This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.
spk03: Greetings and welcome to Eagle Point Credit Company's third quarter 2020 financial results conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Garrett Edson of ICR. Thank you. You may begin.
spk08: Thank you, Rob, and good morning. By 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 eaglepointcreditcompany.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 that involve risks and uncertainties that may cause the company's actual results to differ materially from those projected in such forward-looking statements or 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 Securities and Exchange Commission. Each forward-looking statement or projection of financial information made during this call is based on information available to us as of the date of this call. 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 third quarter 2020 financial statements and our third quarter investor presentation with Securities and Exchange Commission. The financial statements in our third 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. I would now like to introduce Tom Majewski, Chief Executive Officer of Eagle Point Credit Company.
spk09: Thank you, Garrett, and welcome, everyone, to Eagle Point Credit Company's third 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, including information about our portfolio and the underlying corporate loan obligors. For today's call, I'll provide some high-level commentary on the third quarter and more recent events. Then I'll turn the call over to Ken, who will walk us through the third quarter financials. I'll then return to talk about the macro environment, our strategy, and provide updates on some recent activity. We'll also open the call to your questions. During the third quarter, the U.S. economy continued its gradual recovery as many shutdown orders were relaxed and governments globally provided liquidity to the market. Worst-case scenarios for corporate credit that some predicted back in March have not materialized. Today, many research desks are actually reducing their near-term default projections. With that said, we're very mindful that we're not out of the woods just yet with respect to COVID as cases have been rising. Given our strong balance sheet and ample liquidity, we've been able to find attractive CLO opportunities both in the secondary and primary markets. During the third quarter, we deployed a little over $27 million of net capital into new investments. We also converted three of our existing loan accumulation facilities into new CLOs. During the third quarter, the company received recurring cash flows from our portfolio of $16.7 million, or about 53 cents per weighted average common share. Our net investment income was 29 cents per common share in the third quarter, well above our common distribution level. We did realize some losses selling a few investments, and that brought our NII net of realized losses to 23 cents per common share. net of distributions paid to common stockholders, our NAV increased by 13% during the quarter. While we're certainly pleased with the upward NAV movement, we're mindful that it still has lagged other risk assets, as CLO equity often does. Our NAV remains below where it started the year, and we believe there may be potential for continued upsides in our NAV. Looking to October, we see some even better news. we received recurring cash flows from our portfolio of $25.5 million during the month of October. This is an increase of 50% over the prior quarter. Cash flows were pressured in the third quarter due to an adverse LIBOR mismatch when many CLO rates were set back in April of this year. That has corrected itself, and now CLOs are benefiting from a positive LIBOR basis driven by 1% floors, which are becoming increasingly common on many loans today. We expect this positive basis to continue as long as LIBOR remains low, and that will benefit CLO equity. In addition, several investments in our portfolio that deferred payments in July resumed making distributions in October as they came on sides with their OC tests. Beyond the positive trends in our cash flows and earnings, We continue to maintain a very solid balance sheet. We have no financing maturities due before October of 2026. We have no secured financing whatsoever, no repo-style financing, and no unfunded revolver commitments. So while we are optimistic that the economy will continue to rebound, we remain very well positioned, we believe, to weather setbacks should they occur. We have ample dry powder, a little over $12 million as of October 31st. allowing us to continue to be on the offense when we see opportunities. We also declared common distributions of $0.08 per share per month for the first three months of 2021, keeping with the rate that we've been paying over the past few quarters. Earlier, I talked about positioning the company's balance sheet. I also want to highlight the value of the right side of our CLO equity portfolio's balance sheet. We continue to believe our portfolio could withstand a prolonged recession should it occur, and we believe it could thrive in it. This is not because we're blind to defaults, but because the value that can be created by reinvesting within our CLO structures. A key metric to evaluate our reinvestment optionality is how much reinvestment period we have left in our portfolio. At quarter end, our CLO equities portfolio's weighted average remaining reinvestment period stood at 2.6 years. This allows our CLOs to continue to be on the offense in volatile markets. This measure was 2.7 years at the end of June and 2.9 years at the beginning of 2020. So despite the passage of nine months, through our proactive management of our portfolio, our portfolio's remaining reinvestment period decayed by less than half. After Ken's remarks, I'll take you through the current state of the corporate loan and CLO markets and share our outlook for the remainder of 2020. I'll now turn the call over to Ken.
spk04: Thanks, Tom. Let's discuss the third quarter in a bit more detail. For the third quarter of 2020, the company recorded net investment income, net of realized losses of approximately $7.2 million, or 23 cents per common share. This compares to net investment income, net of realized losses, of 28 cents per common share in the second quarter of 2020, and net investment income plus realized gains of 37 cents per common share in the third quarter of 2019. When the unrealized portfolio appreciation is included for the third quarter, the company recorded GAAP net income of approximately $44.5 million, or $1.40 per common share. This compares to GAAP net income of $1.71 per common share in the second quarter of 2020 and a GAAP net loss of $1.59 per common share in the third quarter of 2019. Just a reminder, our short-term cash flow generation is largely unaffected by the unrealized appreciation or depreciation we record at the end of each quarter. The company's third quarter GAAP net income was comprised of total investment income of $16 million and net unrealized mark-to-market gains of $37.3 million, partially offset by expenses of $7 million and realized losses of $1.8 million. As of October 31st, the company had $12.9 million of cash on hand, net of pending settlements. As of September 30th, the company's net asset value was approximately $268 million, for $8.45 per common share. Management's unaudited estimate of the range of the company's NAV as of October 31st was between $8.53 and $8.63 per share. The company's asset coverage ratios at September 30th for preferred stock and debt calculated pursuant to Investment Company Act requirements were 288 and 433 percent, respectively. The current measures are comfortably above their statutory requirements of 200 and 300 percent. As of September 30th, the company had debt and preferred securities outstanding, totaling approximately 34.7 percent of the company's total assets, less current liabilities, which is within but at the upper end of our range of generally operating the company with leverage between 25 to 35 percent of total assets under normal market conditions. Moving on to our portfolio activity in the fourth quarter, through October 31st, the company received current cash flows on its investment portfolio of 25.5 million, or 80 cents per common share. To highlight Tom's earlier point, this is a 50 percent increase compared to the 16.7 million, or 53 cents per common share received during the full third quarter. Consistent with prior periods, please note, Some of our investments are expected to make payments later in the quarter. During the third quarter, we paid three monthly distributions of $0.08 per share of common stock and are paying the same amount for each month in the fourth quarter. Additionally, this past Friday, we declared common distributions for the first three months of 2021 in the same amount. In terms of our at-the-market offering program in the third quarter, the company issued approximately 82,000 shares of its common stock at a premium to NAV for total net proceeds to the company of approximately $0.6 million. I will now hand the call back over to Tom.
spk09: Great. Thanks, Ken. Let me take you through where the macro loan and CLO markets currently stand, then I'll touch on our recent portfolio activity as well. The Credit Suisse Leveraged Loan Index continued to see a nice recovery, generating a total return of nearly 4% for the third quarter of 2020. As of September 30th, the CS Leveraged Loan Index was down less than 1%, and as of November 13th, the index had actually reached positive territory for the year. This is remarkable, in our opinion, when one considers how dire the outlook was for credit back in March. According to S&P, 13% of the loan market was trading below 90 at the end of September, and that compares to 22% at the end of June. This is a very big improvement, and we're happy to see it. Despite the improvement in the loan market, we believe opportunities continue to exist for our CLOs to reinvest and build par through buying loans at discounted prices. Our CLO equity investments should be well-positioned to continue reinvesting given the benefit of the long-term opportunity locked in place, non-mark-to-market financing inherent in our CLO structures. Retail fund loan fund outflows lightened a bit but still persisted in the third quarter, and we saw outflows of a little over $4 billion. On a look-through basis, the weighted average spread in our portfolio increased slightly from 3.55% in June to 3.59% at the end of September. An increasing number of loans in the market now include LIBOR floors, which further increased our interest collection when short-term rates are as low as they are at present. Simply, we're earning floored LIBOR, and we're typically paying LIBOR that is not floored or subject to a floor of zero. That's very, very powerful. The trailing 12-month default rate at the end of September stood at 4.17%, according to S&P 500. While we still expect additional defaults in the coming months, the rapid recovery in the market is causing many research desks to reduce their projections of default rates, and this is a very hopeful sign compared to where things stood six to eight months ago. While defaults will likely continue at elevated levels in the short term, we believe the corporate default rate will remain lower than it otherwise would have been had more loans featured financial maintenance covenants. The company's default exposure as of September 30th stood at 2.03%, well below the trailing 12-month default rate. Further, only 5.4% of loans in our portfolio mature prior to 2023, providing a significant majority of our corporate borrowers with years and years of runway before their deaths are actually due. Our portfolio's weighted average junior OC cushion was 1.12% as of September 30th, and that's up from 0.83% or 83 basis points at the end of June. That's a big improvement, but it's still below where it stood prior to the COVID onset. This principally reflects the impact of 40% of all corporate loans being downgraded by the rating agencies. However, as previously mentioned, the pace of downgrades has slowed, and we've actually started to see some upgrades of stronger issuers. In addition, many of our largest holdings have significantly greater OC cushion than the average. By market value, 95% of our CLO equity positions that were scheduled to make payments in October did so. Think about that for a minute. Eight months after one of the largest crises we've seen in several years, 95% of CLO equity in our portfolio is paying current distributions. It's the primary reason why CLOs are such an attractive and resilient asset class and what attracts us to invest the company's capital and our own personal capital in the stock of the company. To sum up, cash flows on our portfolio increased by 50% in October versus the third quarter. Our balance sheet remains strong, and we have no debt maturities for nearly six years. We have $12.9 million of dry powder ready to invest. The long-term locked-in-place, non-mark-to-market financing in our CLOs is significant, and we consider it to be a generally underappreciated advantage of CLO equity. And we believe our advisors' deep expertise and strong track record are keys to our success, particularly during uncertain times. We continue to closely manage our investment portfolio and remain opportunistic with respect to deploying capital. As a reminder, we know how CLOs have performed historically. Many consider 2006 and 2007 CLOs to be some of the best vintages of the 1.0 era. If today's CLOs perform half as well as the 1.0 set did, we believe that this will be a very attractive ultimate outcome for investors. With that, we thank you for your time and interest in Eagle Point. Ken and I will now open the call to your questions.
spk03: Thank you. At this time, we'll be conducting a question and answer session. If you'd like to ask a question, please press star 1 on your telephone keypad. The confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question comes from Randy Biner with B Reilly. Please proceed with your question.
spk02: Good morning. Thank you. Yeah, I have a few. Just on the commentary on the OC test, you mentioned it's trending better, and I think from page 30 of your deck, it's up to 112 basis points. Just as a reminder, is that the right figure to be looking at? Where could that trend back to, do you think? Can it get back to historic levels?
spk09: Sure, a very good question. Yes, on page 30, the 112 basis points, that's the number, and you can see that's up from 83 basis points at the prior quarter end. Some of the drivers of that are going to be a factor of how much CCC we have in any given portfolio. And if you look back on pages 25 and 26, you can see the CCC percentages, or CCC plus CAA1 or lower over on the right-hand side. I mean, you can see quite a few of the CLOs are over 7.5%. And there's a haircut taken in typical CLO. There's a haircut taken in the OC test for excess CCCs. So the way to think about this broadly is to the extent we had more CCCs or the price of CCC loans fell, that would hurt the OC cushion. At the same time, if we have fewer and fewer triple Cs or the price of triple Cs rally because the OC test looks at a market value of the triple Cs, we could actually get more cushion in the test. In addition, the other factors in there, should a loan default, would be a detriment to the extent there are trading gains or losses in the portfolio that can help or hurt the OC cushion. As to where it could get to, there's There's no functional limit on the upside. And to the extent you look at our average is about 13.5%. If you think of the average triple C as being around 70 cents on the dollar, just pick that as a number, you're taking a haircut over 7.5%. So 13.5 minus 7.5 is six points. If times 30%, we could be taking off 180, 200 basis points off the OC test on average, as a result of the high triple Cs. So to your question, if the triple C buckets continue to come down, which is certainly the trend we've been seeing across many CLOs, you could see a path to get back to the threes.
spk02: Thank you for that. And then I guess the follow-up question is, you know, understand the marks have been better and, you know, but the Some of your credits, this is my perception, and if I'm mistaken, please correct me, but I feel like some of your credits would be more exposed to kind of worsening COVID trends in the economy maybe versus corporate credit more broadly. And so do you have a concern that if kind of the incidence of COVID continues to increase, there's more lockdowns? that you could see a reversal, or do you feel like kind of the current credit trend is still catching up and moving in a positive direction? And if it's helpful to talk about certain subsectors, you know, to describe that, please do.
spk09: Sure, sure. So to the first part of the question, I don't think we have a particularly adverse selection of above-average COVID exposure versus broader below-investment-grade credit at a high level. And if anything, I think the trend in the portfolios have been for collateral managers to reduce exposure in COVID-related industries. So I struggle to see us being in an adverse selection, and perhaps we've been fortunate enough to get to a better situation. So when we look at these shutdowns, and you look at changes in unemployment and changes in GDP, you know, a year ago, people would be fussing over 50 basis points shift in GDP. you know, quarter over quarter. Then we have this gigantic drop in the second quarter and then the slow recovery now. And all of a sudden, the double-digit default rate from what was functionally near full employment at the turn of the year. Yet we're sitting here with 95% of our investments still paying current. So at a high level, that's bad inputs and a good result. To the extent we see more shutdowns and or more restrictions and which is unambiguously a trend throughout the country right now. That's a bad fact, but I don't see it as a dire fact in that things that are helping us, certainly the Fed is providing a lot of capital into the investment grade market, which then by sort of definition brings along the high yield market, which brings along the loan market as well. And frankly, the high yield market has been a source of funding for many loan borrowers who might have needed additional liquidity. And whereas when we started this COVID period back in March, you would think broadly of the average leveraged borrower as having three to nine months of liquidity as a broad generalization. It's hard to see companies not having doubled or tripled their liquidity runway through different measures of cutting expenses and putting additional debt on their balance sheets. While that debt does eventually need to be repaid, it's typically many, many years out in the future before that's due. So if we were to see another turndown and slowdown in economic activity, I think companies have much stronger balance sheets today. Even the cruise lines and airlines and hotels, Hilton just did a bond deal yesterday at 4%. So even guys who would be squarely in the crosshairs have raised a ton of liquidity, which is great, which would give them more runway. And then assuming we get some degree of political resolution in Washington, obviously no guarantees there, it's hard not to see some degree of additional stimulus coming out helping those who are unemployed. And when you think about how we made it through such a high unemployment rate with a relatively low default rate, that's largely because the government masked it, in my opinion, by sending checks to lots and lots of people every single week. Those checks have stopped, but to the extent something resumes in the new year, I think that would also be an offsetting fact. Long answer, but hopefully you kind of get the flavor of how we're thinking about it.
spk02: No, yeah, that's exactly what I was looking for. I'll drop back in the queue. Thank you.
spk09: Thank you.
spk03: Our next question comes from Chris Kotowski with Oppenheimer. Please proceed with your question.
spk06: Yeah, good morning. Thanks for having me. I guess my first question was, I mean, in terms of the distributions, you highlighted the fact that third quarter distributions are, you know, up 50% from the second quarter. And I'm wondering, is that a function of the improvement in the OC cushion or is it kind of the natural lumpiness from quarter to quarter? And is there a way to kind of think triangulate between, say, what moving back to a three-ish percent OC average, OC cushion, what kind of impact that would have on your distributions from CLOs?
spk09: Sure. A good question. A little bit of none of the above on the first part, and then we'll talk about how the OC test could impact the second, impact future distributions. The principal thing, and if you look at the chart, in our deck on, let me find the page, on page 23, this is a chart we don't like. We started at 108, 90, 68, 53. That's a tagger no one's a fan of. The Q4 cash flows in October as we shared up over 50% from the Q3 levels. So what caused the degradation? Broadly, the drop in the cash flows from Q1 to Q2 were new OC failures and CLOs that were making payments all of a sudden diverting cash flows to either buy new collateral or pay down the AAAs. The drop from Q2 to Q3 broadly was due to a pretty grievous LIBOR mismatch back in the second quarter in that CLOs, each given CLO sets its LIBOR rate four different times a year. Loans set their LIBOR rates at, you know, probably one loan sets their rate every single day in a given CLO portfolio or pretty darn close to it. As LIBOR fell precipitously during the second quarter, many CLOs were burdened with paying roughly 1% LIBOR during the second quarter, but loans kept resetting lower and lower and lower. And in many cases, we actually had a negative LIBOR basis, which is what manifested itself in the reduction in cash flows from Q2 to Q3. So just due to a timing of the rapid movement in LIBOR rates, we were borrowing at 1% LIBOR proverbially and investing at a much lower LIBOR rate, which is bad. Roll the clock to October, two good things happened. Principally, LIBOR stayed low. which then, and as more and more loans now have LIBOR floors, we were borrowing from the CLO debt investors at about 25 basis points LIBOR, but investing about half of the portfolio, a little less than half in loans with 1% LIBOR floors. So all of a sudden, whereas in the second quarter we had a negative basis in LIBOR, here we had a positive basis. To the extent LIBOR stays low, which is certainly the broad expectation in the market, even the I'll give you the current five-year swap rate is 45 basis points. Current three-month LIBOR is 22 basis points. So the market is saying the short-term rates are going to stay low for quite a period of time. Many, many loans have 1% LIBOR floor, so we're actually now in a positive basis, which we expect will continue. And certainly as long as rates stay low, that will keep going. So we don't think it's a one-hit wonder with the October payments being so far up. Then to the second part of your question, the OC cushion, the OC test is a binary test. You either pass it or you fail it. So there's not a reduction, oh, if the OC goes a little down, you trim a little. It's kind of an all-or-none test. You could partially pass it and cure, but usually when these things go, they go by a enough of a margin. I guess it's possible you could have a tweener, but nearly all of the CLOs you can see are either comfortably passing or failing by a non-trivial amount. So that OC cushion, the real thing to look at is deal specific. And so the question to ask yourself is, do I think these deals can come back on sides? Some of our highest payers are the ones that are off sides. Those are the ones often with the most aggressive and most spready portfolios. As we construct our portfolio of CLO equity, we seek to have both conservative portfolios and more aggressive portfolios, and it's a continuum. And as you'd expect in choppier times, the more aggressive deals, frankly, are the ones that are more likely to be offsides. Principally concentrated in Marathon and ZEISS, if you had to kind of put it into two shelves. That said, each of the teams at those shops are working keenly. They have, in many cases, meaningful personal co-investment, and even part of their fees are deferred. So there's significant incentive to get those transactions on side. I think some have the potential to, while others might have a more challenged period ahead of them. But so when you're looking at our future cash flows, the question is deal by deal. And broadly, we're seeing a trend of OC cushions improving on the failing deals, but it takes a while for some of the most severe portfolios.
spk06: Okay. And then you mentioned, you talked about the LIBOR floors. And I've been kind of under the impression that most leveraged loans had LIBOR floors for years. And I'm just kind of thinking, is it the percentage different now than it was, say, in 2015 and 16 when we were also near zero LIBOR?
spk09: Yeah, so mindful that loans typically prepay, you know, so yes is the short answer. Mindful that loans typically prepay at a pretty rapid rate, kind of, you know, 30%, 35% per annum in normal market conditions. It slowed somewhat during the COVID period. If you see on page 19, we show the annual prepayment rate for loans, which I guess averages just less than 33%. So the universe of loans keeps changing. From 2015, indeed, the vast majority of loans had LIBOR floors. As LIBOR crept up to 2%, 3%, it seems like so long ago, many of those loan borrowers, as they were issuing new loans or refinancing, they said, hey, maybe let's not put a floor in. The market kind of said, we're at 3%, 2%, doesn't really matter, that's fine. So now we're in a situation where probably between 40% and 50% of the market broadly has LIBOR floors. That said, the vast majority of new loans getting issued today, or a significant majority, do have LIBOR floors of new loans getting created. So the market kind of let that slip away in a high LIBOR day, but the trend is certainly coming back our way.
spk06: Okay. Got it. All right. That's it for me. Thank you. Great. Thank you, Chris.
spk03: Our next question is from Mickey Shalayan with Leidenberg Thalman. Please proceed with your question.
spk05: Yes, good morning, Tom and Ken. Hope you're well. Tom, how would you describe trading in CLO equity currently in terms, in the secondary markets, in terms of volume and bid-ask spreads? I'm asking because, you know, sort of in the middle of the year, it was very choppy with wide spreads, and that causes difficulty both in terms of making investments and in terms of valuations, so curious where we stand now.
spk09: Certainly, volume has continued to pick up broadly. One of the things, so it's the, and we've been active on a number of investments. We both bought and sold in the secondary market for CLO equity and debt, so the market is open and active. you see a typical pickup in activity right about now, kind of right after payment dates. So if the CLO is typically paid October 15th to October 30th, now is the time, oh, we just got the payment. People will look to refresh or buy or sell things in their portfolio. So we're probably at a period of time with some meaningfully increased activity. There's a number of BWICs today that actually have CLO equity on them, including maybe even one or two matchers within the Eagle Point complex. The bid-ask spread is an interesting dynamic in the CLO market in that while some dealers maintain inventory and a significant block of inventory, the vast majority of CLO equity trades on a customer-to-customer basis with a dealer intermediating for a small fee. In the case of CLO equity, typically a quarter point. So there might be Bank A in between of customers one and two, In theory, you don't know who the other person is and the dealer just takes a small markup. So it's not as if you're kind of working off an offer sheet, which you might be in the loan or high yield market where the dealers are going to have between a half and two point market. Here you're able to get to a much tighter, the difference between what buyers and sellers pay is much lower because you don't have a dealer taking risk in between. Against that, buyer and seller expectations may vary, and that does give rise to a non-trivial spread where you put a bond out for auction, the highest bid might be 60, you get a couple bids in the high 50s, seller doesn't want to sell below 65, so there's nothing to do and the auction fails or it's DNTed is what it's called, it does not trade. There's probably, I think, buyers have gotten a little more realistic and sellers have gotten a little more realistic. Just probably in April, there was close to no secondary activity. And I'll say the volume has picked up slowly, gradually. Not every month has been up month over month, but in general, the volume has picked up. While there's still a few unrealistic sellers out there, when you put stuff out for bid, you'll definitely get five to 15 bids depending on the security. And it's really just your choice as the seller if you want to take them.
spk05: Thank you for that. That's helpful, Tom. And how would you characterize the investment opportunity in the primary markets within CLO equity?
spk09: I'd say it's recently gotten better in that probably the best piece of news is many CLOs are able to get done now with five-year reinvestment periods again. To kind of roll the clock back, if we were talking in February, we would have said, oh, CLOs have a five-year reinvestment period, and that's standard two-year non-call. Then all the bad things happened in March, and by April we were seeing CLOs get done on a static pool basis or with a one-year reinvestment period. We didn't participate in any of those. We did begin to participate in CLOs that had three-year reinvestment periods, which was kind of commonplace, say, between March and September. Those had one-year non-calls, and that's actually going to help us because we did maybe two CLOs Back in late Q2, early Q3, we did an Octagon deal and a CIFC deal, both of which have AAAs, you know, like 150s, 160s, 170s context, which could easily be refinanced tighter. And thankfully, those only have one-year non-calls. So while we had to suffer only getting a three-year reinvestment period, you can be assured if markets stay the way they are today, we'd keenly try and refinance those deals as soon as next Q2 next year, whenever they roll off of lock. Seeing deals go out to five years now is even better, but at the price of a two-year non-call. But we are seeing AAAs broadly in the 130 context, which is generally in line with probably the long-term average or the average over the last seven-plus years in the CLO market.
spk05: Pretty amazing when you think about it, right?
spk09: Yep. Well, I mean, again, remember where we were. I mean, 95% of our portfolio by market value is still making current payments. We were at a double-digit unemployment rate, radical double-digit GDP contraction, no CLO forcibly liquidated, some turned off payments for a while, and now they're gradually coming back on sides. We have a stable hand, and ECC itself has a stable hand, that obviously we like everything to pay all the time, Something bad is going to happen at some point in the future as well. We've got the steady hand both within the CLOs and within the company to be able to weather those storms. Now that we're back to five-year issuance, we'll probably turn up the gas a little bit. The one drawback when I talked about the price of loans that so many – what was the stat? It was pretty small. Only 13% of the loan market was below 90%. That both is good and bad news. It's improved from 22% below 90% at the end of June. But when you're creating a new CLO, you want to buy loans cheap. When you've already got a CLO, you like loans to go up, I guess. So the price of loans certainly has continued to rally. The loan index is positive for the year. So loans are not being given away by any stretch, making it a little more difficult to make new CLOs work. That said, deals are getting done. We have a number in formation phase. Whether we do anything more this year, kind of still to be determined, but we're actively evaluating.
spk05: Okay, I understand. Tom, if we look at your portfolio, you know, broadly speaking, could you give us a sense perhaps of what percentage of your portfolio is in vintages you believe may not survive the impact of the pandemic and will have to eventually be unwound? This may be I'm thinking maybe the 14, 15, 16 vintages with a lot of oil and gas and maybe more retail in them, things like that.
spk09: Yeah, that's a very astute question. That 14 vintage certainly was, and for all participants, the 14 vintage, particularly the middle of 14, had particularly high oil and gas rates. in those portfolios. The beginning of 2014 didn't, and the end of 2014 didn't generally, but the second and third quarter really was pretty darn high. So that's a bad fact. If you have started with high energy, you already kind of used some of your cushion dealing with that when that all went pear-shaped in 2015 and 2016. When you look at our portfolio, probably the biggest thing I would look at is those that could be the most problematic are those with low or negative OC cushion and those that have nothing left in the reinvestment period. That's where you could see things, you know, be kind of the least good. And I'll even compare two CLOs here. Let me just make sure I get the right row. If you look at ZEISS 3 versus ZEISS 5, so these are both CLOs that are failing their OC test right now. ZEISS 3, we were able to get a reset off in Q2 of 16. We did that via Goldman, I remember. That deal's got 2.8 years left to go, and so lots and lots of runway. ZEISS 5, We worked on doing a reset of that. We struggled to get the AAAs placed. And unfortunately, on that one, the reinvestment period is over. So despite the reverse order, because three was reset, if I had a bet on one of those horses, I'd bet on three versus five, just by virtue of it's got a lot more runway to go. So it's a combination of OC cushion and remaining reinvestment period that should kind of form the collage of how you think about which deals might be tougher.
spk05: I appreciate that. If I could switch gears maybe to yields. There was about a 60, 70 basis point decline in the average effective yield excluding non-call deals. So I was curious. We don't have a lot of time to look at your presentation materials before the call, so I was curious if there was something specifically driving that. And if we think about the future, you've talked about, relatively speaking, very strong cash flows in October, which implies cash yields meaningfully higher than they've been in the last couple of quarters. And I'm wondering, with that trend, can we expect you to book more of that into income through the effective yield just to reflect the dynamics in the market?
spk09: Let me hit one or two points, and maybe Ken will comment a little further around it. So one thing that moved against us, when we model CLOs, the short-term basis risk of LIBOR high versus the high LIBOR that we set the CLO debt at versus the low LIBOR we were earning at in Q2 is not something that the average industry model really factors in. People kind of assume LIBOR cancels each other out with the exception of LIBOR floors. Broadly, if you were to look at where our yields were and what our cash flow projections were back at the beginning of the year, we wouldn't have projected the significant drop on a deal. Forgetting about deals that went off sides, of deals that continued paying, we didn't model the drop in cash flows simply because we didn't model that LIBOR would be paying 1% and investing at lower than 1%. So when you have less cash coming in versus your accrual, then your amortized cost stays higher than it otherwise would have. So when you're going into recasting, and we recast these every quarter now, now we're starting in a situation where we have a higher-than-expected amortized cost. So whatever future cash flows you have, it's just going to be a lower yield because you've got more basis that you're lending those cash flows over. And then, Ken, do you want to comment any further around that?
spk04: That's exactly right, Tom. It's a function of cash. relieving your amortized cost, as well as any accreted costs, which would include previous interest receivable, which was not fully relieved when cash flows came in lower than expected. So I think if you follow the cash, Mickey, that would be decreasing the basis, and as long as projected cash flows in the future continue to sustain and in some cases go up, the yield should follow. There may be a little bit of a lag because when those cash flows, a little bit, maybe a quarter lag, when those cash flows are coming in, they are amortizing the current cost, which is gonna be used as a basis for the projection in the next quarter.
spk05: I understand. Thank you for that, Ken. My last question, Tom, triangulating your GAAP cash and taxable incomes, obviously, very difficult for analysts or for investors.
spk00: And for company management, just to be clear.
spk05: Ken and I have talked about that. So this year, or I guess year to date, there's been some return of capital reported. I think some of that is obviously because in the first quarter, at least on a gap basis, you over-distributed, but now you're under-distributing. And then we've seen this dynamic where the CLO managers are reducing their triple C buckets. I suspect some of that is active, you know, selling and harvesting tax. Well, the consequence of that is maybe perhaps generating tax losses, which will depress taxable income. So, you know, looking ahead, I'm trying to understand, you know, where the distribution may end up, you know, when we're past COVID, given that NII is now running, you know, comfortably ahead of, the dividend and things look like they're moving in the right direction?
spk09: Yes. I think you hit the nail on the head. There's definitely some losses getting realized in the CLOs, even though they might not impact our current cash collections, can have the impact of sheltering taxable income. For some of the largest positions in our complex, which may include positions in ECC, We hired an accountant to do a couple of preliminary estimates, and I think the answer is, unfortunately, answers vary. Some CLOs, to the extent we own them in PFIC form, are typically floored at flashing zero income. They can't flash up a negative taxable income to us. But it wouldn't surprise me to see some CLOs in the portfolio that are still generating full cash flows without interruption will be flashing zero taxable income to us this year. So, oh, I think, well, we like cash without the burden of tax. That's a good fact in general against that. Others will be failing OC tests but might generate and not paying cash and actually still flash us taxable income because they didn't take the losses. So it'll be a little more scattered. Overall, I think it's safe to say that taxable income will be down year over year. Against that, as you point out, the gap earnings are comfortably in excess of the – the NII is comfortably in excess of the distribution. The cash is – up 50% in excess of the distribution last quarter, and it's up 50% quarter over quarter, and expenses don't really go up that much when cash goes up that much. So those are some good facts. Hopefully a path to both build back NAV over time, both through appreciation and getting extra cash off the investments. I'll say when we set the new distribution rate back in the spring of We tried to be prudent and conservative with it. So we weren't trying to squeeze every last cent out. So perhaps there's more good things to come as well. But we'll continue to, you know, continue to watch the portfolio behave. These are long-term decisions we make, not short-term decisions. And, you know, our number one objective, let's just keep the cash flow coming, keep hopefully getting more and more of the investments back on size. And that can kind of help the board set the distribution policy into next year.
spk05: I understand. Those are all my questions. I appreciate your time. Thank you very much.
spk03: Thanks, Mickey. As a reminder, if you'd like to ask a question, please press star 1 on your telephone keypad. One moment while we poll for questions. Our next question comes from Ryan Lynch with KBW. Please proceed with your question.
spk01: Hey, Ryan. Good morning, Ken. It's been a really good discussion you guys have had so far this morning. I just have two questions. First one's probably for you, Ken. If I look at your net income this quarter of $1.40 per share, and then I look at your 24-cent dividend, that's about $1.16 net income after distributions this quarter, your NAB was only up about $1 this quarter. So I was just curious, could you bridge that 16-cent gap
spk04: Sure, that would, $0.16 would be the change in other comprehensive income during the quarter, which we report separately from the income statement. That's $0.16.
spk01: And what was driving that?
spk04: That's the change in the, so we have one of our unsecured notes is using the fair value option of accounting. As a result, when there is a change in the fair value, we need to bifurcate that fair value through what is market-related versus what might be individual company risk or individual credit risk. As you probably could recall from the beginning of the year, there was a significant decrease in the fair value of that liability, which would increase NAV and increase income. So, we bifurcated that out at the time, and what you're seeing is a reversion of that effect coming back. So, if you just look at the change between the two quarters of that other comprehensive income, that will get you to the 16 cents per share. It's a technical .
spk09: Yeah. So, it's just the mark-to-market on the Xs, basically.
spk01: A portion of it.
spk09: A portion of it, yeah. Got it.
spk01: Okay. Got it. Maybe just a rough math of about the $27 million of net capital deployed in the quarter. Roughly, how much of that was deployed into new primary issuance CLO equity versus secondary CLO purchases and or loan accumulation facilities or CLO debt? And just going forward, Given the broader loan markets have started to recover pretty nicely, it feels like CLO equity markets are starting to recover nicely as well. Where are you seeing the best opportunities to deploy capital? Is it more going to be in primary issuance opportunities or are you still going to be pretty active in secondary markets?
spk09: Sure, so let me give you a couple of stats here. During the third quarter, on a gross basis, ECC deployed 35.1 million into CLO equity, and of that, 8.4 was in the secondary market, and everything else was in the primary market. We also sold 4.8 million of securities, obviously all in the secondary market. During the quarter, we bought, we put new money in to loan accumulation facilities of 30.1 million, and we took cash out of loan accumulation facilities of 26.4. We actually net sold CLO debt, looks like we bought 19.8 and sold 27.1. So, very active in the portfolio across all the different categories of investment. In terms of the rationale on primary versus secondary, Some of the primaries looking through. You know what? All the primaries in Q3 were actually all post-COVID de novo primaries. We did one in Q4 that was a part of one of the predecessor pre-COVID accumulation facilities. But maybe even just one post Q3. But so the four primary deals were all entirely post-COVID portfolios that were built. Kind of where we're seeing the best value, and maybe just also highlight, we're actively trading within CLO debt as well. To the extent the company had extra cash, debt opportunities in general were more plentiful than equity opportunities. buying things, selling them out a couple points higher. We're happy to do that as well while we're also looking for CLO equity opportunities. So that explains some of the debt portfolio turnover. Where we see the best opportunities today, really clean, long, secondary CLO equity, long as to a lot of reinvestment period remaining and lots of OC cushion. Like if you have more than three years reinvestment period, and more than three points of OC cushion. That's kind of the holy grail right now, and that's bid very, very keenly. Someone showed us a piece of paper yesterday. We didn't buy it. It would have been a sub-15% yield if we hit the level the seller was looking for. Where we have been putting new money into the ground broadly across the CLOs, kind of 15.7% 18.6, it looks like, for the CLO purchases during the quarter in terms of the expected yield measured at time of purchase. The thing we like the best is tough to find, as is always the case, but looking for CLOs with lower OC cushions. If you look at a CLO that only has one point of OC cushion versus three, the market's going to value that very differently and say, well, this is thinner. It's got a higher risk of interruption. All very true. But then you have to overlay the collateral manager. And this is kind of where our deep inside knowledge in the market and personal connections and just knowing how people act really comes to be helpful in that some CLO managers have never missed a payment to the equity. There's usually a reason for that because they focus very hard in the days leading up to the payment dates to keep their deals on side, even if it's close. So these are tough to come by, but we have from time to time been able to source these, buying things that are hopefully longer but with lower OC cushion. Very good CLO managers in some cases got unlucky with COVID. You could have had a couple of really good names that you had a couple of gyms or whatever it may be that in January were considered very good credits. change radically. So you could have something that's lower cushion, but with a CLO collateral manager at the DNA to keep it on sides and focused. That's something that we really gravitate towards. I wish we had 20 of those opportunities. They're pretty scarce, however. So we look at a collage of all of these. I expect we'll continue to keep deploying in both the primary and secondary markets, certainly to the extent we can get out to five-year reinvestment periods on new CLOs. I guess even a three-year new deal will help lengthen our weighted average. A five-year will help lengthen it even more. So that's something we're going to focus towards. That said, we will continue to look for cheap secondary opportunities when they exist.
spk01: Okay. That's really helpful commentary and really good color on the market opportunities. Those are my questions. I appreciate the time today.
spk03: Thanks so much, Ryan. Our next question comes from Chris Witowski with Oppenheimer. Please proceed with your question.
spk06: Hey, yes, thanks for taking the follow-up. I have a question which I think is kind of basically like Mickey's, but I'm not sure I totally understood it, so let me ask it my way. I'm looking at page 24 of the supplement, and, you know, kind of if you think about the relationship between the – you know, distributions received from CLO equity and the investment income you recognize, you know, as investment income. You know, in the current quarter, it was like 76 percent. Last quarter, it was 70. If you go back, you know, for most of the year, it was probably closer to 50 percent. So it seems like more of the distributions are flowing down to the income line. Less of it is being treated as a return of capital, you know, as we can see from that other line on page 24. And so what is driving that and what should we expect for the next couple of quarters? We'll, you know, roughly is what we see in the, you know, second and third quarters dropping down from distributions to investment income. Is that what we should expect or... Should we expect it to revert back to where it was a year or two ago?
spk04: Sure. So, it's Ken here. And just one aspect before I get into the detail of the answer is this is a Q3 2020 view. The cash flows are the ones I received in the current quarter, and the income is also recorded for the current quarter. In large part, the cash flows that are coming in in the current quarter reflect income that was accrued or recorded in the previous quarter. That said, to your point, if there's less expected cash coming in, there would be more of a shift toward recognizing that as income versus return of capital. So, if we fast forward this to Q4, where we're recording the cash flows coming in or the ones I received in the fourth quarter versus previous income, you'll start to see a reversion of that effect where you'll see more of a balance between income and return of capital. So it may not be all the way there that we were in the first quarter, but you'll start to see steps towards it.
spk09: So broadly, if you think of our yield staying flat, we went down modestly, but if cash flow is up 50% and yield is flat, all that excess, in theory, should flow down as return of capital, if that makes sense.
spk06: Okay. I guess the more that number increases, the more of it is going to be a return of capital. Correct. Okay, and is there any way, if we were clever enough, would there be a good way for us to model that and figure out what percentage we should plug into our models for, you know, fourth quarter and first quarter?
spk09: Well, you know the income is going to be largely driven by the effective yield. There could be gains and losses. There's obviously CLO debt and loan accumulation facilities, but on the CLO equity side, The effective yield, which we put at the end of the quarter, was 11 and change times the amortized cost of the CLO equity, not the market value. Take that 11 and change percent divided by four times amortized cost. That's going to give you a rough cut at the CLO equity income. The cash, we've told you what the cash is. So for Q4, you could figure that out. And then for Q1 and onward, to the extent you think LIBOR is going to remain low, that cash projections and OC tests aren't going to – deals aren't going to come back or go offsides. It's a pretty good base case for keeping that cash flow consistent.
spk06: Okay. All righty. I think I got it. Thank you. Okay. Great. Thanks, Chris.
spk03: Our next question comes from Steven Bavaria, a private investor. Please proceed with your question.
spk00: Steven Bavaria Hey, Steve.
spk09: Steve, I'm having a hard time hearing you. Are you on the line?
spk03: Steven Bavaria Are you muted, Steven? Steven, you're live with our speaker. Steven Bavaria Yep.
spk09: I think he's actually dropped off. Maybe we'll just move on to Mickey again, and if Steve comes back, we'll pick him up.
spk03: Our next question is from Mickey Shalyan with Leidenberg Thalmann. Please proceed with your question.
spk05: Tom, just a quick follow-up on looking at the right-hand side of the balance sheet. We look at hopefully what will be a much better economic situation a year from now. It's conceivable that the fair value to cost of the portfolio will be a lot better than it is today. and your leverage measured on fair value could decline to levels that would be less than optimal. So my question is, if that were to occur, do you have more appetite to issue unsecured notes, or would you prefer to issue preferred shares in that scenario?
spk09: Got it. So broadly, we seek to run the company at 25% to 35% leverage. Ideally, we're right at the midpoint of that. If you set a range, you kind of want to be at the middle. We are at the upper end of the band, but in the band as of September 30th. How do we say it? Broadly, the way we've thought about the use of debt and preferred is we've kind of gone roughly halfsies between the two, never perfectly so. Each of them have different pros and cons. Debt is... the cheapest source of financing for the company in that there's no management fees in kind of our shareholder-friendly fee structure. So I think we have about $100 million of debt outstanding, give or take. That's all money that we manage on behalf of the company without any sort of base management fees, so that's accretive. The flip side, the preferred stock, which we did repay the A's last year and the beginning of this year, we still have, I think, $45 million of the B's outstanding, give or take. Those aren't even callable until October of next year, I think. There's a little ways to go before the Bs are even callable. Those do attract a management fee. Those have the advantage of also being deferrable. We could defer payment on those for up to two years, not that we have any intent to, but that's always a nice option. And B, it attracts the lower asset coverage ratio of 200% versus 300%. So as we kind of look at the collage, we've generally run the company kind of 50-50 between the two. Repaying the A's kind of moved us a little more debt than preferred. But to the extent you saw the company at the low end or below the range, we consistently try to get back to the range. So in that case, it's possible we'd look to do something.
spk05: I understand. That's helpful. That was it for me. Thank you.
spk03: We've got Steve back on, it looks like. Yes, our next question is from Stephen Bavaria, a private investor. Please proceed with your question.
spk07: Hello, Tom. I hope I'm coming through now. Technical glitch here.
spk09: We can hear you perfectly.
spk07: Oh, great. Hey, just a question. You paint a wonderfully positive picture that I've heard elsewhere about the speculative grade universe, the companies that are the underlying borrowers. being in a much better position now than they were probably at the beginning of the year to deal with whatever comes next with COVID and its economic consequences. I'm trying to square that with the projections from our friends at Standard & Poor's who throughout the summer and as most recently as October are still projecting a speculative grade future default rate up in the 12% area, which would be right about where it was back in 2008, 2009 at the height Do you have any thoughts on whether they're just wrong or whether we're talking about different subsets of the universe to try to square the two views?
spk09: A very good question. Yes, there's a little bit of a different universe set, and there's probably a different view between rating agencies and banks right now. And the rating agencies published lots and lots of different default outlooks. Maybe they even have competing departments sometimes. In one report from S&P, this is on a report from November 2nd, they predicted the S&P LSTA leveraged loan index 12-month trailing default rate by number of issuers would increase to 8% by June of 2021. was their forecast. So the other thing is, are you looking at notional, outstanding, or by count? All else equal.
spk07: That's down from their October. Okay, well that means they're bringing it down a bit too. I hadn't seen that.
spk09: Now this is by count. It could be different by dollars. So there's a little bit there. Moody's, on the other hand, their global default rate will rise to 7.2% by the end of 2020. and peak in March at 8.1% before dropping back to 6.3% in October of 2021 is the Moody's outlook. Now, compare that to Bank of America and J.P. Morgan offering loan default rates, JPM saying this year is 3.5%, next year is 3.5%, and I think B of A has got it down to 3.5% next year as well. So when you know the bankers are a little more, you've been both, the bankers are a little more optimistic than the rating agencies. Maybe the right answer is somewhere in between. But just to frame it as well, CLOs typically have lower defaults than the broad market. While there's a few outliers the other way, if their current market rate is somewhere in the very low fours at present, ECC has about 2% default exposure. So in general, The CLO universe, I'd say broadly, has lower default exposure than the overall market. And then when you look at our portfolio, one of the metrics, let me draw your attention to a particular page. Let me give you the exact page.
spk07: Yeah, I was looking for the, you know, we,
spk09: I was looking for a number we actually don't publish, the below 80 numbers in our portfolio. In general, the percent of what we talk about the below 90 in the market and then the below 80, this is when you look at loans, what percentage are trading below 90, are trading below 80, and so on and so forth. Broadly, the percentage below 90 has come down a bunch and the percent below 80 market-wide has also come down a bunch. And in my opinion, stuff that's trading below 80 today, you really, at a minimum, have to scratch your head at. But market-wide, that's probably in the 7% to 9%, 7% to 8% range, broadly. I might be off a little bit on that. Those are the names in the market that, kind of knowing what we know today, the market price is a reasonable indicator of default probability. Those are the ones that are really the watch list names. In my opinion, obviously higher priced ones can fall, but even that's indicating mid to upper single digits. And that typically looks at the likelihood of default over the next one to three years. Even a company like Belk, which is a retailer in the Southeast, that loan's trading in the 30s. I think the market still thinks they have a moderate liquidity runway, but maybe not a lot of ultimate recovery value.
spk07: Great. Thank you. Sounds like the assumptions that you've got in your own yield model probably reflect closer to what the banks are projecting, I'm assuming.
spk09: Yeah, broadly. And, you know, the variables, kind of the big variables to think about, the default rate, the recovery rate, and the reinvestment price. And that's predicated on being in the reinvestment period and being able to reinvest. But it's the collage of those three that really drive how these things will perform. And that goes to my comment earlier on two deals with the same collateral manager. I take the one with two plus years of reinvestment period versus zero just because I know they have a much easier time trying to fight their way out of it in the one deal versus the other.
spk07: Thank you very much.
spk03: Great. Thanks, Steve. We've reached the end of the question and answer session. At this time, I'd like to turn the call back over to management for closing comments.
spk09: Great. Thank you very much. We appreciate everyone's interest in Eagle Point Credit Company and certainly appreciate the thoughtful and insightful questions. We look forward to speaking with folks in the first quarter as well and also invite people to join Eagle Point Income Company's call, which will begin promptly in 18 minutes. Thank you very much.
spk03: This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation.
Disclaimer