The CLO Investor Podcast · Oct 9, 2026 · 1h 7m · 48m saved
With Shiloh Bates, Chief Investment Officer at Flat Rock Global
CLO equity, the riskiest slice of a collateralized loan obligation, lost 8% last year on Flat Rock's own index, Shiloh Bates said, in a year when credit in general did well.
Most investors expect a CLO to make up its loan losses by buying cheap loans in a downturn. Bates said that has not happened for two years, because there are too many buyers for leveraged loans and the healthy ones trade above face value.
"And so the default rate in the loan market is up. And at the same time recoveries are down." — Shiloh Bates
Shiloh Bates, Chief Investment Officer at Flat Rock Global, on The CLO Investor Podcast, buys CLO equity and BB notes from a market of more than 3,000 CLOs without ties to any of the roughly 200 managers who run them. He compiles the public Flat Rock CLO equity index, started his career as a buy-side credit analyst more than 20 years ago, and wrote a book on CLO investing. This interview was recorded for the Fixed + Floating credit podcast and republished on his own show.
The full interview is covered here so you can skip it. 1 hour 7 minutes of audio, 19 minutes of reading.
Here are the 14 insights that matter.
Key Takeaways
CLO equity bought in 2006 and 2007 earned about 30% a year over 12 years, because the CLOs bought loans cheaply during the crisis
That mechanism has not worked for the last two years
CLO equity lost 8% last year from higher defaults, lower recoveries and borrowers cutting their loan spreads
Recoveries on defaulted loans have fallen from 80 cents to about 50, and Bates thinks the drop is structural
Weaker loan documents, a service-heavy economy and out-of-court restructurings are his three causes
The default rate is not permanently higher, he said, because the trouble is concentrated in 2021 buyout loans
Private credit CLO equity can target 15% against 10% for broadly syndicated deals, on loans paying about 175bps more
Captive equity funds are forming CLOs at 10% projected returns, which Bates said hurts every equity investor
Flat Rock does not chase 25%–30% returns in the secondary market, because underperforming CLOs levered 10 times are too volatile
Borrowers cannot keep repricing their loans tighter forever, one of his reasons for optimism on CLO equity
1. Why Equity Lost 8%
The interviewer opened by asking why CLO equity fell 8% last year when credit had a good year. Bates began with how a CLO works.
A CLO is a simplified bank that earns the gap between its loan income and its financing costs
"So the way I'd think about a CLO is that it's a simplified bank and it makes its money by lending at a higher rate than its financing costs." — Shiloh Bates
A CLO might hold 200 senior secured loans made to companies bought in leveraged buyouts. A private equity firm such as Ares, Apollo or KKR puts up half the purchase price in equity and borrows the rest as a first-lien term loan, which ends up spread across thousands of CLOs. The CLO's debt is rated AAA down to BB and paid at fixed spreads. The equity takes whatever profit is left, targets returns in the mid-teens and takes the first loss when a loan defaults.
Equity buyers build a loss reserve into the price. The loans are rated single B and default at around 3% a year or a little less. Many investors assume 2% of loans default each year and recover 70 cents on the dollar.
Defaults rose because buyout loans made at zero rates now pay about 4% more in base rates
The main problem, he said, is buyouts from 2021, when private equity firms overpaid and financed at zero rates. All the loans float over SOFR, the benchmark that replaced LIBOR. SOFR was zero in 2021, is about 4% now and reached 5.3% about a year ago.
"For a lot of companies, their interest expense doubled as rates went up again because the loans are floating rate." — Shiloh Bates
Most of these companies grew revenue and profit and can carry the higher interest. A small minority also lost a major customer or turned over management, and those are defaulting. At the same time, recoveries that used to be budgeted at 70 have recently been closer to 50.
The healthy 95% of borrowers cut their spreads, and that comes straight out of equity income
Lenders compete hard for the companies doing well, so a borrower paying SOFR plus 350bps can ask its lenders for SOFR plus 300.
"And so over the last year and a half, we've seen just spread come out of the loan portfolios." — Shiloh Bates
The CLO's debt has contractual payments, so lower income barely touches the AAA to BB notes. The equity absorbs it dollar for dollar. Bates said the 8% figure comes from the Flat Rock CLO equity index, which the firm compiles and publishes on its website.
