Eagle Point Credit Company Inc. (NYSE:ECC) Q2 2023 Earnings Call Transcript

Eagle Point Credit Company Inc. (NYSE:ECC) Q2 2023 Earnings Call Transcript August 15, 2023

Operator: Greetings, and welcome to Eagle Point Credit Company’s Second Quarter 2023 Financial Results Conference Call. [Operator Instructions]. 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: Thank you, and good morning. By now, everyone should have access to our earnings announcement and investor presentation, which was released prior to this call, which may also be found on our website at eaglepointcreditcompany.com. 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.

Thomas Majewski: Great. Thank you, and 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 continue 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 continuous — 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 1-month and 3-month LIBOR and SOFR continue 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 for aggregate monthly distributions of $0.16 through the end of the year. Inclusive of the July 31 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 continue 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. And 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 30. 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, and 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. And 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 3 years at the end of 2020. Despite the passage of 6 months through our proactive portfolio management, the warp on our CLO equity portfolio was just reduced by 4 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 period 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. And 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.

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Kenneth Onorio: 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 30, 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 and live 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 30 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% to 35% of total assets under normal market conditions.

Moving on to our portfolio activity in the third quarter through July 31, 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 31, 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 31 was $9.08 to $9.18, reflecting a 4.7% increase from June 30. During the second quarter, we paid 3 monthly common distributions of $0.14 per share and 3 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.

Thomas Majewski: 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 12-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% and 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 CLO’s 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 our — in the CLO market, we saw about $22 billion of new CLO issuance in the second quarter of 2023 and $56 billion for the first 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 AAA 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. As we have consistently noted, it’s 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 and using par paydowns from other loans and outperform the broader corporate debt markets over the medium term as they have done multiple times in the past.

To sum up, we generated net investment income in the quarter of $0.32 per weighted average common share. We saw a significant increase in cash flows in the second quarter and we expect cash flows to be robust in future quarters. We remained active in the quarter in terms of sourcing and deploying capital investments with attractive yields, principally in the secondary market. We continued our existing regular monthly common distributions and variable supplemental distribution through the end of the year. We further strengthened our liquidity position during the quarter generating $0.12 per share of NAV accretion through our ATM program and have ample cash on our balance sheet as of July to deploy into new attractive investments. We continue to maintain 100% fixed rate financing.

We have no maturities prior to April of 2028. We have no secured debt or repo financing whatsoever. This gives us very stable financing and protection from any further increase in interest rates. We believe the company’s investment portfolio continues to be in strong shape given its weighted average remaining reinvestment period, strong OC cushion and consistent recurring cash flows. We remain pleased to return extra cash to our investors in the form of special or variable supplemental distributions. And we’ll remain opportunistic and proactive as we manage our investment portfolio with a long-term mindset. We thank you for your time and interest in Eagle Point Credit Company. Ken and I will now open the call to your questions.

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Q&A Session

Operator: [Operator Instructions]. Our first question comes from Paul Johnson with KBW.

Paul Johnson: Yes. Good morning. I hope you can hear me okay. As far as this quarter goes on just the marks for the portfolio, were there any onetime items, I guess, that drove the realized losses in this quarter? Or is that just kind of a result of paid off, CLO equity positions that you guys have?

Thomas Majewski: Do you want to take that, Ken?

Kenneth Onorio: Sure. So, are you referring to the $0.22 or the overall portfolio?

Paul Johnson: Yes. Correct. I mean I’m just looking at the $16.1 million or so, the realized loss this quarter.

Kenneth Onorio: Yes. Sure. So that — the $0.22 is an accounting reclassification where we are walking down amortized cost to fair value for a handful of late-in-life CLOs. So it’s a reclassification from unrealized loss since it was already reflected in our fair value in previous quarters, and it’s being reclassed to realize loss. So we are basically pushing out loss through earnings, moving it from below the line to above the line. So that is an accounting classification with no meaningful impact to NAV. It’s just a reclassification that we have to do for temporary impairment accounting. When we have CLOs that are late in life without any sort of meaningful chance of recovery into profitable or cash flowing investments.

Thomas Majewski: We had already marked these down as the takeaway. This is simply a balance sheet geography.

Paul Johnson: Got you.

Thomas Majewski: Or [indiscernible] balance sheet geography.

Paul Johnson: Got you. I understand it can be complicated, especially late in the life of these things. I mean, then just in general, I mean, what was kind of the driver of the marks this quarter? I mean, I know loan prices were up. It sounds like the portfolio is turning pretty well. You guys explained kind of the reclassification here. But were there any other kind of items that you could see just conserving from kind of the top-down that drove the decline now in the quarter.

Thomas Majewski: No significant portfolio specific items, if anything, yields widened during the second quarter. So while cash flows increased, the market yield, the market demand or the yield demanded in the market for CLO equity unambiguously widened during the second quarter. And so that has the reflect of reducing the secondary sale value of our portfolio. So we’ve been always very, very proactive and accurately marking our portfolio. Sometimes it’s up, sometimes it’s down on a marked basis, what you’ll see if you look back going back quarters to 2014, regardless of the markets going up or down, the cash flow 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 and frankly, all — and all the capital deployed during the second quarter into CLO equity has done quite well in July, and NAV was up between 4% and 5% in the month of July based on our estimates, and that’s net of the distribution, the regular and supplemental distributions paid to the shareholders during the month.

Paul Johnson: Appreciate that. And then I guess, you mentioned on the call, a big pickup and yield differential between what you’re seeing in the secondary markets versus the primary I’m just curious why there is, I guess, such a big difference in secondary opportunities today? And are you guys seeing enough of those to sort of, build a pipeline? Or do you — would you rather see, recovery in the primary issue market?