Animal Spirits Podcast - Talk Your Book: The CLO Playbook

Episode Date: May 5, 2025

On this episode of Animal Spirits: Talk Your Book, ⁠⁠Michael Batnick⁠⁠ and ⁠⁠Ben Carlson⁠⁠ are joined by Shiloh Bates, Partner and CIO of Flat Rock Global to discuss the relationship between income and volatility, how CLOs perform during recessions, what CLO equity is, what happens when loans default, characteristics to look at for CLO managers, and much more! Find complete show notes on our blogs... Ben Carlson’s ⁠⁠A Wealth of Common Sense⁠⁠ Michael Batnick’s ⁠⁠The Irrelevant Investor⁠⁠ Feel free to shoot us an email at ⁠⁠[e-mail]⁠⁠ with any feedback, questions, recommendations, or ideas for future topics of conversation.   Find Shiloh's book here: https://www.amazon.com/CLO-Investing-Emphasis-Equity-Notes/dp/1642376566 Check out the latest in financial blogger fashion at The Compound shop: ⁠⁠https://www.idontshop.com⁠⁠ Investing involves the risk of loss. This podcast is for informational purposes only and should not be or regarded as personalized investment advice or relied upon for investment decisions. Michael Batnick and Ben Carlson are employees of Ritholtz Wealth Management and may maintain positions in the securities discussed in this video. All opinions expressed by them are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. See our disclosures here: ⁠⁠https://ritholtzwealth.com/podcast-youtube-disclosures/⁠⁠ The Compound Media, Incorporated, an affiliate of ⁠⁠Ritholtz Wealth Management⁠⁠, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. For additional advertisement disclaimers see here ⁠⁠https://ritholtzwealth.com/advertising-disclaimers⁠⁠. Learn more about your ad choices. Visit megaphone.fm/adchoices

Today's Animal Spirits Talk Your Book is brought to you by Flat Rock Global. Go to Flatrockglobal.com to learn about their suite of credit funds, CLO's private credit, flatrockglobalt.com. He'll learn more. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Redholz wealth management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ridholt's wealth management may maintain positions in the securities discussed in this podcast. Welcome to Animal Spirits with Michael and Ben. On today's show, we talked to Shiloh Bates,

who is a partner of CIO at Flat Rock Global. I have to admit a brand new one to me. This is, I think you would say, a boutique firm. Is that correct? Yes. Right? I don't know who came up with that as a name, but it just, if you say I work for a boutique asset management firm, I don't know. You get like a premium in my eyes. You know, it's interesting. You say boutique. I say boutique, but Kobe.

Like finance and finance? In kindergarten, he went to a boutique. He held the boutique and we thought it was the cutest thing in the world. I don't even know what boutique means. Let's say. A small store selling fashionable clothes. Yeah, it's a smaller. It's not one of the big, huge brand names.

It's a smaller. Anyway, we, we, we, We spoke a lot about CLOs today, and at the end, I finally got it. I got it. I get it and I got it. These are, so Flat Rock is essentially the bank that is making loans to these alternative asset managers as their debt financing to do these private equity deals. Yes, right.

Banks can't do it anymore because all the regulations from 2008. It is kind of weird. You could do that, the meme of the guy knocking the dominoes over, right? Great financial crisis. 10% yields for advisors and private credit funds. 10%? I don't know. Well, yeah, we'll hire in some cases, right?

So, anyway, we've had a handful of discussions about private credit and CLOs recently, but I think bringing this together, it's, it is kind of slowly but truly becoming clear to us. Because this stuff is, you know, you and I track this stuff pretty closely, and it's still not always easy to understand. So I think if you're going to invest in this stuff, you have to make sure the firm you're working with is really good on it on the education piece. Yes. And so Shiloh, actually, he wrote a book on this. He hosts a podcast. So he's all on the content piece, which obviously you and I are very familiar with. I think an educated investor, excuse me, makes for a good investor. And we covered a lot of it today. Like, you asked a good question, which actually I was going to ask, but great minds think alike. You got to it before I could. What are some of the unknown risk? What are some of the risk that advisors might not be at thinking about? So this was an instructive conversation with Shiloh Bates from Flat Rock Global. Shiloh, welcome to the show. Great to be with you guys.

We are recording this. It is Monday, April 21st, and once again, there is a lot of volatility in the stock market. And in the bond market, for that matter. Anything that is liquid, anything with a ticker, it's going up and down violently. One of the appeals to private markets and CLOs, which are going to talk about today, two things. Number one, high income. people love that. Number two, I'm looking at a chart of your total return, and it is basically

up until the right with very minimal blips in between. I mean, the drawdowns are not existent. Anytime I see something like that, my antennas go up. So why is this, how does that happen? Like, where's the free launch? How do we get big income distributions and very little price volatility? Sure. So we manage three different funds. And if you're talking about, the CLO Equity Fund. Basically, it's been around for about seven years, and it's lagged the S&P 500 by about 150 basis points since inception, but it's had a third of the volatility of the S&P. And the reason that I think, you know, we can offer attractive risk-adjusted returns versus the S&P are a few things. So one is, you know, really across all three of our funds, we provide

exposure to private credit loans. And so these loans, they start their lives with like a 50% loan of value. They're senior. They're secured. But they pay floating rates of interest. Sofer is the rate in my market. And if you go back to 2021, Sofer was basically zero. Now Sofer is at four and a quarter. So that's meant more income into our funds, more income into the CLO. So that's one dynamic that we benefit from. When did, sorry, when did Soper take over from LIBOR? So that was about a year and a half ago. So there was, so LIBOR was fixed.

There was a big kind of scandal about that. And SOFER is, LIBOR was basically like a theoretical rate where they pulled banks and said, hey, if you needed to borrow overnight, what would the rate be? And there was like a shenanigan scandal, right? Yes, out of the, out of the UK. And so now we use SOFER, which is a real rate where banks lend to each other on a secured overnight basis. All right.

So that's a terrible first question on my part. Forgive me. I should have started here. Who is Flat Rock Global? Sure. So we started in business about seven years ago. We manage a billion five of AUM. And our three strategies are in interval funds.

So that's one thing that's unique about us. And across three of our funds, we provide exposure to private credit loans. So really, the only question is, do you want to own the loans directly on your balance sheet or do you want exposure to them through the CLO structure? And then within CLOs, we have private credit loans owned in CLOBs, double B notes, and also CLO equities. So those are our three strategies. And I think one thing that's different about our firm is, again, being in business for about

seven years, growing to a billion five of AUM, it's been like nice, steady growth. And along the way, we've been hyper-focused on our track record. So I've seen months and quarters where other firms have raised almost the totality of our business. And, you know, that might be good for the asset management firm they work for. But we're really just more focused on our track record. That's kind of our DNA at Fly Rock. Mike and I have talked about this before, but I think it's good for a refresher.

Explain to the audience what an interval fund is and how it works. Sure. So it's very similar to a mutual fund. You can buy a share any day using a public, like a share price or nav. But the difference, the key difference is that because what we own, the underlying assets are illiquid, we're not in a position to do redemptions daily. So how we set it up is that people buy shares using the nav, and if people want out of the fund, we agree to buy back 5% of shares each quarter.

So those are the tenders, and that's a fundamental policy of our funds. So that's not something that's at our discretion or at board discretion. So that's basically how an interval fund is different from a U.S. mutual fund. Where can you buy an interval fund? Any brokerage firm, where do you get? Where can you buy them? Yeah. So our funds are on all the custodial platforms. So if you're an RAA, it's just a point and click. And then if you're not an RIA, you can send in mail in a subscription document. All right, dumb question. Where does the nav come from? Because the point that I opened with, like, it just seems literally up. into the right. Is that who's making that? Is that the market? Is that you? Is that an auditor? Like

where, where does the price actually come from on a day-to-day basis? So if we're talking about CLO equity, it's not always, you know, up into the right. So during COVID, for example, our peak to trough drawdown was 22%. So we captured about two-thirds of the drawdown of the S&P. And how we do the daily nav is that our CLOs are marked by a third-party daily. So they send us an Excel file with all the marks for our securities, and then that flows into Ultimus is our fund accountant, and they calc the nav using those third-party prices. That's how it's done. Okay, so the big question right now for everyone is, okay, the economy's slowing, recession is perhaps at our doorstep, who knows, but it's possible. What does that do to this type of strategy?

So you mentioned in the COVID period. And that was interesting. because yes, that was a recession, but you also had this credit event where, you know, spreads were blowing out and people were selling treasuries too. Like everything was getting sold there for a little bit until the Fed stepped in. So it's hard to know if we get a recession, if that would be some sort of credit event like this where this happens. But, you know, what sort of baselines do you, in expectations, do you set for investors if we do go into a slowdown period? So when we invest in CLO equity, we provide exposure or we get exposure to 200 different private credit loans. And the loans are rated single B on average by Moody's and

S&P. And we know that not all of the loans are going to be money good at the end of the day. So looking back over the last decade, we see roughly a 2% default rate on the loans and a 70 cent recovery. And so we bake that into all of our financial projections. And you could think of that as a loan loss reserve. So one thing to keep in mind is we already have a loan loss reserve, and that's very different from other asset classes where if you're in a loan fund like a BDC or a separately managed account and a loan defaults, you just kind of, there's no loan loss reserve and you just kind of take the hit on your nap. So then what we've seen in CLOs is that when you hit pockets of instability or higher recessionary risk, that the overall loan market tends to trade

down. And loans in the CLOs are constantly prepaying at par. And with those par proceeds, the CLO manager goes out into the market and they buy new loans, often at discounts to par. And so when you hit a recessionary period, on the one hand, you expect to take more losses on loans, which is negative for your returns. But at the same time, lots of loans are still prepaying at par. And the expectation is that you can buy discount of loans that can offset the the higher loan losses that you might experience. What is CLO equity? So think of it like this.

So basically the CLO has 500 million of assets in it. So it's called a loan pool of 200 different senior secured loans, floating rate. The loans are created in leverage buyouts. So imagine Ares, Apollo, KKR, they buy a company. They put up about half the purchase price in equity. and they financed the remainder with a term loan. And that term loan today might end up in literally dozens of different CLOs. So that's the vehicle that owns these loans.

And then so that's the CLO's assets. And then we finance this we financed the CLO by issuing debt that's rated AAA down to double B. And that's long-term non-marked market. financing. And then CLO equity, you could think of that as like the owners of this pool of loans. So it's kind of, imagine if you bought a stock in a bank today, except the bank is only a pure play lender. That's the way to think about CLO, CLO equity. And so in this investment strategy, kind of how it works is, the CLO is very profitable. And so it distributes to the equity, very large payments each quarter. But then the risk is that you're on the hook. When loans

default, that's the risk that you're running there. So I'm curious, who are your investors in a fund like this? Is it retail? Is it mostly advisors? Like who's coming to your door and ask for help with this? Yeah. So it's large RIAs who, you know, their clients go to them and might say, hey, listen, I'm not sophisticated in how I should have, how I should allocate my portfolio. A lot of RAs would have funds like ours in a model where, say, we're 5% or something of their assets. And as those clients kind of increase their exposure to the markets or decrease, that's, you know, funds that, you know, might make their way into the Flat Rock funds.

Hey, I apologize for the mischaracterization of the line go up earlier, twice earlier. I was talking about the enhanced income fund as well as the, the, you know, the, the diversified private credit fund. So those are legitimately up until the right. But this is a different animal. So apologies there. Happy to describe the enhanced income fund. If you'd like, that's the other CLO strategy.

I guess before we get there, just sticking with the CLO equity. So you're investing, like, you're loaning money to the areas of the world who are then loaning money to the deal sponsors. Is that? Am I misdescribing? it? So think about it like this. So at Flat Rock, we're not a CLO manager. So we're not picking the underlying loans that go into CLOs. So we hire a CLO manager to do that. And at Flat Rock, our biggest CLO managers are people like Black Rock, like New Mountain, like Jeffries,

bearings. A lot of the big alternative asset managers are our CLO managers. So how does that process work? Like what are you looking for to determine, all right, we're giving BlackRock 8% of the portfolio. this company is getting that. What are you looking? What are some of the characteristics that you're looking for? So in CLOs, there's roughly 130 different CLO managers. And my job, one of my jobs is to kind of distill that list of 130 to about 20 or 25 that we want to work with. And then within that list of who we think are the top performers, my job is to buy the CLOs that offer the best risk-adjusted returns, and part of that is trying to buy CLO securities as cheaply as possible. So there's a ton of money going into private credit these days. And working in the wealth management

space, Michael and I are inundated to the emails all the time. How do you try to stand out in this space and get people to trust you? Because it seems like there's an endless opportunity to find managers in this space. Sure. So in our CLO funds, I think the opportunity is that, you know, I go to lot of private credit conferences and the conclusion of, you know, all the panelists and, you know, I think people in the audience is that they think private credit's pretty attractive. And if you come to that conclusion, CLOs are one way to, to implement that strategy. So, for example, we have a CLO double B fund. And how that works is that if people want exposure to today 2,000 different private credit loans,

they can do that through the CLO double B note. And the attraction of doing that is that in the CLO structure, there's a third-party equity investor who signed up to take the risk on the underlying loans. And so, again, if you invest in a GPLP fund or a BDC and loans default, you know, that's the risk that you're taking, right? But if you do CLOBs, it's, again, exposure to this diversified pool of loans, but there is a CLO equity investor who signed on to take the primary risk of loan defaults.

And so if you look back over 30 years, CLOBs have basically a de minimis default rate. It's about 25 bibs. And so like what we found from our RIA clients is that for people who are either concerned about the economy in general or they think maybe too much money is flown into private credit, the CLOB space is a way to invest. in that in a more conservative way. So you mentioned that the CLO equity, the ticker is FROPX, FROPX. Yes.

It did have a 20-ish percent drawdown during COVID. But it's, I don't know, it's given you like, you can fact check me here, 85% of the upside of the S&P with much, much, much smoother ride. I mean, I guess if you're investing in equity, then an equity benchmark is appropriate. That's right. There's also no other, like, great benchmarks for, I mean, we benchmark against the S&P 500. We could also benchmark, I guess, against the Russell. If we did that, we'd handle the outperform the Russell. Sorry to cut in. How often do you get distributions in this? Is it monthly quarterly? So this pays monthly distributions that are covered by the funds net investment

income. You know it would be a good benchmark for this? I'm an idea's guy. So I got to lay it out there. I feel like a covered call strategy is a pretty good benchmark for something like this. because it's probably lower volatility. You're getting the higher income, but you also have equity like characteristics. Thoughts? You know, that's an interesting idea, but I don't, I'm not an options guy,

so something to consider. All right. Just the kind of stuff that we heal a lot. I'm curious how often do you have advisors coming to you and they're just focused on the yield piece of this? Like, they're picking the fund based on the yield versus how much to advisors actually understand the different fund structures in the different variations

among the funds that you're getting to. I guess what I'm trying to get at here is like how much education is necessary when you're helping people figure out what fund is right for them? Yeah, so it's a very big educational process. So I don't think our end clients are buying for yields. In fact, because we have three different strategies, you know, they rank from like a distribution yield of 9% at the low end to CLO equity at 15.5. and we're not just seeing people by the higher one.

That's not what they're doing. In my strategy, you know, I like to and have to do a lot of education for folks. So I wrote a book on CLO investing, and I wrote it really with kind of the target. The target reader is like an RAA, you know, somebody with financial knowledge, but, you know, not in the CLO space. And I think that it's very comprehensible. And then also, you know, like you guys, I have a podcast where, you know, once every couple weeks I have somebody on from the CLO market to talk about the performance of the underlying loans or anything that's really kind of topical in the space.

I like to do that kind of education. Hey, we're all about plugs here. What's the name of the book and the podcast? Give it to us. So the podcast is the CLO investor. and by Shiloh Bates, me. And the book is CLO investing with a focus on CLO equity and double B notes. And it's the books on Amazon and the podcast is on Spotify and everywhere else.

So what's a pitch for investors? If somebody's like, hey, why do I need this? Like, why can't I just buy anything else? What's the pitch? Yeah. So the pitch is that our funds have pretty low correlation to other asset classes like the S&P 500 and high yield or the ag. And so, and they also offer like pretty favorable returns. So by including our funds and investors portfolio, you can, if you think about it in kind of

the parlance of economics, whatever, it's like basically you're pushing out your expected return and lowering the overall risk of your client's portfolio. That's what our, that's what our funds are designed to do. When you have conversations with advisors, do you get the feeling that they're using these strategies and taking from fixed income and having that be just a diversified portion of that? Are they taking a little from stocks and bonds? What is the asset allocation decision here? Sure. So for CLO equity, we see it kind of as a one-to-one into our fund out of the S&P 500. We see it as a way to get equity-like returns, but with, again, a fraction of the volatility of the S&P. One thing, one piece of research we've looked at is,

you know, over the last 20 years or so, CLO equity, there's only like 5% of deals that have had negative returns. So it's a great way to try to get that equity return you want, but with limited or reduced downside exposure. And then for our CLO double B fund, I think people allocate to that fund in lieu of private credit funds where they own the loans directly, where they're taking the first loss risk on the loans, and also high yield. That's another asset class where we think our funds can really kind of shine in comparison. What do investors need to believe for this to make sense? Do they need to believe a story about interest rates, a story about the economy, the growth in private markets?

What's the thesis that drives this investment making sense? I don't think you need to believe a lot because the loans, again, that we provide exposure to, they start their lives with a 50% loan value. These are companies that a sophisticated private equity firm wanted to own the equity, thought the business would be able to grow revenue and profits over time. And because the loan is senior and secured, if the business has problems, if there's a restructuring, if there's a bankruptcy,

we're first in line in that senior secured position. And so the underlying loans that we provide exposure to, we see them as much more conservative than other investments, you know, like the S&P 500 or like high-eal bonds, which are unsecured. And so our asset classes can definitely underperform at times in like an absolute sense. But in periods of heightened economic risk or potential recession, we think people want to be first-leaning senior secured and not unsecured or not unsecured or not owning equity. We think in a recession, our underlying loans will certainly outperform other sort of corporate securities. When you have your conversations with advisors, do you get

the sense that they are using multiple private credit strategies to, because you keep talking about comparing and contrasting your strategy with other private equity or private credit strategies? Do you get the sense that they're doing that, or are they pretty much picking one and sticking with it? So I think they're taking a portfolio approach. I mean, there's like one or two very large funds in interval funds that are that are private credit um and when i talk to rAs they usually have exposure a lot of times they have exposure there and then there's like probably five other private credit focus interval funds that are also very popular so um we were often you know compared burst them and kind of pitching against their against their products

but i don't i don't think there's anybody where we get 100 percent wallet share and i don't I don't think our competitors do either. If an investor were to look under the hood into the pool of loans themselves, and I know it's like a diversified pool of a diversified pool of loans, what are we investing in in terms of, are these U.S. based only? What sort of sectors, industries are we talking about? What size of the companies? Sure.

So each CLO might have 200 different borrowers in there. And it's going to be diversified also by industry. So there's going to be a cap on how much. much, you know, the largest industry in there. In CLOs, generally, the biggest industries are going to be technology, health care, and business services. And then these are going to be companies, U.S.-based companies where they're doing, kind of call it 20 million of EBTA or cash flow per year up to 100 or 150 million of EBTA. So they're not going to be companies that are on page one of the Wall Street Journal, but they're going to be. companies that, you know, provide a material product and service in the economy. The recession risk is the obvious one to everyone. Like what could be a problem for some of these types of strategies? What are the other risks you think that advisors aren't really considering when investing in private credit? Like, is there anything that people are overlooking?

Sure. So I think a challenge now is not just the performance of the loans, but also just staying fully invested, right? So if you're an interval fund and you've raised a lot of money for private credit strategy, it turns out that these loans, the underlying collateral, is created in leverage buyouts. And since 2022, you know, interest rates went up and LBO activity has gone way down. And so I think it's very hard for private equity firms to find companies that they believe in that they can acquire at a price where they can pencil out that 20% plus returns they're going for, especially given the higher Sofer-based rate, right? So they're paying their lenders. Again, the loans are floating rate. They're paying their lenders, you know, much higher interest expense.

And so there's a risk that, you know, you fund into, say, an interval fund and sit in cash for longer as it, you know, takes time to deploy. And I think kind of one of the benefits of our slow growth, hyper-selective approach is that we just don't, we don't see those kind of inflows that would give us, you know, concern on just kind of the negative cash drag there. What if you were to triple overnight in terms of the assets that you manage? Like you mentioned that you're very focused on performance and not overextending yourself. Would you not be able to deploy that or what would be the risk of you getting too big? Well, I mean, you know, basically we raise in all of our funds in the interval fund structure, we might raise, you know, one or two million a day in each of our funds. You know, it's something like that. And if more money came in, then we could accretively deploy, we just put, we just put the brakes on it. That's how we think about it. So I'm a big investor in our funds as our, and other members of management as well. And so we're kind of, we're aligned along,

our investors. And if more money came in, then we could handle, we just put the, put the brakes on it. Meaning, like, you could actually prevent money from, you could like gate it on the way. Oh, interesting. Yeah, we could. One of the things I caught my eye as looking at the material was there's a big gap between like the, and I want to get your compliance in trouble here, but the gross expense ratio versus the management fee. Sure. Could you, could you talk about that? Yeah. So basically, the way the SEC requires you to, um, disclose your expense ratio. In that, they would include, for example, like if you do, if you borrow, or if you have preferred shares, the interest expense for both of those would be in the

expense ratio. And so like we borrowed, let me give you an example of our CLO equity fund. So we have preferred shares that were put in place during the zero interest rate period that have their fixed rate in the 6% area, and we're going to enjoy that cheap cost of capital for years in that fund. And it's a huge benefit to fund returns and to our return on equity. Well, in our expense ratio, all the distributions from preferred are captured in the expense ratio there. So it looks skewed. I mean, what investors should care about is what's the amount of profits that are leaving the fund in a way that doesn't kind of benefit them, right? So across all three of our funds, we have a one in three-eighths management fee, and we have an

incentive fee of 15% over a hurdle that varies by strategy. So that's when people are asking about the expense ratio, I mean, I would kind of, you know, explain the debt. And then also, I mean, management fees are what, what I think investors should, uh, should focus on. And then for all three strategies, you know, what we do is, we think these are inefficient strategies. So they're not, it's not something that you can kind of like index. If you want, if you want to invest, you know, at 50 bips or something like that, you're not going to find anybody who's kind of doing our strategies. You don't need to name any names, but are you seeing deals go down these days where investors are simply because they have so much

money to put the work over levering up because they want to keep the yield high. Is that something that's happening in the private credit space a lot these days? So I don't think so. So in my CLO funds, the CLOs, all their securities are rated. You know, again, by Moody's and S&P, the top part of CLOs is rated AAA. The most junior CLO debt security is double B. And to get those ratings, to have the CLO rated, all the underlying loans that go into the CLO also have to be rated. And so it's, you know, a lot of money has flown into private credit. People ask me, you know, hey, is it, is it a bubble or not? Well, the rating agencies have not changed their rating criteria for the underlying loans

that go in, nor have they changed their rating criteria for the CLO securities that are that are sold. And so I don't think lenders are stretching on leverage. one and two, like kind of one of the benefits of having this higher Sofer base rate is that, you know, company's interest expense is higher, which benefits us. And that means that the initial leverage of the deal, you know, has to be a little lower than it would have been, for example, during like 2021. Shiloh, back in the, in the GFC, a lot of these three-letter acronyms were at the epicenter of the decline in our financial system? What's different or improved about the current crop of products

versus the derivatives that almost took the system down in 08? Sure. And I think my answer to this question maybe ties into one of your previous questions about why we earn excess returns in our space. And one of the reasons I think is that we're kind of painted with the same brush of the securitizations that failed during the financial crisis. So the CDOs that failed and that almost brought the economy to a halt, if you look through to the underlying loans, what you would see is subprime mortgages, maybe no docs, the end mortgage holder had no job, no income. This is very different from the kinds of assets that are in CLOs, right?

So again, the CLO has corporate borrowers with call it 20 million of cash flow. and higher. And so one of the things that surprises people is that if you bought CLO equity right before the financial crisis and you held it through its 12-year life or so, the IRAs there would have been in the 30% area. And so the CLO equity, that's who takes the most risk in the CLO. So that performance is in sharp contrast to CDOs where there were defaults, all the way up into the AAAs.

And CLOs, no AAA is defaulted. And in fact, even the CLO double B, which is the most junior debt that's sold by the CLO, that has a de minimis default rate as well. So today's CLOs are one trillion in AUM. It's like a very big asset class. And the growth has been partially driven by performance since the GFC.

Last question for me, I don't think we spoke a lot about the borrowers themselves. Why are they tapping this form of a loan instead of a more traditional financing? So banks are no longer making the kinds of loans that end up in CLO. So if you're Apollo and you're buying software as a service, you know, technology company, maybe you want to leverage it five and a half times or thereabouts. Banks are not making those loans. So that's going to be made in the trade of the, loan market or the private credit market. And the financing rate today, like on average for

private credit, it's about 5% over Sofer. So that's like basically a little bit over a 9% yield. And, you know, that's kind of, I mean, that's really kind of the story for private credit. That's like why, you know, why it's interesting. 9% yields on the underlying assets and first in line for repayment if the business gets into trouble. This is why Jamie Diamond hates private credit because he feels like he's missing out, correct? That's correct. All right. So, Shal, I know we've already been on the line for 34 minutes.

But just in wrapping up, this is not an easy space to wrap your head around. So for somebody's like, wait, what is this? These are the, I'm investing in Flat Rock Global, which is an interval fund, that invest in different CLO pools, whether it's Black Rock, Ares, KKR, or whoever, and then they're investing or they're loaning money to these middle market companies for operations, and then it's all flowing back? That's correct. Okay.

Nailed it, Michael. Yeah, I mean, I could try to do it myself. So, again, so in my example, Apollo is buying, you know, making a person. private equity investment, they only put up half the purchase price and equity. The remainder is a first-lane term loan. That term loan ends up in literally dozens of CLOs. It pays its interest into the CLO. And then in the CLO, the equity is, you know, that's the junior security. That's who gets paid last. And then that, those distributions go into, are received by our fund. And then they're paid out by the fund in monthly distributions. Wait, hang on. So,

I actually think I misunderstood a part. I think I miss explained this. Or maybe I'm misunderstanding now. So your loaning money or buying a piece of, so BlackRock is putting up, I'm sorry, BlackRock, Blackstone is putting up half the money in a deal. The other half is coming from the CLO. So it's not like your, it's not like Blackstone is making loans to, well, all right. Okay. Well, in that example, Blackstone needs a loan because they're only going to put up 50% of the purchase.

price. They're going to borrow the rest. And those borrowings are the fuel for the CLO market. All right. So ultimately, you're making the loan to the all-term investment manager who is that making the loan to, or not making the loan, who is using this loan to purchase these companies. Yeah. That's right. So I guess the one follow-up question would be what happens if the private equity deals come under fire for some reason or they run into trouble? Is it just because you're a senior note that you're not that worried in that situation? Yeah. So again, these loans do, occasionally defaults. So looking back over 10 years or so, it's about a 2% default rate. Fortunately, when you're senior and secured, the recoveries are going to be better than

if you would have owned a high-eel bond, for example. But basically, the income from the CLO, if we're talking about CLO equity, enough profitability is kind of produced by the CLO that even in times where default rates are above your loan loss reserve, it can still be a good year. So, Shiloh, for people that listen to us and are still not quite sure what CLOs are, how do they reach you? Yeah, so I would start with a book. So, again, CLO investing on Amazon. And then they can reach out to us just through our website. It's very easy.

We're happy to do a lot of CLO education. And I think we're pretty good at it. Cool. Thanks for coming on today. Thanks. Enjoyed it. All right. Remember, check out Flatrockglobal.com.

Check out his book. We'll have links to that in his show notes. Email us, Animal Spirits at the CompoundNews.com.