people really want things ASAP. So, you have a very tight time crunch to turn things around, and it’s a client base that’s highly demanding. They want what they want. So, it’s the ability to have the resources and the technology to be able to turn. As you know, these funds are massive. We have clients as largest 2 trillion in assets under management. So, it’s the ability to use technology and the resources to be able to continue to fundamental robust work product, but also be able to turn the volume given it’s on a quarterly basis and there’s a number of credits and number of investments that need to be covered each quarter. That’s the biggest challenge.

Shiloh Bates:

Do your clients usually share with you the initial financial model from the private equity sponsor?

Melissa Brady:

Correct. They do. And then they do their own type of stress testing on that original forecast.

Shiloh Bates:

And how often do you think is the sponsor, the private equity firm’s investment case realized?

Melissa Brady:

No one meets their budget. No one meets their budget. And I keep on telling my staff, don’t worry if they miss the budget, who can budget? Well, it’s such a hard challenging thing to do. And so I’m not so concerned about if they miss their budget. I’m more concerned about seeing the fundamental trends. So if they’re growing, but maybe not growing as fast as the sponsor predicted, especially when you have a lot of equity cushion, I’m not worried about that at all.

Shiloh Bates:

When you guys provide marks for your clients, should the person who views the mark, the end investor in the fund that your client manages, should they think of that as a realizable price? If their fund closed up and sold all of its loans that they should get your prices more or less from that exercise? Or how should they think about it?

Melissa Brady:

That’s a great question, and I see that struggle with the definition of the deal team really fixated on investment value and our team focused on fair value, and the definitions are very different. So, the fair values we’re providing is really okay. It really is. The basis is on the codification code out there for GAAP, but it’s based on exit value. So, what you would get not under any duress, arm’s length, willing participants, participants with the same level of information as of that valuation date, the challenge comes in or the deal teams that well hold on, but we’re going to hold onto it for four years and we’re expecting to do X, Y, Z in the next four years and realize a much, much higher valuation. Well, that’s great, but that’s investment value that you’re expecting to realize four years from today. So sometimes it’s reminding the deal team on, Hey, what is the principles behind fair value? And listen, we can be wrong, absolutely. But what we try to do is when there is an exit, I always ask, okay, what did you get for the investment for the security? Because I want to know, well, if it was different from our last valuation, why was that the case? And there might be buyer-specific reasons that we can’t incorporate in our fair value definition. The assumptions need to be based on a market participant basis and has to strip out a buyer specific synergy or buyer specific reasons for that purchase.

Shiloh Bates:

Well, one of the things I’ve noticed in terms of comparable company analysis that similar to what you guys are doing, I imagine, is just that you have one borrower that you’re looking at and you’re adjusting EBITDA and you’re saying, okay, the private equity firm paid, I don’t know, 8x EBITDA for this company on the adjusted EBITDA number. And then you want to compare that to comps in the market, but then people don’t adjust the EBITDA of the comps. And so if you don’t adjust the EBITDA of the comps, what you’re going to see is a set that’s trading at 15 times or 12 times, and then you say, look, well, I’ve got all this equity cushion, but what you’ve done, it’s not apples to apples.

Melissa Brady:

Oh, absolutely. Absolutely. Have to be apples to apples. And you do see some deal teams being more savvy and understanding valuation better than others. Like you said, Shiloh, we look at, alright, what was the buy in multiple? What was the last trade of that underlying business? What’s happened to the market? But what’s also happened to the company over time to refinance and readjust the multiple? As you know, years ago, what PE firms were doing were basically, they looked at, let’s say a group of comps and they took the street median or mean, and they applied a 30% discount and that was their multiple. So we’ve certainly moved far and away from that over the years. But the whole idea is let’s have a better starting point, a better transaction point that you can say, Hey, this company that is privately held just got bought for 8x. To completely disregard that, especially if you’re looking at it a year out or two years out, is I don’t think conforming with the AICPA standards on best practices and how you deal with valuation.

Shiloh Bates:

So, could you tell us a little bit about your quarterly publication that you do that’s your middle market update?

Melissa Brady:

Sure. So each quarter we release our private credit update. We’re looking at a lot of different data and resources. We’re looking at primary trade, secondary indices, looking at a lot of our research internally, looking at the deal flow that we have internally, and other research and data that we have. We use a lot of good information from PitchBook, LCD, and I’ve got a small team here, and I run that team where we put together a report and we try to add a lot of color and discussion. I know we have our competitors do the same thing each quarter as well, but we like to differentiate ourselves a little bit by adding a lot more discussion rather than just charts and graphs to get the reader a little bit better understanding of what’s happening in the market. And we do that quarterly. I think it’s important because you want to get a very good in depth, deep knowledge of what’s happening in the markets.

I release that internally and externally every quarter, and that’s some of the key basis on how we’re looking at private credit for that quarter in addition to what we do for that specific credit in those schedules, that’s unique to that credit. So, this is to give everyone a good update, be aware of maybe what’s the key trends going on, how are deals getting priced right now and why? And getting a little bit more color. I mentioned before, we’re starting to see deals now getting priced at S plus 450 S plus 475. So, if we’re seeing a deal price at S plus 525 with reasonable equity cushion, reasonable leverage ratios, reasonable interest coverage, that’s a performing credit. We don’t need to worry about that, especially if it can be repriced in the market at a much lower spread.

Shiloh Bates:

So is your publication available to anybody in the market, or do they need to be a client?

Melissa Brady:

Yes.

Shiloh Bates:

Okay. So, they can find it on your website presumably?

Melissa Brady:

I have it on my LinkedIn profile. I will try to find a way to publish it on our website. I have not done that yet, but I tend to distribute that on my LinkedIn profile.

Shiloh Bates:

Are there any trends in the middle market that we haven’t discussed today?

Melissa Brady:

I think the asset class is growing. You see these relationships with banks. Banks want to get involved, but they can’t get involved directly in private credit. So they’re partnering up with private credit funds to provide more capital. We’re seeing more interest in the retail side, which interesting. So you’re getting more money from the retail investors. We’re seeing more interest by insurance companies seeing the asset class grow in other areas such as asset-based financing and even stuff like student loans. So I think McKenzie published a report a couple months ago predicting this asset class to reach 30 trillion at one point for the US. Who knows? But it’s certainly grown so much since I got involved back in 2007 for sure. And it’s evolved so much and it’s changed so much over the years.

Shiloh Bates:

Good stuff. So I launched this podcast last year. I listened to a lot of podcasts myself and some of my favorite hosts- they closed their podcast by asking something kind that somebody has done for you, or recommend three books. And what I’ve decided I’m going to go with going forward, we’ll see how it works. And this may be a little bit unfair to you, but I think my closing question is going to be, when somebody asks you what a CLO is, and you have 30 seconds to answer, what would you say? And again, I know you’re not a CLO day-to-day professional, but what we do, you’re also in our market.

Melissa Brady:

And my husband is Andrew Brady, who was a CLO manager for years. So I’ll piggyback off his knowledge and what I’ve picked through his brain over the years. So collateralized loan obligations, think of it as a big gorilla of number of loans that are put together in a big basket and you bifurcate or split it up based on the quality of that particular tranche. So AAA, BB and all that, all the way down to the equity class. And you get a different return based on your risk profile. So if it blows up, the AAA gets their money first followed by the next tranche in the structure. So that’s how I look at CLOs. I don’t know if that’s right or not, but it’s definitely the big player in private credit space for sure, because they gobble up so many of these credits. Absolutely. So they’re a big factor. So Shiloh, how would you define or describe a CLO?

Shiloh Bates:

What I would say is the easiest way to think about a CLO is that it’s a diversified pool of senior secured loans, and it finances itself by issuing debt sold in portions, AAA, as you said, down to BB, and then there’s equity investors in the pool of loans, and they effectively own the pool. And so you could think of a CLO just as a simplified bank, the banks in one business line only, and that’s lending and it lends at a higher rate than it borrows, and that generates profitability for the CLOs equity investors, and hopefully it also results in high quality debt investments for the people who lend the CLO.

Melissa Brady:

Great.

Shiloh Bates:

Melissa, thanks so much for coming on the podcast. I really enjoyed it.

Melissa Brady:

Thank you, Shiloh. It was a pleasure.

*******

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.

–        Payment In Kind, or PIK, refers to a type of loan or financial instrument where interest or dividends are paid in a form other than cash, such as additional debt or equity, rather than in cash

–        A covenant refers to a legally binding promise, or lender protection, written into a loan agreement.

–        Net Asset Value (NAV) – The value of a fund’s assets minus its liabilities, typically used to determine the per-share value of an interval fund or investment vehicle.

–        Dividend Recapitalization (Dividend Recap) – A refinancing strategy where a company borrows to pay a dividend to its shareholders, often used by private equity sponsors.

–        Continuation Vehicle – A fund structure that allows investors to roll their interest in an existing portfolio company into a new vehicle, while offering liquidity to those who want to exit.

–        Equity Cure – A provision that allows private equity sponsors to inject equity into a company to fix a financial covenant breach.

Risks:

§  CLOs are subject to market fluctuations. Every investment has specific risks, which can significantly increase under unusual market conditions.

§  The structure and guidelines of CLOs can vary deal to deal, so factors such as leverage, portfolio testing, callability, and subordination can all influence risks associated with a particular deal.

§  Third-party risk is counterparties involved: the manager, trustees, custodians, lawyers, accountants and rating agencies.

§  There may be limited liquidity in the secondary market.

§  CLOs have average lives that are typically shorter than the stated maturity. Tranches can be called early after the non-call period has lapsed.

General disclaimer section:

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

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

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