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Shiloh Bates

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2024-04-11
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2024-04-11
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  1. “Equity, and that's supported by very high quarterly cash distribution. So unlike owning stock and the SP 500, where you're counting on capital appreciation maybe as being the biggest part of the return you get in CLO equity, it's actually the quarterly distributions that come to you right away. So that's the equity trade in a nutshell. We're also investors in double B-rated notes that works differently. That's just a debt security where all the loans in the CLO are pledged to you as collateral. There are other debt investors in the CLO that are ahead of you. But if you look back over 30 years, the default rate on CLO double B's is around 20 basis points. So if you compare that to Hyo Bonds or to levered loans, if you're just talking about the default rates of indices in general, not what's in CLOs in particular, but high yield bonds default it like 3% per year loans in the loan index defaults around 3% per year”

    2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source

  2. “To the CLO equity after all the CLO's debt has been paid, and there's a CLO manager as well that earns a fee to look after all the loans in the CLO. So if you're an investor in CLO equity, today you're targeting returns in the mid to high teens. And basically you're exposed to any loss on the CLO's loans. So the risk that you're taking is loans in the CLO default. But fortunately, it's not a unquantifiable risk. You can look back 30 years. And by our estimate, the default rate in CLOs is about 2%. So whenever somebody buys a CLO equity tranche, we budget in the 2% default rate into all of our profitability projections. So in a CLO, you might have 200 different loans in there. I've never met a CLO manager who goes 200 for 200. Unfortunately, so you kind of budget in a 2% default rate. That's the game in CLOS.”

    2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source

  3. “So, the easiest way to think about a CLO is that it's a simplified bank. So if you buy a share of, for example, Bank of America or JPMorgan stock today, basically you're going to get exposure to maybe 20 or 30 different lines of business. But in a CLO, it's really just a pure play lending vehicle. So the CLO might have 500 million of assets in it. Again, the loans are almost exclusively first lien floating rate loans. And then to finance that pool of loans, there's long-term financing. And it's sold in tranches which are rated AAA at the top and that's most senior and secured. And then down to BB, which is the junior most CLO debt tranche. And then there's the CLO equity. Similar to my bank analogy, the loans that the CLO owns is assets. They pay much higher rate than the CLO's financing cost. So that means each quarter there should be a nice amount of profitability that”

    2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source

  4. “I'd love to dive in a little bit, maybe through your book about what these investment opportunities are today. So we talked about what the assets are in these pools. Why don't you talk some about what is involved on the right-hand side of these balance sheets?”

    2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source

  5. “Concepts, and I think people can benefit from it. And it's all in there. If you wanted to learn about CLOs a different way, you could do Google searches. And there's tons of different articles, but I tried to make this book the one-stop shop, if you will, for all your CLO knowledge needs.”

    2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source

  6. “So, in my role, I spend 80 or 90 percent of my time investing, but I do need to do some investor education. And during the COVID period where I had some extra time on my hands, I decided to just write a little e-book that was 60 pages and we put it on my firm's website and it described how I go about CLO equity investing. And after I did that, I was really surprised by how many people read it. It was widely circulated in the market and that gave me the idea of doing a full book. So the book's 220 pages, a lot of the writing from it, at least initially just came from stuff that we used to educate investors in our pitch decks or our Q&As with them. And at the end of the day, it's like a trillion dollar asset class market now. There should be a book. So we wanted to bleed with that. And I wrote it in a way where I think people that are familiar with financial concepts, no CLO knowledge is required, just the basic financial.”

    2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source

  7. “So initially, my job was again just picking the loans that go into the CLOs. So I did that for about 10 years, and then I had opportunity to start investing instead of the loans, investing in CLO securities directly. So I started buying CLO double B notes, which are back.”

    2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source

  8. “Investment grade IG bonds traded into the 80s and sometimes lower. So I think it's a confluence of all those factors drawing people to the asset class. And the reason that I think it'll continue to grow.”

    2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source

  9. “CLO equity through the financial crisis on a buy and hold basis. A lot of the equity in those deals return high 20% returns and the debt in the CLOS defaults rarely as well. So performance has been very good over the last 30 years, so that's going to attract a lot of investors. And then I think the final thing is that pretty much every security in the CLO market is floating rate. So we've been benefiting as the Federal Reserve's been increasing rates. And when you buy a CLO of security, you just don't have the interest rate duration that you might have if you're buying a high-o bond or an investment grade bond. If you look at the banking crisis of the spring of last year, look, if banks would have owned AAA rated CLOs instead of some of the bonds that might be in the Bloomberg aggregate bond index, CLOAs might have traded to 97 cents on the dollar or something like that.”

    2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source

  10. “Growth of CLOs has really been driven by a few factors. So, one is that investors, they find first lien loans very attractive. Today, the yield on these loans are close to 10% or higher. So people look at that and say, hey, if I can get an equity-like return and I'm at the top of the capital structure, I'm first lien and I'm secured, that's an opportunity I want to participate in. So in CLOs, people are looking for actively managed exposures to these pools of loans. And then the CLO securities really up and down the stack have performed very well over the last 30 years. So a lot of people have seen the movie, the Big Short. The CLO industry is sometimes painted with a brush of the performance of CDOs where during the GFC you'd saw defaults really all the way up to AAA securities and initially rated AAA. And then if you were in contrast,”

    2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source

  11. “So, from that early experience looking at a very niche market at the time, what did you see in the evolution of CLOs alongside the rest of structured credit between then and when you started Flatrock?”

    2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source

  12. “To sort through the downside risks of the loans that go into the CLO and figure out the ones that survive really in if there's a pretty substantial downturn in the economy.”

    2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source

  13. “So basically, I was a credit analyst picking loans for the CLOs. So there might be 10 or so different loan opportunities that would come across your desk in a month, and your job is to sort through the best opportunities. So the typical loan that goes into a CLO is going to be a first lian and senior secured loan. Today, the loans pay around sofer plus three and a half to 4%. And basically the idea is that if you're investing in first lien loans, you're starting off with a loan to value of around 40%. So you're not so sensitive to whether or not the economy grows at 2% or 3% or even shrinks a little, you're exposed to is really the situation where the wheels fall off the cart in terms of the company's business model. So loans with a 40% initial loan to value they do default rarely, fortunately. Usually it's due to some regulatory or technological change or loss of big customers. But as the credit analyst,”

    2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source

  14. “Trillion of CLO AUM, the CLO equity tranche is about 10 of the CLO's financing. So it's a hundred billion asset class for CLO equity in particular.”

    2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source

  15. “Was a very small little niche of finance, so there was basically about six billion in AUM when I joined, and there was six different CLO managers. And today there's really over a trillion in CLO AUM and about 100 different active CLO managers.”

    2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source

  16. “Sure. So I went to graduate school at Harvard, and after graduating, I went to work for Wells Fargo as an investment banking analyst. And then at Wells Fargo basically, I think somebody in HR takes a pool of 100 different investment banking analysts and just assigns them to different groups. I was in financial institutions and one of my initial projects in the group was to work on a financing for a CLO manager. And then two years later, I actually found myself working for that same CLO manager in Los Angeles. So I worked as I'd must have been banking analyst for just a little bit and then quickly transitioned to the buy side.”

    2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source

  17. “Again, this year, at least you can turn to that podcast app on your phone and listen to capital allocators for about as perfect an hour as you can get each week. Thanks so much for spreading the word. Enjoy my conversation with Shiloh Bates. Shylah, great to see you. Thanks for doing this with me”

    2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source

  18. “My guest on today's sponsored insight is Shiloh Bates, the chief investment officer at Flat Rock Global, an alternative credit manager specializing in the junior tranches of CLOs. Last year, Shiloh published CLO Investing, a comprehensive review of the structure, payoff rules, and historical performance of the space. Conversation covers Shiloh's 25 years spent in and around the space, an overview of the market, characteristics of CLOs, attractiveness of CLO equity relative to other credit opportunities, and flat rock's approach to investing in CLO equity and bees.”

    2024-04-11 · Capital Allocators · Shiloh Bates – CLO Investing at Flat Rock Global (EP.379) · IDENTIFIED FROM THE TRANSCRIPT · source