Animal Spirits Podcast Summary: "Talk Your Book: The CLO Playbook"

Release Date: May 5, 2025
Host: Michael Batnik and Ben Carlson
Guest: Shiloh Bates, Partner CIO at Flatrock Global

Introduction

In this engaging episode of the Animal Spirits Podcast, hosts Michael Batnik and Ben Carlson delve into the intricacies of Collateralized Loan Obligations (CLOs) and private credit funds with their guest, Shiloh Bates, Partner CIO at Flatrock Global. The discussion aims to demystify CLOs, explore investment strategies, assess risks, and compare these instruments with traditional asset classes.

Understanding Flatrock Global and CLOs

Michael Batnik kicks off the conversation by introducing Flatrock Global as a boutique asset management firm specializing in credit funds. He remarks, “I have to admit, a brand new one to me, this is, I think you would say, a boutique firm” (00:43).

Shiloh Bates explains that Flatrock acts as a bank for alternative asset managers, providing debt financing for private equity deals. He clarifies, “Flatrock is essentially the bank that is making loans to these alternative asset managers as their debt financing to do these private equity deals” (01:20).

The Appeal and Performance of CLOs

Ben Carlson outlines the performance and appeal of CLOs, highlighting their low volatility and attractive risk-adjusted returns compared to traditional indices like the S&P 500. He states, “We provide exposure to private credit loans...we get more income into our funds” (03:50). The discussion emphasizes that CLOs offer high income distributions with minimal price volatility, making them attractive to income-focused investors.

Interval Funds Explained

Michael requests a refresher on interval funds, to which Ben Carlson responds, “It's very similar to a mutual fund... we agree to buy back 5% of shares each quarter” (06:54). This structure allows investors to buy into the fund while accommodating the illiquid nature of the underlying assets.

Navigating Economic Downturns and Risks

As the conversation shifts to economic uncertainties, Ben Carlson addresses how CLOs perform during recessions. He explains, “Loans in the CLOs are constantly prepaying at par...buy discounted loans that can offset the higher loan losses” (11:06). This mechanism helps mitigate risks associated with economic downturns by allowing managers to reinvest at lower prices.

Shiloh Bates raises concerns about the minimal drawdowns in CLO funds, prompting Ben Carlson to elaborate on the default rates and recovery processes: “Looking back over the last decade, we see roughly a 2% default rate on the loans and a 70 cent recovery” (02:57).

Investment Strategies and Fund Management

The hosts inquire about the investment strategies employed by Flatrock Global. Ben Carlson explains that they select top-performing CLO managers and focus on risk-adjusted returns by purchasing CLO securities at discounted prices (14:31). He emphasizes the importance of a selective approach to maintain strong performance and avoid overextension.

Market Position and Competitive Edge

Ben Carlson discusses Flatrock’s competitive edge, noting their focus on track record and disciplined growth: “We're more focused on our track record. That's kind of our DNA at Flatrock” (06:47). He highlights how their strategies offer low correlation to other asset classes, enhancing portfolio diversification and reducing overall risk.

Educational Initiatives and Investor Support

Education is a key component of Flatrock’s strategy. Ben Carlson mentions his book, "CLO Investing with a Focus on CLO Equity and Double B Notes", and the podcast "The CLO Investor", designed to educate RIAs and investors about CLOs (19:43). This commitment to education ensures that investors understand the complexities and benefits of CLO investments.

Risks and Challenges in Private Credit

The conversation addresses potential risks beyond economic downturns, such as challenges in deploying capital due to reduced leveraged buyout activity: “Interest rates went up and LBO activity has gone way down...hard to deploy” (25:14). Ben Carlson assures that their selective approach allows them to manage these risks effectively without experiencing significant negative cash drag.

Regulatory Environment and Market Integrity

Addressing concerns about the current market environment, Ben Carlson differentiates CLOs from the problematic CDOs of the 2008 financial crisis: “The CLOs have corporate borrowers with 20 million of cash flow and higher... no AAA is defaulted” (31:36). He emphasizes the robust underwriting standards and regulatory compliance that ensure the integrity and performance of modern CLOs.

Borrower Profile and Loan Characteristics

Ben Carlson provides insights into the typical borrowers within CLOs, describing them as U.S.-based companies with substantial EBITDA, operating in diversified industries such as technology, healthcare, and business services: “These are going to be companies that provide a material product and service in the economy” (24:28). This diversification enhances the stability and resilience of the CLO portfolio.

Investment Thesis and Future Outlook

The investment thesis for CLOs revolves around their senior secured position and high-yielding nature: “The loans... they start their lives with a 50% loan value... first lien, senior secured” (22:04). Ben Carlson asserts that CLOs offer favorable returns with reduced downside risk, making them a compelling addition to sophisticated investment portfolios.

Conclusion and Final Remarks

As the episode wraps up, Shiloh Bates succinctly summarizes the CLO investment process: “Investing in Flat Rock Global, which is an interval fund that invests in different CLO pools... the distributions go into our fund and then they're paid out” (35:07). Ben Carlson reiterates the alignment of interests between Flatrock and its investors, ensuring disciplined growth and robust performance.

Ben Carlson concludes with a call to action for listeners interested in learning more: “Check out flatrockglobal.com, check out his book... Email us at animalspiritscompoundnews.com” (37:26).

Notable Quotes with Timestamps

• Michael Batnik: “I have to admit, a brand new one to me, this is, I think you would say, a boutique firm” (00:43).
• Shiloh Bates: “Flatrock is essentially the bank that is making loans to these alternative asset managers as their debt financing to do these private equity deals” (01:20).
• Ben Carlson: “We provide exposure to private credit loans...we get more income into our funds” (03:50).
• Ben Carlson: “It's very similar to a mutual fund... we agree to buy back 5% of shares each quarter” (06:54).
• Ben Carlson: “Looking back over the last decade, we see roughly a 2% default rate on the loans and a 70 cent recovery” (02:57).
• Ben Carlson: “We're more focused on our track record. That's kind of our DNA at Flatrock” (06:47).
• Ben Carlson: “The CLOs have corporate borrowers with 20 million of cash flow and higher... no AAA is defaulted” (31:36).
• Ben Carlson: “Our funds are designed to... push out your expected return and lower the overall risk of your portfolio” (20:10).
• Ben Carlson: “These loans do occasionally default... it can still be a good year” (36:47).

Key Takeaways

• CLOs offer high income with lower volatility compared to traditional equities.
• Flatrock Global specializes in managing CLO funds, focusing on risk-adjusted returns and disciplined growth.
• Interval funds allow investment in illiquid assets with periodic redemptions.
• Risk mitigation is achieved through diversified loan pools, senior secured positions, and loan loss reserves.
• Educational resources like books and podcasts play a crucial role in investor understanding and confidence.
• Modern CLOs are distinct from the CDOs that led to the 2008 financial crisis, with robust underwriting and lower default rates.

For those interested in deepening their understanding of CLOs and private credit investments, this episode provides a comprehensive overview and valuable insights from industry experts.