XAI Octagon Floating Rate & Alternative Income Term Trust (NYSE:XFLT) Q2 2022 Results Conference Call August 18, 2022 11:00 AM ET
Company Participants
Robert Chenoweth – VP, IR
Kimberly Flynn – Managing Director
Gretchen Lam – Senior Portfolio Manager, Octagon Credit Investors
Robert Chenoweth
Welcome everyone to the XAI Octagon Floating Rate & Alternative Income Term Trust Quarterly Webinar. Welcome Kim and Gretchen as well.
Kimberly Flynn
Thanks Robert.
Gretchen Lam
Thanks Robert.
Robert Chenoweth
My name is Robert Chenoweth, Product Specialist at XA Investments and I’ll be your moderator. In today’s webinar, we will provide a second quarter update for XFLT and take questions from the audience.
Before we begin, there are a few disclosures I’d like to make you aware of. The information discussed today does not constitute investment, tax, legal, regulatory or accounting advice. This information should not be considered as an offer to sell or buy any security. Investors are advised to make an independent review before purchasing or selling. Investments carry a risk of loss and past performance does not guarantee future results.
All right. So, before we begin, registrants, everyone who registered will receive a link to the replay following the webinar. I’ll send it to the email you provided when you registered, so you can listen and download the presentation as well. You can also resource additional information on our website, past webinars, white papers, things like that at xainvestments.com under the “Knowledge Bank” tab, lots of useful information there. You can also submit questions during this webinar through the questions box. It’s on your webinar toolbar.
We may not be able to answer all the questions. If we don’t get to yours, please feel free to reach out to us afterward and we’ll be happy to help you. We’ll share our contact information towards the end. It’s also on our website as well.
All right. So, today we are joined by Gretchen Lam from Octagon Credit Investors. Gretchen joined Octagon in 1999 and is a member of Octagon’s Investment Committee and serves as Senior Portfolio Manager across CLOs and oversees the firm’s structured credit investment strategies. We are also joined today by Kimberly Flynn. Kim is a founding partner and Managing Director at XA Investments responsible for all product and business development activities. Previously, Kim was Head of Product Development at Nuveen, leading their Global Structured Products Group.
So, we have already prepared questions and topics for today’s discussion. They’ll be relevant to XFLT and the bank loan and CLO market. They will correspond to the slides that you will have access to with the replay a little later, so. But feel free to send questions our way as well.
And before we begin, I’ll give a quick review of Octagon Credit Investors. Octagon has focused on below-investment grade credit since 1994 with assets under management of $32.9 billion. Their investment process is rooted in fundamental credit and relative value analysis. They are an experienced team with a track record exceeding 25 years. And they’re a leading institutional credit investor.
So, with that, I’ll go ahead and hand it over to Kim.
Kimberly Flynn
Great. Thanks, Robert. I’m going to hit the highlights this month. For those of you who are with us every quarter, thanks for joining us again. There are many things that we report every quarter on a regular basis, there’s some new information we’re going to share with you. In the quarter, we did see declines in both, the NAV and the market price of XFLT at the 6/30 date, the NAV was $6.65 price was $6.98, and this was largely due to the mark-to-market valuation of the fund’s securities.
You’ll see the asset allocation pie chart on the right hand side. And the fund is largely comprised of investments in senior loans, and also CLO equity and CLO debt. And this period, we saw significant pricing declines in the loan market and that has been reflected in the fund’s net asset value. And I think that we’ll talk about the Fed rate hikes, there’s been a lot going on in the period ended 6/30. And then subsequent to quarter-end in July, we saw the Fed raise rates again. So, a lot going on in the loan market and CLO market.
XFLT remains a fund that is attractive to investors who want monthly distributions. The fund does have a distribution rate on NAV of 13.17%, as of the end of the quarter, distribution rate on price of 12.55%. So, attractive distributions. As a reminder, the fund does pay distributions on a GAAP basis, which means we pay out what we earn. And the fund is now approaching its 5th anniversary. The fund was launched in September of 2017. So, the maturity profile of the holdings has increased in terms of the breadth and the depth of the types of securities we’re holding. Right now, we’ve got 448 different holdings in the fund. A large part in terms of the growth of the holdings is due to the growth of the asset level in the fund. We’ve been successful in the last 2.5 years, raising additional capital to grow the size and scale the fund, which means more efficiencies for the fund and for shareholders.
Next slide. This is the composition. It does look largely the same for this last quarter in terms of composition of loans, CLO equity and CLO debt. And I think this is really purposeful in terms of the mix. You will see intra-quarter — you’ll see some movement as opportunities arise. Octagon is an active manager. And if they see opportunities within some of the asset allocation segments that they focus on, they will take advantage of them. And in different market environments, CLO equity might be more attractive than CLO debt. In the latest quarter, CLO debt yields are quite attractive. And so, where there are opportunities, Octagon will be dynamic to the extent they can shift the portfolio. But we do end up seeing a composition that generally has been very consistent since the fund’s inception and this mix of assets, which we would think of as like a 50-50 mix between loans, CLO debt, and CLO equity is designed to enhance risk-adjusted returns over time.
In terms of net returns for the quarter, for 6/30, as I mentioned, we saw significant declines in both price and NAV. And the benchmark was down less. As I mentioned, the composition of the fund is a combination of loans, CLO equity, which are leveraged portfolios of loans. So, you would expect that the fund’s NAV would be down to a greater degree than just the simple loan benchmark index. One of the things that’s important to point out is that when we calculate net returns, obviously, we reinvest dividends, which are a large part of the total return of the fund. But the biggest risk of investing in this asset class in CLO equity, CLO debt is the mark-to-market risk of holding these investments. And we do encourage investors to hold these types of high-yielding cash flow of the assets for long periods of time. For this very reason our fund is a daily NAV. And so, we mark-to-market our assets daily, which we think is important as it provides transparency. But to the extent the market is volatile, the portfolio in the NAV can be volatile. We think it’s important to share that with — that information with real time.
And the returns, the reason I mentioned it now is, the returns reflect these mark-to-market losses, if you will, associated with positions that we continue to hold. We are not selling out of these positions even though the marks or the prices of those assets are lower. And so, that is reflected in the NAV of the portfolio, and even though the portfolio itself continues to earn cash flows and pay distributions at a much higher rate than the total returns. So, it’s really important when investing in a fund like XFLT to think about what goes into these net return calculations. It’s important to understand that that mark-to-market piece of it is a large driver of the return calc.
And to the extent that these assets increase in price, obviously, at that later point in time, that would also be reflected in the marks and that would be reflected in the NAV of the fund. So it’s just one thing to think about, if you’re looking at periodic returns of a fund that invests in CLO equity.
The fund does continue to trade at a premium to net asset value. I think it’s in large part due to the cash flow nature of the CLO equities that we have in portfolio. The current premium is about 6%, inception to date has been about 3.5%. And in the last 18 months, floating rate investments have been in favor. And so, this does, in part, lead to the premium pricing for the fund.
Just a little bit in terms of price and NAV. You see a little bit better here in this picture the price and NAV declines. It does happen to be over the same period of time that we’ve seen a significant decline in the S&P 500. And you all have experienced this market volatility and so, nothing new to report from my end.
What is new is on the next slide, which just captures the activity that we’ve observed in terms of the four Fed rate hikes from March 16th to July 27th. So significant increases in rates, we’ve seen three-month LIBOR in this year alone, move up 250 basis points. It’s now — three-month LIBOR is now sitting at 2.79%. And obviously, the inflows into floating rate products in 2021, we’re in anticipation of these potential Fed rate hikes to try to get ahead of inflationary pressures in the economy.
So, this has also been impacting the assets in the portfolio in a significant way. We’ve seen spreads move — excuse me. We’ve seen base rates move up and we’ve seen overall yields move higher in the marketplace.
Not a lot to report in terms of trading volume. We always show volume analysis. This is really a sign of the health and wellness of the fund, in terms of liquidity in the secondary market to the extent that you wanted to buy or sell shares. We do actively monitor trading volumes and the fund’s trading has been healthy in the last 30 days at 140,000 shares. And it’s been a little quieter I would say in the last two months, just given kind of summer — summer quiet, but we’ll hopefully see volumes continue to trade strong.
On the next slide, this speaks to the growth of the fund and some of the efficiencies that I mentioned. In the quarter, we did end up pricing direct registered offering, a combination of equity and preferred shares, which has continued to grow and scale, the fund. This was press released on June 30th. And as we tried to do in terms of transactions to grow the fund, we want them to be accretive to all shareholders and bring some form of benefit. In this case, the convertible preferred shares were done at an attractive rate and reduced the overall cost of the preferreds. Previously, we had a preferred issuance outstanding at about 6.5%, these convertible prefers were issued at 6%. Thank you.
The leverage sources here are outlined. In terms of where we are with overall leverage, it’s about 41%. So, obviously, well short of the regulatory limits of 50%. The average cost of leverage in the quarter did move up slightly, as we’ve seen increases in LIBOR. We do have a bank facility with SocGen that is a floating rate facility. The preferreds were at 6.50%. The convertible preferreds that I mentioned that were issued right at the end of the quarter on that date, 6/30, were done at 6%. So, we’re always looking at trying to manage the average cost of leverage, so that we can be borrowing at what we think is an attractive rate, and attractive spread to where the portfolio is earning and where we can borrow.
As we’ve talked about in the past, these floating rate assets do lend themselves to the use of leverage, and the portfolio can benefit in terms of earning additional income each month. And so we’re very proactive in terms of managing the funds. Sources of leverage, and the reason for having both bank borrowings and preferreds is that it really lines up nicely with the asset mix in the portfolio with the combination of loans, and CLO, debt and equity.
We continue to pay regular monthly distributions. Since October 1st of 2020, we’ve been declaring monthly distributions at the same steady rate, $0.073 per share. And, as of the end of the July, that distribution rate was just north of 12%. And we endeavor to, as I mentioned, pay earnings based, based on the income the fund receives to pay that out to shareholders.
And I’ll just end here with a quick comparison. We do get a lot of questions as advisors and investors follow a number of the CLO-focused close-in funds in the marketplace. Our fund is distinguished in a couple of ways. And that’s really by design. XFLT was modeled after an institutional strategy that Octagon runs and the composition of the portfolio, as I’ve mentioned a couple of times is unique in the marketplace, and it is designed to enhance risk-adjusted returns. But the benefit of having that asset mix allows us to have much lower leverage costs compared to our competitors who are usually because CLO equity, because those assets you’re not able to secure bank facilities you have to issue preferred at a higher rate. This is an advantage for XFLT because we have the combination of sources of leverage that we’ve always — already discussed.
I mentioned the net asset value. We think that having a daily NAV provided by third-party valuation experts is important in terms of transparency. And XFLT also does not charge a performance fee. So, I’ll leave it there and we’ll turn the discussion now to Robert and to Gretchen.
Question-and-Answer Session
A – Robert Chenoweth
Great. Thank you, Kim. Very good job talking about XFLT, and we’ll talk a little bit more about the fund going forward in our prepared questions. Let’s talk a little bit about the market what we have seen. So, Gretchen, this first question is for you.
Loan market volatility has continued on the heels of slowing economic growth, rising rates, supply chain issues and recession concerns. Can you give us some insight into what you are seeing in the loan market?
Gretchen Lam
Sure. Happy to Robert, and good day to everyone on the phone. Thanks for joining. Indeed, the second quarter really bore the brunt of these forces that you mentioned. The average price of the Leveraged Loan Index fell almost 5.5 points in the second quarter, which is pretty remarkable in the context of history. This is largely due to a broader risk proposition across the credit market and specifically driven by concerns about the effects of inflation and the Federal Reserve’s efforts to tame this inflation with quantitative tightening and rising rates.
I would note that, unlike in the first quarter, we did see a distinct delineation based on perceived risk of loans. So, in other words, the market today is assigning a hefty risk premium to loan with a perceived higher likelihood of default. To put some numbers around that, at the end of the second quarter, for example, the sub index for BB rated loans, trading at a price of about $0.945 on $1. The sub index for CCC rated loans was priced at an average level of 13 points below that. So, the market pushing between higher quality, below investment grade loans and CCC rated loans, which historically have had a much higher risk of default over time.
It is worth noting, however, that since the end of the quarter, we had seen a strong rally in loan prices similar to what we saw in the public equity markets over the same period of time. Some of this we think is a bit of a sigh of relief after the second quarter earnings came through and were largely better-than-expected, or perhaps I should say better than peers. But also I think the market is taking comfort from signs that inflation is starting to abate, notably in commodities and easing supply chain costs. But also I think that, at a price below $0.92 on the $1, which is where loans bottomed out in early July, they were just too cheap. They were oversold, we think, recessionary fears notwithstanding.
Robert Chenoweth
Great. Thank you. So, I know half the portfolio is in individual loans, the other half CLOs. So, can you give us an update on the CLO performance in Q2?
Gretchen Lam
Sure. So, according to the CLOIE BB sub index for CLO tranches rated BB, those tranches returned a negative 7% in the quarter. There is no broad index for CLO equity that our internal analysis suggests that the market-wide returns were down 10% to 12% in the quarter. It is important to understand though that this was due to unrealized drawdown in loan prices, which, as we’ve discussed, have been partially rebounded and not on average was due to realized losses in underlying loan portfolios. So, in CLO equity, by virtue of the leverage in the structure, a movement in loan prices will have a material impact on the NAV of the CLO, but these represent unrealized mark-to-market movements, not realized losses.
While we never wish for negative returns, I think it is worth pointing out that loans, CLO debt and CLO equity, all materially outperformed other adjacent asset classes in the quarter. And in fact, high yield was down almost 10% in the second quarter, which was more than two times the last that the loan market saw.
Looking forward, we think that despite the recent rebound in loan prices and prices of CLO tranches and equity, they all continue to offer very compelling returns to investors, loans of note for the first time ever, and thanks to rising reference rates, now has an average coupon in excess of the average coupon in the high yield market. That has never happened previously. CLO BBs, which today are generally trading in the mid-90s in the secondary market, are in many cases generating 10%-plus current income, while at the same time offering price convexity upside.
And CLO equity cash distributions have benefited from increased loan spreads, which of course accrete to equity investors and managers’ ability to buy discounted loans in the secondary market over the last three to five months with the proceeds that they’ve received from loan prepayments, which in the fourth quarter loan prepayments market-wide was about 4%.
Robert Chenoweth
Great. Good answer. One more question for you, next here, Gretchen. So, I know probably a couple quarters ago we were talking about COVID and how COVID was negatively affecting certain industries in the loan markets. Now, we’re talking about inflation and rising interest rates. Are there industries facing similar economic pressures now?
Gretchen Lam
Yes, a couple of themes that we’re seeing in corporate performance. We continue to see lingering effects of COVID for many borrowers. For some, quote unquote COVID winners, furniture manufacturers or craft stores or pool chemical companies, for example, we’re generally seeing a slowing of demand as revenues begin to revert to pre-COVID levels. Other companies that were COVID losers, like airlines or restaurants or casinos, they’re still seeing strong revenue growth as consumer spending habits have shifted in favor of experiences and services.
In 2022, we, of course, as we’ve discussed also seen inflation emerge as a big headwind. And while we expect these inflationary headwinds to continue, we do see signs that we are beyond the worst event, at least sequentially over the course of the year. But I think the most noteworthy emerging theme in corporate performance is [Technical Difficulty] of a discernible theme. And what I mean by that is that we are seeing more idiosyncratic dispersion of performance across loan borrowers, sometimes even within the same sectors. And we think that this is likely to continue into 2023 and really underscores the importance of solid fundamental credit analysis.
Robert Chenoweth
Great. Thank you. Kim, we’re coming back to you here. So, after almost six quarters of retail inflows and rates on the rise, the loan market is now experiencing retail outflows. So, why do you think that is, and shouldn’t rising rates drive more investor demand to the asset class?
Kimberly Flynn
Yes, absolutely. You can see this in terms of what Robert’s referring to in the lower left chart in terms of retail loan flows. And this is what I mentioned about I think, in anticipation we all saw the amount of federal spending. I think we all knew that inflation was coming. And so — in an anticipation of Fed rate hikes coming from a very low base in terms of where rates were in 2021, we did see tremendous amount of retail fund flows. And I think that the market has taken a bit of a pause this summer, I think not just the loan market, but the close end fund market, which this fund is part of, in terms of sort of a risk-off stance, and investors are on the sidelines. We’ve actually seen people move to cash and look to liquidate things.
So, I think that’s really part of what we’re seeing. It’s really not a reflection of what the potential I think that the asset class can do. There are concerns, I think, about potential to the extent that the recession is worse than people would expect or that there were credit pressures. I think Gretchen’s already mentioned where the default picture is which is a fairly positive fundamental view. So, I think people have taken a moment. I think the outflows in the loan funds was really more of that kind of getting to cash that we talked about. To the extent that we’ll see loan inflows going forward, it will depend on, I think, how investors and advisers are feeling about fundamentals, how they’re feeling about the credit outlook going forward.
We did see inflation come down a little bit in July, which helps a bit, but I think it’s probably too soon to determine. I think that loans are a great place to be. I think there’s an expectation that the Fed is going to continue to raise rates. And so that — this asset class is floating rate and these assets are poised to benefit from that. And as I mentioned, XFLT among other types of floating rate funds are typically borrowing also at floating rate levels. And so, having both the assets and the liabilities in the portfolio being floating, the fund can maintain its arbitrage. And a lot of closed-end funds use leverage. This fund is going to continue to benefit from the use of leverage. And the reason we do use these tools is to provide income and to provide steady monthly cash flows. So, it will be interesting to see what the next few quarters hold, Robert.
Robert Chenoweth
Thanks, Kim. Yes. And keeping on the topic of rising rates, Gretchen, this next question is for you. The Fed raised interest rates by three quarters of point in June and July. These were the largest rate hikes since 1994. So, how has this aggressive action impacted the loan and CLO market?
Gretchen Lam
I mean, I think the simple answer, of course, is rising reference rates increased the coupon on loans and in theory, make them relatively more valuable as a result. And as Kim just referenced, we saw throughout 2021 and early 2022 that the expectation of rising rates drove material inflows into the loan asset class. The more important question, I think, is and one that the market has been acutely focused on in the second quarter is the reason why the Fed is raising rates, which is of course to combat inflation, and the success that they may or may not have in attempting to do so.
And additionally, what is the impact on corporate income statements and cash flow due to this higher interest burden. And this concern is what has caused certainly been a major driver of the recent price volatility in the loan and CLO market, even with the coupons having moved up due to higher interest rates.
If we look over recent history, during periods of time when the Fed has persistently raised rates and excluding this current period of time since we’re still in the midst of it, over the last 30 years, there have been four such periods of time. And if we look at these periods, the last was in 2016 through 2019. Loans have outperformed not only high yield, but also IG corporates, municipal bonds, TIPS and 10-year treasuries.
Robert Chenoweth
That’s very interesting. So, as a follow-up, has the weakness — and this is for you, Gretchen. Has the weakness in the loan and CLO markets created buying opportunities?
Gretchen Lam
Absolutely. I mean, the price action that we saw in the second quarter and into early July was remarkable. As we said, loans fell below $0.92 on the $1. And for context, the last time that we saw loans reach those levels other than during the pandemic was in early 2016. And in 2016, loans ultimately returned over 10% for the full year. There were many buying opportunities due to this volatility in the quarter, particularly in the secondary market, given secondary trading levels, The CLO equity that we purchased in XFLT was executed at an average purchase price of $0.615 on the $1 in the quarter. And the loans that we purchased in the quarter were at an average price of $0.955 on the $1. And these purchases represent really meaningful convexity upside over time.
Robert Chenoweth
It’s good to hear. So, that sounds pretty good for investors getting some cheap loans in there. Great. Kim, we’ll go back to you. How have loans and CLOs performed in rising rate and inflationary environments versus a more traditional fixed income investment like high yield?
Kimberly Flynn
Sure. Well, why don’t we just talk about right now year-to-date performance in 2022? And it may surprise people that if we look at relative returns between asset classes that — for example, the loan market is down about 2.5% and that’s compared to the high-yield market, which is down about 9% and the S&P 500, which was down 12.6%. That’s for period ended July 31st. So, on a relative basis, the loan market has held up pretty well compared to high yield or compared to the equity market, despite the volatility that we’ve experienced year-to-date. And I think Gretchen talked about the way these assets performed in prior inflationary periods. And the expectation is that these assets will perform well in those environments.
Now, if you — we talk about CLOs, there’s no index for CLOs. But as you can see in the chart that we’ve got on, you can see that the average CLO price, according to JPMorgan, has come down year-to-date, down to 95.7%. And so, I think that the CLO pricing is a derivative of loan pricing, and it’s also reflected in XFLT’s net asset value, and we’ve talked about that that with both, the marks on loans and the marks on CLO debt down, you’re going to see total returns in negative territories. But the reason that investors buy these assets is they’re cash flowing every month, every quarter and loans and CLOs remain a very attractive source of floating rate yields over time.
And so, I think that it’s helpful to think about — on a relative basis, loans have outperformed other assets this year. But if we look back over a longer period of time in different market cycles, one thing I want to remind the audience about is, there have been a number of research studies done about performance of the CLO market in the great financial crisis in 2008-2009. And the performance was actually quite terrific for CLO equity investors. And part of that is that CLOs are actively managed vehicles. And to the extent that they’re still in their reinvestment period, the CLO managers, which are some of the best managers in terms of low investment-grade credit, can take advantage of buying opportunities in the loan market and that benefits the CLO investor. We do have a white paper on our website and the Knowledge Bank if you’d like to look more into performance over different market periods.
Robert Chenoweth
Great. Thank you guys. Just about to let everybody know, check up the white paper, discover CLOs, or if you reach out to me, I can certainly email that over to you. Very helpful and can elaborate — get into more detail on that. Great answer, Kim.
And speaking that — we’ll stay on performance a bit. I’ve got a two-part question for you, Kim. So how has XFLT performed relative to its fund peer group? And I know you talked about this a little bit earlier, XFLT continues to trade at a premium. What do you attribute this to?
Kimberly Flynn
Well, I think it’s the demand for monthly cash flows that investors have, and they’re looking for opportunities to do better. And that’s why many investors turn to closed-end funds, which are known as income vehicles. Now, XFLT, as I mentioned, its fifth anniversary is coming up. And we have done an analysis comparing XFLT to other closed-end funds, partly because I think there’s a lot of dissatisfaction and unhappiness with respect to other closed-end funds in the marketplace. But XFLT is one of the best performing funds to come to the market. And I think it’s largely part due to the fact that you can’t buy this strategy in a mutual fund. You can’t buy it in an ETF. It’s designed with the strategy in mind and the CLO debt, CLO equity assets must be held in this type of product structure.
And so, therefore, this fund offers something unique in the marketplace. And the performance — just — we measure performance on price, on NAV and on secondary market trading. So, we look at a number of dimensions of performance. We’d love to see NAV improve. We’d love to see the marks on loans and CLO equity improve. They will with time as the market recovers. And so, our guidepost for managing this fund is paying shareholders distributions based on what we earn and delivering those cash flows. And we are doing that. And XFLT’s performance on that basis in terms of distribution is quite attractive relative to its peers.
When we do technical peer analysis, we look at both the floating rate loan category and then we look at these CLO-focused closed-end funds in particular. And we compare our fund because of our fund’s 50-50 mix between loans and CLO equity, we must compare it to both groups. Obviously, performance expectations are going to be that XFLT outperforms a straight loan fund. And the expectation perhaps is that XFLT is going to underperform a CLO equity fund, simply given the risk profile because XFLT holds a mix of both.
And so, we are uniquely positioned in the marketplace that is by design. Octagon is a fantastic active manager, both in the loan market and the CLO market. And it’s really in markets like this, I think, Robert, that active management is so important. I would not encourage investors to passively hold loans. I think Gretchen’s talked about the dispersion in the marketplace in terms of — dispersion in the loan market. And it’s in this type of market that an active manager can really add tremendous value and performance for shareholders.
Robert Chenoweth
That’s great. And you actually led me right into the next question for Gretchen. An important part of active management, of course, is looking out for defaults. Gretchen, so the last 12-month loan default rate has only been 0.28%, but it’s expected to rise. Are we headed back to the long-term historical average of around 2.6%?
Gretchen Lam
No, Robert, I wish I had that option on my 8 ball. Unfortunately, time will tell. But here’s what we know today. As you mentioned, the LTM default rate is 28 basis points. That’s roughly a tenth of the long-term historical average for the loan market. We also know that default rates to be a lagging indicator of credit stress and so, perhaps not the best indicator of future defaults. What tends to be a better indicator of future defaults is looking at loan prices, trading in the secondary market at discounted levels. And that number continues to be low historically. Today, it’s about 3.5% of the market trading below a price of 85%, which has historically — loans trading below 85% have historically had a much higher risk of default over time.
So looking at that 3.5%, even if half of all of those loans default in the next 12 months, we’d still experience a default rate comfortably below the long-term average for the market of 2.6%. I would also know, and this is something we’ve highlighted in previous calls that while we do expect defaults to increase from very low levels, corporate balance sheets are really well positioned today to face those — to face the macro headwinds that we’ve discussed.
The percentage of the market that is maturing over the next couple of years is quite modest, less than 10% [ph] of the loan market matures before 2025. Balance sheet liquidity, corporate balance sheet liquidity is robust. Cash flow, even in the face of rising interest rates, is in a very good position by our analysis, even overlaying the expectation of rising rates. We believe approximately 90% of borrowers in our analysis should continue to generate free cash flow. And corporate performance has been positive. I recently saw a statistic that just came across this morning that of publicly reporting loan borrowers, the EBITDA growth in the second quarter was 11% higher year-over-year, which is quite strong, slightly less robust than the year-over-year growth that we saw in the first quarter, but still quite a strong number, and I think really bodes well for the overall default rate and for the overall credit health of the loan markets.
Robert Chenoweth
Well, that seems like a positive. Good to hear. We’ve got one more prepared question. This one goes to you, Gretchen. And if there are any last-minute audience questions, please submit those quickly, if you have any, or after the webinar, feel free to reach out. The last prepared question we have for Gretchen is, what type of headwinds do you expect loan investors to face near term?
What is your outlook for the loan and CLO markets going forward?
Gretchen Lam
Sure. While loans and CLO tranches are off the local bottoms in terms of where they’re trading in the secondary market, we do expect volatility will continue into 2023. And this creates opportunity. And we would expect this will also create an environment where credit spreads will remain high on a historical basis. This bodes very well for prevailing cash coupons and distribution streams for loans and CLO debt and CLO equity, even if price volatility causes unrealized mark-to-market movements in the short term.
I think, we are in a very unique period of time with asset classes offer both, high current income, thanks to reference rates approaching 3% and discount. And this creates an environment where investors are benefiting from high current yield, high running yields as well as attractive pull-to-par opportunities. There are — to be clear, there are many macro crosscurrents that I think we will continue to face and be challenged by over the coming months and quarters. But as we’ve discussed, it’s these very crosscurrents that I think really underscore the importance of loan managers and tranche managers, really relies upon those managers’ deep understanding of both, underlying credit risk and insights into the loan and CLO markets.
Robert Chenoweth
Great. Thank you so much. Okay, we just got an audience question here. Gretchen, this will be for you. If you can briefly touch on the impact of LIBOR floors on CLO equity.
Gretchen Lam
Sure, happy to. So, what we saw in the April payment date, so the distributions that were paid in April, is that on average, distribution as a percentage of par was about 4% — a little under 4%. Now, over the course of the second quarter — the good news is that rates rose, the bad news is that the benefit of LIBOR floors on loan assets was effectively eliminated as rates rose beyond those floors. And that did have a temporary negative impact on distribution. So, while not flowing through the second quarter numbers, of course, but the distribution [Technical Difficulty] in July were — and this is across the entire CLO market, we’re about 3.5% cash on cash, so about 50 basis points of negative impact relative to the April payment date. And most of that negative impact is the result of the elimination of the benefit of LIBOR floors.
Robert Chenoweth
Awesome. Thank you so much. It looks like that is the last question we have. So, I just want to thank the audience for taking the time out. I’ll send you the replay. You can download the presentation. Obviously, we mentioned a few papers on our Knowledge Bank that could be helpful. And Gretchen, thank you so much for taking time. And Kim, thank you. Your update was great. The information was very helpful.
And if you do have further questions for us, please feel free to reach out. Our contact information is up on your screen, or feel free to reach out to the website. And you can follow us on LinkedIn for future webinars and events you might be interested in attending as well. So, with that, thank you again, and hope you have a wonderful day. And we’ll be in touch.
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