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spk03: remain on the line. Today's Eagle Point Credit Conference will be starting shortly. Again, we do thank you for your patience and ask that you please remain on the line. Today's conference will be beginning shortly. Thank you. Greetings and welcome to the Equal Point Credit Company Third Quarter 2022 Financial Results Conference. At this time, all participants are on a listen-only mode. A question and answer session will follow the formal presentation. If you would like to ask a question, please press star 1 on your telephone keypad. If anyone should require operator assistance during the conference, please press star 0 on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Garrett Edson of ICR. Thank you. Please go ahead.
spk01: Thank you, Donna, and good morning. By now, everyone should have access to our earnings announcing investor presentation, which was released prior to this call, 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 and 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. 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 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 2022 financial statements and our third quarter investor presentation with the Securities and Exchange Commission. Financial statements and our third quarter investor presentation are also available in the investor relations section of the company's website. Financial statements can be found by following the financial statements and reports link, and the investor presentation can be found by following the presentation and events link. I would now like to introduce Tom Majewski, Chief Executive Officer of Eagle Point Credit Company.
spk00: Great. 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 and our portfolio. The company's portfolio performed well again in the third quarter despite the challenging macroeconomic environment. During the quarter, we generated net investment income and realized gains above our regular common distributions and modestly increased our NAV. CLO equity continues to prove its overall resilience compared to many other risk assets. With a meaningful percentage of the loan market trading in the low to mid-90s, it has been a great time to opportunistically deploy capital into both the secondary and primary CLO markets. We believe our diverse CLO equity portfolio, with a 3.2-year weighted average remaining reinvestment period, would be very difficult to recreate and remains well-positioned to thrive in the current environment. For the third quarter, our net investment income and realized gains totaled 47 cents per share, exceeding our regular common stock distributions of 42 cents per share for the quarter. We actively managed our portfolio, deploying over 60 million in net new capital into new portfolio investments during the quarter. We had strong recurring cash flows on our portfolio in the third quarter of 40.8 million, or 89 cents per share. which was 21 cents above our total expenses and regular common distributions paid during the quarter. NAV per share ended the third quarter at $10.23. Since the end of the quarter, we estimate our NAV at the end of October to be between $9.66 and $9.76. We also continued to raise capital through our At the Market program and issued over 4 million common shares at a premium to NAV, generating an accretion of $0.06 per share for all shareholders. We also used the ATM to issue approximately 2,600 Series C preferred shares. Together, these sales generated net proceeds of approximately $47.5 million during the third quarter. Importantly, all of our financing remains fixed rate and unsecured. This gives us a strong measure of protection in a rising rate environment, and we have no financing maturities prior to April 2028. We paid a special distribution of 25 cents per common share in October, and just yesterday we declared an additional special distribution of 50 cents per common share, our second special distribution declared this year, to be paid in January of 2023. We were able to do this because of the strong cash flow from our portfolio and it reflects our proactive portfolio management in a challenging market. We believe there may be more spillover income in 2023 as well. As of September 30th, the weighted average effective yield of our overall portfolio was 16.29%, down slightly from 16.71% at the end of June. Our portfolio's weighted average effective yield was aided by our ability to put new investments in the ground at attractive levels, few borrowers defaulting, and very muted levels of loan repricing. As I mentioned, during the quarter, we deployed over $60 million of net capital into a broad number of CLO and other investments. Across the eight CLO equity purchases we made during the third quarter, the weighted average effective yield was approximately 17%. We continue to find attractive opportunities in both the primary market and selectively in the primary market. And in October, we deployed an additional $16 million of net capital into CLOs and other investments. As of the end of the third quarter of 2022, our CLO equities weighted average remaining reinvestment period stood at 3.2 years. And this is just a small reduction from the 3.3 years this measure stood at as of June 30th. Our current weighted average remaining reinvestment period is well above the 2.4 years that it stood at at the beginning of 2021. And what that means is despite the passage of 21 months through our proactive portfolio management, the reinvestment period on our CLO equity positions actually increased meaningfully. And we believe this strategy helps our portfolio during times of market volatility like today. Even in the secondary market, when we're looking to buy secondary CLO positions, we remain very focused on finding opportunities to invest in CLO equity with generally longer reinvestment periods, which enable us to deftly navigate through today's and the inevitable future bouts of market volatility. I would also like to take a moment to highlight Eagle Point Income Company, which trades under the symbol EIC. EIC invests primarily in CLO junior debt, specifically the double B tranche of CLOs. For the third quarter, EIC generated net investment income of 47 cents per share, excluding non-recurring items. Last week, EIC announced that it was raising its monthly common distribution by 14% to $0.16 per share for the first quarter of 2023. And since the first quarter of 2021, EIC has now doubled its monthly common distributions. And with the rising rate environment, EIC remains very well to continue increasing NII given that the performance of CLO Junior Debt, which plays a floating rate coupon linked to either LIBOR or SOFR, is heavily correlated with rising rates. We invite you to join EIC's investor call at 1130 a.m. today and also to visit the company's website at www.eaglepointincome.com to earn more. Overall, we continue to keep a watchful eye on our portfolio and the broader economy. After Ken's remarks, I'll take you through the current state of the corporate loan and CLO markets, and I'll share our outlook as we wrap up 2022. I'll now turn the call over to Ken.
spk05: Thanks, Tom. For the third quarter of 2022, the company recorded net investment income and realized gains of approximately 22 million or 47 cents per share, which is above our third quarter regular common distribution level. This compares to NII and realized gains of 43 cents per share in the second quarter of 2022 and the NII and realized gains of 39 cents per share for the second quarter in the third quarter of 2021. For the third quarter, when unrealized portfolio depreciation is included, the company recorded net income of approximately $9.7 million or 21 cents per share. This compares to a net loss of $2.35 per share in the second quarter of 2022 and net income of $1.35 per share in the third quarter of 2021. The company's third quarter net income was comprised of total investment income of $30.2 million and realized capital gains of $3.4 million, partially offset by total net unrealized depreciation of $11.9 million, expenses of $11.5 million, and distributions on the Series D preferred stock of $0.5 million. The company's asset coverage ratios at September 30th for preferred stock and debt Calculated pursuant to Investment Company Act requirements were 285 and 421%, respectively. These measures are comfortably above the statutory requirements of 200 and 300%. Our debt and preferred securities outstanding at quarter end totals approximately 35% of the company's total assets, less current liabilities. which is at the high end of our target range of generally operating the company with leverage between 25 to 35% of total assets under normal market conditions. Moving on to our portfolio activity, in the fourth quarter through October 31st, the company received recurring cash flows on its investment portfolio of $31.2 million. This compares to 40.8 million received during the full third quarter of 2022. Please note that some of our investments are expected to make payments later in the fourth quarter. The reduced October amount is largely attributable to our CLO equity portfolio due to the continued divergence between one-month and three-month reference rates, which was brought on by the rapid acceleration of interest rates throughout the past several months. As of October 31st, we had $23.4 million of cash available for investment. Management's estimate of the range of the company's NAV as of October 31st was $9.66 to $9.76 per share, with the midpoint of that range reflecting a decrease of approximately 5% from September 30th. During the third quarter, we paid three monthly common distributions of 14 cents per share. We also declared monthly common distributions of 14 cents per share through March 2023. In addition, the company paid a special distribution of 25 cents per share in October, and yesterday we declared an additional special distribution of 50 cents per share to be paid in January 2023. As we estimate our taxable income for the tax year ending November 30th, will exceed the aggregate distributions paid to stockholders with respect to such tax year. I will now hand the call back over to Tom.
spk00: Great. Thank you, Ken. Let me take the call participants through some of our thoughts on the loan and CLO markets. The Credit Suisse Leverage Loan Index, which is a broad representation of the corporate loan market, generated a total return of 1.19 percent during the third quarter, and that's well in excess of investment-grade bonds or the return on high-yield bonds as well. The index was down 3.31% for the year as of September 30th, but through October and parts of November here is now down only 1.67% for the year as of the 10th of November. As we have foreshadowed on several calls, leveraged loan defaults have begun to slowly rise with a total of six loans defaulting in the third quarter of 2022. Notably, there were no loan defaults in October. At quarter end, the trailing 12-month default rate stood at 90 basis points, still well below the historic average. During the third quarter, 2.6% of loans outstanding repaid at par. To frame it, this is over a 10% annualized pace and provides our CLOs with par dollars to reinvest in today's discounted loan market. Given the market conditions, the percentage of loans trading over par continues to be essentially zero, and as a result, repricing activity in the loan market is also essentially zero. In fact, some borrowers are addressing 2023 maturities and are refinancing those loans at wider spreads. On a look-through basis, the weighted average spread of our CLOs' underlying loan portfolios increased by three basis points from the end of June. This measure of our portfolio has now increased for four consecutive quarters. In addition, many banks holding hung buyout debt on their balance sheet have begun to capitulate and are selling loans that they underwrote earlier in this year at discounted prices in the 80s and low 90s. In my experience, bankers often like to take all their pain in one year, and our CLOs are well positioned to capitalize on these highly motivated sellers going into the end of the year. Our portfolio's weighted average junior over collateralization cushion was 4.24% at the end of September, a slight increase from the 4.20% that measure stood at at the end of June. In the CLO market, we saw about $33 billion of new issuance during the third quarter, and new issuance in total eclipsed the $100 billion mark through the end of the third quarter. Reset and refinancing activity has essentially stopped. And at today's wider debt levels, they simply don't make economic sense. At today's spread levels, frankly, the current CLO financing of nearly any CLO is in the money. And indeed, looking at our portfolio, while the broad market for AAAs today is about 230 basis points over the base rate, the weighted average AAA embedded in our CLO equity portfolio is 115 basis points, roughly half the market spread. While the market gives credit to the in-the-money nature of our CLO's financing partially, we believe the market doesn't give full credit and that this reflects embedded hidden value within our CLO equity portfolio. Our CLO security valuations did face mark-to-market drawdowns during the first half of 2022 and through some challenges in the third quarter. However, it is an environment of loan price volatility where we believe CLO structures, and CLO equity in particular, are set up well to buy loans at discounts to par with a very stable financing structure using par paydowns from other loans and gives the CLOs the ability to outperform the broader corporate debt markets over the medium term, as they have done so in the past. To sum up, NII unrealized gains once again exceeded our common distributions. We paid a special distribution in October and just yesterday declared an additional 50-cent special common distribution, which will be paid in January. The new CLO equity investments that went into the ground during the third quarter had a weighted average effective yield of 17% as we continue to deploy capital into investments with attractive yields. The weighted average effective yields on CLO equity, of course, include a reserve for future credit losses. We continue to maintain 100% fixed-rate financing With no financing maturities before 2028, all of our financing is unsecured, and this gives us a measure of protection from rising rates and, frankly, has locked in attractive cost of capital for the benefit of our shareholders for many years to come. The third quarter was a strong one for the company. We're happy to keep returning extra cash to our investors in the form of special distributions, and as we close out the year, we'll remain opportunistic and proactive as we manage our investment portfolio with a long-term mindset. We thank you for your time and your interest in Eagle Point Credit Company. Ken and I will now open the call to your questions.
spk03: Thank you. The floor is now open for questions. If you would like to ask a question, please press star 1 on your telephone keypad at this time. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would 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. Again, that's star 1 to register a question at this time. The first question today is coming from Mickey Schleen of Lattenberg. Please go ahead.
spk06: Yes, good morning, everyone. Tom, I see that the portfolio's junior OC cushion climbed, but so did the triple C bucket on average. And when we think about those trends, how would you say CLO managers are behaving in terms of managing portfolio risk? And how do you see the ratings agencies' actions trending in this cycle and going into next year?
spk00: Sure, good morning, and all very good questions. So the agencies are certainly picking up on downgrades to some degree. I'm looking at our triple C is about, let me just zoom in here so I can see the number. Looks like, what are we up to? I think it's like six and a half. We are up to 6.45%. Yep, and the junior OC cushion is 4.24%. And as you look through the portfolio, you can obviously see a dispersion of a wide variety of triple C levels across different CLOs. Obviously, the weighted average is 6.45. Downgrades to upgrades have picked up. It's not a massive downgrade wave, and there are still some companies getting upgraded, but downgrades right now are outpacing upgrades. just as you see in, not that we have a lot of big tech companies in our portfolio, but you see big tech companies doing layoffs and things like that. With the inflation environment, the likely slowdown in economy, we are seeing some companies getting downgraded and frankly at a faster pace than loans are getting upgraded. Against that, That 6.45 is obviously a weighted average. If you just assume that was a representative CLO, you'd need to get to roughly 7.5% before you started taking any sort of haircut on the excess above that in the OC test. Frankly, this 4.25 OC cushion we have is great. It's exactly where we'd like to be. If anything, I wish it was higher, but it's as high as one could reasonably hope, in our opinion, going into a period of some continued choppiness. What we're seeing from CLO collateral managers is they're behaving rationally. Just because a loan is triple C doesn't mean it's going to default. This really indicates a higher risk of default, but skilled collateral managers are hopefully able more often than not to get those right versus wrong. And while we obviously, although Sequel, prefer clean portfolios versus those with triple Cs, what we don't want to see happen is anything with a triple C inherently is going to trade at a discount to fair value compared to a B3 loan simply because of the adverse, potential adverse treatment within a CLO. So we want them to sell if they think there's risk of further loss. At the same time, if they think it's a temporary thing, we have no problem with them holding. And by and large, we've seen CLO collateral managers behave quite rationally around this behavior. The last time we saw a big uptick in downgrades was kind of into the March, April, May of 2020 period. And there we saw the rating agencies downgrading broad swaths of the market before earnings, you know, based on educated guesses or maybe even uneducated guesses, depending on your opinion of what company earnings would be. Here we're seeing the agencies. Well, we don't like the actions in general. I describe them as pretty rational and pretty measured as well Looking forward while we can't predict these things perfectly. It does feel like the the agency actions are taking place at a measured pace It's not wholesale action frankly, but company specific review and to the extent there's slow moves in ratings up or down that gives That certainly gives CLO collateral managers plenty of time to manage their portfolios. What's most important with that OC test is how it is on the determination date. OC tests matter four minutes of the year. The proverbial 5 p.m. on four days a year when the waterfall is run on the CLO. To the extent rating actions are moving slowly, which they are right now, that gives CLO collateral managers plenty of time if they were to get some surprise downgrades and if they needed to make a change to get their portfolio onside typically would give them enough time to be able to make such a change.
spk06: Thanks for that, Tom. That's quite helpful. Just one follow-up question from me. When we look at the debt to EBITDA ratio in the leveraged loan market, it climbed to a high of five and a half times in the third quarter. And when we think about that ratio and consider the impact of higher interest rates and existing pressure on borrower margins, I'd like to understand what's your view on how you think CLO equity cash flows will trend next year, given the underlying borrower performance. Sure.
spk00: So if you look at our investor deck, probably the relevant numbers to look at are on pages 32 and 33. And just grapple with one or two data points here. There's leverage multiples and outstanding loans. and new loans, and then interest coverage multiples of outstanding loans and new loans. The one thing we'll say is because there's so many private companies, if you look at the data on page 32, the outstandings, which is really what in theory should be the most relevant, is just of those that are public reporters, which in my opinion probably show a positive bias towards larger, more established companies. So it's nice to look at the outstandings as a broad measure, but this is just a subset of the loan market. The newly issued loans are also interesting. This is what's clearing the market today, but just represents a point-in-time snapshot of what the market's accepting, not long-term trends. I like to look at interest coverage more than leverage. At the end of the day, interest coverage is really the measure that If you can pay your interest, that's a good fact. You can see for outstanding loans, interest coverage is actually at highs going back to 2024. So that's very, very good. Interest multiples, interest coverage for newly issued loans in the second quarter, which is the latest data we have available, 3.8 times. That's probably both of those numbers probably trending down just as base rates have continued to go up. But to frame it, if you just take the average of those two numbers and kind of say companies have about five times coverage, just picking the average of the outstanding and newly issued, you could see a further significant increase in interest rates before many companies struggled to pay their debt. While these are averages, so you could have higher and lower. Obviously, not every company is at the average. there is some pretty good cushion for most borrowers to be able to continue servicing their debt. And then if you flip ahead to page 33, this shows one other interesting piece. I like to look at this bottom chart as well. And this is the annual year-over-year EBITDA change for below investment grade companies. Again, this is just public issuers, but it gives you the flavor. We're still seeing some some decent growth in EBITDA of these companies. We're not seeing, well, there's a dispersion, obviously, and some are shrinking or some are not growing to plan is often what causes downgrades. We are still seeing double-digit top-line growth and double-digit EBITDA growth on average for below-investment-grade companies. As long as that continues, that's probably the best fact we can point to. Companies growing at double-digit percentages typically don't get into too much trouble.
spk06: Thanks, Tom. That's very insightful. Those are all my questions this morning. As always, I appreciate your time.
spk00: Great. Thank you so much, and we appreciate your calling in.
spk03: Thank you. The next question is coming from Paul Johnson of KBW. Please go ahead.
spk02: Yeah, good morning. Thanks for taking my questions. So I have two questions, sort of in one, but I was wondering if you could just talk to us kind of what it means for your portfolio with the refi and the reset market essentially at a standstill or in pause mode at the moment. What does that mean for you guys in terms of just deployment as that's always been a fairly big part of your strategy? And are you still able to buy loans in the secondary market or are you still able to reset loans? CLOs in any way and then the second part of that question is just with repayments being lower this quarter or year to date I should say what does that mean for just new issuance in the CLO market I imagine it's potentially a you know, increasingly difficult to get a CLO to market just with rates. But I was wondering if that's true and if, you know, what are your expectations around CLO issuance and deployment in your portfolio?
spk00: Sure. A couple different questions there, all woven into one. Let me try and address each of the points. Indeed, the refi and reset market is essentially shut at this point. The market spreads for CLO debt are slow. so wide right now that, you know, in our case, just on the AAA, as you heard, our weighted average AAA is roughly half the level of the broader market. So we're thrilled and savoring the financing we locked in yesterday. If you look back over our history, ECC has been public for over eight years now. Refine, reset waves are episodic. So 2021 was, you know, reset mania. we did over 30 corporate actions during the course of the year. I don't remember the exact tally, but, um, it was a lot, um, be it refis and, and, and resets, but extremely busy last year. Um, today what we're doing is we're buying in the secondary market. Um, refis and resets typically, um, are not actually a big capital in or capital out transaction for us. Um, once in a while, um, There were some exceptions. There's some exceptions both ways where we can either take a dividend out. We were doing that in summer of 21, doing what we called like dividend recaps of some of our summer of 2020 CLOs where we actually took a reset the deal, lowered our cost of debt, and took a check out. That's obviously great. I wish we could do that every day. We haven't done that in a little while. And other times you reset, you actually put a little money in. But by and large, you should think of refi and reset as more portfolio management rather than a deployment matter. in that, by and large, there's not a lot of cash coming in or out. Where we're deploying sometimes is in the primary market. And right now, the vast majority by count of our trades has been into the secondary market. And we've been able to buy majority blocks from motivated sellers. Why they're selling, varying reasons. Might the securities go down further? Sure. Are they good long-term fundamental investments? We certainly believe so. So the vast majority of our focus right now is on the secondary market. Interest rates certainly are up a ton. Three-month rates are over 4%, seemingly usurious. We were at 20 basis points at the beginning of the year. So the movement in rates is radical. I mean, the CLO, on both the asset and liability side, it's up. The bigger challenge is, frankly, the movement in spreads, in that while loan spreads are creeping up a little, CLO debt spreads have moved up a ton. And that's probably the biggest hindrance to getting new issue CLOs over the finish line. So where we sit in the current market today, I'd expect to see more activity or continued activity buying secondary. Even there, we still look for CLOs with longer remaining reinvestment periods versus shorter. The number one thing I don't like about buying secondary and not having the reset and new issue market readily available is our weighted average remaining reinvestment period, which fell one-tenth of a year quarter over quarter, is probably, you know, it's not crazy to expect to see that to continue to go down over time, over the next few quarters, simply because our ability to reset the, you know, lengthen that out is muted with the market not open. That said, we were very low two years at the beginning of 2021, so when the market's open, we take advantage of it and lengthen out as much as possible. When we have to be a little more quiet on that side, we're gonna have a little bit of decay, very likely, but we let the portfolio run itself out. In terms of, and still able to reinvest and capture, and to your point, so loans, the loan index, probably 92, 93 cents on the dollar right now, depending which index you look at. The 10% prepayment rate that we're seeing on loans is about the low that we've seen over the history of the loan market in my recollection. That said, if you're getting 10% of your money back and you can reinvest at 92, that still helps you build 80 basis points of par through the course of the year. If you just assume 50 cent recoveries on loans to be conservative, that's 1.6% defaults is offset through that discounted buying. So even though that 10% is much slower than the long-term average of 30% per annum on prepayments, even at that low rate, it still gives you plenty of optionality to keep reinvesting within the CLOs. And then there's also discretionary trading within CLOs. And beyond just reinvesting paydowns, a CLO collateral manager could also sell a loan at 94 and buy a different one at 90, and in that case build four points of par on that trade. So obviously prepayments, that's the easiest because that's just the opening the mail school of portfolio management to reinvest that cheap. But more proactive CLO collateral managers and many that we choose to do business with are those that will sell and rotate within the portfolio building par. Sometimes it's to avoid a further loss and sometimes it's to be offensive and actually build par. So we still see in many CLOs turnover in the portfolios between 20 and 40%. There's a wide dispersion there, but in general, we like to see continued portfolio turnover, and by and large, we're seeing that across our portfolio.
spk02: Got it. Thanks, Tom. That's a very helpful answer. A lot of detail in there, but very helpful. My last question was just more on the balance sheet in terms of the ATM, the amount of capital raised through the ATM this year. In this quarter, most recently, you guys had obviously one of your more aggressive quarters in terms of the number of shares that were sold and a fairly high number of shares that were raised through the ATM year to date. I'm just curious. You're raising so much capital at these prices. How do you, I guess, evaluate the current environment, I guess, the set of returns that are available to you, obviously, against where shares are trading in the market? Just curious what you're seeing that obviously makes it so attractive to raise capital at that pace.
spk00: Yep. So let's look at the asset side of the balance sheet for a minute. And the weighted average effective yield of the new CLO equity investments we made was about 17%, give or take. And that includes a reserve for future credit losses. And we think it includes some fairly punitive assumptions. So then we look at what our distribution rate is, the ongoing common distribution, obviously the costs of and expenses of the fees and expenses of running ECC. and then the benefit of the leverage as well. Of all of our financing, I think our highest is 6.75% at this point. So that certainly helps matters. So when we look at the combination of issuing equity, the highly in-the-money financing that we have baked in at ECC, that were able to put money in the ground that a loss adjusted 17% yield, we think the new investments that we're buying today we believe will be accretive to earnings over time for the company. When we look at the calculus of what we can earn on it minus the cost of running the company plus the benefit of leverage, the math in our opinion is pretty darn clear. And when we make the decision to issue on the ATM It's based on cash balance. To the extent cash is lower, we're going to issue more. To the extent we've just received payments, maybe we're going to issue a little less, and also a function of the investment opportunity. The marginal, while we don't like to have much cash on the balance sheet, and indeed we typically run things fairly lean, we do want to be able to, with 700 plus million of assets, We want to have eight digits of cash on the balance sheet whenever possible to be able to pick up an opportunity when we see it. But at the same time, we're mindful of cash as an NII drag. So we seek to minimize it, but it's a balance of being able to have our catcher's mitt open to capitalize on things. So I'd say the ATM is really a very elegant solution for companies like ECC in that it allows us to have kind of a nice slow trickle of capital Doing those overnight deals, there's any number of challenges with those. The ATM we find to be a really elegant solution, and I think we're very disciplined around it vis-a-vis the deployment pace and the anticipated NAV accretion from issuing at a premium and hopefully earnings accretion from being able to invest at today's very attractive levels.
spk02: Got it. Thanks, Tom.
spk00: That's a long answer. How about the short answer? We try and do it carefully when we think it makes sense. But those are all there. There's no science to it. It's an art, and I think we've done it very responsibly since we've been public.
spk02: Yep, I agree. I appreciate it. Thanks for the answers, and those are all the questions.
spk00: Great. Thank you very much.
spk03: Thank you. Once again, ladies and gentlemen, if you would like to register a question, you may do so by pressing star 1 on your telephone keypad. The next question is coming from Matthew Howlett of B. Reilly Securities. Please go ahead.
spk04: All right. Good morning, Tom. Thanks for taking my question. Just first, bigger picture, Tom. I mean, when you look at it, you guys are still staying fairly aggressive, and it's great to see. But, I mean, you talked about in the past about technical factors impacting leverage loan market. We pick up the newspaper here about U.K. pension funds, outflows from a lot of the major fixed income interests. Is that still the case? Does it feel like, even though defaults could rise, that technically speaking, that there's sort of added pressure on the market today?
spk00: So the articles you might have read about the UK pensions, that was actually principally driven around them selling CLO debt securities, not CLO equity securities. And, you know, in our opinion, there's not enough for sellers in the world. That was a point in time as they had some extreme movements in guilds unprecedented or not seen in many decades. Less a statement about fundamentals of CLOs in my opinion on their part, but where Eagle Point as a firm is very happy to step up and help ourselves in those situations. Broadly, we've seen defaults have been close to zero generation or 10-year type lows at 15, 20 basis points not too long ago. We're still only at 90 basis points right now. Not a single loan defaulted in October. We talked about debt service coverage. And in a covenant light world, as long as companies can keep paying their earnings, keep paying their interest, the risk of default remains relatively low. One of the things that's essential, and it's important that you have to be in your reinvestment period to capitalize on this. In our view, price volatility in loans will be greater than the actual credit expense in the loan market. Put it another way, the rumor is worse than the news. And what I'd say is, you know, if loans trade off 10 points, maybe there's going to be five points of defaults. It's hard to see a scenario where loans trade off five points and there's 10 points of defaults, and the market ignores that greater piece. So a broad thesis that we have, obviously history is on our side on this, the future could be different, of course, is that price volatility in loans will nearly certainly be greater than the actual credit expense. And as long as your CLO is in the reinvestment period and you have a halfway decent collateral manager running the ship, and I think we do a pretty good job of picking those, you're going to win over the medium term. On the short term, you could have your marks go down. And we saw that with our October NAV. Frankly, CLO marks fell. It doesn't mean bad things happening. No companies defaulted. But the broad view that price volatility in loans will be greater than ultimate credit expense As long as you're in the reinvestment period, your CLOs can capture that. And one of the things I look at is if you look at like ECC's change in NAV from pre-COVID, you know, from December 31, 2019 through December 31, 2021. So if you invested, you know, the proverbially the day before COVID and just let the portfolio go, our NAV went up significantly over that time. It wasn't a straight line. It was obviously a dip the wrong way. But that's evidence of the price volatility was greater than the ultimate credit expense, and our NAV came out better on the other side of that. To the extent defaults get meaningfully worse, we certainly have an expectation. There's no assurance, but an expectation that our portfolio would do the same thing.
spk04: Thanks for that. I do think. there's a misunderstanding about the CLO reinvestment periods and how those work, and I'm glad you went over that again. I did notice the CLO equity percentage came down a little bit in October. I think it was 81.7. I mean, is that down from 85? Is that going to be a moving target still above? Do you want to keep it above 80, or is there anything? Is that just a month over a month change?
spk00: That was just the price of CLO equity securities fell. That was not a conscious decision on our part. Markets are down. Gotcha.
spk04: Gotcha.
spk00: I could probably net have more par of – more notional of CLO equity at the end of the month than the beginning if I had to guess. But that was not a conscious decision, just the price of stuff fell.
spk04: That's just it, right, the fair value. And the dynamic between three months and one month SOFR, can you just go over that again, the little CLO liabilities for three months? And how much is that going to impact cash?
spk00: Yeah, so forget about LIBOR versus SOFR. Let's just – let's actually use LIBOR because most loans and CLOs are still on LIBOR. So – CLOs pay off three-month LIBOR as a general rule. We have one or two CLOs in our portfolio, which in certain unusual circumstances can pay one month, but the vast, vast, essentially all CLOs pay three-month LIBOR. And those rates are set four times a year, you know, on the quarterly determination date, usually in January, April, July, and October. Straightforward, simple, you know, the trustee looks at the screen on Bloomberg, here's the rate, they type it in, and that's that. They do it four times a year. can reset their rates randomly throughout the year. They're all short-term rates, but loans can pay off a one-month LIBOR, three-month LIBOR, six-month LIBOR, or even prime. And the borrower gets to choose, and they can change what rate they choose, what base rate they want to pay off of. But even if they were just on three-month LIBOR, loans set their coupons randomly throughout the quarter. So at a broad level, these things cancel each other out. But With this rapid movement in rates, what we've been seeing, and I'm just looking at the screen right now, one month LIBOR is 3.87 and three month LIBOR is 4.6%. So if you're the CFO of one of these levered borrowers, let me take a step back. Typically, in my experience, the difference between one month and three month LIBOR is measured in a single digit number of basis points, kind of five to seven basis points, judgmentally is my opinion. Now you're looking at over 70 basis points. If you're a borrower on one of these loans, if you're the CFO at the borrower, you have to fill out a whole compliance certificate. It's a royal pain in the you-know-where to get those things done. If you're going to save five bips a year, you're not going to do it. But if you're going to save 70 bips a year, you're damn well going to do it. So in this rising rate environment, borrowers are being very smart and trying to lower their debt cost as much as possible. They don't want to be paying 4%, you know, frankly, I get it. So when we're seeing rates move very rapidly, which is what we're seeing right now, I don't remember the last time LIBOR moved up 400 basis points in a year. Maybe it has, but not to my recollection. What that's done is it's caused some timing mismatches. So that's why we saw cash flows come down in October and because the base rates, which were set back in July, there was a big enough spread back then as well. As rates start to slow down, I think few people in the market are predicting base rates or three-month LIBOR is going to be 8% at the end of next year. We're certainly not. To the extent that pace slows down, we expect that mismatch to close out and potentially even move in our favor if rates start moving down for a period of time. By and large, it's a frictional thing. You know, you'll never get it perfectly right. It's more pronounced than I recall it, but it's, in my opinion, principally due to the rapid movement in rates, and we would expect as rate movements slow, those two numbers would start to converge again.
spk04: It makes complete sense. Just the timing, and it will be made up of it. It's stopping at some point. And with the special dividends, I mean, these are just obviously bonuses for shareholders. I think you said in your comments that it could be some spillover next year. I mean, how do you think, you know, how should investors think about special dividends sort of next year? I mean, cash flows are running well above, you know, the operating EPS and the dividend.
spk00: Yeah, so there's three things, three masters we live by, cash, gap, and tax. Obviously, the number one answer is just make the cash flow the highest as possible, and probably everything else will work itself out if we're successful there. Over the life of every CLO equity investment, cash and gap and tax will equal each other. However, in any given year, in my experience, they've never been equal. So if you look back in ECC's history, there's been years where we've had 75% of the distribution plus be a return of capital. Right, yeah. 80% even in one year a few years ago. And in other years, we've had taxable income well in excess of our gap income. And so what drives that? One of the biggest, a couple things. Let's say CLOs keep paying their payments nicely, but there's a bunch of defaults. You could actually get a lot of cash out of a CLO, but have no taxable income in that year. So that's kind of cool. Obviously, cash without current tax is great. Yeah. At the same time, in an extreme case, a CLO could pick, and you fail the triple C, massive triple Cs, but no defaults, and keep getting taxable income without cash. That's obviously bad. That doesn't happen too often, though. The other thing that goes on in CLOs is when we do a reset or refinancing, we get to take a write-off, a tax deduction, for the previously unamortized issuance costs related to the CLO debt we're retiring in the refi or reset. So last year, in fiscal 21, when it was reset refi mania here, and we did, again, over 30 corporate actions, if my memory serves, that created a lot of what I'll call non-cash tax deductions in that, like the original rating agency costs and the banking fees and all the other gobbledygook that it takes to get a CLO issued, we could take a deduction on. This year, that activity has been highly muted, so we've lost that deduction and we expect taxable income to comfortably exceed our common distributions. So we're happy to, you know, we're shareholders as well. Everyone likes to get a special distribution. We have to pay out substantially all of our taxable income within roughly 10 months of the end of the tax year. Am I right on that, Ken? Yeah. So there is a small excise tax you have to pay. And again, there's not an art if you defer it. There's not an art or a science. It's much more an art than a science. As we've looked at this, the rationale for declaring the 50 is that we think taxable income, we'll have even more spillover income. So let's pay some out now. We can avoid the excise tax because that'll be paid quickly enough to the extent our final tax returns look like we'll have even more. We'll pay that out. We'll have to take a reserve for it in the fourth quarter for that excise tax. And then we'd expect to pay out one or more specials during 2023 related to 2022 taxable income to the extent our projections are correct. That said, we're very good at predicting cash flows, pretty good at predicting gap income. There's so many behind-the-scenes variables in tax that it moves around a lot, and it's hard to put an exact number on it. But where we are today, we think it's quite comfortable, and we certainly hope to issue more specials in the future.
spk04: Yeah, great job managing, and I'm sure no complaints from investors with those specials on top of what is already – We did not hear any yesterday.
spk00: No, sir.
spk04: And I'd be at fault in not asking the last question. You mentioned the hung leverage loans. that are going to be out there on bank balance sheets. But Twitter, I mean, what's your just sort of thought for you? Are you referring to those type of trade deals?
spk00: Well, now I'm mindful the CEO also publicly talked about bankruptcy already. But that's one that probably comes out. I think the banks have about $13 billion in debt. Some of the interesting ones that have come out have been Citrix, which I think was issued around $0.91 on the dollar. There's another one out right now, Tenneco, which is an auto parts manufacturer. That loan's in the mid-80s. Nielsen, like the TV rating and all that, you hear the Nielsen ratings and whatever that is. They're out with a loan between 89 and, it's offered 89 to 90 right now. 50 bps SOFR floor at SOFR plus 500. And these are, in many cases, loans that were committed to pre-Ukraine invasion, you know, and for whatever reason, banks continue to provide underwriting at set levels where they tell the sponsor, we'll take the loan down if we can't sell it. Whoops, you know, something happens and, you know, we're, you know, we, the loan market and our CLOs in particular, you know, love those opportunities and the market, while the market doesn't do everything well, I think when there's, When they know there's a bank with a hung LBO, I say the market's pretty disciplined at holding out for a pretty darn good price on things like that. So hopefully we'll have some more of those. Bankers, if you're a banker, you might be able to take all your pain this year so you don't have an overhang. Your bonus may be down this year, but hopefully if you cleared the decks, you can start making money again next year. So bankers are usually heavily motivated to get all their problems off the books by year end. So we like that and hope there's more to come. And then at the same time, companies continue to refinance their debt. Sitco, the fund administrator, they have a number of different maturities, but they refinanced, I think, 150 basis points wider for part of their 2023 debt just to get that maturity done. Four Seasons Hotels is out with a loan today. It's, I think, 100 basis points wider. then the old loan they're replacing, but that loan is coming due. So, you know, they're a fine business and they're making lots of money, which is bad luck. They have to refinance at a choppy time. But for CLOs like ours, you know, we'll take it. In 2019, I was crying about their 2018 about loan spread compression and loans were repricing down on us. So, we certainly didn't like those days, but these things all go in cycles, and today that's very much in our favor, and we hope it continues that way for some time.
spk04: We certainly look forward to it. Keep up the great work, and thanks for answering the questions, Tom.
spk00: Very good. Thanks so much, Matthew.
spk03: Thank you. I'm showing no additional questions in queue at this time. I would like to turn the floor back over to management for any additional or closing comments.
spk00: Great. Thanks so much, Donna. We appreciate everyone's time and attention today. We're quite pleased with how the company is positioned. There's risks and uncertainties ahead, but we believe our portfolio is set up very well to capitalize on those opportunities as they play out. We appreciate your time and interest today. Ken and I are available later today should anyone have any follow-up questions. Thank you very much.
spk03: Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines or log off the webcast at this time and enjoy the rest of your day.
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