Eagle Point Credit Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
August 6, 2024

There are 9 speakers on the call.

Operator

Welcome to the Eagle Point Credit Company Inc. 2nd Quarter 2024 Financial Results Call.

Operator

At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. I will now turn the conference over to your host, Garrett Edson of ICR. You may begin.

Speaker 1

Thank you, and good morning. By now, everyone should have access to our earnings announcement and investor presentation, which was released prior to this call, which may also be found on our website at eaglepointcreditcompany.com. As a reminder, before we begin our formal remarks, matters discussed on this call include forward looking statements or projected financial information that 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 Form N CSR half year twenty twenty four financial statements in our Q2 investor presentation with the Securities and Exchange Commission. The financial statements in our 2nd quarter 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 will now turn it over to Tom Majewski, Chief Executive Officer of Eagle Point Credit Company.

Speaker 2

Thank you, Garrett, and welcome, everyone, to Eagle Point Credit Company's Q2 earnings call. We'd like to invite you to download our investor presentation from our website, which provides additional information about the company and our portfolio. Recurring cash flows from our portfolio increased on both an absolute and per share basis in the quarter to $71,400,000 or $0.79 per share. This is up from 56,200,000 dollars or $0.70 per share in the Q1 and exceeded our quarterly aggregate common distributions and total expenses by $0.13 per share. The higher recurring cash flows were in part due to the growth of our portfolio as well as the results of semi annual interest payments received certain of our assets in our CLOs during the Q2.

Speaker 2

It's worth noting that roughly 3% of our CLOs underlying portfolios are now invested in bonds, which typically pay interest on a semiannual basis and we do expect some fluctuations in cash flows from quarter to quarter. The company generated net investment income less realized capital losses of $0.16 per share, which comprised of $0.28 of net investment income and $0.12 of realized losses. The realized losses included $0.15 per share related to the write down of amortized cost to fair value associated with 2 legacy CLO equity positions, which had already been reflected in NAV as unrealized losses. This was basically a reclassification on our balance sheet from unrealized to realized. Excluding this, we realized $0.03 per share of gains principally from selling appreciated CLO debt positions during the quarter.

Speaker 2

Excluding the reclassifications, net investment income and realized gains would have been $0.31 per common share. NAV per share as of June 30th was $8.75 Ken will walk you through more of our financial results shortly, first I'd like to take you through some additional highlights from the Q2. We deployed over $135,000,000 in net capital into During the quarter, we completed 4 resets and 2 During the quarter, we completed 4 resets and 2 refinancings. Also, we launched our new Series AA and Series AB non traded convertible preferred perpetual stock offering. The offering so far has generated proceeds for the company of approximately $9,000,000 The total program size is expected to be $100,000,000 We believe the non traded perpetual program will be significantly accretive to ECC over time and we're very excited about it.

Speaker 2

We were able to issue approximately 12,000,000 common shares through our at the market program or ATM. These shares were issued at a premium to NAV and it generated NAV accretion of $0.11 per share. We also issued a smaller amount of preferred stock under the ATM. Over the previous quarters, we had opportunistically purchased CLO BBs at discounts, which we started selling this quarter, harvesting gains and beginning to rotate the proceeds from those sales back into CLO equity. We expect to continue this rotation over the coming months and expect to invest the proceeds of those CLOBB sales into higher yielding CLO equity.

Speaker 2

During the Q2, along with our regular monthly common distribution of $0.14 per share, we paid an additional variable supplemental monthly distribution of $0.02 per share for an aggregate monthly distribution of $0.16 per share. Consistent with our long term financing strategy for operating the company, all of our financing is fixed rate and we have no financing maturities prior to April 2028. In addition, some of our preferred stock financing is perpetual with no set maturity date. As we've stated consistently in the past, we actively manage our portfolio towards having a long remaining reinvestment period and this drives performance we believe and guards against future market volatility. Similarly, rotating CLO BBs back into CLO equity, we believe remains highly attractive in today's market.

Speaker 2

In this prolonged environment of tightening CLO debt spreads, the refinancing and reset market has also returned. We completed 4 resets and 2 refinancings in our portfolio during the quarter. These actions have extended the reinvestment period of the reset CLOs to 5 years and lowered the debt cost of the refinanced CLOs by approximately 20 basis points. We have a robust pipeline of additional reset and refinancing opportunities under negotiation. As of June 30, our CLO equity portfolio's weighted average remaining reinvestment period or WARP stood at 2.7 years, which is 0.2 years longer than where it stood on March 31.

Speaker 2

And this is despite the passage of 3 months' time. Our portfolio's WARP is 59% above the market average of 1.7 years. We continue to believe keeping our WARP as long as possible is our best defense against future market volatility. I would also like to take a moment to highlight Eagle Point Income Company, which trades on the New York Stock Exchange under the ticker symbol EIC. EIC invests principally in CLO Debt.

Speaker 2

For the Q2, EIC generated net investment income and realized gains excluding non recurring expenses of $0.54 per share. EIC continues to perform well and we believe remains well positioned to continue generating strong NII. We invite you to join EIC's investor call today at 11:30 am after this call and to visit the company's website, Eagle Point Income, to learn more. After Ken's remarks, I'll take you through the current state of the loan and CLO markets. I'll now turn the call over to Ken.

Speaker 3

Thank you, Tom, and thanks everyone for joining our call. For the Q2, the company recorded net investment income less net realized capital losses of approximately $15,000,000 or $0.16 per share. This compares to NII and realized gains of $0.29 per share in the Q1 of 2024 and NII less realized losses of $0.05 per share in the Q2 of 2023. 2nd quarter results include the effect of $0.15 per share of realized losses due to the write down of amortized cost to fair value for 2 legacy CLO equity investments. The two investments are no longer generating cash flow, have a zero effective yield and we're at least 1 year past their reinvestment period end date.

Speaker 3

Since the fair value of these investments had already been previously reflected in the company's NAV, the realized loss was a reclassification from an unrealized loss. There was no impact to NAV as a result of the write down. Excluding the write down, our 2nd quarter NII and realized gains would have been $0.31 per share. When unrealized portfolio depreciation is included for the Q2, the company recorded a GAAP net loss of approximately 4,000,000 dollars or $0.04 per share. This compares to GAAP net income of $0.43 per share in the Q1 of 2024 and GAAP net income of $0.11 per share in the Q2 of 2023.

Speaker 3

The company's 2nd quarter GAAP net loss was comprised of total investment income of $42,300,000 and net unrealized appreciation on certain liabilities held at fair value of $1,100,000 offset by net unrealized depreciation on investments of $19,400,000 dollars realized capital losses of $10,800,000 expenses of $16,100,000 distributions on the Series D preferred stock of 600,000 dollars and distributions on the convertible preferred stock of $100,000 Additionally, the company recorded an other comprehensive loss of $2,800,000 for the quarter. The company's asset coverage ratios at June 30 for preferred stock and debt calculated pursuant to Investment Company Act requirements were 3 52% and 682%, 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, below the midpoint of our target range of generally operating the company with leverage between 25% to 35% of total assets under normal market conditions. Last week, we declared monthly common distributions for the 4th quarter in line with our recent distributions.

Speaker 3

The $0.16 per share monthly aggregate distribution is comprised of $0.14 per share regular distribution and a $0.02 per share supplemental distribution. We will continue to review our variable supplemental distribution on a quarterly basis. Moving on to our portfolio activity. So far in the current quarter through July 31, the company received recurring cash flows on its investment portfolio of 60,400,000 The lower recurring Q3 cash flow figure compared to the 2nd quarter is driven by approximately $80,000,000 in new CLO equity investments, which have not yet made their first payment. Some spread compression and off cycle semi annual paying loans and bonds in the underlying portfolios.

Speaker 3

We do expect our portfolio cash flows to move higher in the 4th quarter. I will now hand the call back over to Tom for his market insights and updates.

Speaker 2

Thanks, Ken. I'll now update everyone on the trends we're seeing in the loan and CLO markets. Starting off with loan performance, the Credit Suisse Leveraged Loan Index continued to perform well in the 2nd quarter, generating a total return of 1.87 percent for the quarter and 4.44 percent for the first half of twenty twenty four. The index continued its trajectory in July with loans up 5.21% through July 31. We continue to believe dealer research desks are significantly overstating overall corporate default risk as the underlying loan borrowers that we see have continued to see revenue and EBITDA growth on average despite the current elevated rate environment.

Speaker 2

Dealer Research Desk default forecasts for 2024 are now typically between 4% 6%. However, during the Q2, we saw only 6 loans actually default, which was the same number as the prior quarter. As of quarter end, the trailing 12 month default rate was 92 basis points, remaining well below the historic average of 2.65 percent and even farther below dealer forecasts. As of June 30, ECC's portfolio's exposure to defaulted loans stood at 53 basis points. Also during the Q2, approximately 9% of all leveraged loans or roughly 35% annualized were repaid at par.

Speaker 2

While there has been some opportunistic repricing activity within the nearly 45% of loans trading at or above par, many loan issuers remain very proactive in tackling their near term maturities through these repayments and refinancings in an effort to further push out their debt maturities. We view this as another sign of the loan market's resiliency. On a look through basis, the weighted average spread of our CLOs underlying loan portfolios was 3.63% at the end of the quarter and that's down from 3.74% at the end of the prior quarter. Meanwhile, spreads on debt tranches issued by our CLOs that were locked in 2 years ago remain unchanged and have the potential to tighten significantly as they roll off their non call periods later this year and early next. Over the past few days, there has been some softness in the loan market in line with the broader market volatility.

Speaker 2

The price movement we've seen in the loan market has been relatively modest to date. In terms of new CLO issuance, we saw $53,000,000,000 in the Q2 of 2024 $102,000,000,000 for the first half of twenty twenty four. This is the fastest pace on record and approximately 82% higher than the new issue CLO volume for all of the first half of twenty twenty three. As CLO debt spreads have tightened, 3rd party CLO equity investors, including us, have returned to the new issue market. During the Q2, we invested significant amounts of capital into both primary and secondary CLO equity as well as other attractive investments.

Speaker 2

Market wide, CCC concentrations within CLOs stood at 6.6% as of June 30 and the percentage of loans trading below 80 within CLOs in the market was about 5.5%. Our portfolio's weighted average junior OC cushion was 4.2% as of June 30, which gives us ample room to withstand potential future downgrades or losses. To compare this, our portfolio's OC cushion remains well higher than the market average of 3.2%. We continue to believe CLO structures and CLO equity in particular are set up well to buy loans at discounts during periods of volatility and ultimately outperform the corporate debt markets over the medium term as they have done in the past. To sum up the quarter for ECC, we generated net investment income and realized capital gains excluding the write down reclassification for the quarter totaling $0.31 per weighted average common share.

Speaker 2

Recurring cash flows were solid in the 2nd quarter, both up on a quarter over quarter basis and comfortably exceeding our regular common distributions and expenses. We sourced a significant number of attractive new investments investing $135,000,000 of net capital during the Q2. Our portfolio's WARP of 2.7 years increased during the Q2 and remained significantly longer than the market average. We expect our WARP to increase further as our new issue investing and reset activity continues. Our existing regular monthly common distributions and variable supplemental distributions were declared through the end of 2024.

Speaker 2

We've also significantly strengthened our balance sheet through the launch of our non traded 7% perpetual convertible preferred stock as well as NAV accretive issuances through our ATM program. We continue to maintain 100 percent fixed rate financing with no financing maturities before 2028 providing protection from any future rise in rates and locking us into an attractive cost of capital for years to come. Further, an increasing amount of our preferred financing is now perpetual with no repayment date obligated. Importantly, we still see an abundance of primary and secondary CLO equity opportunities and have a robust pipeline of refinancing and reset opportunities under consideration to further enhance the value of our portfolio. In closing, we're encouraged by the performance in the first half of the year.

Speaker 2

Our proactive investment approach has resulted in the portfolio's significantly greater than market average warp, strong OC cushions and high recurring cash flows. We believe our portfolio is well positioned continued strong performance through the second half of the year. We appreciate your time and interest in Eagle Point. Ken and I will now open the call to your questions. Operator?

Operator

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

Speaker 4

Yes. Good morning, everyone. Tom, there has been a leverage loan repricing wave, which we're all aware of that's been driving down loan spreads. I see that your portfolio's weighted average AAA spread is near the market average. So how much of an opportunity do you have left to refinance or reset the liabilities in your CLO equity portfolio to help defend your yields against that spread compression?

Speaker 2

Hey, Mickey. Good morning. Excellent question. A couple of things in there. The definitely loan spreads tightening, I forget the exact number, tighter about 10 basis points plus or minus quarter over quarter.

Speaker 2

Flip side of that, of course, defaults very few in a spread tightening world. But to your specific question of how do we manage the right side of our CLO balance sheets. While the average is about the market average, we give you line by line detail in the investor presentation, there's a tremendous dispersion. And I don't know exact number, but about half of them are probably above the average. And some of the highest cost CLOs start running off of non call later this year.

Speaker 2

So we have been very proactive in I think we had 4 resets and 2 refis in the second quarter and we continue to be active with those here in the Q3. And we have an active pipeline. Obviously, market conditions can change at any time. But what I would less focus on the average and more focus on, kind of sorting by the highest AAA ones and looking at the non call dates on those and those are the ones we're most focused on, particularly as they run off of non call.

Speaker 4

I appreciate that. Thanks for that clarification. You mentioned that default forecast seemed fairly pessimistic. And the ratings agencies have also remained pretty conservative and haven't seemed to accept what I would price are decent odds of a soft landing. And they also don't seem to recognize the amount of capital available to lower quality borrowers.

Speaker 4

So the downgrade to upgrade ratio is still a problem. That situation can obviously pressure CCC buckets. So how are your portfolio managers dealing with that trend?

Speaker 2

Yes. I mean, there's always too many CCCs as long as there's 1 CCC, I guess there's too many. Against that, our CLOs in general have tons of cushion. We provide the average in our deck, for both our CCC bucket. Let me just pull up the number here.

Speaker 2

Bear with me. We need to CCCs. This is on kind of the right deck here, Page 28 of the investor presentation, 6.37% is the weighted average triple Cs, which is I think slightly better than the overall market, which is good across our CLOs. Again, there's an average and a dispersion. You'll see some of them have higher numbers, others lower.

Speaker 2

The higher ones are typically later in life and in many cases are amortizing. Against that, We also have 4.2% junior OC cushion on a weighted average basis. And that is very, very powerful in that you need to have CCCs on the typical CLO go over 7.5% and then you start taking a haircut above 7.5% to lower of your market or a stated number in a given CLO. But in general you could probably cuff it that we could have 15% CCCs on average give or take before we actually faced interruption on CLO equity payments. Now if we got to a market where there was 15% CCCs, the current market is in the 6s, there's clearly something going on in the world and a continued downdraft.

Speaker 2

And what that would suggest is while a non trivial amount of loans right now are priced at pretty heavy prices, relatively high prices although coming down a little bit lately, you'd imagine you'd see a drawdown in all loan prices, which would then help discounted reinvesting in non CCC loans to help build back par. Quite a few of the CLO managers in our portfolio frankly have never missed a payment to the equity through COVID, through the financial crisis. These OC tests are very important. I hope there's no AAA investors on the call right now, but they only matter 4 minutes a year. They manage they matter on the end to close a business on the quarterly determination dates.

Speaker 2

So it's a known target and good CLO managers, they have a schedule, they know when they need to be passing that OC test. And the folks we work with have a pretty good knack of doing that. Obviously, who knows what the future brings, but having been involved in CLO management here over the years at Eagle Point as well, Those are relatively manageable tests, but we've got a better than average portfolio and I think the collateral managers we've partnered with have a real good knack in maintaining these beating these tests and they really just matter 4 minutes a year.

Speaker 4

Tom, in terms of the folks you work with, Eagle Point has grown significantly over the years. So I'm curious whether you can still focus on just top tier managers? Or have you grown to a point where you need to consider tapping into maybe 2nd and third tier managers assuming the pricing is right to be able to deploy capital?

Speaker 2

Yes. So I would say over an extended period of time, we've had collateral managers that the market would rank in varying tiers. What we're focused on at ECC are CLO collateral managers that have the DNA to deliver superior equity returns. On the surface, you think all CLO collateral managers want to deliver superior equity returns. The equity investors are the owners, the residual holders.

Speaker 2

All companies work for the owners. In our opinion, some purportedly Tier 1 CLO collateral managers think of the equity as nice, but not really important. So we've one of the things our investment process is focused on honing in on CLO collateral managers who have the DNA to outperform for the equity class while respecting their creditors, A. Then B, while ECC has certainly grown and Eagle Point's our overall CLO equity holdings which are far greater than just what's in ECC have grown. We still remain what we believe to be a single digit percentage of the market.

Speaker 2

The CLO market itself is about a $1,000,000,000,000 outstanding give or take in just the U. S. And the nice thing is when you look through our portfolio, I'm just looking at that same page 28 like Octagon which is a CLO manager we've worked with a bunch. You can see we've got 26, 27, 29, 37, 44, 45, so on and so on and so on, all the way up to Octagon 58 and Old Octagon 14, our original investment, back when they used Roman numerals. So the good news is the chefs we like, so to speak, are always in the kitchen and there is always another one coming.

Speaker 2

So sometimes we buy new, sometimes we buy used depending on what's better in the market condition, but we've not struggled to find access to the collateral managers that we've wanted to. And frankly, our continued size and scale has net helped us in that we're in many cases their most relevant equity investor.

Speaker 4

That's very helpful, Tom. Thanks for your time this morning.

Speaker 2

Great. Thanks so much, Mickey.

Operator

Thank you. Our next question comes from the line of Mitchell Penn with Oppenheimer and Company. Please proceed with your question.

Speaker 5

Thanks so much. Quick question, just a follow-up on Mickey's question. The impact of spread compression during the quarter you said was around 10 basis points. Is that are you taking is that just the loans that were repriced or is that taking the amount that was repriced and spreading it over the total portfolio?

Speaker 2

And I had used the number 10 earlier. I said approximately the exact number is 11 basis points, just to be clear and good morning.

Speaker 5

Good morning.

Speaker 2

That's just the weighted average spread of the loans in our portfolio. It doesn't matter if it was a repricing, if a loan was sold, a loan was bought, whatever the weighted average spread as of the prior quarter, weighted average spread of this quarter taking into account all changes in the portfolio. Got it.

Speaker 5

Got it.

Speaker 2

So new CLOs, both changes in the CLOs and different CLOs that we bought and sold during the quarter as well.

Speaker 5

Got it. Because we had heard a higher number mentioned, and I assume that's just one of the few deals or whatever deals reprice it was a higher number, but then we

Speaker 2

I'm sure some loans reprice 50 basis points, 100 basis points tighter. Got it. That means Others may have repriced wider if they were kicking out their maturity.

Speaker 5

So

Speaker 2

that's just overall what our portfolio did in aggregate.

Speaker 5

And you said the research guys are like their streets like 4% to 6% default forecast And you guys thought it was lower. I think and tell me if I'm wrong, if you're looking at just defaults, you're not including distressed exchanges. Is that correct? Because distressed exchanges are running over 4% right now.

Speaker 2

Correct. So the number we cite and what triggers a D rating, some distressed exchanges do trigger D rating, others don't. Facts and circumstances vary. Our number is anything I believe that's rated D or failed to pay, it would be immediately rated D.

Speaker 1

But that would be Sometimes

Speaker 2

the expressed exchanges happen below us, sometimes they do happen at the loan level as well.

Speaker 5

Got it. But that would probably be why The Street's estimating a higher number probably because they're including those distressed exchanges?

Speaker 2

Different dealers include different things in their measures. As long as your par is not impaired, I don't know that I mean that to me seems like the most important thing. And some distressed exchanges, you do take less par back, but in many you don't.

Speaker 5

Got it. That's all for me. Thank you.

Speaker 2

Great. Thanks, Mitchell.

Operator

Our next question comes from the line of Matt Houset with B. Riley Securities. Please proceed with your question.

Speaker 3

Good morning. Hi, Tom.

Speaker 2

How are you?

Speaker 3

Good, thanks. Thanks for taking my question. Congratulations again. I'll just first start on a follow-up. I mean, how much do

Speaker 6

you look at these analyst forecast or default rates? I mean, they've been dead wrong for a number of years. So just curious like when you look at that stuff, would you say your portfolio is 50 bps of long term growth?

Speaker 2

Yes, we don't really we don't really care about it. I mean it's just interesting to see. I mean in 2022, one leading investment bank predicted 11% defaults for 2024. I mean it's fascinating, but it doesn't really make a difference one way or the other for us as long as our loans keep paying, that's the relevant measure.

Speaker 6

Yes. I mean, and that's why I want to kind of dovetail into my question here. I mean, you have this incredible phenomenon that you have reoccurring cash flows that are way above the dividend, way above what you report for GAAP NII. And this has been going on ever since I've been covering the company, I mean, really for several years now. I know at some point GAAP and cash flow and tax all kind of converge.

Speaker 6

Just what can you tell us about what you've really believed is the economic earnings power? Like what metric? What should we look at? Should we just I'm assuming that we're not going to get this huge reoccurring cash flows above the dividends forever and otherwise you'd have to raise the dividend a lot over time. Just walk me through how to think about it, because lots of I mean, it's been great.

Speaker 6

Ever since I've covered the company, you've seen this phenomenon.

Speaker 2

CLOs generate gobs of cash as a general rule. And even when loans are defaulting, something that's really powerful and important to remember is the default, let's say you have a 50 basis point position in a CLO and it defaults. And let's just say it's a total wipe out, a 0 recovery. Let's take the most conservative position here. If that all happens, you get a little bit less interest on an ongoing basis, but your principal loss is 5 to 7 years from now when you ultimately redeem the CLO.

Speaker 2

And so interest income is far more important in the CLO equity IRR than principal income. Frankly, in many of our investments, we would have a positive IRR even if we never got a dollar of principal at the end of the CLO because in many cases the cash flows, not all cases, but in many cases the cash flows on an ongoing basis from the CLO frankly outweigh the are greater than the principal we invested at the beginning. So along the way, if we have a bunch of those defaults where the 0 recoveries are very bad recoveries, again, we're not predicting 0 recoveries, the price of loans is going to be down nearly certainly on that day if you're having a bunch of those. And that's what gives us as long as you're in the reinvestment period gives us a lot of collateral matters the opportunity to reinvest. So if you look at like the performance of ECC from January 1, 2020 through the end of December 2021, so a 24 month period, our NAV grew somewhere between 25% 35% during that timeframe.

Speaker 2

NAV grew and obviously we continued paying distributions throughout that period, never failed the ACR or anything like that on a measurement date. So it's CLO's equity is very nice and that it generates cash flow on an ongoing basis pretty robustly. When things get go haywire, COVID financial crisis, what you want to have is a long RP, so you can continue reinvesting. In April of 2020, approximately 2% of the loan market paid off at par. No CFO like Ken walked in and said, hey, why don't we optionally pay down our debt today?

Speaker 2

But the previously announced M and A, I remember the thing with the T Mobile loan paid off that month, just stuff keeps happening. If you're a CLO manager, you're just opening the mail, getting money at $100 when loans are for sale on $0.80 If you're in the RP, you're able to take advantage of that. So that's the formula that makes this work. The drawback of CLO equity, the prices move around far greater than the fair value in my opinion. But the very nice thing of it is the cash flow just keeps coming.

Speaker 2

And we've seen that we're that will be 10 years public in October of this year. A lot of things have happened and what hasn't changed is the cash flows continue being very robust.

Speaker 6

Yes. Look, in my opinion, it's better. In my opinion, that number is more important than the GAAP number. I don't know how I mean, I know you give everything

Speaker 7

Cash pays the bills.

Speaker 2

We don't send out GAAP dividends. We send out cash dividends.

Speaker 6

So our distribution

Speaker 2

is covered right.

Speaker 6

I've covered REITs and closed end plan that I've only focused. They only give a CAD or a FAD number. That's all we really focus on in any given quarter and almost ignore the gap. But certainly that's the number that's just remarkable and really I think speaks to the value inside ECC. So congrats on that and hopefully you keep it up.

Speaker 6

The next question, I mean your capital structure is evolving as you really mature here and grow. Just with the new with more perpetual and preferred and this non traded exchange or convertible note, how do you feel about targeted leverage? Do you think about that differently as the capital structure evolves?

Speaker 2

Obviously the best financing is financing you don't have to pay back. So those are from a common equity perspective that's great. We have issued a little bit of the preferred D which is the traded perpetual via the ATM from time to time there's activity there. The Series AA and AB which we're issuing through a non traded channel really, really nice. We don't have any maturities I think until April of 2028 at this point.

Speaker 2

Our target leverage is unchanged between 25% 35%. And I've always roughly thought of that roughly half debt, half equity. It's moved around a little bit, but that's always kind of been the benchmark in the back of my mind. I don't think we although obviously with perpetuals in theory you have a little more wiggle room. In general, I've tried to avoid something I'm very proud of, let's put it this way.

Speaker 2

We didn't fail the ACR during COVID. And that's something on any measurement date we passed. And there's no scientific rule for this other than than 30 years of experience in this market and in the securitization markets to say, I've never been through a pandemic before, no one had, but kind of gut feel when things get really ugly really fast, this is kind of what's going to happen. And that's honestly how we size that purely based on judgment. Obviously, we know the statutory limits we have to be within those.

Speaker 2

But when we've sized it, so why certainly have more flexibility without ever worrying about repaying this, perpetuals, it's still we always want to be able to our goal is never to fail the ACR. So that's an equal governor on how much leverage we would add to the company. So I don't see us going above 25 to above that 35 band in normal market conditions. But I certainly love pushing out taking away the maturity well. How about that?

Speaker 6

Yes. No, in theory someone should use a lower discount rate on your on the cash on the dividend because of it. On that

Speaker 3

note, on that, you can do up

Speaker 6

to $100,000,000 on that new exchangeable convert series. I mean, can you what's the term what are the terms? Can you force conversion or call it when the stock trades over a certain price for a period of time?

Speaker 2

So, the exact details, I'm going to start here and then maybe Ken will finish. He's been a closer to this one. So it's perpetual and like, so that's always nice. If people and the conversion, the owner of the security has the conversion option, anytime after 4 years they can call us up and say, I'd like to get rid of my security and we have 2 choices as a company. We can either pay them cash or give them stock equal to the ECC common stock equal the market value of that equal to the par amount of their preferred or $25 So if the stock is $10 a share, we'd have to give them 2.5 shares in exchange for that new shares in exchange for that $25 of preferred.

Speaker 2

We can also call it after a certain date. I don't recall what that call date is Ken. 5.

Speaker 3

5 years, yes.

Speaker 2

So and we can mandatorily repay it if we want after 5 years. But at 7% perpetual, obviously, we'll happily have that option. I would struggle to see a scenario, where we in current conditions where we'd exercise that, but it's nice to have and obviously if we got off size on the ACR or things like that. And if investors wanted to redeem or convert prior to 4 years there's a penalty 8, 654 or something like that over the 1st 4 years. So it's a great piece of paper for it's investment grade rated for investors who might want to hold it.

Speaker 2

It's because it's non traded. It sits in people's accounts that typically people just carry it at par. You get a monthly coupon of 7, investment grade rated, a ton of capital beneath you, really good assets underlying. It's a nice piece of paper unto itself frankly, but it's a great tool for the company to keep a very stable balance sheet. And I think one of the things Is perpetual?

Speaker 2

I'm sorry?

Speaker 6

Is perpetual, did you say?

Speaker 2

Yes, perpetual, but you have a path out after 4 years if you want.

Speaker 6

Right.

Speaker 2

Well, I

Operator

assume as you're getting it.

Speaker 2

And we'll get cash stock at our option. But not a lot of things paying 7% on a monthly pay basis that don't move around that don't have really any NAV volatility. So it's an interesting or very interesting people usually carry it at par. So it's one of those kind of really feels like if someone can invest their cash for 4 plus years, it feels like win win, win for the person who invests in that security and win for the company because it's a great and stable piece of financing.

Speaker 6

And there have been a lot of electric conversion feature, the dividend is that much higher, dividend is 15% or something.

Speaker 2

I mean, it's okay. They're welcome we're always we're welcome to do that. People are welcome to do that. I think if you're buying the 7%, you're probably seeking just that

Speaker 8

kind of

Speaker 2

more You're focused more on the stable price on your statement if I had to guess but we'll see in 3.75 years what people do.

Speaker 3

It's Ken here. Just to clarify the call option, it's actually 2 years.

Speaker 2

Sorry, even better. Great, apologies. Because our other properties are 5 years. Yes.

Speaker 6

You can call it a par in 2 years. I mean that we could be reissuing this stuff at 6% or something in 2 years.

Speaker 2

We can only hope.

Speaker 6

Yes, exactly. Look, same here. Look, congrats on that. And the last question, what is the opportunity, the BB opportunity to sell those at premiums? It's been obviously a great trade.

Speaker 6

Just any way to quantify what's left and what could be sold?

Speaker 2

Yes. We still have everything in the BB portfolio is in the has certainly available for sale, shall we say, to use an accounting term. We bought most of that when BBs were in the 80s 90s. Just looking at the portfolio here, we are at 15%. We're about 15%.

Speaker 2

So We'll continue as of that was as of June month end, we'll continue the market soft this last couple of days probably brought things down a little bit, but through July, we bought this stuff at discounts thinking it would get back to par, close to par, theory has been correct. I think we mentioned we had $0.03 of realized gains from sales in the quarter, last quarter. And we certainly our goal is to continue reducing that. We increased it when there was some nice convexity and now that the convexity is largely gone, we're continuing to reduce it. Hopefully, I don't think we'll get rid of everything, but ask the team, please get rid of everything.

Speaker 6

Well, certainly accretion to bake into our model. Really appreciate it. Congrats. Thanks, Ken and Tom.

Speaker 2

Thanks so much, Matt.

Operator

Thank you. Our next question comes from the line of Paul Johnson with KBW. Please proceed with your question.

Speaker 8

Yes, good morning. Thank you for taking my questions. I'm just wondering to get your thoughts kind of on how you think broadly on kind of new investments. Obviously, there's some interplay here between the of yield and cash yield on what's realized over investments, but the cost of equity for ECC has been increasing, that's hard to deny. I mean the cost of equity is getting close to 20%.

Speaker 8

The effective yield on new investments this quarter was around 19%. 19%.

Speaker 2

How does that math work? No, very good question, Paul. When we look at the bogeys we're trying to meet, we look at it on a blended basis. And if you just say the distribution rate, I'm just putting a number as 20%, we're investing at 19%, that's not a formula for success, overlay those costs and expenses as well. But just looking at just the raw equity cost, obviously, is not the full picture.

Speaker 2

We look at the blended cost of capital on the right side of our balance sheet, which includes stuff that has coupons in the 6s, even though the old perpetuals, the Ds are 6.75 if memory serves. We have other coupons, probably the highest is 8 across the stack. But so we've got roughly a little less than a third of the portfolio financed in the 8th. So the actual cost is an average of the distribution rate on the common in our opinion and the attractive debt cost that we have at the top of the stack. Without the attractive debt, our distribution yield would need to be lower frankly, debt and preferred.

Speaker 8

Got it. Thanks for that. And then, last one, just out of curiosity, I mean, just with the development of some liability management exercises in the leverage loan market, lender on lender violence in some of those workout situations. I'm just curious, how was that dealt with, I guess, at a CLO manager level? I mean, obviously, you would assume you're in a minority position within CLO.

Speaker 8

How is that dealt with? Or is that just a situation where it just basically never comes to fruition because it's an investment that would probably be exited due to downgrades or whatever?

Speaker 2

Yes, a very good question. So the good news, lender on lender violence is certainly that proverbial lender on lender violence is certainly down versus where it was 1 to 3 years ago. The market's kind of calmed a little bit in terms of that. It's not 0, but it feels judgmentally to me like it's less than it's been in the past, A. And B, while any given CLO, if you think of a CLO as a $500,000,000 CLO, typical position size is 60 basis points or something, big ones, so that's $3,000,000 Against that these collateral managers manage tens of 1,000,000,000 of dollars.

Speaker 2

So some of them might own $100,000,000 $200,000,000 $300,000,000 of a loan. So there's good and bad of that. The bad part is if they wanted to exit the loan, that would take them a little while. The good part is CLOs own roughly 2 thirds of the loan market that percentage moves up and down a little bit, but directionally I think that number is accurate. And many of the collateral managers that we work with are some of the largest investors in loans.

Speaker 2

So while our any one CLO might be a little pipsqueak of a holder, when you aggregate any given many of the collateral managers we work with, you're going to see they're really quite relevant in here. One of the things that happens in the loan market though, and this is something this is a bad part. It's still it's all worked out over the last 10 years, but it's if the new loan is issued at 99.5 CLOs buy it there, let's say it trades down to 60 other distressed funds, purported bad guys come in and buy it at 60. For them getting out at 80 is a nice win. For us, recovery at 80% kind of stinks.

Speaker 2

We just lost 20% at roughly 20%. So one of the things that does cause a problem sometimes, you get these people with divergent starting points, the same outcome can be a win or a loss for different people. That said, I think the loan market is getting better at not being intimidated and bullied by distressed funds as much as perhaps used to be. So while there will continue to be some degree of lender on lender violence in some situations where the CLO community does get the CLO collateral manager community gets a little outsmarted by these distressed guys. It feels like the tide has been turning in the CLO market's favor for a while now.

Speaker 8

Very interesting, Tom. Thanks for taking my questions. It's all for me.

Speaker 2

Great. Thanks so much, Paul.

Operator

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

Speaker 7

Hi, Tom.

Speaker 2

Hey, Steve. Good morning.

Speaker 7

Hey, since typical syndicated loans partially amortized principal over the term of the loan, at least they did when I was doing them, then with a balloon payment of the unamortized principal at the end at the loan maturity, what is your estimate of within your recurring cash distributions, what's your estimate of the percentage of that that consists of principal payments? And then sort of follow-up, to the extent that that would cause any erosion over time of the ultimate principal of that particular CLO, how much is that then offset through building par, resets, portfolio trading, buying new loans at $0.70 when old ones mature at $100 that kind of thing?

Speaker 2

It's an easy estimate, 0. 0? With one asterisk, 0, yes. So within a CLO, I will explain the asterisk. When money comes in to the CLO, there's a trustee, Wells Fargo Bank or Citibank serves as trustee for the CLOs.

Speaker 2

When the money comes in, they put it in 2 accounts. There's an interest account and a principal account. And the interest is what gets paid out to us as the equity after the AAAs and all the debt holders get paid. The money that comes to us is purely from the interest account. All the principal that comes in whatever amortization a loan makes or sale proceeds or recoveries on defaults or anything goes in the principal account, which is during the reinvestment period entirely used for reinvesting into new loans.

Speaker 2

So even if a loan makes a 1% quarterly amortization payment, that's going to be trapped in the principal account and not used to pay out current income distributions to the equity. There is one exception I did mention in Asterisk, and this is something called the principal flush. And on one hand that sounds bad, but if you're the receiver of it, it's actually pretty good. In many CLOs on the 1st and second payment date, if the collateral manager was able to buy the loans cheaper than the targeted price, that savings, let's say they modeled buying them at 99.75%, they bought them at 99.5%, that quarter point, which is left over in the principal account, can be reclassified into interest and is paid out as a one time or two time special distribution to the equity. That would be the only situation when that occurs.

Speaker 2

But like randomly on the 7th payment date of a CLO, if some of the loans are amortizing, all that money is trapped in the system and we don't get any of it. So, all the latter parts of your question kind of go away, frankly, other than that one special distribution at the beginning or 1 or 2 to the extent we can buy loans cheaper or have some trading gains early, the balance of the principal stays within the system.

Speaker 7

So is there a simple answer to the question then of what accounts for the big difference between your NII plus your capital gains and then the much larger recurring cash distributions. That's close. Yes.

Speaker 2

So you were a banker back when bankers made loans in the old fashioned days? Yes. Loan loss basically loan loss reserves. So when we calculate an effective yield on a CLO, there's a provision for losses baked into there, Whether or not those losses actually happen, so we might be getting cash far if we're accruing, I think that was 19.4% was the new purchases this quarter. So those investments on average, Ken is going to book 19.4% divided by 4% is going to be the income in the Q3 on those.

Speaker 2

We expect to get more cash than that, but we're taking a reserve for losses along the way. To the extent those losses don't occur, we might get a little more at the end. To the extent the losses are greater, we get a little less at the end.

Speaker 7

As you take that reserve, I assume that's not part of your pre tax income from which you're supposed to pay whatever 90%. So in other words, the losses don't actually get taken for tax purposes until later on when you

Speaker 2

Until they're incurred. Yes. Yes. So it's basically accrual accounting for GAAP and cash accounting for tax, I guess, would be a pretty basic simple way to put it.

Speaker 7

Perfect. Thank you so much. That's a question that a lot of people have and I think now maybe won't I don't. I mean that really happens.

Speaker 2

I mean the number one there's cash, GAAP and tax. They've never equaled in any given period, but over the life of a CLO absent a few slightly non deductible a handful of non deductible items, cash profit, tax profit and GAAP profit will equal in aggregate, but sadly not in any given quarter.

Speaker 7

You put out an explanation of that about 5 years ago or so. I think

Speaker 2

it was 9 years ago. I think it was August 2015 or 2016.

Speaker 7

Exactly. Yes. And it'd be great It's

Speaker 2

the most downloaded thing on our website.

Speaker 7

I'll go take a look. One other quick question or point is, I don't know how many of your investors realize that even a 4% default rate, which you would probably never achieve even though that's being except in a real recession, after 60% or so recoveries, you're talking about a loss rate that's only 1.5% or so. Big difference. In

Speaker 2

that direction. And I would also then say, well, Steve, if 4% of the corporate loan market is defaulting every year, what's the price of loans on that day? It's probably not par.

Speaker 7

Yes. Anyway Every loan

Speaker 2

that doesn't default pays off at par. That's fine. Binary outcome.

Speaker 7

Thanks a lot.

Speaker 2

Appreciate it. Thanks for your time, Steve.

Speaker 7

Pleasure.

Operator

Thank you. And it looks like

Speaker 8

we have reached the end of

Operator

the question and answer session. I'll now turn the call back over to Tom Majewski for closing remarks.

Speaker 2

Great. Thank you very much for joining Ken and I appreciate your time and interest in Eagle Point Credit Company. For those interested in Eagle Point Income Company, we invite you to join me, Lena and Dan at 11:30 this morning. Thank you very much.

Operator

And this concludes today's conference and you may disconnect your lines at this time. Thank you for your participation.

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Earnings Conference Call
Eagle Point Credit Q2 2024
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