Eagle Point Credit Co (ECC) Q2 2023 Earnings Call Transcript

Transcript

Operator (participant)

Greetings, welcome to Eagle Point Credit Company's second quarter 2023 financial results conference call. At this time, all participants are on 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, Peter Sceusa with ICR. Thank you. You may begin.

Peter Sceusa (Investor Relations Associate)

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

We disclaim any obligation to update our forward-looking statements unless required by law. A replay of this call can be accessed for 30 days via the company's website, eaglepointcreditcompany.com. Earlier today, we filed our Form N-CSR half Year 2023 financial statements and our second quarter investor presentation with the Securities and Exchange Commission. The financial statements in our second 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.

Tom Majewski (CEO)

Great. Thank you, welcome everyone, to Eagle Point Credit Company's second 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 had a solid second quarter. Our recurring cash flow in the second quarter was 27% larger than our recurring cash flows in the first quarter. We also continued to proactively manage our CLO equity portfolio by taking advantage of attractive secondary market opportunities. CLO equity investments purchased during the third quarter-- pardon me, during the second quarter, had a weighted average effective yield of 20.8%, and as of quarter end, our CLO equity portfolio had a weighted average remaining reinvestment period of 2.7 years.

As we have stated in the past, we believe keeping our weighted average remaining reinvestment period as long as possible is one of our best defenses against future market volatility. For the second quarter, our net investment income totaled $0.32 per share before the impact of some reclassification realized losses. We continue to actively manage our portfolio, and we deployed $29.7 million in net capital into new portfolio investments during the quarter. We received recurring cash flows on our portfolio during the second quarter of $53.7 million, or $0.90 per common share, a $0.27 increase from the prior quarter and exceeding our aggregate common distribution and expenses by $0.21 per share. Cash flows in the second quarter improved as the mismatch between one-month and three-month LIBOR and SOFR continued to compress.

Along with our regular monthly common distribution of $0.14 per share, we declared additional variable supplemental distributions of $0.02 per share, or aggregate monthly distributions of $0.16 through the end of the year. Inclusive of the July 31st distributions, we've now delivered cash distributions of $19.19 per share to our common stockholders since our 2014 IPO. NAV per share as of June 30 was $8.72. Since the end of the quarter, we estimate our NAV at July month-end to be between $9.08 and $9.18 per share, a 4.7% increase from quarter end. We also continued to prudently raise capital through our at-the-market program and issued approximately 4.3 million common shares at a premium, generating a NAV accretion of about $0.12 per share.

These sales generated net proceeds of nearly $44 million. We've continued to access our ATM program in July, issuing approximately 3.8 million of additional common shares at a premium and generating net proceeds of approximately $38.5 million. At the end of July, we have $83.6 million of cash on our balance sheet, thanks in part to our strong July cash flows, providing us with ample dry powder to deploy into new investments over the coming weeks. All of our financing remains fixed rate and unsecured, giving us protection in a rising rate environment. Investors should take comfort that we have no financing maturities prior to April 2028.

As of June 30, the weighted average effective yield of our CLO equity portfolio was 15.23%, which is a slight reduction from 15.83% at the end of March. However, new CLO equity we purchased during the second quarter had a weighted average effective yield of 20.8%, which should help bolster the portfolio's weighted average effective yield prospectively. Additionally, the weighted average effective yield, expected yield of our CLO equity portfolio, based on market value, increased to 27.5% as of June 30th. As I previously mentioned, during the quarter, we deployed $29.7 million of net capital into secondary CLO equity, CLO debt, loan accumulation facilities, and other investments.

We believe many of the primary CLO equity IRRs available in the market today do not represent an attractive value at the moment. We continue to focus our investment efforts on the secondary market. Recently, we've seen at least an 800 basis point pickup in yields from comparable secondary opportunities versus primary opportunities. As a result, we've continued to opportunistically deploy our dry powder principally into the secondary market. As of June 30, our CLO equity portfolio's weighted average remaining reinvestment period stood at 2.7 years, and that's a modest reduction from three years at the end of 2020. Despite the passage of six months through our proactive portfolio management, the WARP on our CLO equity portfolio was just reduced by four months. We believe this continues to drive the portfolio's outperformance relative to the broader CLO equity market.

We remain focused on finding opportunities to invest in CLO equity, with generally longer remaining reinvestment periods, to enable our portfolio to navigate through volatility whenever it occurs. I would also like to take a moment to highlight Eagle Point Income Company, which trades under the symbol EIC. EIC invests principally in junior CLO debt. For the second quarter, EIC generated net investment income of $0.49 per share, once again exceeding its regular common distribution for the quarter. Additionally, we recently raised EIC's monthly common distribution by 13% to $0.18 per share beginning in October. EIC has performed very well throughout the rising rate environment and remains very well-positioned to continue generating strong net investment income. After today's call for ECC, we'll be hosting a call for EIC at 11:30 A.M. and invite you to join that call.

You can find more information at the company's website, eaglepointincome.com. Overall, we remain very active in managing our portfolio and keep a close eye on the broader economy. After Ken's remarks, I'll take you through the current state of the corporate loan and CLO markets. I'll now turn the call over to Ken.

Ken Onorio (Senior Principal, CFO and COO)

Thanks, Tom. For the second quarter of 2023, the company recorded net investment income, net of realized losses, of approximately $3 million or $0.05 per share. This compares to NII and realized losses of $0.32 per share in the first quarter of 2023, and NII and realized gains of $0.43 per share for the quarter ending June 30th, 2022. The second quarter of 2023 included the effect of a $0.22 per share of realized losses as a result of the write-down of amortized cost to fair value for certain late-in-life CLO equity investments.

Please note, since the fair value of these investments had already been previously reflected in the company's NAV and is a reclass for accounting purposes between an unrealized and realized loss, there was no meaningful impact to NAV as a result of the write-down. Excluding the write-down, our second quarter NII, less realized losses, would have been $0.27 per share. For the second quarter, when unrealized portfolio appreciation is included, the company recorded GAAP net income of approximately $6.5 million or $0.11 per share. This compares to GAAP net income of $0.35 per share in the first quarter of 2023, and a GAAP net loss of $2.35 per share in the second quarter of 2022.

The company's second quarter GAAP net income was comprised of total investment income of $31.7 million and net unrealized appreciation on certain liabilities held at fair value of $4.7 million, offset by total net unrealized appreciation on investments of $1.3 million, realized losses of $16.1 million, total expenses of $12 million, and distributions on the Series D Preferred Stock of $0.5 million. Additionally, for the second quarter, the company recorded an other comprehensive loss of $6.9 million, representing the change in fair value on the company's financial liabilities attributable to instrument-specific credit risk. The company's asset coverage ratios at June 30th for preferred stock and debt, calculated pursuant to Investment Company Act requirements, were 307% and 455%, respectively.

These measures are comfortably above the statutory requirements of 200% and 300%. Our debt and preferred securities outstanding at quarter-end totaled approximately 33% of the company's total assets, less current liabilities. This is within our target range of generally operating the company with leverage between 25%-35% of total assets under normal market conditions. Moving on to our portfolio activity in the third quarter. Through July 31st, the company received recurring cash flows on its investment portfolio of $48.1 million.... Note that some of our investments are expected to make payments later in the quarter. As of July 31st, we had $84 million of cash available for investment.

Management's estimate of the range of the company's NAV per share as of July 31st was $9.08 to $9.18, reflecting a 4.7% increase from June 30th. During the second quarter, we paid 3 monthly common distributions of $0.14 per share and three monthly variable supplemental common distributions of $0.02 per share, for aggregate monthly common distributions of $0.16 per share. Additionally, we have declared aggregate common monthly distributions of $0.16 per share for the remainder of 2023. I will now hand the call back over to Tom.

Tom Majewski (CEO)

Great. Thank you, Ken. I'll now provide an update on the loan and CLO markets. The Credit Suisse Leveraged Loan Index generated a total return of 3.12% during the second quarter, and 6.33% for the entire first half, as loans performed quite well. The index has continued its positive momentum through July and is on pace to have its best full-year return since the financial crisis. The asset class continues to show its resilience to market volatility and ability to generate strong returns in multiple macroeconomic environments. During the second quarter, we saw about 15 leveraged loans actually default, and as a result, at quarter end, the trailing twelve-month default rate stood at about 1.71%, which is up from the prior quarter, but still well below long-term historic averages.

Most bank research desks have modestly raised their expectation for the default rate to end up between 3%-4% by the end of 2023. Despite the increase in defaults during the second quarter, about 4% of leveraged loans, or roughly 16% annualized, repaid at par, which is comparable with the first quarter. This provides our CLOs with valuable par dollars to reinvest in today's discounted loan market and to partially offset losses from defaults. With a significant share of high-quality issuers continuing to trade at discounted prices for their loans, CLO collateral managers remain well-positioned to improve underlying loan portfolios through relative value credit selection in the secondary loan market. Given ongoing market conditions, the percentage of loans trading over par continues to be minimal, and with the Credit Suisse Leveraged Loan Index price at around 93.5 as of June 30.

As a result, repricing activity in the loan market remains quite subdued. We continue to observe sizable refinancing activity as loan issuers tackle their 2024 and 2025 maturities in an effort to further push out their maturity wall. As part of this, they're continuing to offer lenders like our CLOs, a higher spread and OID on newly issued refinance loans. As a result, this provides our portfolio with numerous opportunities to build par and increase our weighted average spread, which in turn, increases the excess spread we receive on our CLO equity portfolio. On a look-through basis, the weighted average spread of our CLOs' underlying loan portfolios was unchanged from the prior quarter at 3.67%. This measure of our portfolio has increased 9 basis points in the last 15 months.

CCC concentrations within our CLOs stood at 6.3% as of quarter end, and the percentage of loans trading below 80 within our CLOs is about 6%. Our portfolio's weighted average junior OC cushion was 4.53% at quarter end, which gives us room to withstand downgrades and losses, and remains well above the market average OC cushion of about 4.2%. This is by design. In the CLO market, we saw about $22 billion of new CLO issuance in the 2nd quarter of 2023, and $56 billion for the 1st half, and this is on pace to eclipse the $100 billion mark once again. We believe a significant majority of this volume, however, was backed by captive CLO equity funds, which are generally less return sensitive than investors like Eagle Point.

Reset and refinancing activity in the CLO market has picked up slightly, and while the market gives the in-the-money nature of our CLOs financing some credit, frankly, we believe the market doesn't give it full credit, and this represents embedded hidden value in our portfolio. We believe the weighted average Triple A spread in our portfolio of the CLOs that we have equity in, of 123 basis points, is about 72 basis points in the money today.

No, no significant, portfolio-specific items. If anything, yields widened during the second quarter. While cash flows increased, you know, the market yield, the market demand, or the yield demanded in the market for CLO equity, unambiguously widened during the second quarter. That has the reflect of reducing the, the secondary sale value of our portfolio. We, we've been always very, very, very proactive in, you know, accurately marking our portfolio. Sometimes it's up, sometimes it's down on a mark basis, which you'll see if you look back, you know, going back quarters to 2014. Regardless of the marks going up or down, the, the cash flow has, has historically continued unabated. What we saw, though, during the second quarter was simply a yield widening market-wide, nothing specific to our portfolio.

That trend has certainly reversed itself, in the third quarter. You know, and frankly, all, you know, and, and all the capital deployed, during the second quarter into CLO equity, has done quite well, in July. NAV was up, between 4% and 5% in the, in the month of July, based on our estimates. That's, you know, net of the, the distributions, the, the regular and supplemental distributions paid to the shareholders during the, during the month.

Paul Johnson (VP)

Thanks for that, Tom. Appreciate that. I guess, you know, you mentioned on the call, you know, a big pickup in yield differential between what you're seeing in the secondary markets versus the primary. I'm just curious to know why there is, I guess, such a, a big difference in secondary opportunities today. Are you guys seeing enough of those to, sort of, quote, unquote, I guess, you know, build a pipeline? Do you, would you rather, you know, see, I guess, a recovery in, in the primary issue market?

Tom Majewski (CEO)

Yeah. The, the, the big driver right now, holding back or the, the why is the primary arbitrage not so good or out of whack with the secondary market opportunity, for CLO equity. Right now, for, for a number of reasons, the, the, the CLO Triple A market is out of sync with the loan market to some degree. You have to buy loans on the same day, proverbially, the same day as you issue CLO Triple A debt. That right now is a little bit out of balance. While the risk retention rules were repealed in the United States, or overturned back in 2018, a small number of collateral managers still have access to captive capital.

In our belief, based on all the CLOs issued in the first half, new issue CLOs, first half of 2023, the vast majority were taken and placed into these captive funds. We use the phrase saying, less return sensitive. We're trying to be polite, I'll admit, when we say that. There's a handful of issuers that have access to that capital. The math is unambiguously, I can't imagine there's any controversy amongst market in, you know, market experts, that there's such a gap between primary and secondary. These things have occurred from time to time in the past. Sometimes secondary is cheaper, sometimes primary is cheaper. They don't usually. They're not usually this pronounced, and they don't usually, or historically, they've not been persistent.

They do continue for a period of time. I think we're probably turning the corner, and that differential is reducing, but it's still going to be there for a little while. There's not enough buyers of Triple A CLO paper in the world right now for certainly large-ticket, primary, new purchases. To the extent there are not, new issue, Triple A spreads will stay wide. In many cases, another example is secondary CLO Triple A's trade tight to primary CLO Triple A's. Why is that? The CLO Triple A market for new issue is often dominated by investors who can take 100, 200, 300 million dollar chunks of CLO Triple A, versus the secondary market, might trade between 5 and 50 million dollar bite sizes.

You know, just the dynamics of the market, there's not a deep enough bid in many cases to get together a syndicated, Triple A across smaller investors. The market's kind of stuck dealing with a smaller number right now of large-ticket buyers, but a few of them are not actively buying. It's, it's just there's more supply than demand, so the Triple A stay wide. These situations have occurred from time to time, but again, in my experience, they haven't persisted for extended periods of time. This one's amongst the longer periods, frankly. That said, there's, you know, give or, you know, somewhere between $800 billion, you know, plus of U.S. CLOs outstanding. You know, a big chunk of that is in the form of CLO equity.

We have no shortage of investment opportunities in the secondary market. We've remained very selective in the things we go after, but there's no shortage of opportunities in the secondary market as well.

Paul Johnson (VP)

That makes sense. That's very interesting. Thanks again. Last question, kind of along the same point or sort of a segue, I guess I'd say, but direct lending CLOs are something that we've heard about relatively recently. I'm not sure if these are things that you can potentially invest in or not. I'm just curious if there's any sort of trend that you've observed at all in terms of direct lending CLO issuance, just obviously, with the lower kind of, you know, leverage loan volume that's out there, if that's the trend that you've noticed and, you know, any sort of commentary you would have there, if any, would, would be interesting to hear.

Tom Majewski (CEO)

Sure. A long time ago, these were called middle market CLOs, and then a little bit of direct lending CLOs, and, I think the phrase of the day in the market, they're now called even private credit CLOs. These are CLOs that look and feel a lot like the typical CLOs that Eagle Point Credit Company invests in, except they're typically to non-spot, non-bank-led deals. They're led, you know, to private credit arranged deals. Many cases, the private credit world is getting bigger and bigger, and many cases will do $500 million-$1 billion loans. These are a small, little, you know, $50 million-$100 million loans. They're still quite sizable, but now, in many cases, they're being arranged by private credit money managers versus investment banks.

Over time, private credit has, has really done quite well from a default and recovery perspective. When we look back historically, you can see if you look at the default rate, and certainly any private credit manager will have some data, or nearly certainly will have some data that shows how private credit has outperformed broadly syndicated credit. I think that's directionally accurate. The one thing that's missing, in our opinion, is in the private credit market, there's not a, an ability or mindset of the collateral managers to reinvest cheap when defaults go up. The classic example is through the financial crisis, where according to many measures, middle market credit, as it was then called, now private credit, had fewer defaults and higher recoveries than syndicated loans.

Syndicated CLOs outperformed middle market CLOs, not because they had better credit, but because the collateral managers were able to reinvest at $0.60, $0.70, and $0.80 on the dollar. Middle market managers were lending at L plus 800 instead of L plus 600. 200 basis points is nice, 30 basis points of discount, 30 points of discount is obviously much better. One of the things we've really grappled with is, while, while actually the arbitrage on private credit CLOs looks better than many syndicated CLOs today, in terms of the potential equity IRR, their, their long-term ability to actually outperform in times of, of market distress, is, is, is, is less certain. We have a small number of what would be called middle market or private credit CLOs in the portfolio.

Yeah

Tom Majewski (CEO)

on a representative CLO equity investment. If you haven't downloaded it, we'd encourage you to. If you have to click way back in the history of our website, but it's up there. Maybe someday we'll update the format of it, but the, the numbers are unchanged. GAAP, GAAP profit, tax profit, and cash profit, minus some odd nondeductible things for tax, over time, will equate in the life cycle of nearly any investment, including CLO equity. In our experience, they never seem to equate, however, in any given year, which causes mismatches. There's been years we've had to pay large special distributions. There's been years where many of our distributions have been treated as a return of capital and not taxed from a tax perspective and, and everywhere in between. So, so there's.

Sadly, I would struggle to see a scenario where they're ever back in alignment, where they're in alignment in any given year. That's been my experience over 20 years. The flip side to your question, how can this persist? What I would say is it's less of an increase in cash flow, although obviously it's a handsome increase, and more of a return to normalization. In that, in theory, in really, the reality is, you know, until recently, when many people modeled the CLO, they just assumed the same three-month LIBOR for the assets and the liabilities. This was back before SOFR, we'll get to that in a minute. The reality is, loans set their rate now at SOFR, you know, 250 days of the year.

CLOs set their SOFR four days of the year. There's always going to be a mismatch between the, the base rate on the asset side and the base rate on the ex- liability side of a CLO. That's just a, a given. It's probably not given enough credit in the market. Overlay the complexities that loans can pay off a one-month, three-month, six-month SOFR. They can even pay off a prime, and sometimes there's other rates. There's, there's all kinds of rate stuff on the, on the asset side. Our liabilities are set three months SOFR. Every single quarter is set month to quarter. The gap between one month and three-month LIBOR and SOFR got really significant for a while. This has happened two times of, of note in, in to my memory.

Once was in early 2017, when all the tax rules were changing. Maybe it was 2018, around bringing offshore corporate money back into the United States. That kind of mucked up the money markets for a while. Then again, in a rapidly raising rate environment, as the short end of the curve got steep over the last 18 months, in many cases, we saw corporate CFOs moving from three-month rates to one-month rates. You know, the reality, they have to then make a loan payment every single month if they move to a one-month rate. That is a lot of pain to do that. You have to send a certificate and all this, you know, other work, which if you're going to save 3 or 5 basis points, it's probably not worth the company's time.

If you're going to save 40 basis points, then it's worth your time. What we saw is when the short end of the curve got steeper, many companies were going and electing one-month LIBOR or SOFR. That's now undoing it as the short end of the curve flattens. We're seeing more and more... We're seeing even if they are paying one month, the differential is, is, is much lower. It's more a return to normal, is my expectation, than it is a short-term spike. A, and then, B, we're mindful that CLO equity is a decaying investment, and that if you invest $100 at the beginning or whatever you invest at the beginning, and our expectation, it's very unlikely your terminal payment from that CLO will also be that same $100 you invested.

We talk about generating very strong cash-on-cash. Approximately 25% kind of cash on value has been distributed on our CLO equity portfolio, some years better, some years worse, over the long term. Now, a portion of that capital-- of that cash flow is a return of capital. When I look at our cash flow of $0.90 being $0.20-odd above distributions and expenses, that actually makes sense. That $0.20-odd of excess really should be thought of generically as a return of capital into our system, or if a CLO, forgetting about tax or GAAP, just was like an amortizing loan for CLO equity. That'd be like the principal payment, on your, on your loan.

You pay out, you know, use the income portion to, you know, pay out expenses and distributions, and then ideally seeking to reinvest the repayment portion into new CLOs. Hopefully, we're back to more of a long-term normal state in the, in the short term, short end of the curve, which I think is, is kind of proving itself out. That then manifests itself quite nicely on a levered basis within CLOs. I hope to see the excess of cash flow be, you know, cash flow be comfortably in excess of our distributions and expenses on an ongoing basis.

Matt Howlett (Senior Research Analyst)

Tom Majewski (CEO)

You know, when, when, when ECC went into COVID, I don't remember what our shortest maturity was. I want to guess it was, like, 2026. You have to please check the notes to be, the, the, the tapes to be definitive. We had no unsecured-- We had no secured debt, and we had no maturities for multiple years. If I went into 2020 with a maturity in late 2021 or even in mid 2021, I would have been like, "Mm-hmm." You know, let's see what... Obviously, it all worked out, but, you know, we didn't know when the market was. I, I'm, just as companies are mindful of their maturity wall, I like sitting where I sit, knowing, you know, we're the nearest deadline we've got to deal with is 2028.

I don't want to move that stuff. I think the ECCCs go out to 2031, then obviously, the perpetuals are great. I'm very mindful of keeping ECC's maturity wall as far out as possible.

Matt Howlett (Senior Research Analyst)

Makes, makes total sense. Thanks for taking my questions.

Tom Majewski (CEO)

Thank you.

Operator (participant)

As a reminder, if you'd like to ask a question, please press star one on your telephone keypad. One moment please, while we poll for questions. At this time, there are no further questions. I would now like to turn the call back over to Thomas Majewski for closing comments.

Tom Majewski (CEO)

Great. Thank you very much for your time and interest in Eagle Point Credit Company. Ken and I will be available later today if folks have any questions you'd like to ask, and we look forward to speaking with you again next quarter. Thank you very much.

Operator (participant)

This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation.

Eagle Point Credit Company - Q2 2023

Transcript

Operator (participant)

Peter Sceusa (Investor Relations Associate)

Tom Majewski (CEO)

Ken Onorio (Senior Principal, CFO and COO)

Tom Majewski (CEO)

Operator (participant)

Paul Johnson (VP)

Tom Majewski (CEO)

Ken Onorio (Senior Principal, CFO and COO)

Paul Johnson (VP)

Ken Onorio (Senior Principal, CFO and COO)

Paul Johnson (VP)

Ken Onorio (Senior Principal, CFO and COO)

Paul Johnson (VP)

Tom Majewski (CEO)

Ken Onorio (Senior Principal, CFO and COO)

Paul Johnson (VP)

Tom Majewski (CEO)

Paul Johnson (VP)

Tom Majewski (CEO)

Paul Johnson (VP)

Tom Majewski (CEO)

Paul Johnson (VP)

Tom Majewski (CEO)

Paul Johnson (VP)

Tom Majewski (CEO)

Paul Johnson (VP)

Tom Majewski (CEO)

Operator (participant)

Matt Howlett (Senior Research Analyst)

Tom Majewski (CEO)

Matt Howlett (Senior Research Analyst)

Tom Majewski (CEO)

Matt Howlett (Senior Research Analyst)

Tom Majewski (CEO)

Matt Howlett (Senior Research Analyst)

Tom Majewski (CEO)

Matt Howlett (Senior Research Analyst)

Tom Majewski (CEO)

Matt Howlett (Senior Research Analyst)

Tom Majewski (CEO)

Matt Howlett (Senior Research Analyst)

Tom Majewski (CEO)

Matt Howlett (Senior Research Analyst)

Tom Majewski (CEO)

Matt Howlett (Senior Research Analyst)

Tom Majewski (CEO)

Operator (participant)

Tom Majewski (CEO)

Operator (participant)