Eagle Point Credit Company - Q3 2023
November 14, 2023
Transcript
Operator (participant)
Greetings, and welcome to the Eagle Point Credit Company third quarter 2023 financial results call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. 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 call over to your host, Garrett Edson, with ICR. Please go ahead.
Garrett Edson (Managing Director)
Thank you, Melissa, 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 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 third quarter 2023 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 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 Thomas Majewski, Chief Executive Officer of Eagle Point Credit Company.
Thomas Majewski (CEO)
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 continues to perform solidly despite concerns about macro volatility in the market. Our NAV grew by 7% during the quarter. We paid $32.5 million in cash distributions to shareholders, and we deployed $119 million of net capital into new attractive investments. Recurring cash flows remain robust as we receive $51.9 million, or $0.70 per common share of cash flow, which is well in excess of our common distribution and expenses. CLO equity investments purchased during the quarter had a weighted average effective yield of 20.3%.
As of quarter end, our CLO equity portfolio had a weighted average remaining reinvestment period of 2.7 years, which is steady from the last quarter, despite the passage of three months. As we have stated in the past, we believe keeping our weighted average remaining reinvestment period as long as possible is our best defense against future market volatility. For the third quarter, our net investment income and realized gains totaled $0.35 per common share. NAV per share as of September 30th was $9.33, which again is a 7% increase from June 30. Since the end of the quarter, we estimate our NAV at October month-end to be between $8.98 and $9.08 per share. We continue to actively manage our portfolio, deploying $119 million in net new capital into new portfolio investments during the quarter.
We received recurring cash flows on our portfolio of $51.9 million, or $0.77 per common share, exceeding our aggregate common distributions and total expenses by roughly $0.10 per share. We have already received cash flows from our portfolio in October, which were greater than all of our third quarter collections, as we benefit from rising rates, strong investment performance, and continued growth of our portfolio. Along with our regular monthly common distribution of $0.14 per share, we declared an additional variable supplemental distribution of $0.02 per share for an aggregate monthly distribution of $0.16 per share for each month during the first quarter of 2024. Inclusive of the October 31st distributions, we've now distributed cash to our investors equal to $19.67 per share since our IPO.
We also continued to prudently raise capital through our at-the-market program and issued approximately 8.8 million common shares at a premium, generating a NAV accretion of $0.14 per share. These sales generated proceeds of approximately $90 million during the quarter. At the end of October, we had $59.3 million of cash on our balance sheet, thanks in part to the strong October cash flows, providing us with ample dry powder to deploy into new investments. All of our financing remains fixed rate, which gives us continued protection in a rising rate environment. Importantly, we have no financing maturities prior to April 2028. As of September 30th, the weighted average effective yield on our CLO equity portfolio was 16.29%, and that's a meaningful increase from the 15.23% at the end of June.
New CLO equity that we purchased during the third quarter had a weighted average effective yield of 20.3%, which should help bolster the portfolio's weighted average effective yield prospectively. Additionally, the weighted average expected yield of our CLO equity portfolio, based on market value, held relatively steady just over 27% as of September 30th. As I mentioned previously, during the quarter, we deployed $119 million of net new capital into primary and secondary CLO equity, CLO junior debt, loan accumulation facilities, and certain other related investments. While there are select primary CLO equity opportunities that represent an attractive value, by and large, we focus most of our investment effort on the secondary market and for other investments that we believe offer appealing returns.
As of September 30th, our CLO equity portfolio's weighted average remaining reinvestment period stood at 2.7 years, unchanged from the prior quarter, and we remain focused on finding opportunities to invest in CLO equity with generally longer reinvestment periods to enable us to navigate through periods of volatility. I would also like to take a moment to highlight Eagle Point Income Company, our sister company, which trades under the symbol EIC. EIC invests primarily in CLO junior debt. For the third quarter, EIC generated net investment income of $0.51 per share, excluding certain non-recurring items, once again exceeding its common distribution for the quarter. Additionally, EIC just increased its common distribution by 11% to $0.20 per share, beginning in January.
EIC has performed very well through the rising rate environment and remains well positioned to generate strong NII, and we invite you to join EIC's investor call at 11:30 A.M. to hear more. Overall, we'll remain active in managing our portfolio and continue to keep a close eye on the broader economy. After Ken's remarks, I'll take you through the current state of the corporate loan and CLO markets. I'll now turn the call over to Kenneth.
Kenneth Onorio (CFO & COO)
Thanks, Thomas. For the third quarter of 2023, the company recorded net investment income and realized gains of approximately $23 million or $0.35 per common share, which is inclusive of a nonrecurring excise tax refund of $0.01 per share. This compares to NII and realized losses of $0.05 per share in the second quarter of 2023, and NII and realized gains of $0.47 per share for the quarter ending September 30th, 2022. When unrealized portfolio appreciation is included, the company recorded GAAP net income of approximately $63.2 million, or $0.93 per share for the third quarter. This compares to GAAP net income of $0.11 per share in the second quarter of 2023, and GAAP net income of $0.21 per share in the third quarter of 2022.
The company's third quarter GAAP net income was comprised of total investment income of $36 million, net unrealized appreciation on investments of $34.8 million, net unrealized appreciation on certain liabilities held at fair value of $4.9 million, and realized capital gains of $0.6 million, partially offset by expenses of $12.6 million, and distributions on the Series D Preferred Stock of $0.5 million. Additionally, for the quarter, the company recorded other comprehensive income of $0.6 million. The company's asset coverage ratios at September 30th for preferred stock and debt, calculated pursuant to Investment Company Act requirements, were 354% and 524%, respectively. These measures are comfortably above the statutory requirements of 200% and 300%.
Our debt and preferred securities outstanding at quarter end totaled approximately 28% of the company's total assets, less current liabilities. This is within our target range of generally operating the company with leverage between 25%-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 $55.3 million. Note that some of our investments are expected to make payments later in the quarter. As of October 31st, we had $59.3 million of cash available for investment. Management's estimated range of the company's NAV as of October 31st was $8.98-$9.08 per share, reflecting a 3.2% decrease at the midpoint from September 30th, as spreads widened.
During the quarter, we paid three monthly common distributions of $0.14 per share and three monthly variable supplemental common distributions of $0.02 per share for aggregate common monthly distributions of $0.16 per share. We have also declared aggregate common monthly distributions of $0.16 per share through the end of March 2024. I will now hand the call back over to Thomas.
Thomas Majewski (CEO)
Thanks, Kenneth. Let me provide a quick update on the loan and CLO markets. The Credit Suisse Leveraged Loan Index generated a total return of 3.37% in the quarter and is at 9.91% year to date through September 30th, as loans continue to perform strongly. It's far better than many other fixed income indices. The index had another solid month in October and remains on pace to have its best full-year return in nearly 15 years. During the quarter, we actually saw only five leveraged loan defaults, down from 15 in the second quarter. In fact, there was not a single corporate loan default in the month of September. Again, evidence of the resilience of senior secured loans, and as a result, CLOs, despite the various macro concerns that people write about in headlines.
While some recent market reports have expressed concern over loans facing rising interest rates, the actual data, the default rate, and the number of defaults paints a very different picture than the headlines in our view. As a result, at quarter end, the trailing twelve-month default rate declined to 1.3%, remaining well below historical averages. Barring a shock in the next few weeks, we expect 2023 to be a far better than average year for defaults. The company's exposure to defaulted loans as of September 30th stood at only 40 basis points, further proof of the strength of our active portfolio management and construction. Approximately 5% of all leveraged loans, or roughly 19% annualized, repaid at par during the quarter.
This represents a quarter-over-quarter increase and provides our CLOs with valuable par dollars to reinvest in today's discounted loan market and to offset losses from the few defaults that are occurring. With a large number of high-quality issuers continuing to trade at discounted prices, CLO collateral managers remain well-positioned to improve underlying loan portfolios through relative value credit selection in the secondary market. Most loan issuers have become proactive in tackling their near-term maturities in an effort to further extend the maturity of their debt, and they continue to offer lenders higher spreads and OID on their newly refinanced loans. As a result, our portfolios continue to have numerous opportunities to build par and increase their weighted average spread, which in turn increases the excess spread we receive on our CLO equity portfolio.
On a look-through basis, the weighted average spread of our CLO's underlying loan portfolios was 3.78% at the end of September. Notably, that's an 11 basis point increase compared to the end of June. This measure has actually increased by 20 basis points in the last 18 months. Meanwhile, spreads on the debt tranches issued by our CLOs that were locked in 18 months ago remain unchanged. CCC concentrations within our CLOs stood at 6.7% as of September 30th, and the percentage of loans trading below 80 within CLOs is at about 4.4%. Our portfolio's weighted average junior OC cushion was 4.41% as of September 30th, which gives us ample room, in our opinion, to withstand potential downgrades or future losses.
Our portfolio's OC cushion remains much higher than the market average, which stands at 3.44%. One of the trends that we are seeing increasingly in the loan market is having private credit funds and BDCs refinance CCC-rated loans out of the syndicated loan market. A recent example of this would be MISys, which is a large software company. For our CLOs, this represents a par repayment and a reduction in CCC exposure. This is great. We hope more of this happens. We wish MISys, frankly, and their new lenders well in the future. As private credit funds, private credit funds and BDCs continue to expand, we expect this favorable trend to continue.
In the CLO market, we saw $28 billion of new CLO issuance in the third quarter of 2023, and $84 billion year to date through September 30th, remaining on pace to eclipse $100 billion once again, while tracking a little below 2022's pace. We continue to believe that a fair bit of this volume was backed by captive CLO equity funds, which, in our view, are far less return sensitive than we are. Reset and refinancing activity related to CLOs issued during the second half of 2022, which was a small period of CLOs, where quite a few were issued with 1-year non-call periods, have picked up, but otherwise, there's essentially no refi reset activity in the market. Indeed, the AAA weighted average level on our CLO equity portfolio is well tight to where CLOs could be issued today.
While the market does give the in-the-money nature of our CLOs financing some credit, we believe the market doesn't give it full credit and that this represents hidden value embedded in our portfolio. Our weighted average AAA spread is about 144 basis points, and this is roughly 39 basis points in the money today. As we have consistently noted, it's an environment of loan price volatility, where we believe CLO equity or CLO structures, and CLO equity in particular, are set up well to buy loans at discounts to par with a very stable financing structure, using par paydowns from other loans and outperform the broader corporate debt markets over the medium term, as they have done in the past. We're seeing that happen right now and expect that to continue. To sum up, we grew our NAV by 7% during the quarter.
We generated net investment income and realized capital gains for the quarter of $0.35 per weighted average common share. We continued to receive robust cash flows during the third quarter and have already collected more cash flow from our portfolio in the fourth quarter than we did in the third quarter. We remain very active in terms of sourcing and deploying investments at attractive yields, investing about $119 million of net new capital, and we continue our existing regular monthly distribution and variable supplemental distributions through March 2024. We further strengthened our liquidity position, generating NAV accretion of $0.14 per share through our ATM program, and at the end of October, we have about $59 million of cash to deploy into new investments.
We continue to maintain 100% fixed-rate financing, entirely unsecured, and we have no maturities prior to 2028. This gives us protection from any further increase in interest rates and locks in a very attractive cost of funding for many years to come. We believe the company's investment portfolio continues to be well-positioned, giving our proactive management the portfolio's long, weighted average, remaining reinvestment period, its strong OC cushion, and consistent recurring cash flows... We also remain pleased to return extra cash to our investors in the form of special or variable distributions and remain opportunistic and proactive as we manage the investment portfolio with a long-term mindset. We thank you for your time and interest in Eagle Point. Ken and I will now open the call to your questions.
Operator (participant)
Thank you. If you'd like to ask a question, please press star one on your telephone keypad. A 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 pull for questions. Thank you. Our first question comes from the line of Mickey Schleien with Ladenburg Thalmann. Please proceed with your question.
Mickey Schleien (Equity Research Analyst)
Yes, good morning, Thomas and Kenneth. Thomas, I wanted to follow up on your comments about the primary market. You noted that it's been spotty, and, you know, with captive funds holding the majority of the new issue volume that we're seeing. And that, that's clearly a function of the high, or I should say, wide AAA spreads. That process or that lack of primary market puts pressure on your financial performance in that it makes it more difficult for existing CLOs to refinance or reset, as you noted. So, what, what's it gonna take for that primary market to finally start to operate on a more normal basis, which is something you would expect, given that, you know, the overall fundamentals, as you mentioned in the data, are pretty good?
Thomas Majewski (CEO)
Yeah. Good morning, Mickey. Good question. I don't know, AAA is ebb and flow, I guess, over the years. If you think back to our performance, again, we've been public for nine years now. There are periods of time where the market's ripe and we're resetting and refinancing absolutely everything. The bad news during those times is if you look at our weighted average loan spread, it's typically going down. And if you look at 2017 and 2018, you'll see we had, you know, I think of it as reset mania here. At the same time, if you look at the portfolio decks, and these are all on our website going back ages ago, you'll see in many quarters, the loan spread is trickling downward. So the bad news today, we didn't do any refis or resets.
The good news today is we picked up 11 basis points in spread in the quarter as loans keep getting reset and loans themselves get refinanced wider. So it's a little bit of, you know, we're while I wish we were resetting stuff as well, I'm also very happy that our weighted average loan spread went up 11 basis points. Multiplied by the leverage of CLOs, that's obviously very impactful to our portfolio and certainly one of the drivers of NAV going up 7% during the quarter. Some of the things going on in the world, broadly of AAA investing, obviously, there's always currency fluctuation. Certainly, the regulators in Japan, you know, continue to ask questions, although we do note that there are quite a number of Japanese banks that are active.
Yeah, some of the new Basel Rules, as proposed, we believe, will make holding CLO AAAs more attractive for banks all around the world. Also, some of the NAIC considerations underway, last we've heard, also suggest AAAs will become even more attractive to hold. So there's some good news there. Probably the one segment of the market that's missing, that might be the most impactful, are some of the large U.S. money center banks. And indeed, if you look in their filings, you can see many of the largest banks in the country have, in some cases, 1%, perhaps even more of their portfolio in CLO securities. That's the one market participant, frankly, that would be nice to see more of.
But while we're obviously disappointed we're not resetting and refinancing, at the end of the day, what we care about is the difference between the spread on our assets and the spread of our liabilities. And this quarter, we made it through the spread of our assets going up. We like to win both ways, but we typically have a good habit of having one of them go in our direction, which we're seeing on loan spreads right now.
Mickey Schleien (Equity Research Analyst)
That, that's very helpful, Thomas. That's it for me this morning. Thank you for your time.
Thomas Majewski (CEO)
Great. Thanks, Mickey.
Operator (participant)
Thank you. Our next question comes from the line of Ryan Lynch with KBW. Please proceed with your question.
Ryan Lynch (Managing Director)
Hey, good morning. My first question just has to do with some combination of you guys raised quite a bit of equity this quarter in combination with you talking about kind of most of that was deployed in the secondary market. And so can you just talk about what sort of secondary opportunities you guys are seeing that that drove you know the decision to to raise quite a bit of bit of equity this quarter? And do you see those trends continuing thus far into the fourth quarter?
Thomas Majewski (CEO)
Yes is the answer to the last question. In terms of attractive secondary opportunities, the pickup in the difference in the spread that I was just talking about with Mickey of loan spreads versus CLO debt spreads, in general, is moving in our favor. Typically, when someone models a CLO, they model spread tightening over time. We're actually getting spread widening, which is great. There are a pretty robust supply of secondary CLO equity opportunities, both majority positions and some cases, minority positions, or minority, where we see a path to build to majority, where frankly, the yield opportunities there, loss-adjusted, applying, you know, punitive portfolio stresses for the tails and portfolios typically pencil out, frankly, to stuff well into the twenties on a loss-adjusted basis.
There was one new investment that came in at a lower yield, where there are other strategic reasons for the company to be participating. But if you look, by and large, at the secondary new adds into the portfolio, you're gonna see those in the mid-twenties. The types of sellers of those investments, and those are all, you know, privately negotiated transactions. Some are done via a BWIC process or bids wanted in comp. Quite a few are done off-sheet, where it's just, you know, over the phone and negotiating a price.
Some of our edge there is our ability, our knowledge of nearly all CLOs, our ability to analyze any transaction and be current on it very quickly, using our own proprietary technology, and our knowledge of the transaction documents and CLO collateral managers. The types of sellers varied widely, from, in some cases, maybe even one or two funds winding down, maybe other investors who didn't always appreciate what they were signing up for, maybe people who bought new issue and got their model wrong and just wanna punch out. The stuff we buy, we typically focus on less seasoned, so newer CLOs, but not brand new, with as much reinvestment period as possible.
We probably pay up for that a little bit, but I will give up, you know, give up some degree of yield on our portfolio to keep the weighted average remaining reinvestment period as long as possible. We value that greatly. We saw through COVID, we saw through, you know, the 2008, 2009 cycle ages ago, that the number one defense to have is reinvestment period. And while it's very, very expensive to get that in the new issue market, we can get it pretty nicely in the secondary market, picking up a lot of 2021 vintage CLOs, maybe some early 2022s.
Ryan Lynch (Managing Director)
Okay, that's helpful color on the market dynamics going on there and what you're seeing. The other question I had was kind of a high-level question about some trends that are occurring in the CLO market and the private credit market. You mentioned the one loan that was refi'd from the broadly syndicated loan market to the private credit market. That's certainly a trend that is likely gonna continue, if not accelerate, going forward. I'm just curious, I've seen some recent projections from different banks on the level of CLO formation that they expect in 2024. And again, these are, you know, just estimates that, you know-
Thomas Majewski (CEO)
Mm-hmm.
Ryan Lynch (Managing Director)
Can subject to change, you know, very much so. But a couple of trends from those was that they expect CLO issuance to be down for the third consecutive year in 2024. Additionally, this is Bank of America, who recently put out a report, who's talking about there's gonna be a big increase in middle market CLO formation in 2024, and there's already been a big increase in 2023, as those trends of loans, more and more loans going to private credit providers that are either holding them on their balance sheet or actually then funding them through middle market CLOs. So I'm just curious, from where you sit, if these trends continue, both lower CLO formation or an increase in middle market CLO formation, what does that mean for your business?
Thomas Majewski (CEO)
Sure. We're working in a, you know, ±$1 trillion-dollar market. Is it gonna get, you know, bigger or the new issue—the newly formed component is one part of it, the called component is another part. You gotta look at the two of those combined. Certainly, to date, we have not seen a situation where, we've had a—even in years where issuance is way down, where we've had a shortage of investment opportunities. Typically, when issuance is down, the secondary opportunities are more robust, frankly. At the same time, when folks are talking about down, it might be going from $100 billion...
I don't remember B of A specific numbers, but it could be going from $105 billion-$90 billion or something like that, while it's still down. All we need to deploy is $200 million in a, you know, in a given year and be more than fine. So our ability to source investments in the short to medium term is not something, frankly, I lose a lot of sleep over. Importantly, ECC actually also has a strategic interest in one CLO collateral manager. You can see in our portfolio, and it's disclosed in the footnotes.
But where the ECC actually owns or has a revenue interest in a piece of the collateral manager, that is independent of further beyond meeting a certain investment requirement that continues one way or the other. It's sort of like, I guess, you know, it's a, it's a permanent revenue share. So one of the things we've done in that case is it's an opportunity to continue to get access to CLOs if we want. While we certainly expect that platform to raise capital elsewhere, it's something that, that we obviously have a very deep tie with, and we'll have continued access. And then finally, when you look across our portfolio, you there are two things you'll see. We have, you know, it's a lot of the—we have deep relationships with a small number of select issuers.
These are issuers that, by and large, for us, have performed very, very well and where we have a special place with them, and, you know, you know, as long as they keep performing, they have a special place with us. So our access to the market, I think, is different and more, durable than a transient coming into the market. Across all of our, different investment vehicles, including ECC, we believe we're the largest holder of CLO equity in the world, which gives us a meaningful advantage. That said, we do have to keep investing to keep the portfolios fully deployed. And then to the point you've raised of the increase in private credit CLOs, formerly called middle market CLOs, you know, whatever, just put a different label on it.
It's like junior debt or senior equity, kind of the same thing. By and large, what we saw during the financial crisis, going back to 2008 and 2009, is that middle market CLOs, as they were called back then, while they had better credit experience, in terms of fewer defaults and better recoveries than syndicated loans, in general, the CLO equity frequently underperformed broadly syndicated CLOs. And that was frankly because the many of the collateral managers didn't have the DNA to reinvest it cheap. Rather, they make a new loan, 200 basis points wider. So we have a small amount of middle market or private credit exposure in our portfolio right now. It's very small, but it's greater than zero.
But some of that, intentionally, that's with folks who we believe can pivot to the extent new secondary syndicated loans are at 80 cents on the dollar. Go buy the really good ones at 85 cents and just be done with it and capture value that way. So we have firsthand personal relationships with all or some or many, at a minimum, of the middle market/private credit CLO issuers. As we look at the market, we believe it's an even smaller set of folks who will know how to deliver superior returns when things get choppy. Frankly, if they're taking out triple C loans from us, we're very, very happy about that. And I suspect we'll see an increase in private credit CLOs in our portfolio over the coming year or two.
No assurance, but that would be my best estimate. And with that, it's gonna be focused on an even smaller number of issuers who actually have experience in managing CLOs through cycles, not just folks that might have run a BDC for a long time, but are just dipping their toe in the CLO world. Running a BDC is very different than running a CLO, for better or worse.
Ryan Lynch (Managing Director)
That's, that's very helpful. That was—you kind of hit on my, my next question was gonna be: What is your middle market CLO exposure? Just because looking at some of these statistics is, you know, 10%-12% has been kind of the historical market share of middle market CLOs historically, and it's up to 22% in 2023, and it's projected, and again, who knows if the projection is gonna be right or not, but it's expected to be 32% of the CLO market. So-
Thomas Majewski (CEO)
Yeah, that strikes me as a—the 32 strikes me as a big nut. Stranger things have happened. I suspect it will be a... The day where we, I mean, well, I know what would happen. The day where we have cash, where we can't invest, we'll stop raising capital and, you know, we'll—we raise capital... I think few in the CLO—we raise capital when we see opportunities, and when it's accretive to shareholders, both on what we can put the money in the ground at and can we raise capital at an accretive to NAV-type price. There's few in the market who would say the summer was not a good time to be deploying capital. And you can see that our NAV was up 7%.
While a little bit of that was from the premium issuance, the vast majority of it was from other than premium issuance. And, you know, what we saw was paper was cheap, so we pushed the pedal to the metal a little bit. There's times when offers are scarcer, and frankly, we're less active on the ATM program. But it's a very effective tool for the company in that, while it's not-- it never is quite as simple as the traders see something attractive in the morning, we call the bank, you know, we issue the capital, and we can do it on a same-day basis. But I wish it was that easy.
But it's, it's something that works really well on a just-in-time basis to when we're seeing when, when the phone's lighting up more than often, we push the gas a little harder. The one challenge in managing a portfolio like ECC, you know, we get, well, make this our worst problem, we get a ton of cash four times a year. Again, make that our, you know, I will never actually complain about that. But, you know, the CLOs kind of pay on a January 15th, April 15th cycle. So that's why we have a little more cash than average as of October 30th. It's simply, you know, it's, it's Christmas here, you know, proverbially four times a year. And we're getting that money in the ground, you know, very, very quickly.
Ryan Lynch (Managing Director)
Okay. I appreciate your thoughts and comments on that. That's all for me.
Thomas Majewski (CEO)
Thank you.
Operator (participant)
Thank you. As a reminder, if you would like to ask a question, please press star one on your telephone keypad. Our next question comes from the line of Matthew Howlett with B. Riley Securities. Please proceed with your question.
Matthew Howlett (Managing Director and Senior Research Analyst)
Oh, hi, Thomas. Hi, Kenneth. Thanks for taking my question. Good morning.
Thomas Majewski (CEO)
Good morning.
Kenneth Onorio (CFO & COO)
Good morning.
Matthew Howlett (Managing Director and Senior Research Analyst)
Hey, you know, look, I think these—the question, look, I think this, it's the elephant in the room is your balance sheet. It just keeps on improving and deleveraging, you know, with the growth, with the growth and net worth. My question, and I think I asked the last time, is, I mean, you got to be looking at putting where your ratios are, putting, you know, some either preferred or, or, you know, term preferred or term debt on the balance sheet. I mean, given with the moving rates the last few weeks, given where you're talking, where yields are... But Thomas, should we be thinking about, you know, getting leverage back up to that 35% and taking advantage of these great spreads before, you know, they don't last?
Thomas Majewski (CEO)
A good question. We certainly, you know, are very proactive in managing the right side of the balance sheet. You know, we're blessed. I love our balance sheet. I'm looking at my Bloomberg screen. The nearest maturity is April of 2028 on the X's. Everything's unsecured, everything's fixed rate. We have some perpetuals out there even. So that's all good. And that's by design. We've intentionally run the company with a 25%-35% target band of leverage, including both preferred and unsecured debt. That's served us well in COVID, for example, where we were on sides in our ACR at all times, which, you know, that's an art as much of a science, kind of judging these things.
As we look at, you know, capital raising opportunities, yeah, ideally, we'd raise some common, some preferred, and some debt every single day. The OID rules on preferreds and debt, sometimes it make that not so easy to do. But I can assure you, we're continually looking at our balance sheet and looking at creative ways to, to prudently stay within that band. But we're comfortably... I think we're around 28% as of the last numbers?
Matthew Howlett (Managing Director and Senior Research Analyst)
Yes.
Thomas Majewski (CEO)
Yeah, around 28% right now. We try and keep it within there. Sometimes we've gone a little above, maybe we've gone a little below once in a while, but ideally, we're close to the midpoint of that band. But I can assure you, we're always thinking of, you know, trying to come up with creative things that may be accretive to the company over time. The flip side, when the stock is at a handsome premium, at a double-digit premium, sometimes it makes sense to capture a little more common equity at that point. But it's a balance of both, and, you know, we'll continue to look at opportunities on the right side of our balance sheet.
Matthew Howlett (Managing Director and Senior Research Analyst)
No, look, look, it's a good—it's a, you know, it's a high-class problem, you know, debt or equity, but I tell you, do you think you could issue... I mean, are the markets open today? I mean, could you issue—we've seen deals in the 8%, you know-
Thomas Majewski (CEO)
Yeah.
Matthew Howlett (Managing Director and Senior Research Analyst)
5 years, 7 years.
Thomas Majewski (CEO)
So the thing I don't like right now, just to be really candid, I hope your banker colleagues are listening. You can get a five-year done. One or two other, you know, 40 AC RICS have been out, CLO-oriented, have done some stuff in that space. But so five years from today puts us, like, right in 2028, right in 2029. I got a 2028 maturity and a 2029 maturity.
Matthew Howlett (Managing Director and Senior Research Analyst)
Right.
Thomas Majewski (CEO)
So, I say, what about us? We used to do 10 years or perpetuals. I said, "What about a 10-year CLO?" For real, I'm joking when I say that, but,
Matthew Howlett (Managing Director and Senior Research Analyst)
What about a seven-year?
Thomas Majewski (CEO)
Well, meet in the middle. I, you know, we'd be open to stuff like that. I haven't seen much get done in the $25 format. I can't point to anything, and we have an active business that invests in these securities from other vehicles, and obviously, sadly, not our own. I don't think I've seen any public deals come across in $25 market north of five years. Perhaps with the recent, you know, more stability in rates going forward, perhaps there's some path there. We've always have things in the laboratory here as well, and, you know, maybe we'll come up with some other ideas to be able to get closer to the midpoint of our range.
I am sensitive to not crowding up our maturity wall into 2028, 2029, which, if I had to do a five-year today, that's, that's where I'd have to, that's where I'd have to put it.
Matthew Howlett (Managing Director and Senior Research Analyst)
Look, I mean, you have a terrific balance sheet, the lowest leverage in the space. So obviously, it's worth pointing out. I mean, obviously, we can do the math on how creative that would be, putting you know leveraging back up modestly. And it just looks very attractive to us, particularly if you know if the you know yields keep on coming down here. And I wanted to dovetail into the question. You talked about defaults going down next year. I know it's a big picture thing, but I mean you know what are you seeing differently you know that the credit you know the leveraged loan market may actually see defaults have retraced? Do you-
Thomas Majewski (CEO)
Yeah, and I probably, just to clarify, I don't believe I predicted defaults going down next year.
Matthew Howlett (Managing Director and Senior Research Analyst)
Okay.
Thomas Majewski (CEO)
I did say that trailing 12-month default rate declined a little bit.
Matthew Howlett (Managing Director and Senior Research Analyst)
Understood
Thomas Majewski (CEO)
... versus the last quarter, versus some other recent data measure. But that was, sadly, not a prediction for all of 2024.
Matthew Howlett (Managing Director and Senior Research Analyst)
Okay.
Thomas Majewski (CEO)
So what the market's missing, though, to the specific way, like, most banks predicted, you know, around 3% defaults.
Matthew Howlett (Managing Director and Senior Research Analyst)
Right.
Thomas Majewski (CEO)
You know, I think one bank predicted 5% or plus defaults loans.
Matthew Howlett (Managing Director and Senior Research Analyst)
One to 10.
Thomas Majewski (CEO)
Wow!
Matthew Howlett (Managing Director and Senior Research Analyst)
Yeah, Deutsche-
Thomas Majewski (CEO)
That might have been for 2024, if-
Matthew Howlett (Managing Director and Senior Research Analyst)
Okay
Thomas Majewski (CEO)
... if memory serves.
Matthew Howlett (Managing Director and Senior Research Analyst)
Okay.
Thomas Majewski (CEO)
But we get questions from investors, you know, so every, you know, like CLO double B index, last I saw, is up, you know, I think 16% year to date. Joined the EIC call, their, their return on equity is even higher than 16% this year. But compare that to the AGG, you know, give or take, as of the last time I looked at, it's roughly flat for the year. All this floating rate is great. You know, it's all the rate problems are just not ours. Companies and defaults remain well below historic averages. The flip side, all these companies have to pay this higher interest to pay our higher cash flows. And, the...
What a lot of people have said is, "My goodness, debt service coverage ratios of companies are gonna get really constrained." It's true that companies' debt service is getting tighter. If your interest rate went from, you know, 1% base rate plus a spread, to now 5% base rate plus a spread, you gotta pay more.... Against that, what I think research analysts didn't give enough, kind of figure to consideration to, CFOs are pretty smart. Private equity sponsors are pretty smart. I don't remember the time where a company was $1 short on its debt service, and the equity handed the keys over to the lenders.
Matthew Howlett (Managing Director and Senior Research Analyst)
Right.
Thomas Majewski (CEO)
You can't say it's never happened, but it kind of sounds silly to even think about. So people have run reports that said, "Well, if rates move to this, my goodness, you know, X% of the loan market won't be able to pay its interest anymore." That's holding everything constant. You know, if things are a little tight, you slow pay your payables for a few weeks, you know, you sell the overseas division, you know, you call some sort of, you know, aggressive lender for a 15% mezzanine loan. As long as your revenue and EBITDA are growing, and according to the market data that we see, the average below investment-grade company, and you can see this in our investor deck. It's way in the back, but it's in there.
This is, I think it's LCD pitch book data, so it's all third-party data that shows revenue and EBITDA for the average below investment-grade company is going up.
Matthew Howlett (Managing Director and Senior Research Analyst)
Wow!
Thomas Majewski (CEO)
So if you own a business and the top line is growing and the bottom line is growing, are you going to hand over the keys because things get a little tight on payments for a couple of months? You know, and, and you know, for two-leggeds, you borrow from Uncle Charlie to, you know, pay your bill that month. You know, companies find ways. So I think too much of the analysis was keeping things in a steady state level without realizing there's, there's, you know, two-leggeds behind the scenes doing this stuff. And frankly, covenant-light. If you had a debt service covenant, you might be failing it.
Matthew Howlett (Managing Director and Senior Research Analyst)
Right.
Thomas Majewski (CEO)
You know, and then you're going to have some mercenary lenders who got in there, and they're going to be pushing for a default. You know, CLO guys, you know, probably got in a little early. We don't want it to default. Covenant-lite's our friend. Against that, only 4% of the loan market is below 80, you know, 4%, give or take.
Matthew Howlett (Managing Director and Senior Research Analyst)
Right.
Thomas Majewski (CEO)
And-
Matthew Howlett (Managing Director and Senior Research Analyst)
That's surprising.
Thomas Majewski (CEO)
I mean, that's a, you know, good indication of, you know, things below 80. You know, that's certainly the market saying there's some hair on the name, or more, a lot of hair in some of the names, but that means 96% of the market is not trading at distressed levels.
Matthew Howlett (Managing Director and Senior Research Analyst)
Right.
Thomas Majewski (CEO)
Either the research is one thing, but the reality, I think, is different.
Matthew Howlett (Managing Director and Senior Research Analyst)
Well, I tell you, you know this, you guys know this market extremely well. You're doing such a great, great job with it, and you've called it. So my last question is, the cash flows, we always go to this, you know, between the recurring cash flows, the gap, and I get the disconnect. Cash flows are back up big in October. I mean, what's driving it? And then when we... you know, it—we still have this. I didn't expect it to last this long, this huge recurring cash flow still way above, you know, the GAAP reported NII. And how long do you see it? Why were the cash flows way up in October? This is the gift that keeps on giving.
I mean, how, you know, assuming there's probably up to be special dividends going forward just to manage that taxable basis. I mean, all this good stuff. I get another high-cross problem.
Thomas Majewski (CEO)
You've got Ken and I smiling here. The number of emails I get from my friends when we announce specials and supplementals, they're always very happy.
Matthew Howlett (Managing Director and Senior Research Analyst)
It's a happy day, a special dividend day.
Thomas Majewski (CEO)
Yeah. No, everyone like, I mean, we're, we're so close to getting to $20 in distribution since the IPO, which, you know, that's, we're, you know, we're within, you know, shooting distance to get that done, which will be great. Just a, you know, a ringing the bell type event for us.
Matthew Howlett (Managing Director and Senior Research Analyst)
Absolutely. Big milestone.
Thomas Majewski (CEO)
But, so, yeah, so what happens, so loan spreads are up a bunch. You know, if we're up 11 basis points on our spread, you know, CLOs are, you know, 10+ times levered, so that just generates more cash right there because our CLO debt spreads are fixed. B, there was a period of time when there was a big basis between one-month and three-month LIBOR-
Matthew Howlett (Managing Director and Senior Research Analyst)
Right.
Thomas Majewski (CEO)
or one month and three-month SOFR, and it was kind of, memory serves, you know, 40, 50 basis points, which, you know, to every time you make a payment on one of these loans, you got to send in a certificate and all kinds, you know, the CFO's got to sign some papers, you got to call legal. If you're saving 50 basis points, you're going to do it. If you're saving five basis points, stop it, just pay the three-month rate. Unfortunately, essentially all CLOs pay only off of three-month, so that differential has closed.
We are probably, if you look back and it was one second one July, not this year, maybe last year, where it was really out of whack, and maybe it's two years ago, we were, "Oh, we're saying one month, three-month LIBOR was out of whack." That's now largely behind us, so that's also helped. You know, the three-month rates have been pretty stable over the last couple of months, which then helps the arb just work even better in CLOs. So, as you saw, third quarter cash flow or fourth quarter cash flows collected better than all of the third quarter, and we still have a few more payments that we're expecting. Combination of the portfolio growing and the spreads on the loans underlying the CLOs continuing to go up.
So, we obviously hope that continues as much as possible. Stuff can happen that moves it around to some degree. It's, sadly, it's not a trend you can predict forever. But some of the things that kind of put us offsides a little bit, I think, are behind us at this point.
Matthew Howlett (Managing Director and Senior Research Analyst)
Unbelievable. Well, we'll enjoy it and, and keep up the good work, and thanks for answering all those questions. Thanks, everyone.
Thomas Majewski (CEO)
Thanks very much, Matthew. Thank you.
Operator (participant)
Thank you. Our next question comes from the line of Steven Bavaria, with Inside the Income Factory. Please proceed with your question.
Steven Bavaria (Investing Group Leader and Lead Analyst)
Hi, Thomas.
Matthew Howlett (Managing Director and Senior Research Analyst)
Hey, Steven. Good morning.
Steven Bavaria (Investing Group Leader and Lead Analyst)
Good morning. I loved your path, your conversation just now. As an old credit guy, you're those are all themes I love. But my specific question, you know, most closed-end funds focus a lot on NII coverage of their just, you know, for distribution coverage. You folks focus primarily on recurring cash distributions, which of course is much higher. Could you just outline for us, what's the primary difference between what additional items are in recurring cash distribution that are not part of standard net investment income? You know, and specifically, does it include recurring principal amortization that's made on, you know, your typical loans, not just a bullet loan. It's, it's got recurring principal amortization. Does that recurring amortization flow down as part of recurring cash distribution?
Thomas Majewski (CEO)
Sure. Very good question, Steven. The recurring cash flows are equity distributions from CLOs, and if we have CLO debt and other things that pay interest, but excludes distributions from called CLOs, period. So it's basically the NII getting generated out, paid in cash from our underlying CLOs. Well, unless all the CLO debt has been paid off, which I don't know, we might have one or two of those, but that's not really our portfolio. Any principal that comes in on a loan, if the CLO is in the reinvestment period, is going to be reinvested into new loans or secondary loans. So that doesn't come to us. And if it's after the reinvestment period, it's going to be used to pay down the Triple As and the Double As and so on and so forth.
So all of the recurring cash flows, with one exception, I'll come to, are really just all NII or coupon income coming out of our investments. The one slight exception, we don't really have much of it now. Sometimes there's called a flush payment on a CLO when it's newly created on the first payment date. Sometimes you get a little extra from that, which can actually be like a special principal dividend. But we don't really, because we don't really have any new CLOs right now, that's not a big part of our cash flow. So the short answer to the first part of your question, what is principal included in recurring cash flows? By and large, the answer is no, because the principal payments on loans are generally trapped in a CLO.
Then B, let me think through this. You had the, what's the difference between cash and NII, GAAP, NII? At the end of the day-
Steven Bavaria (Investing Group Leader and Lead Analyst)
Yeah.
Thomas Majewski (CEO)
Cash is what pays the bills. Cash is what we distribute to shareholders. That's the most important, you know, tax, GAAP, all this other stuff. Cash, money in the bank is always the most... Statement of cash flows is the most important of the three financials on a company, in my opinion. The difference, the principal difference between cash and GAAP, is a reserve for credit losses and a handful of other smaller things. But when we predict NII, one of the things we say when we talk about these effective yields, or we often say, these include a reserve for future credit expense. In old bank speak, you know, if you worked at, say, Bank of New York a few years ago, you'd call that a loan loss reserve.
Steven Bavaria (Investing Group Leader and Lead Analyst)
Right.
Thomas Majewski (CEO)
For variable interest entity accounting, VIE accounting, we take a reserve for losses. We disclose a lot of this in our financial statements, but you can see, you know, we typically get default rates up to 2%, 2+%. Right now, we have 40 basis points of default exposure. So we are taking reserves for future losses, and, you know, very rarely do defaults happen exactly as modeled. Sometimes they're higher, sometimes they're lower. Right now we're seeing lower defaults than we'd expect. If we did have a default on a loan in a CLO, it doesn't come dollar for dollar out of the cash flow of a CLO in that-
Steven Bavaria (Investing Group Leader and Lead Analyst)
Mm-hmm.
Thomas Majewski (CEO)
It reduces our interest income a little bit, but the recovery on that loan is invested in a new loan, which generates new cash flow. A default principally reduces the terminal value of a CLO, but-
Steven Bavaria (Investing Group Leader and Lead Analyst)
Mm-hmm
Thomas Majewski (CEO)
... that could be five, seven years from now, and we're, we're mainly interested in money today. So the big difference is a reserve for credit losses, and by and large, credit losses are lower than the models today. But they could go back up tomorrow, but that's the, that's the big driver.
Steven Bavaria (Investing Group Leader and Lead Analyst)
So the NII actually is net of a loan loss reserve?
Thomas Majewski (CEO)
Correct. That's a fair way to think of it, yes.
Steven Bavaria (Investing Group Leader and Lead Analyst)
Oh, okay. That's that answers a big question, and it also answers the question, I believe, that your recurring cash distributions, to the extent you use those to pay dividends, distributions, does not include an eroding factor like as it would if it included principal payments.
Thomas Majewski (CEO)
Yeah. We're not taking loan principal payments and distributing those.
Steven Bavaria (Investing Group Leader and Lead Analyst)
Perfect. Okay, that's really good news, you know, and answers a question a lot of retail investors, you know, have been asking me, frankly, and I'm glad I have the forum now. Thanks.
Thomas Majewski (CEO)
Yeah. The number one thing we look at recurring, I mean, if any business you underwrite, what's the recurring cash flow? If you could have only one measure, would you have GAAP, tax, or cash? In my opinion, I would go with cash over the other two all day long, and maybe keep tax as low as possible. But that's, you know, at the end of the day, the cash flow is what we want to pay out to shareholders every single quarter. And we do everything we can to keep that as high as possible.
Steven Bavaria (Investing Group Leader and Lead Analyst)
Great! Hey,
Thomas Majewski (CEO)
Hopefully, Matt's bankers will call us back about a 10-year deal, not... so.
Steven Bavaria (Investing Group Leader and Lead Analyst)
Yeah. That's great. Okay, thanks, Thomas.
Thomas Majewski (CEO)
Appreciate it, Steven. Thanks so much.
Operator (participant)
Thank you. Ladies and gentlemen, that concludes our question and answer session. I'll turn the floor back to Mr. Majewski for any final comments.
Thomas Majewski (CEO)
Great. Thank you very much, everyone, for joining. Both Kenneth and I appreciate your interest in Eagle Point Credit Company. Obviously, very pleased with our third quarter results and, we shared cash flows in the fourth quarter, trending very favorably. Kenneth and I will be available if anyone has any follow-up questions later today, and we appreciate your time and attention. Thank you.
Operator (participant)
Thank you. This concludes today's conference call. You may disconnect your lines at this time. Thank you for your participation.