CLO equity returned about −8% in 2025, on Flat Rock Global’s CLO Equity Index. Over the same year, CLO AAAs returned about 5.5% and BBs about 9%.
Borrowers did two things to CLO equity. LBOs financed in 2021, when SOFR was zero, defaulted at higher rates. Recoveries fell to around 50 cents, against the 70 that CLO equity buyers typically budget. Performing borrowers, meanwhile, repriced their loans tighter.
CLO liability spreads are contractual. Spread compression on the loans therefore comes out of the equity tranche one-to-one.
Loans in a CLO prepay at par all the time. In a stressed market the CLO manager reinvests that cash in loans trading at a discount, and the gains offset the defaults. CLO investors call this the self-healing mechanism. For two years managers have rarely been able to use it, because performing loans are bid above par.
Shiloh Bates, Chief Investment Officer of Flat Rock Global, has invested in CLO equity and BB notes since 2012. We start with how a CLO earns its money and why self-healing stopped working. We then cover recoveries and liability management exercises (LMEs), and private credit CLOs. We close on captive CLO equity funds and the outlook.
“There’s been no self-healing in the last two years… the loans that are not defaulting and are doing well are all bid above par.”
Shiloh Bates, 24:20
What is in it
The two legs of the −8%. Defaults at low recoveries were loan losses, while spread compression cut income against contractual liability spreads.
The loss budget, re-run at 2025 defaults. Underwriting 2% defaults at 70 cents implies about 60bp a year, against about 140bp on Josef’s 2.8% and 50 cents.
Broad discounts, not defaults alone. In 2015–16 energy loans fell while the rest stayed at par; today 2021 LBOs default while performing loans trade above par.
Recovery rates moving lower. Underwriters targeted 80 cents, then 70, and recent recoveries sit closer to 50, which Shiloh ties to documentation, asset-light borrowers and LMEs.
CLOs in LMEs. Equity and excess CCCs give no credit in the CLO’s tests, so CLOs now sweep equity cash to fund restructuring equity instead.
Private credit CLO economics. Roughly 175bp more loan spread and about 40bp more AAA cost leave the equity about 500bp ahead, in Shiloh’s estimate.
Captive CLO equity funds. Funds obliged to buy one manager’s next four or five deals keep CLOs forming at projected equity returns of about 10%.
Chapters
00:00 Cold open
00:39 Introduction: CLO returns by tranche and Shiloh Bates (Flat Rock Global)
03:47 How CLO equity makes money
06:05 CLO equity −8% in 2025: 2021-vintage LBO defaults
08:23 Loan repricing and spread compression
10:13 CLO equity and BB notes: default history and spread
12:54 CLO structure: closing date and non-call period
16:18 Reinvestment period, amortisation and calls
21:00 The CLO self-healing mechanism
24:20 Why self-healing stopped working: loans bid above par
26:03 Loan dispersion, default rates and the 2021 vintage
29:50 Loan recovery rates: a structural shift lower
31:02 Loan documentation and lender protections
34:35 Liability management exercises and recoveries
36:43 CLOs in LMEs: CCC limits and equity restrictions
38:21 Distressed funds, debt-for-equity swaps and CLO tests
41:49 Private credit vs broadly syndicated loans in restructurings
46:44 Private credit CLO equity: the extra 175bp of spread
49:46 Self-healing and diversification in private credit CLOs
53:50 Middle-market vs large borrowers: credit quality and spread
57:06 Competition for private credit loans and LBO activity
1:01:46 Captive CLO equity funds and market discipline
1:06:46 Secondary CLO equity returns and NAIC capital charges
1:11:10 Outlook for CLO equity and CLO BB notes
1:15:34 The CLO Investor podcast and the CLO Investing book
About the guest
Shiloh Bates is Partner and Chief Investment Officer of Flat Rock Global, which he joined in 2018. He was previously a Managing Director at Benefit Street Partners. After two years of investment banking he joined CLO managers as a credit analyst, and has invested in CLO equity and BB notes since 2012. He wrote CLO Investing, with a focus on CLO equity and BB notes, and hosts The CLO Investor podcast.
LinkedIn · Flat Rock Global · CLO Investing · The CLO Investor podcast
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Fixed + Floating
Fixed + Floating is a credit podcast hosted by Portfolio Manager Josef Pschorn. Long-form conversations with credit market practitioners - portfolio managers, analysts, restructuring advisers and academics - on private credit, high yield, distressed debt, CLOs, liability management and credit policy.
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