Shiloh Bates, CIO at Flat Rock Global, explains the historical downside probability of CLO equity investments.
Assertion Supported
CLO equity returns reached the high 20s during the Global Financial Crisis
“And then if you were in contrast, an investor in 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.”
Assertion Supported
30-year default rate on BB-rated CLO debt tranches is 20 basis points
“If you look back over 30 years, the default rate on CLO double Bs is around 20 basis points.”
Assertion Supported
BB-rated CLO debt currently yields over 12% with minimal defaults
“Today, because CLO BBs 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.”
Assertion Not checkable as stated
Only about 15 institutional investors provide initial CLO equity
“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, ah, you know, there's new investors coming into the market, and you kind of always hear this,…”
What-if
AAA CLOs would have buffered banks during the 2023 banking crisis
“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, CLO AAAs might've traded to 97 cents on the dollar or something like …”
Insight
A diversified CLO portfolio requires roughly 20 positions at 5% maximum
“To be diversified in the CLO market, I would say it's something like having max positions of around five percent of the portfolio. Each CLO, again, is going to have 200 or 300 different loans in it. You would not need a hundred CLO equity tranches to be divers…”