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Shiloh Bates

lines on the record: 68
first: 2024-04-11
most recent: 2024-04-11
sittings or episodes: 1
sources: podcast

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“Found that I really like learning, so I have three different master's degrees. I study public policy at one point, financial mathematics, and statistics. And then after graduate school, instead of learning in the academic environment where you're really spoon-fed information to try to learn things as an adult. So just like I go to the gym multiple times a week and I'm working out whatever muscle group I try to treat my brain the same way so I'm constantly learning new things. So piano I mentioned Jiu-Jitsu. I try to stay current with Spanish and just always finding mental challenges. I think that's at least for me it's a key to feeling good during the day and I think it might keep you a little younger as well.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“One of the things that I do, and one of the things I think we try to do as a firm is to take the most generous interpretation of what's happening in a situation where you feel like you're not being treated well or you don't like what the other person's doing instead of jumping to the conclusion, oh, assigning the worst motivations to the person instead really assigning the best. Somebody shows up late to a Zoom call, the worst impression would be, okay, this is somebody who's not motivated or didn't care or didn't prioritize this. The best is, hey, you just don't know what other people have going on in their life. I make an effort daily to go with the generous one and start with that.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“So, I think the two biggest people are going to be the two people on HR who took Excel spreadsheet with 100 names on it of people from different universities and decided which industries they were going to cover. So I think we like to go through life thinking we're in charge of everything that's happening to us. What's happening around us is the result of our hard work or a lack thereof or of the smart calculated risks that were taken. But in reality, there's a lot of random things that affect our life in huge ways. And assigning me to the financial institutions group, that's what resulted in us chatting here today. It could be another universe I could have been in the telecom group and who knows where I'd be. And fortunately, I'm pretty happy with how it worked out.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“My biggest pet peeve at work at least is where people reach out to you trying to sell you something but don't really have anything that they're offering back. So let me give you the example from the perspective of how we do fundraising. One way would be to call a bunch of RIAs and family offices and say, hey, we want you to invest in our fund. Okay, we want that. Why should they want that? The better way to do it is to offer something instead of to ask. So what we offer is education, education on private credit, on CLOs we have the CLO investing book that I wrote and other resources. So we're reaching out to people we want something, but we have something to offer. And I think it's important that people try to think about framing what they want in a way where maybe something's coming back to the other person.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“One of the standout experiences for me was living in Rio, where a lot of people are living in favelas or slums, and they're living on maybe $5 a day or something or less. But when you meet these people, when you spend time with them, they are some of the happiest people in the world. They've got the Brazilian flag painted inside their home. They're playing soccer on the beach. They're swimming in the ocean. And if you compare that to a lot of guys who might have a corner office on Wall Street, the contrast is just so stark. And I think it just shows you the value of being fulfilled or being happy with what you have and thinking about ways to live your life in a way that you can get that enjoyment and satisfaction.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“So once I started working, I did two years on the sell side and then transition. I think I worked for six years on the buy side in Los Angeles. And then after that, that would have been a time where a lot of people in my position would have maybe gone back to school and got an MBA. But I had already done the CFA and I had a master's in public policy where there would have been some overlap. I also did a lot of surfing, so I'm from lower middle class family and we didn't have the opportunity to take a lot of vacations when I was younger. And I took that two years to see the world and really enjoy life.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“Almost every night I go to the Jujitsu studio and train that with the guys. What I really like about it is with a mental challenge and also physically exhausting, there's the camaraderie of training with the same team every day. But the other part of it is that in jiu-jitsu you are 100% present. You're just really in the moment trying to deal with the immediate problems. And it also teaches you out of learn and acquire new skills and really think about the best way for you to learn new movements and tricks. I find it to be really enjoyable.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“Think the market continues to grow probably at a mid single digit clip. I think that we talked earlier about drivers being people wanting exposure to first living loans, the performance of CLO securities over time. And I think it's partially just an education process. So when we're marketing our funds to investors, a lot of times they're not familiar with private credit. They're not familiar with CLOs or even traded loans. So there's a lot of education. I think that's what's being done. So far is a little bit less than five and a half percent today. If you're lending, again, 4% above that, people are going to find that to be a pretty attractive yield. So that I think is just going to pull more and more people into the space.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“In the CLO aren't even open for business, that's obviously not good. But at the same time, what we did is we looked at CLO double B notes that were trading in the market in the 60s, 70s, and 80s. And in looking at those, you just ask yourself, okay, well, what percentage of the underlying loans would have to default such that I'm not money good on this double B? And even during COVID, we saw double Bs as securities that we expected to be really rock solid. So we are CLO equity fund and I put equity in quotes now because after COVID started you were buying double Bs. We felt like, hey, you can get equity-like returns here or better and be more senior and de-risk yourself. Why wouldn't you do that? So a lot of times people who are investors in CLO equity are looking to the double B as a potential alternative. And when those are trading at discounts that can be a pretty compelling place to look for a turn.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“Let me give you an example of some of the upside that I think exists in these deals that we try to take advantage of as an equity investor. So I mentioned there's refis, there's CLO life extensions. Every quarter after the reinvestment period ends, the CLO equity investors looking to maximize their returns. It may be the case that a call one year after the reinvestment period is the ideal one for the equity. And it could go as long as four years. So that's some other upside that comes to us. I think another source of potential outperformance for equity fund, something that I've done and I think our competitors have done to some extent as well is that if I rewind the clock to the spring of 2020, CLO securities are trading at really discounted levels. So if you're an investor in CLO equity, you don't have a crystal ball for how quickly the economy is going to recover. So equity feels a little bit scary, especially when some of the underlying business”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“So, one of the things that's interesting about CLOs is that I mentioned they have this two year non-call period on them in which you can't really tinker with your AAA and B or what they are. But after that, what we hope to do with a lot of our CLOs is really have them as permanent capital vehicles. So I mentioned that the reinvestment period might be five years. But if you go out five years and the CLO has performed well, you're incented to just try to go back into the market and extend the CLO's life and add another five-year reinvestment period to it. So by doing that, you skip two to three years of potential deleveraging and receiving lower cash flows. Instead of having that period, you just stay fully invested and keep going. So a transaction like that would be very accretive for the equity.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“Should go. So one is if you got a really good financing cost at AAA, even if you're losing it partially over time, it may make sense to just keep it. And then the other function in there would be the liquidation value to the equity. So if, for example, we're in a period where loans have traded down, then there might not be a high liquidation value for the equity. And in that case, you're not incented to call a deal. If you're an investor in double bees, you're basically trying to figure out what the equity might do. So a lot of the double bees we buy are later in their life and we buy double bees at discounts to par almost all the time. So the quicker you can get repaid, the better. So when we're buying double B securities, we're figuring out, hey, which of these CLOs are interesting? Call candidates, which ones would we call if we were the equity, and that's part of our decision-making and how we filter out the double Bs that we buy.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“So, the typical CLO is going to have a five year reinvestment period. And during that time, loans are constantly prepaying at par. The CLO managers going out into the market and they're buying new loans with the proceeds. Then after the reinvestment period ends, for the most part, that stops. So when a loan prepays at par, instead of buying a new loan, that cash is used to repay the AAA security first. Then when that's fully retired down to the AAA. So after the reinvestment period ends, the CLO is losing its most attractive financing cost. So the CLO equity distributions are declining. Whoever owns 50% or more of the CLO, when they decide that they've delevered enough and want their money back, they can notify the CLO manager and tell them to put all the loans out for sale. So the thinking, once you get past the end of the reinvestment period for somebody like me, there's a few variables that would determine how long the CA.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“It with loans, for example, if you buy a first lien loan with a 40% loan to value, and for some reason there is an error in the model. At the end of the day, you still lend at 40%. CLOs and CELO equity in particular, that's not the case. So CLOs are going to produce a stream of cash flows over time. And then there's one payment at the end when the CLO is liquidated and people get whatever cash remains. There's no par payout at the end. A lot of times you're getting back 40 cents, 50 cents on the dollar. Now, over the eight-year life of the CLO, you've got these very large distributions along the way. Hopefully it nets to a nice return for you. But you don't get par back at the end. So the modeling of it really needs to be 100% accurate because every dollar is going to be part of that IRR. There's no magical 100 cents that comes back to you at the end.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“We have an investment committee which is three folks, myself, our CEO, and our CFO, and then people who are working on a CLO team, there's three of us. And CLO investing is not similar to the team structure you might see at a private equity firm or even private credit firm, for example. CLOs are modeled in software that everybody uses. So to get a good sense of what's happening, you pull it up and literally in 10 minutes. You have a pretty good idea of what you're looking at and if it's interesting. So in CLO investing, as you become more senior in your career, you don't start flying over from 10,000 feet and making broad pronouncements about the market or managers. All the details are super relevant. I've been doing this 20 plus years and I'm still reading indentures and modeling CLOs and involved in all the negotiations that go with putting a CLO together.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“The primary difference is going to be in liquidity, how the 5% tenders work is that if every single investor tendered at the same time, you'd get back 5% of your money. But realistically, only a small percentage of your investors should be tendering at the same time. If you want to tender your shares, you should get back a lot of your money from these tenders. If you're in a GPLP fund, you're committed to lock up capital seven plus years. I think it's becoming pretty tricky for a lot of large institutional investors to make commitments that are that long in duration”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“If you contrast it to a BDC, I think one of the challenges for BDC investors is on the one hand, the BDC is like a closed-in fund, the shares trade around all day, so you can get liquidity really at any time. But the BDC can trade at a premium or discounted book. Unfortunately, for BDC investors, usually it's a discount. So an investor in those shares, they have both the volatility of changes in the underlying prices of securities. But on top of that, the volatility of just the difference between where the funds trade in the market versus the underlying nav. So the end result of that is BDCs are wildly volatile. And in a period like COVID, for example, that downturn, a lot of BDCs cut in half. If that can happen from a portfolio of predominantly secure loans that pay a dividend yield of 9 or 10%, the risk reward there, I think, would feel funny to a lot of people.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“Interval fund structure is one where I see it taking market share over time. One of our three funds was initially a private BBC, and we converted that into an interval fund because we believe so much in the structure. And then if you're an investor in an interval fund, it's the same SEC reporting as mutual fund.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“What we do at FlatRock is we have three different interval funds. They work similar to a mutual fund, so people can buy them with the ticker through an RAA. Actually, they're not available just to the public. The contrast to a mutual fund is that the securities we're investing in are pretty liquid. So we're not in a position to give anybody daily liquidity if they want out. So what we can do is have these 5% quarterly tender periods where people want to tender their shares to us, the fund will buy them back. So this is a great structure, I think, for CLO equity because the CLO equity does pay these high cash distributions quarterly. So a common question I get asked from our investors is, well, if you're tendering for 5% of shares, where does a cash come from? And the first answer is, well, the CLO equity pays very high cash distribution. So you have that on hand and then backup answers would be, yes, I also have a line of credit from a bank where I can just borrow or there's cash on the balance sheet.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“When you own this portfolio of the 20 CLO equity pieces and you're getting distributions along the way, what are the structures that you put together look like that you offer to investors that can match the right liquidity that you'd need to optimize how you want to manage this portfolio with the experience of your investors on the other side?”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“To your non call period during which the rate on the AAA down to BB, it's all fixed and you can't really monkey around with it. But after the two-year non-call period comes off, if it's to the advantage of the equity, you can go into the market and refinance the CLO's debt at lower rates. You can extend the life of the CLO, or you can decide to call the CLO. And that's just liquidating all the loans and getting your money back.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“To be diversified in the CLO market, I would say it's something like having max positions of around 5% of the portfolio. Each CLO again is going to have 200 or 300 different loans in it. You would not need 100 CLO equity tranches to be diversified. And then to a lot of the CLOs are going to own similar loans. So for example, Assurion is the largest loan in CLOs today. They do contracts for iPhone and Samsung phones, the insurance contracts. If you go out and buy a CLO, you'll probably find them in there. I think having call it 20 different CLO equity tranches would result in a pretty diversified portfolio. The one thing you want to be diversified though is just the life of the CLO. So in a diversified CLO fund, you wouldn't want to own 20 CLO equity tranches all bought in 2021. You would want the CLOs bought at different times, and that's important because the CLO starts its life with...”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“To that of what you see in the broadly syndicated CLO market. And so that's where we're focused is roughly this 10% of the market niche. And in this part of the market, instead of there being 100 managers, there's about 15 or so that we're working with in a typical year.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“So, the 90% of the CLO market is broadly syndicated CLOs. So if you look in there, you're going to find companies who borrow a billion dollars and up, basically. And so our focus, though, at FlyRock is really middle market CLOs, where your typical borrower is going to be $200 to $400 million of revenue. It's not going to be a company that you're going to read about in the Wall Street Journal or anything like that, but still going to be a business that provides a material product and service in the economy. So what we found is that portfolios of middle market loans, they both pay higher rates to the lender, but they also have more favorable loss statistics over time. And on top of that, middle market loans tend to be much less volatile than broadly syndicated loans. And as a result of that, the volatility that you see on middle market CLO double Bs and middle market CLO equity is just going to be more favorable.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“Lot of the big investment banks have CLO research teams, they're analyzing the data as well as we are. So they'll put out a stat that says something like, hey, in the last year, these are the top 15 managers who have grown the par balance of their loans. Or another bank might say, hey, these are the managers who reduce their CCC loan exposure. And when you look at that, one of the challenges in evaluating a CLO manager is that there's so many different metrics that you could choose I could list a dozen of them. At the end of the day, what it really adds up to is what I care about and what our investors care about is the IRR of their Dels. But pretty much every market”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“You have what sounds like just a massive data. So all of these CLO managers over 10 years, each one HCLO having 200 names in it, the performance of all those, how do you process all of that information that's coming in?”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“Of loans that might be more risky or just be more seasoned. So, those are some of the strategies they do, but the amount of churn CELO equity investors are definitely looking for managers with more churn of the loan. So that implies active management. Now it needs to add alpha. It's not just rotating in and out, but I think that's a metric that people in my seat are going to focus on. I think there's also qualitative component to this, which is I've been investing with the same CLO managers for 10 plus years. So when we're looking at a new CLO in the primary, you can do so much analysis on the underlying loans and how they performed, but qualitatively, you've already done a few deals with the guys, and you can just pull up this CLO positions that you already own with them. And I think that's obviously something that you need to wait in your decision process.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“So, I think active management is very important. You're paying them 40 basis points on average. And for that, you're not just getting somebody who's picked an initial portfolio of loans and then just let us sit there. The CLO manager is the good ones. They're actively trading their portfolio. In the loan market, how that works is, for example, if JP Morgan or B of A is underwriting a new leverage loan, they price that in a way to really incentivize buyers of the loan to come in in the primary transaction. So a new loan might come at a price of 99 cents on the dollar, but it was underwritten in a way that after it was allocated, that it's worth $99 and a quarter or $99.5, some little bump in economics is what you get by playing in the primary market for loans. So a lot of the time some successful strategies in leveraged loan management would be to be very active in primary where you're getting loans that trade up incrementally and over time rotating out.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“Left, and if you're only really signing up for that last part of the CLO, or you're not getting a lot of distributions along the way and you're just interested in the outcome of a liquidation, that's not a trade that would work for us.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“Another metric would be the amount of loans trading below a $90 price. So we usually think of loans that are worth $91 or higher as being worth par and loans that likely to fault at that 2% rate. But if the loans at 80 might not have defaulted yet, it might not even be CCC, but you would never buy a CLO with a loan trading at 80 and not make some kind of adjustment in terms of the price you'd be willing to pay. Another thing that we would shy away from is often there's very high returns offered for CLO equity securities that are short. So the CLO equity might have an eight-year life. And if you want to step into that in the secondary with one year to go or something like that, usually you can buy that at returns that would at least model to be very attractive. But that would be the most risky CLO equity securities you can buy because sooner or later the loans will be liquidated and the CLO's debt gets repaid and the equity gets what”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“So, one of the things that we don't do is deep dive due diligence on the underlying loans. And the reason for that is if you, so one, there's going to be 200 or 300 different loans in the portfolio, usually the max loan size is going to be 1% of AUM or thereabouts. And then if we're talking about broadly syndicated CLOs, the loans are traded. So you could do due diligence on underlying loan. It's 50 basis points of the loan portfolio. And then you found out three months later the CELO manager traded it and replaced it with another loan. So you're not really going one by one through loans and asking the CELO manager to explain themselves. So there's some big picture details that are reported by the CLO that would be of interest. So one is the amount of defaulted assets in there, which usually there are going to be some, the amount of triple C rated assets. So those are loans that you have much higher risk to default.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“You're diving into any one of those opportunities, you've got a different capital stack on the right-hand side of the balance sheet of the CLO. And then you've got, say, 200 loans on the left-hand side. How do you go about doing your research to determine whether you think it's an attractive opportunity?”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“On the loans, and then you're screening highest to lowest return opportunity. But it's much more complicated than that. So if the CLO equity has a higher return associated with it, then you need to delve in and be like, okay, what's the reason? And sometimes it's reasons that are good and that are going to lead to pursue the opportunity. And then other times it's just not going to be an opportunity that you want to chase. Great reasons to get a high IRR would be I'm buying at a good price. I have good debt execution out of Asia. The CLO manager is working for a reasonable fee. There's some deal specific things. If the CLO equity offers high returns, but the reason is that the loan pool is very spready, well, that means, okay, that's nice for the equity, but a higher spread loan portfolio could result in higher loan defaults over time. So that's the opportunity that we would screen out, for example.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“So, if you want to buy a CLO equity tranche, your options really are to do it in the primary market where CLOs are being created, or you can buy CLOs in the secondary market. So broker dealers, they make markets in these securities. The securities also trade in auction processes. So for example, a seller of CLO equity might put out a notice to the market that says, hey, in two days, I'm going to sell these three securities and I'm looking for the best bids. And people put in bids through broker dealers for that. So the first thing that you need to decide is just where you're seeing more interesting opportunities, the primary or the secondary market. So what we do is we basically have a tracking sheet which has every CLO opportunity that we've ever been shown in it. And the first screen is just, well, you buy CLO equity tranche very simply. You put in the price and you put in your 2% expected default rate.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“Insurance companies and CLOA investors will give you such attractive financing against a diversified pool of loans that usually people take it. So it's that leverage in the CLO that bridges you from the unlevered return to the levered one. And we think for an investor that can have a little bit more volatility on their nav that at the end of the day doing it with leverage is probably the best way to do it. I think the attraction of CLO equity is that the returns that we're expecting to earn should pretty much rival what we think you get from the S&P 500. But we also think that you can get the returns with a lot less risk. So somebody putting together a diverse portfolio of assets would find CLO equity can push out their efficient frontier or just have a portfolio with better returns and lower risk. So I think that's the selling point for CLO equity is that the distribution of returns around what I'm targeting should be, I think, a pretty tight.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“Great question. So, if we're comparing private credit owned predominantly unlevered, a lot of times you're going to get in a CLO exposure to the same underlying loans. But the difference is in the CLO, we're employing this long-term attractive funding cost that comes along with the CLO vehicle. So if you own trade of loans, they might pay today a call it a yield of around 9%. So if you're in an unlevered fund, that's the yield, then what investors would get would be less management fees and some loan losses. Now, if you're investing in CLOs, the CLO comes with attached leverage to it, so it might be the same underlying pool of loans, but you have seven to nine times leverage associated with that. So that's a leverage that would be similar to US bank today. So in my business, whenever you see a diversified pool of loans, usually somebody is financing against it. And the reason is that banks”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“So, when you are discussing the value of CLO equity relative to other alternatives of someone who's looking for a certain type of risk return profile, how did you compare it to the other ways people might get exposure to credit markets?”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“So, I think there's about 15 of us. One of the common jokes in the CLO industry is that you go to CLO conferences of which there's many. And it's a common theme that, oh, you know, there's new investors coming into the market. And you kind of always hear this. But really, I see the same 15 guys. We are often sharing in the same deals. We're speaking at conferences together. It is a niche asset class, although it's grown to be a trillion, but it's just a little bit more complicated than owning a high yield bond directly or S&P 500 stock or a mutual fund. So it does take a little bit of learning to get up the curve, but I think for people who spend the time, I think the risk adjusted returns are very favorable.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“Equity needs to be first, but the AAA is probably on deck, and there's probably already been a number of conversations there. So that's part of it. But another thing is that in my market, it's very transparent as to which managers are getting the best debt execution. A seal of manager might come to me and just say, hey, I print the tightest AAA in the market. I did it last month and three months before that. And I was talking to Japanese bank and they seem pretty interested. And so that gets the conversation going. But the other part of this once you have the equity, you're going to seal a warehouse and you're buying loans prior to the formation of the CLO. You have three to six months to figure out the full commitment on the AAA. So if it comes back maybe wider, then you might like as an equity investor, you can always just stay in the warehouse and just wait for a better time or better execution.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“So, when you're looking at the CLO equity and you want to know that they have that attractive debt financing, it sounds like there's a chicken and egg. If you're supplying the equity before you know what the terms of the debt will be, how do you resolve that in your research?”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“That puts together an indenture which has the rules that the CLO is going to follow and that negotiates economics with people up and down the CLO capital stack.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“So, to form a CLO, really, the first thing you need is a CLO equity investor like myself. So without the equity, there's really not much that can be done. Maybe the manager can put up the equity themselves. Sometimes it's going to be part of the CLO's permanent financing. Other times it's maybe a bridge until they locate a third-party CLO equity investor like myself. But once you have the equity, then you can set up what's called the CLO warehouse, and that's used to acquire loans prior to the formation of the CLO. And then you start marketing the CLO's debt. So the AAA then is the most important. And then the other CLO securities, the ones rated AA down to BB. Those are important, but less so. The AAA is 65% of your funding costs, so you need to get good debt execution there. And then later in the process, the other tranches get filled out. So each CLO has a CLO arranger. They have a team.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“So, the best financing for CLOs comes out of Asia, it's large Japanese banks and insurance companies that like to buy the AAA. And basically, they have approved lists. So they have 10 or 15 guys that have somehow made it onto the list. A lot of the criteria, it looks to me like from afar is just name recognition. So if it's a big household name, then that puts them pretty close to the top. But then if you're not on the list in Asia, issuing CLOs is a much harder business because your initial cost of capital is higher and that means less equity distributions over time. So a CLO management firm might say, hey, I didn't get a good debt print for the CLO, but I'll cut my management fee or I'll do something else for you. But the good debt execution really puts the top quartile of managers significantly ahead of anybody else who's in the business or trying to enter the business.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“So, the biggest alternative asset managers are all going to have large CLO groups. So Blackstone, BlackRock, KKR, Aries, they all have CLO management teams. They earn, call it 30 to 50 basis points to put together the initial loan portfolio to keep the CLO fully invested during its reinvestment period, and really to make sure the CLO is passing all of its tests. So the CLO managers are competing amongst themselves for capital from people like me. So they do that by having the best performance of the underlying loans in their CLOs. And they also do it by getting the best debt execution on their CLOs. So for me, that's the two things. Those are two really of the key ingredients that make for good CLO equity returns and also for nice stable performance of double B rated notes.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“You mentioned at the onset that there are now 100 different managers of CLOs. I'd love to map out what this investment universe looks like. So of these hundred that create these and manage the CLOs, who are these organizations?”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“One of the things that's interesting to me about CLOs and why I gravitated to this segment of the leverage finance market is it's very quantitative. In graduate school, I studied statistics, among other things. We're buying a double B note. Instead of asking ourselves, hey, is this one loan a great loan? Is it a defensible business model? Does it have a good management team? Does it have a good competitive position? These are things that we could debate, you and I, for hours. I don't know if there would be a right answer, a wrong answer at the end of it, but in CLOs it's very different. It's, hey, I have this pool of first lane senior secured loans. And as long as seven or eight percent of the loans don't default each year for the next seven years.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“So they would be highly incentive to support a business that has decent prospects, that has a good business model, help them make the higher interest payments rather than just turning over the keys to the lender. So that's for the underlying loans that are in the CLO. Depending on the pool of loans in the CLO, you're still going to see interest coverage ratios so that compares the amount of cash flow the business produces each year to its annual interest expense. For the most part, the loan pools are going to be above two times, which is still pretty comfortable.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“An owner of the underlying lounge, higher rates is great to the extent that the borrower can make the payments. How we think about that is, well, the initial loan to value is around 40%, maybe 50% at the max. So there's a lot of junior capital and equity that supports the business. So these loans are created in leveraged buyouts where a large private equity firm, they're buying a company, and they might put up, call it half of the equity purchase price. From the perspective of the borrower, they can either make their interest in principal payments or they can toss the lenders the keys. Those are really the only options. So because the loan to value starts off, we think pretty attractive place, even as rates have gone up, borrowers still have the capacity to make the payments. And even if they didn't from the perspective of the private equity firm that owns the company, they're looking at a future interest rate environment that should be decreasing. At least that's what the SOFER forward curve would say.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“How do you pencil out on the one hand most of that 30 year history was in a declining rate environment, some pretty stable economic environment with lower defaults? So that could be a negative if defaults go up. On the other hand, with rates going up and you own floating rate paper, you're going to have a higher yield. How do you think about going forward the balance of those two?”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source
“So, this is really just a small fraction of the default rate. And then today, because CLOBs are floating rate and because the Fed has hiked so much, we're getting yields in the 12% plus area. And defaults have been really, really minimal. So that's a pretty compelling opportunity that we're going after today.”
2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source