XAI Floating Rate & Alternative Income Trust (XFLT) Earnings Call Transcript & Summary

Good morning, and welcome to the XAI Octagon Floating Rate and Alternative Income Term Trust quarterly webinar. My name is Robert Chenoweth, Product Specialist at XA Investments, and I will be your moderator. In today's webinar, we will provide a first 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 can carry a risk of loss and past performance does not guarantee future results. All right. So we will move on. A few things before we begin. All registrants will receive a link to the replay following the webinar. I'll send that to the e-mail you provided when you registered. So look for that over the next few days. You can also resource additional information on our website at xainvestments.com. Take a look under the Knowledge Bank tab, you'll see replays and all sorts of value-added papers. And as far as questions go during the webinar, you may submit questions through the questions box on your webinar toolbar, you can see it there on the right. We may not be able to answer all questions that come in. So please feel free to reach out to us after the webinar as well. We'll share our contact info towards the end. 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, serves as a portfolio manager across CLOs and oversees the firm's structured credit investment strategies. We're also joined today by Kimberly Flynn. Kim is a Founding Partner and Managing Director at XA Investments responsible for all products and business development activities. Previously, Kim was Head of Product Development at Nuveen, leading their global structured products group. So you'll notice we have prepared questions and topics that we'll discuss on our webinar today. When you receive my e-mail with the replay, you can also download this presentation off the website as well. So this can kind of work as a summary of what we'll cover today. And yes, so we'll keep moving here. So a quick review of Octagon where Gretchen works. Octagon has focused on below investment-grade credit since 1994 with assets under management of $31 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'm going to hand it over to Kim, and she'll start her discussion on XFLT.

Great. Thank you, Robert. We're going to start with an XFLT overview. For those of you joining us who've been with us in the past, you'll see some familiar slides. We've also added some additional content in this quarter's presentation to respond to some of the questions that we get in the secondary market. So we're always open to your feedback and to your questions. So please reach out to Robert to meet at any point in the quarter, if you'd like to discuss. A few highlights. The fund has grown. We've continued to add shares in an accretive fashion through our at-the-market program. Total managed assets for the funds stand at $410 million as of 3/31/2022. A couple of things to highlight. We think that the health and wellness of the secondary market is largely driven by average daily trading volume. The shares 229,000, the range can be anywhere from 175,000 to 230,000. And I think it's important for us to continue driving new potential investor interest to the fund, which helps drive daily volume and overall is a positive indicator for buyers and sellers in the secondary market. Leverage is just under 40%. One of the unique advantages that XFLT has given its asset mix is that we can borrow through a credit facility more cheaply, which results in a lower average cost of leverage relative to competitor funds that also invest in CLO debt and CLO equity. The current distributions, this is the 20th regular monthly distribution that's been paid at that $0.073 rate. We think it's important to maintain those regular steady cash flows. The distribution rate as of 3/31 was $11.47 as of last night's close, it's $11.62. So fairly close in terms of the current distribution rate on NAV. One of the things to point out as the fund has grown, the number of holdings is now north of 400, specifically 442. While that hasn't changed necessarily the overall asset allocation that you see in the pie chart below, you do see, for example in the top 10 holdings, while the top 10 represents 12.76%, all of those positions, not surprisingly, are CLO equity, the way that Octagon goes about acquiring and buying new CLO debt and CLO equity, it can be lumpy, getting access to those pieces of CLO equity. And so it has resulted in a number of increase in the fund's holdings. Average asset price, $91.7. We'll talk about this. Gretchen in her remarks will cover loan market pricing and consequently, what the impact is to CLO debt and CLO equity with loans pricing below par in the current market. In terms of the asset allocation, I'll turn you now to the next slide. Composition has not changed terribly much. And the reason for this is that it's a strategic asset allocation designed to keep the senior loan being a large portion of the portfolio, senior loans as of 3/31 were 43.4%. The only change in the quarter, I think, reflects the opportunities that Octagon has observed and has acted upon in CLO debt. So you did see CLO debt allocation increase from 9.7% to 11.1%. The aftermarket inflows into the fund allows Octagon to shift the mix of the portfolio without necessarily having to sell out of other positions that they remain positive or constructive on. And so we would imagine on a going-forward basis that this general mix of assets will remain roughly the same. And the reason for that is the goal is to enhance risk-adjusted returns. And the view at inception and the view today is that having a healthy mix of loans, CLO equity and CLO debt together results in an optimal composition for purposes of generating returns and also generating those monthly cash flows that we talked about. In terms of performance for the quarter, I'll refer to the since inception far right. Price returns 6.8%, NAV returns, 4.9%, benchmark returns of 3.75%. In terms of this quarter, we did see negative price and NAV returns for both XFLT and the benchmark reflecting some of the pricing changes in the quarter. And if you are investors in XFLT, you appreciate that any given quarter, the total returns can be driven quite a bit by the NAV's reflection of where the market values of CLO equity in particular are held in the fund. So that is reflected. XFLT has a daily NAV. We think that's important in terms of the transparency that we provide investors. But I remind you that one of the biggest investment risks of investing in CLO equity is the mark-to-market risk associated with the pricing of CLO equity and so the NAV returns that you see here do reflect NAV decreases pertaining to unrealized losses associated with model-driven valuation changes for CLO equity. Simply put, as loan values decline, CLOs are a leverage portfolio. And so obviously the values for CLO will decline in a corresponding way. So we can talk about that, but I think it's really important for investors. A lot of investors buy closed-end funds for income. In particular, this category of closed-end funds that have a focus on CLO investments that mark-to-market risk is really important to understand. And you can be an income buyer, but you also -- it makes sense to be a long-term holder of these assets because of this mark-to-market risk from period to period. So we'll talk more about that with Gretchen and in the Q&A. Moving on to premium discount. Here, we've shown that in the last 18 months, XFLT has had strong secondary market trading. The inception to date has been about a 3.4% premium. In 2021, it was about a 10% premium. This moves around quite a bit. As of last night, the fund was trading at a 9%, 9.28% premium, but that is off of a depressed price and a depressed NAV. So everyone's entry point is different. Everybody's performance is going to be subjective based on where they are and where they came into the fund and so we appreciate that. One of the things with the CLO asset class is that because of what we were just talking about in terms of the pricing of CLO equity, we think that XFLT because of its daily NAV, its transparency, that's a helpful communication tool for XFLT investors so that pricing is clear even when you have periods like the one that we're navigating through this quarter. In terms -- there's nothing really to note on Slide 11. We've just showed, I think, the dramatic recovery, obviously, off of the bottom in 2020. And the news, I think, is on Slide 12. This quarter, we've obviously seen 2 Fed rate increases and with floating rate assets, the fund invests in floating rate loans and CLO debt and CLO equity are also considered floating rate securities. So they will benefit, particularly as rates -- as they have, and moved past LIBOR floors, so that benefit for future rate increases will be more visible, I think, for investors. Let's talk just on Slide 13 in terms of the trading volume. The green bars just highlight the increased level of volume that we've observed in the fund for the last 18 months. And we think this is helpful in terms of the overall health and wellness in the secondary market. Slide 14, I mentioned that through asset growth, the fund has grown in size and scale. What this means for investors is reduced expenses and some economies of scale for the fund. And you can see that the expectation is that the fund would continue to use the asset market to grow the funds in a way that is accretive for shareholders. Slide 15 gives you a breakdown of our leverage sources. As I mentioned, this is an advantage because of significant allocation that we have to floating rate senior loans, bank borrowings, the average cost is $141 million compared to the preferreds at $650 million. Our competitor funds that have healthy allocations to CLO equity typically are not able to use bank borrowing. So this is a strategic advantage that XFLT has. It results in a lower overall average cost of leverage at 2.67. The other benefit of the issuance of preferred that XFLT did last year was that it allows the portfolio management team increased flexibility. It's a better alignment of the assets and the liabilities of the fund being liabilities being leveraged. The regulatory limit because the fund does have preferred is 50%. So it provides headroom for managing the fund through volatile periods. The target leverage that we've communicated to you all in the past is 38% to 40%, and we've stayed in that zone, which gives significant headroom. And it also helps to have 2 forms of leverage in terms of managing this portfolio in a dynamic way. Next slide is about distribution history. I'll end here and just underscore the importance of regular steady distributions. The May declaration represented the 20th level distribution at the same rate. In today's market, the distribution rate is 11.62% on current price and NAV. And I think this -- as you all know, XFLT uses an income-based distribution policy, and that means that we're looking at GAAP income to make these distributions. And so I'll stop here and we can get into market outlook discussion with Gretchen.

Great. Thank you, Kim. Excellent job. And I know there are some topics that you hit on that we're going to dive into a little deeper going forward. And then Mike, you mentioned this webinar, we've kind of worked in a lot of common questions that we've been receiving from investors. So looking forward to the prepared questions. Now the first one will go to Gretchen. So there are several factors affecting the market. I think we're all hearing about this in the news, high inflation, interest rate hikes more in Europe, another COVID outbreak in China. Two questions. How has the loan market reacted to this? And did you get any sleep in the first quarter?

Not enough, in answer to your second question. Thanks, Robert, and good morning to all. I'll tackle your first question now. In the first quarter, the loan market materially outperformed many other asset classes. Loans were essentially flat in the quarter, down about 10 basis points, which compares to investment-grade bonds, which were down 7.7%, high-yield bonds were down over 4.5%. The S&P was down over 4.5%. And of course, U.S. Treasuries were down 6.8% in the quarter. We believe the outperformance was driven in large part by the fact that loan coupons incorporate, as you may know, a floating rate component either LIBOR or SOFR, which absent any additional provisions that would overlay a reference rate floor, results in loan investors being paid more when reference rates move up. And since these reference rates are reset every quarter, loans have very low interest rate duration. Now historically, this low duration has caused loans to outperform other higher duration assets such as investment-grade or high-yield corporate bonds in periods of rising rates. And the first quarter was no exception in terms of the relative performance of loans versus other fixed income asset classes. Now later in the quarter and certainly into April and May, we have seen that the Russian invasion of Ukraine and concerns about near-term economic growth have caused the loan market to drift lower, but the market has still fared better than most other asset classes. And today, the loan market is priced at approximately $0.94 on the dollar, which incidentally is almost the exact same level as the lows of the fourth quarter of 2018, which outside of the pandemic was the last time the loan market has seen such volatility.

Great. That's an interesting way to look at it, loans outperforming versus the traditional asset classes in the rising rate environment, kind of how we've thought. And now with CLOs for the CLO market, how CLOs performed?

Sure. Similar to CLOs, CLO debt tranches of floating rate coupons and as a result have fared well versus other asset classes in the quarter. The BB [ Corley ] tranche, the subindex lost 33 basis points in the quarter, which again compared to a return in high yield of about 4.5%. CLO equity, while there's no third-party index that tracks that performance, we believe CLO equity saw a negative low to mid-single-digit return in the quarter, which was driven by the price movement in loans in the quarter, which were down about a point which in turn drives CLO equity NAV. And so that was the main driver of CLO equity performance in the quarter.

Great. So I know this next topic about issuance has come up in previous quarters. It seems like each quarter, I would say, another record issuance. So the chart looks a little different. So we saw record issuance in 2021 for both loans and CLOs, but as you can see in that top right, it slowed in Q1. So how does this affect loan issuers and investors?

Yes. The market was certainly cranking on all cylinders last year. We had record issuance in both the loan and the CLO market as well as very high levels of CLO resets and refinancings. Even with this strong loan supply last year, the demand for loans was also quite strong as a result of new CLO creation as well as other buyers of loans, such as retail loan mutual funds, which we're seeing strong inflows over the course of the year. This year, both the issuance of loans and the new issuance of CLOs have been lower versus 2021, though in both cases, still a pretty heavy -- pretty healthy levels historically. Where we have seen selling pressure on loans is really from cross asset holders for example, a high-yield mutual fund that may own up to 20% of their assets in loans and had seen duration-driven outflows and what we have observed is that in order for these high-yield mutual funds to meet those redemptions, they might look to sell their loans, which are generally higher priced than many of their high-yield bond positions instead of selling high yield. And so that type of selling has put pressure on secondary loan prices, and we think this presents an opportunity for managers of CLOs, which, of course, benefit from long-term locked-up non-mark-to-market financing. And it's an opportunity for CLO managers to buy high-quality loans at discount prices. And I think that this observation is underscored by the fact that the L100 index, which is the 100 largest, most liquid loans in the market is trading a full point lower than the broad index, which really speaks to the fact that these are the loans which are being used as currency by some of these cross-asset holders of loans to meet redemptions also they're seeing particular pressure in some of these large most liquid loans.

I love hearing about when you talk about buying opportunities, which we'll get into a little later with the depressed pricing. Next question, we're going to go back to Kim for this next question. I get this question a lot. So Kim, floating rate loans have attracted considerable attention around the Fed rate hikes. Retail loan funds recorded their 16th consecutive monthly inflows and $18.7 billion in the first quarter, which marks the second largest quarterly inflows on record. How do rate hikes affect the strategy like XFLT?

Great. So I'm going to refer to the graph in the lower left corner of the technical dynamics slide, just to highlight what Robert is talking about in terms of the inflows that we've observed. And part of what I want to address here is that I think the reason Robert gets a lot of questions is, you see a lot of press and articles talking about senior loans, floating rate loans and based on investors' prior experiences in prior cycles, there's concerns about if the rate hikes actually result in increasing or higher levels of income. And part of that frustration or confusion in the marketplace, I think, is attributed to the LIBOR floors and that are commonly in place, and that is true. I think the difference with this rate hike cycle, we've already observed 75 basis points of rate hikes. The expectation by the marketplace is that there will be future rate hikes. And so the speed at which the rate hikes have happened and the expectation for future rate hikes, I think that's what's causing a lot of people to take a second look at floating rate investments, including senior loans, but also CLO debt and CLO equity. Another source of question here is, okay, so if the Fed raises rates, how quickly will that be reflected in my income? Is it reflected in this month distribution or is it going to be reflected next month or the following quarter? So there is a bit of a lag. I talked about the impact of LIBOR floors. That should no longer be -- we're largely above those LIBOR floors. But when you're below them, you don't see that immediate impact. And so that in past rate cycles, I think that has frustrated some investors because they bought senior loans thinking it would keep pace. So to the extent that you're investing in CLO debt, CLO equity, there are also other dynamics to understand when you're investing in these types of assets. And the CLO equity, when you're investing in it, there is sort of -- there can be lags associated with the income increasing for similar reasons. And so -- and if you recall, CLO equity distribution payments are made on a quarterly basis. So there may be some time lags associated with that as well. And so generally speaking, investors can look to floating rate securities for a source of floating rate income and it should benefit investors to be invested in assets of this nature and that expectation, I think, is why you see the consecutive inflows and why the expectation is that, that might continue. And so we have a whole white paper that we put together. So my apologies if I -- we don't have time to get into all of the specifics, but if you're curious about some of the dynamics I mentioned, please go to the knowledge bank and take a look at that paper and it goes into some of the specifics that you'll want to bear in mind as an investor in these types of assets.

So I know earlier, we talked a little bit about the loan asset class returns versus some of the more traditional fixed income asset classes. So as far as senior loans and CLO debt, compare with the other income-producing asset classes. Can you give us some insight on a risk-adjusted return basis, what are we seeing?

Okay. So on Slide 17, this is just risk return plots. And then on the next slide, both are useful. In the next, we talk about sharp ratios, which is actually showing that ratio. We've actually had a lot of questions, and I think there is confusion in the marketplace about -- and here, we're showing the index for loans and the index for BB CLO debt. So obviously, this is not the returns and the risk of an active manager, which would be different than a passive index. But I think it illustrates the point that senior loans on a sharp ratio basis, here, they're shown with the higher return per unit of risk higher than high yield, higher than U.S. equities. And then you see BB CLO debt in the middle of the pack there, but better than other forms of income. And I think this is a source of concern for retirees or other income-oriented investors, which is that if you look at the sharp ratio for investment-grade bonds or real estate, treasuries, even not nearly as attractive. Maybe we go back one more slide and just look at how the risk return plots out. And so depending on your risk tolerance, I think this visual helps you kind of think through, so standard deviation being measured for risk on the bottom, you are taking on incremental risk by diversifying the portfolio, let's say, it's a portfolio of loans where you start to add in BB CLO debt or you add in CLO equity, you're going to be introducing risk and the trade-off is that you're potentially generating higher returns. The rationale for doing so is that you'd also be generating higher current incomes. The reason we don't show CLO equity on this chart is that the -- there's no good benchmark index, partly just due to the vintage, the nature of how CLOs are issued. But that's also why we have Octagon at the helm, managing this portfolio and what Gretchen and her team are going to do is potentially the goal is to improve upon these passive measures. And as I mentioned, the mix that XFLT has was by design that we would be able to invest in a mix of loans, CLO debt and CLO equity because over time and even from quarter-to-quarter, those opportunity sets change and the dynamic allows Octagon to take advantage of some of the current market opportunities. Those are my thoughts, Robert, on that.

We've got 2 more questions for you, Kim. So a double here. So you just went over asset classes. Now let's talk about XFLT specifically. So how has XFLT performed relative to its fun peer group? And second question, can you explain how CLO equity valuations may impact the funds NAV and performance?

Yes. So let's talk about the peer group first. So XFLT, because it is all floating rate investments, it tends to get grouped in with the senior loan, the floating rate loan category. Within that category, there is a subset, 6 or 7, what I would call more true comparables given that those closed-end funds also invest in CLO debt and CLO equity. So this slide, while it doesn't list the peers, we're not really comfortable doing that. But if you take the senior loan peer group, XFLT is going to outperform just because of what I talked about, you're introducing the risk of CLO debt and CLO equity, but the benefit is the additional return on additional income. So you would expect that XFLT would outperform senior loan funds and the senior loan benchmark the way it has since inception. So typically, when Robert and I talk about performance, we tend to focus more, particularly in terms of secondary market trading performance, not necessarily NAV performance, but we look at how XFLT trades, behave relative to the CLO peer group. And the benefit is that in some ways, XFLT, you have to be very thoughtful because there isn't another peer that exactly has the asset mix of XFLT. And it's unique because that was Octagon's institutional strategy. It was the approach that made sense for this fund, and it does make it different in the marketplace because XFLT invests in a healthy amount of senior loans, it is not going to have the same level of return or the same level of income as a fund that would invest in 100% CLO equity. And we're comfortable with that positioning in the marketplace because, once again, we're looking at risk-adjusted returns over time, and we're looking at the sustainability of the funds distribution over time as well. And so you can expect XFLT to perform in the middle, outperform senior loan funds and not perform to the degree of CLO equity. The one point I would add is that it's also going to be less volatile than a fund that is invested 100% in CLO equity. A couple of the other advantages of XFLT's positioning, we can talk about it in a moment.

Gretchen, you're up. So we're going to set the stage here just a bit. And then we've got a 2-part question for you. So the last 12-month loan default rate is only 0.18%, which is just off the 2007 all-time low, and it's expected to remain low for at least the near term. So question one, how do you add value as an active loan manager? And two, what kind of buying opportunities have you seen recently?

Sure. The loan market today is trading at less than $0.94 on the dollar. And at the same time, as you said, the LTM default rate is extraordinarily low. It's 115 of the long-term average for the market on a trailing 12-month basis. Now to be clear, we do expect more dispersion in the earnings of corporate borrowers, and we've certainly seen that thus far in the first quarter. And we do expect defaults to move up from the very, very low levels that we've seen over the last year, though, as you said, still remaining below historical averages. However, it's worth noting that the discounted secondary trading price of loans allows managers to reinvest cash into loans at lower prices that have real price convexity over time. And just as a reminder, the loan market typically experiences prepayments of 10% to 40% in any given year. So just to put some numbers around that, in a CLO with $500 million in loan assets. Prepayments of just 10% provide a manager with $50 million of currency to then go by loan assets that say, $0.95 on the dollar, which in turn generates $2.5 million in additional notional value for the fund and for the benefit of CLO equity investors. And then on top of that, given the wider credit spread, these newly purchased loans may have a coupon that is on average, relatively higher than the other loans held in the CLO. So as long as credit losses can be mitigated, a skilled manager can take advantage of periods like this to both grow the notional value of the loans in the CLO as well as increase the income stream generated by these loans, both of which benefit CLO equity investors in the long term.

Great. I can -- it's nice to see the advantages that an active manager can provide. Kim, so on the topic of competitive advantages, I mean we just kind of talked about XFLT funds. So let's talk about some of the features of XFLTs. The advantage is there and how those compare to competitor funds?

Sure. So we put this comparison together because I think of the distinct asset mix that I mentioned earlier to help clarify how XFLT is different. And in some ways, we have a number of advantages because of that. I've mentioned 2 of them already on this webinar. One is the leverage cost, our senior loan allocation allows us to have a leverage facility where we can borrow, and that's at 1.4% and brings the overall cost to leverage down to 2.67%. So very, very attractive relative to CLO focused funds, CLO debt, CLO equity, very difficult, if impossible, to get borrowings on those exposures. So closed-end funds are left using preferreds or baby bonds, which are more costly, typically 2x the cost. When it comes to transparency, XFLT is also unique with its daily NAV, we work with SS&C ALPS and there's a very robust process for valuation for the fund. Market is also with an eye market is involved, obviously, being an expert in valuation of loans, CLO debt, CLO equity. So that's a distinct advantage to relative to CLO focused funds, which typically have a monthly estimates and quarterly valuation for those CLO equity assets. The valuation is done by a third party, as I mentioned, it's not done internally, with our portfolio allocation, that's the driver for some of these advantages. Another important fact to point out is that with XFLT, it's the only way for non-institutions to access Octagon and they can do so without paying performance fees with CLO equity, typically, there are performance fees and higher base management fees. XFLT charges a 1.7% flat fee. It's higher than senior loan funds because of the significant CLO exposure, but there are no performance fees. So that given what we've talked about, given the portfolio allocations, that does result in a distribution rate that's attractive, we believe, is attractive. As of May 9, it was 10.68% on market price, and that was relative to the CLO funds, which have higher distribution rates, 13.22% on average. So that's one of the differences I pointed out. Premium-level trading, this can vary quite widely. All of the funds, including XFLT that have CLO allocations tend to trade at a premium. My view is partly because of what we talked about in terms of how these assets are valued and some of the unrealized losses associated with mark-to-market declines in the value of those assets given market volatility. And investors are bidding up the price of these funds, partly because of these attractive distribution rates that are north of 10%.

Last prepared question is going to go to Gretchen. So we're going to kind of come full circle here. Gretchen, your first question, we talked about how the markets reacted to inflation and COVID and war in Europe. So now maybe we can touch on outlook. What is your outlook for the loan and CLO markets going forward?

Sure. I think there's no doubt that corporate borrowers are facing headwinds in the current environment. We will continue to be highly focused on Fed actions and the strength and sentiment of the U.S. consumer. And there's a lot of uncertainty as to how the rest of the year will play out. At the same time, corporate borrowers are very well-positioned to face this uncertainty. As we've discussed on previous calls, corporate balance sheets are liquid. Debt maturities have been extended in large part, interest coverage, which will certainly fall with rising rates is very robust today. And worth pointing out as well that thus far, companies have generally been successful in raising prices, that we do think this will become more difficult over the course of the year. This environment is particularly well suited, we think for managers to our strong credit pickers and active traders to outperform. We expect a broad dispersion of corporate performance to continue. We expect macro and technical-driven volatility to continue. The credit spreads in both the loan and the CLO market have widened and loan prices have fallen. And we believe it will be managers who can take advantage of this attractive entry point, while at the same time avoiding defaults and avoiding credit losses who are best poised to perform well in 2022.

Right. All right. So it's audience question time. I've got a few here. But just as a reminder, if you would like to submit a question, you can do so in your webinar toolbox here, but we'll go ahead and get started. Let's see here, Kim, this first one will go to you with it looks like a Merrill Lynch client. Merrill Lynch recently blocked purchases of XFLT for their clients. Do you have any insight into why this happened?

Sure, Robert. Yes, luckily, we were informed by our investors actually days before we received the official e-mail from Merrill Lynch, but it did give us an opportunity to connect with the capital markets team at Merrill Lynch that's responsible for closed-end funds, both in the IPO and the secondary market. So the good news here, I think, is that Merrill Lynch has made a commitment at the CIO level to cover closed-end funds, which in the past, they had not. Merrill Lynch said that close-end coverage was long overdue. Merrill Lynch seeks to have coverage for all their products -- it started years ago in terms of their coverage process with mutual funds that it moved to ETFs and now most recently closed end funds. And now I will say that by way of Merrill Lynch's process, they did give us a heads up about a year ago. So we knew that closed-end funds were going to be added to that coverage. And I think the goals are that they want Merrill Lynch advisers to be able to make informed decisions. I think the bad news is, is that XFLT, we were not provided any specific issues or reasons that XFLT was blocked. We were also told that we were given the criteria, which I'm happy to outline, it seems like reasonable criteria. But once again, XFLT, in particular, because of its strong performance in the secondary market and its continued growth. The growth within the Merrill Lynch system was all organic, meaning investors and advisers who wanted XFLT, who had researched it on their own and it bought the fund. So it's disappointing that it was locked. It represents about 3% of the box position. So it's a small box position that Merrill had specifically Merrill cited $9.5 million on their platform. This includes discretionary accounts and Merrill Edge. And so for all discretionary accounts, not only are XFLT purchases block, but the advisers have been asked to sell out of the physician over the course of the next 180 days. We don't expect that this would have an impact on the secondary market just given the smaller size. But because we want our Merrill advisers and Merrill investors to be able to buy XFLT, but also to be able to do dividend reinvest, which is important for an income-based fund. We are going to go through a process with Merrill Lynch. They have a quarterly review going forward. I don't think that they'll reverse themselves immediately after implementing the decision, but we plan to remain diligent submitting a quarterly pack on XFLT, highlighting its uniqueness and its performance it's attractive fees relative to competitors, the liquidity and trading dynamics that we've talked about on this call. And we are hopeful that they will consider that. The CIO's office does have an open-door policy for this type of review going forward. And we are hopeful that we can make XFLT accessible to all. But I will give some perspective, Robert, on the Merrill Lynch. It's a small position. And a lot of the growth in XFLT's demand has been away from the wire house firms and has really shifted into the hands of individual family office and independent advisers, and we track that from quarter-to-quarter as that investor mix changes. So as I said, it's disappointing, and we plan to go through a process to see if we can reverse the block, and we will report back as we're able to make progress.

And of course, anyone who would like to talk more about it, feel free to reach out to me, and I'll do my best to fill you in, and we can discuss. Next audience question, we'll go to Gretchen for that. So with over 1/4 of CLO collateral rated B on average triple-C buckets at over 4% and the loan upgrade, downgrade ratio deteriorating, how do you feel about the outlook for potentially tripping triple-C bucket limits, particularly if a recession developed?

Sure. So probably worth noting to start that the low and upgrade downgrade ratio today, depending on which agency you look at and what point in time, it's about 1:1, which means that there is an equal number of loans currently being upgraded as are downgraded. Now that ratio was as high as 2.5:1 last year, and it has since moved to roughly parity in 2022. Now just for context, in late March of 2020 and the 6 to 8 weeks that followed, the rating agencies downgrade a full 1/3 of the loan markets in 8 weeks. Now in 2009, a similar percentage of the loan market was downgraded, but those downgrades happen over the course of almost a year. And I cannot overstate how difficult it was in 2020 for managers to manage through those downgrades in the spring of 2020 because they were coming so fast and so furious. So what does that mean in the context of today's environment? First, I think it's worth pointing out that triple-C today are down well over half from the peak in 2020. And also worth pointing out that triple-Cs from today's percentages could double on average before it would have any impact on the ability of CLOs to pay out equity distributions. So there is meaningful cushion in triple-C buckets today to withstand future downgrades before there would be any impact on near-term equity distributions. And also, I would say that there are still -- because the rating agencies were so aggressive in 2020 and downgrading, there are still triple-C loans that in our view are well overdue for upgrades. And those upgrades are happening now still in 2022 from that 2020 crop of downgrades. So we expect that those COVID era downgrades will continue to be upgraded in 2022, and that will help to offset some of the downgrades from credit that I'll call them inflation impacted loans. I think we will see an increasing number of downgrades related to companies that are facing meaningful inflation headwinds. And we've certainly seen that in recent months in the wake of first quarter financial performance releases coming through. So as we look at it on a go-forward basis, we may very well and I think it's likely that we will see downgrades outpaced the number of upgrades in the back half of the year. Importantly though, we believe that the piece of these downgrades will be relatively measured. We believe that they will be most often driven by earnings performance. So there may be some sort of seasonality, if you will, to those downgrades. We don't think that there will be a consolidated wave of downgrades to the extent that there was in 2020. And for CLO managers to manage through those downgrades, the more -- the longer they take over time, the easier it is for CLO managers to effectively mitigate the impact of those downgrades trade out of those positions if they deem that’s the best thing to do, while at the same time, trading on the follow in a way that reduces and mitigates any car losses, any credit losses that were experienced as a result of trading out of those CCCs. So in summary, I think there are currently meaningful cushions to the triple-C, the mass triple-C bucket before equity distributions would be impacted. And on top of that, I think that the pace of downgrades will be measured such that CLO managers, for the most part, will be able to effectively mitigate their impact.

All right. Last question, we are at about time. So we'll do this one last one from the audience. Gretchen, will send this your way. On average, how are revenues and margins trending among loan issuers and what is the outlook for their ability to service their debt now that LIBOR, SOFR is above typical floors, which based on the forward curve will meaningfully increase the interest rate on their loans?

Sure. Worth noting, and I think sometimes this gets lost in the conversation about real growth, but I do think it's important to point out that nominal growth is quite strong. We saw that in first quarter earnings. And in fact, our analysis points to both double-digit growth in both EBITDA and revenues across a broad universe of loan issuers. However, we are seeing that EBITDA growth is lower on a percentage basis than revenue growth, suggesting that margins on average are compressing. We have been surprised by the level of pricing power that companies have had to pass on higher input costs, but they are not, by and large able to pass on all of the increase, the impact of all of the increase of higher input costs. And so as we look out over the course of the year, we anticipate that, that environment will continue and would also anticipate that it will become more and more difficult to pass on price increases, and we may see enhanced elasticity of demand. And that's something that we're watching very closely. But through the first quarter, strong revenue growth, strong but slightly less strong EBITDA growth margins compressing but net-net profitability on average, improving year-over-year. Now that addresses input cost, P&L impacts of inflation, what about interest. To put some numbers around it, LIBOR started the year at 22 basis points. Today, it's plus or minus 152. And if you look to the forward curve, LIBOR is expected to be over 3% by year-end. Now some of that rise has been mitigated from the borrower standpoint in that most loans have a LIBOR floor associated with them. So over the course of the first part of 2022, even as LIBOR moved up, many borrowers did not pay additional income, additional coupon up until the point at which they hit the floor. That LIBOR is now through any floor. Good news for holders of loans and XFLT is that as rates move up, as Kim discussed, the income stream on those loans and CLO tranches is increasing. But from the standpoint of the loan borrower, obviously, that makes servicing their debt more difficult. Maybe to just use an example for a 5x levered loan borrower, they may have at the end of last year, have generated EBITDA to result in interest coverage of 5x. If we look at the forward LIBOR curve, that 5x interest coverage may go to something like 3x, still robust, still very -- still leading the company with more than enough EBITDA to pay their interest, but clearly, less coverage from an interest standpoint. Now that is a very simplistic analysis, which ignores 2 really important factors. The first is, it assumes that EBITDA is flat year-over-year. And as we've seen in the first quarter, most companies have been able to grow their EBITDA double-digit. It also assumes that the company has no fixed debt in their capital structure, and it assumes that there are no existing interest rate hedges that the company has entered into. Many, many borrowers in the loan market have either a fixed rate debt to some extent or hedges. And so we do think that those 2 things will soften the blow, will mitigate the impact to loan borrowers over the course of the year. And then on top of that, we think that many loan borrowers will continue to grow with their EBITDA, which will reduce the impact of rising rates. So we continue to obviously watch this closely, but we do believe that because the loan universe is starting from such strong levels of interest coverage, which as of late last year, we're approaching 6x interest coverage among publicly reporting from loan borrowers. And there's a fair amount of cushion from which to withstand increasing rates.

Fantastic. We are at an hour right now. So I want to make sure everyone knows if there's anything more you need from us, please don't hesitate to reach out. And as I mentioned earlier, I will send the replay link to you in the next few days. You can also access this presentation. Those visuals were great and helping tell the story. Thank you, big to Kim and Gretchen, you all provided amazing information, so helpful. So thank you so much. Thank you, everyone who attended. We appreciate the time you have taken out and don't hesitate, reach out any time and have a wonderful day.