Eagle Point Credit Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 14, 2023

There are 8 speakers on the call.

Operator

Greetings, and welcome to the Eagle Point Credit Company Third Quarter 2023 Financial Results Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the call over to your host, Garrett Edson with ICR.

Operator

Please go ahead.

Speaker 1

Thank you, Melissa, and good morning. And now everyone should have access to our earnings announcement and investor presentation, which was released prior to this call and which may also be found on our website at eaglepointcredit company.com. Before we begin our formal remarks, we need to remind everyone that the matters discussed on this call include forward looking statements or projected financial information involve risks and uncertainties that may cause the company's actual results to differ materially from those projected in such forward looking statements and projected financial information. For further information on factors that could impact the company and the statements and projections contained herein, please refer to the company's filings with the Securities and Exchange Commission. Each forward looking statement and projection of financial information made during this call is based on information available to us as of the date of this call.

Speaker 1

We disclaim any obligation to update our forward looking statements unless required by law. A replay of this call can be accessed for 30 days via the company's website, eaglepointcreditcompany.com. Earlier today, we filed our Q3 2023 financial statements and our Q3 investor presentation with the Securities and Exchange Commission. Financial statements and our Q3 investor presentation are also available within the Investor Relations section of the company's website. The Financial statements can be found by following the Financial Statements and Reports link and the Investor Presentation can be found by following the Presentations and Events link.

Speaker 1

I would now like to introduce Tom Majewski, Chief Executive Officer of Eagle Point Credit Company.

Speaker 2

Thank you, Garrett, and welcome everyone to Eagle Point Credit Company's 3rd quarter earnings call. If you haven't done so already, we invite you to download our investor presentation from our website, which provides additional information about the company and our portfolio. The company continues to perform solidly despite concerns about macro volatility in the market. Our NAV grew by 7% during the quarter. We paid $32,500,000 in cash distributions to shareholders and we deployed $119,000,000 of net capital into new attractive investments.

Speaker 2

Recurring cash flows remain robust as we receive $51,900,000 or $0.70 per common share of cash flow, which is well in excess of our common distribution and expenses. CLO Equity Investments purchased during the quarter At a weighted average effective yield of 20.3 percent. As of quarter end, our CLO equity portfolio had a weighted average remaining reinvestment period of 2 point 7 years, which is steady from the last quarter despite the passage of 3 months. As we have stated in the past, We believe keeping our weighted average remaining reinvestment period as long as possible is our best defense against future market volatility. For the Q3, our net investment income and realized gains totaled $0.35 per common share.

Speaker 2

NAV per share as of September 30th was $9.33 which again is a 7% increase from June 30. Since the end of the quarter, we estimate our NAV at October month end to be between $8.98 $9.08 per share. We continue to actively manage our portfolio deploying $119,000,000 in net new capital into new portfolio investments during the quarter. We received recurring cash flows on our portfolio of $51,900,000 or $0.77 per common share, exceeding our aggregate common distributions and total expenses by roughly $0.10 per share. We have already received cash flows from our portfolio in October, which were greater than all of our 3rd quarter collections as we benefit from rising rates, strong investment performance and continued growth of our portfolio.

Speaker 2

Along with our regular monthly common distribution of $0.14 per share, we declared an additional variable supplemental distribution of $0.02 per share for an aggregate monthly distribution of $0.16 per share for each month during the Q1 of 2024. Inclusive of the October 31st distributions, we've now distributed cash to our investors equal to $19.67 Per share since our IPO. We also continued to prudently raise capital through our at the market program And issued approximately 8,800,000 common shares at a premium, generating a NAV accretion of $0.14 per share. These sales generated proceeds of approximately $90,000,000 during the quarter. At the end of October, we had $59,300,000 of cash on our balance sheet, Thanks in part to the strong October cash flows providing us with ample dry powder to deploy into new investments.

Speaker 2

All of our financing remains fixed rate, which gives us continued protection in a rising rate environment. Importantly, We have no financing maturities prior to April 2028. As of September 30th, The weighted average effective yield on our CLO equity portfolio was 16.29 percent and that's a meaningful increase from the 15.23 at the end of June. New CLO equity that we purchased during the Q3 had a weighted average effective yield of 20.3%, which should help bolster the portfolio's weighted average effective yield prospectively. Additionally, the weighted average expected yield of our CLO equity portfolio Based on market value held relatively steady just over 27% as of September 30.

Speaker 2

As I mentioned previously, during the Quarter, we deployed $119,000,000 of net new capital into primary and secondary CLO Equity, CLO Junior Debt, Loan Accumulation Facilities and Certain Other Related Investments. While there are select Primary CLO equity opportunities that represented attractive value. By and large, we focus most of our investment effort on the secondary market and for other investments that we believe offer appealing returns. As of September 30, our CLO equity portfolio's weighted average remaining Reinvestment period stood at 2.7 years, unchanged from the prior quarter. And we remain focused on finding opportunities to invest in CLO equity with generally longer reinvestment periods to enable us to navigate through periods of volatility.

Speaker 2

I would also like to take a moment to highlight Eagle Point Income Company, Our sister company, which trades under the symbol EIC. EIC invests primarily in CLO Junior Debt. For the Q3, EIC generated net investment income of $0.51 per share excluding certain non recurring items, Once again exceeding its common distribution for the quarter, additionally, EIC just increased its common distribution by 11% to $0.20 per share beginning in January. EIC has performed very well through the rising rate environment and remains well positioned to generate strong NII. And we invite you to join EIC's investor call at 11:30 am to hear more.

Speaker 2

Overall, After, we remain active in managing our portfolio and continue to keep a close eye on the broader economy. After Ken's remarks, I'll take you through the current state of the corporate loan and CLO markets. I'll now turn the call over to Ken.

Speaker 3

Thanks, Tom. For the Q3 of 2023, The company recorded net investment income and realized gains of approximately $23,000,000 or $0.35 per common share, which is inclusive of a non recurring excise tax refund of $0.01 per share. This compares to NII and realized losses of $0.05 per share in the Q2 of 2023 And NII and realized gains of $0.47 per share for the quarter ending September 30, 2022. When unrealized portfolio appreciation is included, the company recorded GAAP net income of approximately $63,200,000 or $0.93 per share for the Q3. This compares to GAAP net income of $0.11 per share In the Q2 of 2023 and GAAP net income of $0.21 per share in the Q3 of 2022.

Speaker 3

The company's 3rd quarter GAAP net income was comprised of total investment income of 36,000,000 Net unrealized appreciation on investments of $34,800,000 net unrealized appreciation on certain liabilities held at fair value of $4,900,000 and realized capital gains of $600,000 partially offset by expenses of $12,600,000 and distributions on the Series D preferred stock of $500,000 Additionally, for the quarter, The company recorded other comprehensive income of $600,000 The company's asset coverage ratios At September 30, for preferred stock and debt calculated pursuant to Investment Company Act requirements were 3 54% and 5 24%, respectively. These measures are comfortably above the statutory requirements of 200% 300%. Our debt and preferred securities outstanding at quarter end totaled approximately 28% of the company's total assets less current liabilities. This is within our target range of generally operating the company with leverage between 25% to 35% of Moving on to our portfolio activity in the Q4 through October 31, The company received recurring cash flows on its investment portfolio of $55,300,000 Note that some of our investments are expected to make payments later in the quarter. As of October 31, we had $59,300,000 of cash available for investment.

Speaker 3

Management's estimated range of the company's NAV as of October 31st was $8.98 to $9.08 per share, reflecting a 3.2% decrease at the midpoint From September 30th as spreads widened. During the quarter, we paid 3 monthly common distributions of $0.14 per share And 3 monthly variable supplemental common distributions of $0.02 per share for aggregate common monthly distributions of $0.16 per share. We have also declared aggregate common monthly distributions of $0.16 per share through the end of March 2024. I will now hand the call back over to Tom.

Speaker 2

Thanks, Ken. Let me provide a quick update on the loan and CLO markets. The Credit Suisse Leveraged Loan Index generated a Total return of 3.37 percent in the quarter and is at 9.91% year to date through September 30th as loans continue to perform strongly. It's far better than many other fixed income indices. The index had another solid month in October and remains on pace to have its best full year In fact, there was not a single corporate loan default in the month of September, again evidence of the resilience of senior secured loans and as a result, CLOs, Despite the various macro concerns that people write about in headlines.

Speaker 2

While some recent market reports have expressed concern Over loans facing rising interest rates, the actual data, the default rate and the number of defaults paints a very different picture than the headlines in our view. As a result, at quarter end, the trailing 12 month default rate declined to 1.3%, remaining well below historical averages. Barring a shock in the next few weeks, we expect 2023 to be a far better than average year for defaults. The company's exposure to defaulted loans as of September 30 stood at only 40 basis points, further proof of the strength of our active portfolio management and construction. Approximately 5% of all leveraged loans or roughly 19% annualized repaid at par during the quarter.

Speaker 2

This represents a quarter over quarter increase and provides our CLOs with valuable par dollars to reinvest in today's discounted loan market And to offset losses from the few defaults that are occurring. With a large number of high quality issuers continuing to trade at discounted prices, CLO collateral managers remain well positioned to improve underlying loan portfolios through relative value credit selection in the secondary market. Most loan issuers have become proactive in tackling their near term maturities in an effort to further extend the maturity of their debt, And they continue to offer lenders higher spreads and OID on their newly refinanced loans. As a result, our portfolios Continue to have numerous opportunities to build par and increase their weighted average spread, which in turn increases the excess spread we receive on our CLO equity portfolio. On a look through basis, the weighted average spread of our CLO's underlying loan portfolios was 3.78% at the end of September.

Speaker 2

Notably, that's an 11 basis point increase compared to the end of June. This measure has actually increased by 20 basis points in the last 18 months. Meanwhile, spreads on the debt tranches issued by our CLOs that were locked in 18 months ago remain unchanged. CCC concentrations within our CLOs stood at 6.7% as of September 30th and the Percentage of loans trading below 80 within CLOs is at about 4.4%. Our portfolio's weighted average junior OC cushion was 4.41 percent as of September 30, which gives us ample room in our opinion to withstand potential downgrades or future losses.

Speaker 2

Our portfolio's OC cushion remains much higher than the market average, which stands at 3.44%. One of the trends that we are seeing increasingly in the loan market is having private credit funds and BDCs Refinance CCC rated loans out of the syndicated loan market. A recent example of this would be Mysis, which is a large software company. For our CLOs, this represents a par repayment and a reduction in CCC exposure. This is great.

Speaker 2

We hope more of this happens. We wish Mysis, frankly, and their new lenders well in the future. As Private credit funds and BDCs continue to expand. We expect this favorable trend to continue. In the CLO market, we saw $28,000,000,000 of new CLO issuance in the Q3 of 2023 $84,000,000,000 year to date through September 30, Remaining on pace to eclipse $100,000,000,000 once again, while tracking a little below 20 22's pace.

Speaker 2

We continue to believe that a fair bit of this volume Backed by captive CLO equity funds, which in our view are far less return sensitive than we are. Reset and refinancing activity related to CLOs issued during the second half of twenty twenty two, which was a small period of CLOs Where quite a few were issued with 1 year non call periods have picked up, but otherwise there is essentially no refi reset activity in the market. Indeed, the AAA weighted average level on our CLO equity portfolio is well tight to where CLOs could be issued today. While the market does give the in the money nature of our CLOs financing some credit, we believe the market doesn't give it full credit and that this represents Hidden value embedded in our portfolio. Our weighted average AAA spread is about 144 basis points And this is roughly 39 basis points in the money today.

Speaker 2

As we have consistently noted, it's in environments of loan price volatility where we believe CLO Equity or CLO Structures and CLO Equity in particular are set up well to buy loans at discounts to par With a very stable financing structure, using par paydowns from other loans and outperform the broader corporate debt markets over the medium term as they have done in the past. We are seeing that happen right now and expect that to continue. To sum up, we grew our NAV by 7% during the quarter. We generated net investment income and realized capital gains for the quarter of $0.35 per weighted average common share. We continue to receive robust cash flows during the 3rd quarter and have already collected more cash flow from our portfolio in the Q4 than we did in the Q3.

Speaker 2

We remain very active in terms of sourcing and deploying investments At attractive yields investing about $119,000,000 of net new capital and we continue our existing regular monthly And variable supplemental distributions through March of 2024. We further strengthened our liquidity position generating NAV accretion of $0.14 per share through our ATM program and at the end of October, we have about $59,000,000 of cash to deploy into new investments. We continue to maintain 100 percent fixed rate financing, entirely unsecured, And we have no maturities prior to 2028. This gives us protection from any further increase in interest rates and locks in a very attractive cost of funding for many years to come. We believe the company's investment portfolio continues to be well positioned, giving our proactive management The portfolio's long weighted average remaining reinvestment period, its strong OC cushion and consistent recurring cash flows.

Speaker 2

We also remain pleased to return extra cash to our investors in the form of special or variable distributions and remain opportunistic and proactive as we manage the investment We thank you for your time and interest in Eagle Point. Ken and I will now open the call to your questions.

Operator

Thank Thank you. Our first question comes from the line of Mickey Schleien with Ladenburg Thalmann. Please proceed with your question.

Speaker 4

Yes. Good morning, Tom and Ken. Tom, I wanted to follow-up on your comments about the primary market. You noted that it's been spotty and with captive funds holding the Majority of the new issue volume that we're seeing, and that's clearly a function of the high or I should say wide AAA spreads. That process or that lack of primary market puts pressure on your financial performance in that It makes it more difficult for existing CLOs to refinance or reset as you noted.

Speaker 4

So, what's it going to take for that primary market To finally start to operate on a more normal basis, which is something you would expect given that the overall Fundamentals, as you mentioned, in the data are pretty good.

Speaker 2

Yes. Good morning, Mickey. Good question. AAA is ebb and flow, I guess, over the years. If you think back to our performance, again, we've been public for 9 years now.

Speaker 2

There are periods of time where the market is ripe and we're resetting and refinancing absolutely everything. The bad news during those times is if you look at our weighted average loan spread, it's typically going down. And if you look at 2017 2018, you'll see we had I I think of it as reset mania here. At the same time, if you look at the portfolio decks and these are all on our website going back ages ago, You'll see in many quarters the loan spread is trickling downward. So the bad news today, we didn't do any refis or resets.

Speaker 2

The good news today is We picked up 11 basis points in spread in the quarter as loans keep getting reset and loans themselves get refinanced wider. So it's a little bit of while I wish we were resetting stuff as well, I'm also very happy that our weighted average loan spread went up 11 bps Multiplied by the leverage of CLOs, that's obviously very impactful to our portfolio and certainly one of the drivers of NAV going up 7% during the quarter. Some of the things going on in the world broadly of AAA investing, obviously, there's always currency fluctuation. Certain of the regulators in Japan, we continue to ask questions, although we do note that there are quite a number of Japanese banks that are active. Some of the new Basel rules as proposed, we believe will make holding CLO AAAs more attractive for banks all around the world.

Speaker 2

Also some of the NAIC considerations underway, less we've heard, also suggest AAAs will become even more attractive to hold. So there's some good news there. Probably the one segment of the market that's missing that might be the most impactful are some of the large U. S. Money center banks.

Speaker 2

And indeed, if you look in their filings, you can see many of the largest banks in the country have, in some cases, 1%, perhaps even more of their portfolio in CLO That's the one market participant, frankly, that would be nice to see more of. But while we're obviously disappointed, we're not resetting and refinancing. At the end of the day, what we care about is the difference between the spread on our assets and the spread of our liabilities. And this quarter, we made it through the spread of our assets going up. So, we like to win both ways, but we typically have a good habit of Having one of them go in our direction, which we are seeing on loan spreads right now.

Speaker 4

That's very helpful, Tom. That's it for me this morning. Thank you for your time.

Speaker 2

Great. Thanks,

Speaker 5

Mickey. Thank

Operator

you. Our next question comes from the line of Ryan Lynch with KBW. Please proceed with your question.

Speaker 5

Hey, good morning. My first question just has to do with some combination of You guys raised quite a bit of equity this quarter in combination with you talking about kind of most of that was deployed In the secondary market, and so can you just talk about what sort of secondary opportunities You guys are seeing that, that drove the decision to raise quite a bit of equity this quarter and you see those trends continuing Thus far into

Speaker 2

the Q4? Yes is the answer to the last question. Just talking about with Mickey, loan spreads versus CLO debt spreads in general is moving in our favor. Typically, when someone models a CLO, they model spread tightening over time. We're actually getting Widening, which is great.

Speaker 2

There are pretty robust supply of secondary CLO equity opportunities, both majority positions And in some cases, minority positions or minority where we see a path to build to majority, where The yield opportunities there, loss adjusted applying, punitive portfolio stresses for the tails and portfolios, They came in at a lower yield, where there's other strategic reasons for the company to be participating. But if you look by and large at the secondary new adds Into the portfolio, you're going to see those in the mid-20s. The types of sellers of those investments and those are all privately negotiated transactions, some are done via A BWIC process or bids wanted in comp, quite a few are done off sheet, where it's just over the phone and negotiating a price. Some of our edge there is our ability, our knowledge of nearly all CLOs, our ability to analyze any transaction and be current on it very quickly using our own proprietary technology, And our knowledge of the transaction documents and CLO collateral managers. The types of sellers varied widely from In some cases, maybe even 1 or 2 funds winding down, maybe other investors who I always appreciate what they were signing up for, maybe people who bought new issue and got their model wrong and just want to punch out.

Speaker 2

The stuff we buy, We typically focus on less seasons, so newer CLOs, but not brand new, with as much reinvestment period as possible. We probably pay up for that a little bit, but I will give up some degree of yield on our portfolio to keep the weighted average remaining period as long as possible. We value that greatly. We saw through COVID. We saw through the 2,008, 2009 cycle ages ago That the number one defense to have is reinvestment period.

Speaker 2

And while it's very, very expensive to get that in the new issue market, we can get it pretty nicely in the secondary market, A lot of 'twenty one vintage CLOs, maybe some early 'twenty two's.

Speaker 5

Okay. That's helpful color on The market dynamics going on there and what you're seeing. The other question I had was kind of a high level question about some trends that are occurring In CLO market and the private credit market, you mentioned the one loan that was refi ed from the broadly Low market to the private credit market, that's certainly a trend that is likely going to continue if not accelerate going forward. I'm just curious, I've seen some recent projections from different banks on the level of CLO formation that they expect in 2024. And again, these are just Estimate

Speaker 2

that's

Speaker 5

subject to change very much so, but a couple of trends from those was that they expect CLO issuance to be down for the 3rd consecutive year in 2024. Additionally, This is Bank of America who recently put out a report. He's talking about there's going to be a big increase in middle market CLO formation In 2024, and there's already been a big increase in 2023. As those trends of loans, From where you sit, if these trends continue both lower CLO formation or An increase in middle market CLO formation, what does that mean for your business?

Speaker 2

Sure. We are working in a Plus or minus $1,000,000,000,000 market, is it going to get The new issue, the newly formed component is one part of it. The called component is another part. You got to look at the 2 of those combined. Certainly to date, we have not seen a situation where we've had a Even in years where issuance is way down, where we've had a shortage of investment opportunities, typically when issuance is down, The secondary opportunities are more robust, frankly.

Speaker 2

At the same time, when folks are talking about down, it might be going from $100,000,000,000 I don't remember We have a specific numbers, but it could be going from $105,000,000,000 to $90,000,000,000 or something like that while it's still down. All we need to deploy is a couple of 100,000,000 in a given year and be more than fine. So our ability to source investments in the short to medium term is not something frankly It was a lot of sleepover. Importantly, ECC actually also has a strategic interest in 1 CLO collateral manager. You can see in our portfolio and it's disclosed in the footnotes, but where the ECC owns or has a revenue interest in a piece of the collateral manager that is independent of Further beyond meeting a certain investment requirement that continues one way or the other, it's sort of like, I guess, No, it's a permanent revenue share.

Speaker 2

So one of the things we've done in that case is it's an opportunity to get access to CLOs if we want, while we certainly expect that platform to raise capital elsewhere, it's something that We obviously have a very deep tie with and we'll have continued access. And then finally, when you look across our portfolio, there's 2 things you'll see. We have deep relationships with a small number of select issuers. And these are issuers that by and large for us have performed very, very well and where we have a special place with them and As long as they keep performing, they have a special place with us. So our access to the market, I think, is different and more durable than a transient Coming into the market, across all of our different investment vehicles, including ECC, we believe we're the largest holder of CLO equity in the world, which gives us a meaningful advantage.

Speaker 2

That's it. We do have to keep investing to keep the portfolios fully deployed. And then to the point you've raised of the increase in private Credit CLOs, formerly called middle market CLOs, whatever, just put a different label on it. It's like junior debt or senior equity, kind of the same thing. By and large, what we saw during the financial crisis going back to 'eight and 'nine Is that middle market CLOs as they were called back then, while they had better credit experience In terms of fewer defaults and better recoveries than syndicated loans, in general, the CLO equity frequently underperformed broadly syndicated CLOs.

Speaker 2

And that was frankly because many of the collateral managers didn't have the DNA to reinvest it cheap, Rather they make a new loan 200 basis points wider. So we have a small amount of middle market or private credit exposure in our portfolio right now. It's very small, but it's greater than 0. But some of that intentionally, that's with folks who we believe can pivot To the extent new secondary syndicated loans are at $0.80 on the dollar, we'll buy the really good ones at $0.85 and just be done with it and capture value that way. So we have firsthand personal relationships with all or many at a minimum of the middle marketprivate credit CLO issuers, as we look at the market, we believe it's an even smaller set of folks who will know how to deliver superior when things get choppy.

Speaker 2

Frankly, if they're taking out CCC loans from us, We're very, very happy about that. And I suspect we'll see an increase in private credit CLOs in our portfolio over the coming year or 2. No assurance, but that would be my best estimate. And with that, it's going to be focused on an even smaller number of issuers Who actually have experience in managing CLOs through cycles, not just folks that might have run a BDC for a long time, but are just getting dipping their toe in the CLO world. Running a BDC is very different than running a CLO for better or worse.

Speaker 5

That was you kind of hit my next question was going to be what is your middle market CLO exposure just because looking at some of these statistics is 10% to 12% has been kind of the historical market share of middle market CLOs historically and it's up to 22% in 2023 and it's projected and again If the projection is going to be right or not, but it's expected to be 32% of the CLO market. So

Speaker 2

it's a lot of Yes. That strikes me as a the 32% strikes me as a big nut. Stranger things have happened. I suspect it will be The day where we I mean, well, I know what would happen. The day where we have cash where we can't invest, we'll stop raising capital and Yes.

Speaker 2

Well, we raise capital I think few in the CLO we raise capital when we see opportunities And when it's accretive to shareholders, both on what we can put the money in the ground at and can we raise capital at an accretive to NAV type price. There's few in the market who would say the summer was not a good time to be deploying capital. And you can see that our NAV was 7%, while a little bit of that was from the premium issuance, the vast majority of it was from other than premium issuance. And what we saw was paper was cheap. So we pushed the pedal to the metal a little bit.

Speaker 2

There's times when offers are scarcer and frankly we're less active on the ATM program. But it's a very effective tool for the company in that while it's It's not it never is quite as simple as the trader sees something attractive in the morning, we call the bank, we issue the capital and we can do it on a same day basis. But I wish it was that easy, but it's something that works really well on a just in time basis So when we're seeing when the phone is lighting up more than often, we push the gas a little harder. The one challenge in managing a portfolio like ECC, We get well, to make this our worst problem, we get a ton of cash 4 times a year. Again, make that our I will never actually complain about that, But all the CLOs kind of pay on our January 15th April 15th cycle.

Speaker 2

So that's why we have a little more cash than average as of October 30th. It's simply It's Christmas here, preferably 4 times a year, and we're getting that money in the ground very, very quickly.

Speaker 5

Okay. I appreciate your thoughts and comments on that. That's all for me.

Speaker 2

Thank you.

Operator

Thank you. Our next question comes from the line of Matthew Howlett with B. Riley Securities. Please proceed with your question.

Speaker 3

Hi, Tom. Hi, Ken.

Speaker 6

Look, I think these the question look, I think it's the elephant in the room is your balance sheet is just keeps On improving and deleveraging with the growth in net worth, my question and I think I asked the last time is, I mean, You got to be looking at putting your ratios are putting some either preferred or term preferred or term debt on On the balance sheet, given the moving rates to last few weeks, given where you're talking where yields are, but Tom should we be thinking about You're getting leverage back up to that 35% and taking advantage of these great spreads before they don't last?

Speaker 2

Good question. We certainly are very proactive in managing the right side of the balance sheet. We're blessed. I love our balance sheet. I'm looking at my Bloomberg screen.

Speaker 2

The nearest maturity is April of 28 on the Xs, everything is unsecured, everything is fixed rate. We have some perpetuals out there even. So that's all good and that's by design. We've intentionally run the company with The 25% to 35% target band of leverage, including both preferred and unsecured debt, that served us well. And COVID, for example, where we were on size in our ACR at all times, which that's an art as much of a science kind of judging these things.

Speaker 2

As we look at capital raising opportunities, ideally, we'd raise some common, Some preferred and some debt every single day. The OID rules on preferreds and debt sometimes make that not so easy to do. But I can assure you, we are continually looking at our balance sheet and looking at creative ways to prudently Stay within that band, but we're comfortably I think we're around 28% as of the last numbers? Yes. Yes, around 28% right now.

Speaker 2

And we try and keep it within there. Sometimes we've gone a little above, maybe we've gone a little below once in a while. But Ideally, we're close to the midpoint of that band, but I can assure you we're always thinking of trying to come up with creative things That may be accretive to the company over time. The flip side, when the stock is at a handsome premium at a double digit premium, sometimes it makes sense to capture a little more common equity at that point, But it's a balance of both and we will continue to look at opportunities on the right side of our balance sheet.

Speaker 6

No, look, it's a high class problem, debt or equity. But I'd tell you, do you think you could issue I mean, are the markets open today? I mean, could you issue we've seen deals in the 8% 5 years,

Speaker 5

70%? Yes.

Speaker 2

So the idea I don't like right now, Just to be really candid, I hope your banker colleagues are listening. You can get a 5 year done, 1 or 2 other 40 Act RICs have been out CLO oriented, have done some stuff in that space. But so 5 years from today puts us like right in 2028, right in 'twenty nine. I got a 'twenty eight maturity and a 'twenty nine maturity. So, I say what about us we used to do 10 years of perpetuals.

Speaker 2

I said what about a 10 year Click. I'm joking when I say that, but

Speaker 6

We'll go to 7, Karen.

Speaker 2

Well, I'm in the middle. We'd be open to stuff like that. I haven't seen much get done in the $25 format. I can't point to anything and we have an active business that invests in these securities from other vehicles and obviously, sadly not our own. I don't think I've seen any public deals come across in $25 market north of 5 years.

Speaker 2

Perhaps with the recent, some of the Maybe people have more stability in rates going forward. Perhaps there's some paths there. We probably we always have things in the laboratory here as well and maybe we'll come up with some other ideas to be able to get closer to the midpoint of our range. But I am sensitive to not crowding up our maturity wall into 'twenty eight, 'twenty nine, which if I had to do a 5 year today, That's where I'd have to put it.

Speaker 4

Look, I

Speaker 6

mean, you have a terrific balance sheet, the lowest leverage in the space. And obviously, it's worth pointing out. I mean, obviously, we do them we can do the math on how accretive that would be, putting leveraging back up modestly. And it just looks very attractive to us, particularly if the Yields keep on coming down here. And I want to dovetail into the question.

Speaker 6

You talked about defaults going down next year. I know it's a big picture But I mean, what are you seeing differently that the credit the leverage loan market may Actually, Seema defaults have retraced. Do you Yes. And I thought,

Speaker 2

just to clarify, I don't believe I predicted defaults going down next year.

Speaker 5

Okay. I

Speaker 2

should say that trailing 12 month default rate declined a little bit, versus the last quarter versus some other recent data measure, But that was not a sadly not a prediction for all of 2024.

Speaker 6

Okay.

Speaker 2

But what so what the market is missing though to your to the specific like Most banks predicted around 3% defaults. I think one bank predicted 5% or plus percent defaults. Wow.

Speaker 6

Yes, Deutsche. That might

Speaker 2

have been for 2024, if memory serves.

Speaker 5

Okay.

Speaker 2

And we get questions from investors. So every like CLO BB index last I saw is up, I think 16% year to date. During the EIC call, their return on equity is even higher than 16% this year. But compare that to the ag, give or take, as the last time I looked at it, it's roughly flat for the year. All this floating rate is great.

Speaker 2

All the rate problems are just not ours. Companies and defaults remain well below historic averages. The flip side, all these companies have to pay this higher interest to pay our higher cash flows. And what a lot of people have said is, my goodness, debt service coverage ratios of companies are going to get really constrained. And it's true that company's debt service is getting tighter if your interest rate went from 1% Base rate plus the spread to now 5% base rate plus the spread, you got to pay more.

Speaker 2

Against that, what I think research analysts didn't give enough I have kind of figured consideration to. CFOs are pretty smart. Private Equity sponsors are pretty smart. I don't remember the time where a company was $1 short on its debt service and the equity handed the keys over to the lenders. I can't say it's never happened, but It kind of sounds silly to even think about.

Speaker 2

So people have run reports that said, well, if rates move to this, my goodness, X percent of the loan market won't be able That's holding everything constant. If things are a little tight, you slow pay your payables for a few weeks. You sell the overseas division. You call some sort of aggressive lender for a 15% mezzanine loan. As long as your revenue and EBITDA are growing and according to the market data that we see, the average below investment grade company and you can see this in our investor deck.

Speaker 2

It's way in the back, but it's in there. This is I think it's LCD pitch book data. So it's all third party data that shows revenue and EBITDA for the Average below investment grade company is going up. So if you own a business and the top line is growing and the bottom line is growing, You're going to hand over the keys because things get a little tight on payments for a couple of months? And for 2 leggings, you borrow from Uncle Charlie to pay your bill that month.

Speaker 2

Companies find ways. So I think too much of the analysis was keeping things in a steady state level without realizing There's 2 leggings behind the scenes doing this stuff and frankly covenant light. If you had a debt service covenant, you might be failing it. Right. And then you're going to have some mercenary lenders who got in there and they're going to be pushing for a default.

Speaker 2

CLO guys probably got in a little early. We don't want it to default. Covenant lights our friend. Against that only 4% of the loan 4% give or take of the loan market is below 80.

Speaker 5

Right. That's surprising.

Speaker 2

That's a good indication of things below 80. Certainly, the market is saying there is some hair on the name Or more, a lot of hair in some of the names, but that means 96% of the market is not trading at distressed levels. All right. So the research is one thing, but the reality I think is different.

Speaker 6

Well, I'll tell you, you guys know this market extremely well and you're doing such a great job with it and you've called it. So my last question is, I mean, the cash flows, we always go to this between the recurring cash flows, the GAAP and I get the disconnect. Cash flows were back up big in October. I mean, what's driving it? And then when we We still have this I didn't expect it to last this long.

Speaker 6

This huge recurring cash flow is still way above the GAAP reported NII. And How long do you see it? Why were the cash flows way up in October? This is a gift that keeps on giving. I mean, assuming there's There have to be special dividends going forward just to manage that taxable basis.

Speaker 6

I mean, all this good stuff. Again, another hard question.

Speaker 2

You've got a Ken and I smiling here. The The number of e mails I get from my friends when we announce specials and supplementals, they're always very happy.

Speaker 6

It's a happy day, the special dividend day.

Speaker 2

Yes. We're so close to getting to $20 in distribution since the IPO, which that's we're within shooting distance to get that done, which It would be great. Just a ringing the bell type of thing for us.

Speaker 6

Absolutely, a big milestone.

Speaker 2

So what happens, so loan spreads are up a bunch. We're up 11 bps on our spread. CLOs are 10 plus times levered, so that just generates more cash right there because our CLO debt Spreads are fixed. B, there was a period of time when there was a big basis between 1 month and 3 month LIBOR or 1 month and 3 months SOFR. And it was kind of, if memory serves, 40, 50 basis points, which every time you make a payment on one of these loans, you got to send in a Tifor Kitt and all kinds of the CFOs got to sign some papers, you got to call legal.

Speaker 2

If you are saving 50 basis points, you are going to do it. If you are saving 5 basis points, Stop it. Just pay the 3 month rate. Unfortunately, essentially, all CLOs pay only off of 3 month. So that differential has closed.

Speaker 2

If you look back and it was one second, 1 July, not this year, maybe last year where it was really out of whack And maybe it's 2 years ago, we were, oh, we are saying 1 month, 3 month LIBOR was out of whack. That's now largely behind us. So that's also helped. The 3 month rates have been pretty stable over the last couple of months, which then helps the arb just work even better in CLOs. So As you saw, Q3 cash flow our 4th quarter cash flow is collected better than all of the Q3 and we still have a few more payments that we're expecting, Combination of portfolio growing and the spreads on the loans underlying the CLOs continuing to go up.

Speaker 2

So We obviously hope that continues as much as possible. Stuff can happen that moves it around to some degree. Sadly, it's not a trend you can predict forever. But some of the things that kind of put us off sides a little bit, I think are behind us at this point.

Speaker 6

Unbelievable. We will enjoy it

Operator

Thank you. Our next question comes from the line of Steven Valverria with Inside the Income Factory. Please proceed with your question.

Speaker 3

Hi, Tom.

Speaker 2

Hey, Steve. Good morning.

Speaker 7

Good morning. I loved your past your conversation just now as an old credit guy. Those are all themes I love. But my specific question, most closed end funds focus a lot on NII coverage of their for distribution coverage, you folks focus Primarily on recurring cash distributions, which of course is much higher. Could you just outline for us What's the primary difference between what additional items are in recurring cash distribution that are not part of standard Net investment income, and specifically, does it include recurring Principal amortization that's made on your typical loan is not just a bullet loan, it's got recurring principal amortization.

Speaker 7

Does that recurring amortization slowdown as part of recurring cash distribution?

Speaker 2

Sure. Very good question, Steve. The recurring cash flows are equity distributions from CLOs And if we have CLO debt and other things that pay interest, but excludes distributions from called CLOs, Period. So it's basically the NII getting generated out paid in cash from our underlying CLOs. If a CLO unless all the CLO debt has been paid off, which I don't know, we might have 1 or 2 of those, but that's Not really our portfolio.

Speaker 2

Any principal that comes in on a loan, if the CLO is in the reinvestment period, is going to be reinvested into new loans or So that doesn't come to us. And if it's after the reinvestment period, it's going to be used to pay down the AAA's and the AA's and so on and so forth. So All of the recurring cash flows with one exception, I'll come to is really just all NII or coupon income coming out of our investments. The one slight exception, we don't really have much of it now. Sometimes it's called a flush Payment on a CLO when it's newly created on the first payment date, sometimes you get a little extra from that, which can actually be like a Special principal dividend, but we don't really have any new CLOs right now.

Speaker 2

That's not a big part of our cash flow. So the short answer to the first part of your question, what is principal included in recurring cash flows? By and large, the answer is no, Because the principal payments on loans are generally trapped in a CLO. Then B, Let me think through this. You had the what's the difference between cash and NII, GAAP NII?

Speaker 2

At the end of the day, cash is what pays the bills. Cash is what we distribute to shareholders. That's the most important tax gap, all this other stuff. Cash money in the bank is always statement of cash flows is the most important of the 3 financials on a company in my opinion. The difference the principal difference between Cash and GAAP is a reserve for credit losses and a handful of other smaller things.

Speaker 2

But when we predict NII, one of the things we say when we talk about these effective yields or we often say, these include a reserve for future credit expense. In old bank speak, if you worked at, say, Bank of New York a few years ago, you'd call that a loan loss reserve.

Speaker 7

Right.

Speaker 2

For variable interest entity accounting, VIE accounting, we take a reserve for losses. We disclosed a lot of this in our financial statements, but you can see we typically get default rates up to 2%, 2 plus percent. Right now, we have 40 basis points of default exposure. So we are taking reserves for future losses and very rarely do defaults happen exactly as modeled. Sometimes they are higher, sometimes they are lower.

Speaker 2

Right now, we are seeing lower defaults than we would expect. If we did have a default on a loan in a CLO, It doesn't come dollar for dollar out of the cash flow of a CLO in that it reduces our interest income a little bit, but the recovery on that loan Invested in a new loan which generates new cash flow. A default principally reduces the terminal value of a CLO, But that could be 5, 7 years from now and we are mainly interested in money today. So the big difference is a reserve for credit losses and by and large Credit losses are lower than the models today, but they could go back up tomorrow, but that's the big driver.

Speaker 7

So the NII actually is net of a loan loss reserve?

Speaker 2

Correct. That's a fair way to think of it, yes.

Speaker 7

Okay. That answers a big question. And it also answers the question, I believe, that Your recurring cash distributions to the extent you use those to pay dividends distributions does not include an eroding As it would, if it included principal payments.

Speaker 2

We're not taking loan principal payments and distributing those.

Speaker 7

Perfect. Okay. That's really good news. It answers a question a lot of retail investors Have been asking me, frankly. And I am glad I have the forum now.

Speaker 7

Thanks.

Speaker 2

Yes. The number one thing we look at recurring If any business you underwrite, what's the recurring cash flow? If you could have only one measure, would you have GAAP tax or cash? In my opinion, I will go with cash over the other 2 all day long and maybe keep tax as low as possible. But that's at the end of the day, The cash flow is what we want to pay out to shareholders every single quarter, and we do everything we can to keep that as high as possible.

Speaker 7

Great. Hey,

Speaker 2

And hopefully, Matt Bankers will call us back about a 10 year deal.

Speaker 7

Yes. That's great. Okay. Thanks, Tom.

Speaker 2

Appreciate it, Steve. Thanks so much.

Operator

Thank you. Ladies and gentlemen, that concludes our question and answer session. I'll turn the floor back to Mr. Raduski for any final comments.

Speaker 2

Great. Thank you very much everyone for joining. Both Ken and I appreciate your interest in Eagle Point Credit Company. Obviously, very pleased with our Q3 results and We shared cash flows in the 4th quarter trending very favorably. Ken and I will be available if anyone has any follow-up questions later today and we appreciate your time and attention.

Speaker 2

Thank you.

Operator

Thank you. This concludes today's conference call. You may disconnect your lines at this time. Thank you for your participation.

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Earnings Conference Call
Eagle Point Credit Q3 2023
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