Eagle Point Credit Company Inc. (NYSE:ECC) Q2 2024 Earnings Call Transcript

Eagle Point Credit Company Inc. (NYSE:ECC) Q2 2024 Earnings Call Transcript August 6, 2024

Operator: Greetings. Welcome to the Eagle Point Credit Company Inc. Second Quarter 2024 Financial Results Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] I will now turn the conference over to your host, Garrett Edson of ICR. You may begin.

Garrett Edson: 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. As a reminder, before we begin our formal remarks, the matters discussed on this call include forward-looking statements or projected financial information that involve risks and uncertainties that it 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 2024 financial statements and our second quarter investor presentation with the Securities and Exchange Commission. The financial statements and 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 will now turn it over to Tom Majewski, Chief Executive Officer of Eagle Point Credit Company.

Thomas Majewski: Thank you, Garrett, and welcome, everyone to Eagle Point Credit Company’s second quarter earnings call. We would like to invite you to download our investor presentation from our website, which provides additional information about the company and our portfolio. Recurring cash flows from our portfolio increased on both on an absolute and per share basis in the quarter to $71.4 million or $0.79 per share. This is up from $56.2 million or $0.70 per share in the first quarter and exceeded our quarterly aggregate common distributions and total expenses by $0.13 per share. The higher recurring cash flows were in part due to the growth of our portfolio as well as the results of semi-annual interest payments received from certain of our assets in our CLOs during the second quarter.

It’s worthnoting that roughly 3% of our CLOs underlying portfolios are now invested in bonds, which typically pay interest on a semi-annual basis, and we do expect some fluctuations in cash flows from quarter-to-quarter. The company generated net investment income less realized capital losses of $0.16 per share, which comprised of $0.28 of net investment income and $0.12 of realized losses. The realized losses included $0.15 per share related to the write-down of amortized cost to fair value associated with two legacy CLO equity positions, which had already been reflected in NAV as unrealized losses. This was basically a reclassification on our balance sheet from unrealized to realized. Excluding this, we realized $0.03 per share of gains principally from selling appreciated CLO debt positions during the quarter.

Excluding the reclassifications, net investment income and realized gains would have been $0.31 per common share. NAV per share as of June 30 was $8.75. And we’ll walk you through more of our financial results shortly. But first, I’d like to take you through some additional highlights from the second quarter. We deployed over $135 million in net capital into new investments. The new CLO equity purchases that we made during the quarter had a weighted average effective yield of 19.4%. During the quarter, we completed four resets and two refinancings. Also, we launched our new Series AA and Series AB non-traded convertible preferred perpetual stock offering. The offering so far has generated proceeds for the company of approximately $9 million.

The total program size is expected to be $100 million. We believe the non-traded perpetual program will be significantly accretive to ECC over time and we are very excited about it. We were able to issue approximately 12 million common shares through our at the market program or ATM. These shares were issued at a premium to NAV and it generated NAV accretion of $0.11 per share. We also issued a smaller amount of preferred stock under the ATM. Over the previous quarters, we had opportunistically purchased CLO BBs at discounts, which we started selling this quarter, harvesting gains and beginning to rotate the proceeds from those sales back into CLO equity. We expect to continue this rotation over the coming months and expect to invest the proceeds of those CLO BB sales into higher yielding CLO equity.

During the second quarter, along with our regular monthly common distribution of $0.14 per share, we paid an additional variable supplemental monthly distribution of $0.02 per share for an aggregate monthly distribution of $0.16 per share. Consistent with our long-term financing strategy for operating the company, all of our financing is fixed rate and we have no financing maturities prior to April, 2028. In addition, some of our preferred stock financing is perpetual with no set maturity date. As we’ve stated consistently in the past, we actively managed our portfolio towards having a long remaining reinvestment period and this drives performance we believe and guards against future market volatility. Similarly, rotating CLO BBs back into CLO equity, we believe remains highly attractive in today’s market.

In this prolonged environment of tightening CLO debt spreads, the refinancing and reset market has also returned. We completed four resets and two refinancings in our portfolio during the quarter. These actions have extended the reinvestment period of the reset CLOs to five years, and lowered the debt cost of the refinance CLOs by an approximately 20 basis points. We have a robust pipeline of additional reset and refinancing opportunities under negotiation. As of June 30th, our CLO equity portfolios weighted average remaining reinvestment period or WARRP stood at 2.7 years, which is 0.2 years longer than where it stood on March 31. And this is despite the passage of three months time. Our portfolio’s WARRP is 59% above the market average of 1.7 years.

We continue to believe keeping our WARRP as long as possible is our best defense against future market volatility. I would also like to take a moment to highlight Eagle Point Income Company, which trades on the New York Stock Exchange under the ticker symbol EIC. EIC invests principally in CLO debt. For the second quarter, EIC generated net investment income and realized gains excluding non-recurring expenses of $0.54 per share. EIC continues to perform well and we believe remains well positioned to continue generating strong NII. We invite you to join EIC’s Investor Call today at 11:30 AM after this call and to visit the company’s website, Eagle Point Income to learn more. After Ken’s remarks, I’ll take you through the current state of the loan in CLO markets.

I’ll now turn the call over to Ken.

Kenneth Onorio: Thank you, Tom, and thanks, everyone for joining our call. For the second quarter, the company recorded net investment income less net realized capital losses of approximately $15 million or $0.16 per share. This compares to NII and realized gains of $0.29 per share in the first quarter of 2024 and NII less realized losses of $0.05 per share in the second quarter of 2023. Second quarter results include the effect of $0.15 per share of realized losses due to the write-down of amortized cost to fair value for two legacy CLO equity investments. The two investments are no longer generating cash flow, have a zero effective yield, and were at least one year past a reinvestment period end date. Since the fair value of these investments had already been previously reflected in the company’s NAV, the realized loss was a reclassification from an unrealized loss.

There was no impact to NAV as a result of the write-down. Excluding the write-down, our second quarter NII and realized gains would have been $0.31 per share. When unrealized portfolio depreciation is included for the second quarter, the company recorded a GAAP net loss of approximately $4 million or $0.04 per share. This compares to GAAP net income of $0.43 per share in the first quarter of 2024 and GAAP net income of $0.11 per share in the second quarter of 2023. The company’s second quarter GAAP net loss was comprised of total investment income of $42.3 million and net unrealized depreciation on certain liabilities held at fair value of $1.1 million offset by net unrealized depreciation on investments of $19.4 million, realized capital losses of $10.8 million, expenses up $16.1 million, distributions on the Series D Preferred Stock of $0.6 million and distributions on the convertible preferred stock of $0.1 million.

Additionally, the company recorded other comprehensive loss of $2.8 million for the quarter. The company’s asset coverage ratios at June 30 for preferred stock and debt calculated pursuant to Investment Company Act requirements with 352% and 682% 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. Below the mid-point of our target range of generally operating the company with leverage between 25% to 35% of total assets under normal market conditions. Last week, we declared monthly common distributions for the fourth quarter in line with our recent distributions.

The $0.16 per share of monthly aggregate distribution is comprised of $0.14 per share regular distribution, and a $0.02 per share supplemental distribution. We will continue to review our variable supplemental distribution on a quarterly basis. Moving on to our portfolio activity so far in the current quarter through July 31, the company received recurring cash flows on its investment portfolio of $60.4 million. The lower recurring third quarter cash flow figure compared to the second quarter is driven by approximately $80 million in new CLO equity investments, which have not yet made their first payment. Some spread compression and off-cycle semi-annual paying loans and bonds in the underlying portfolios. We do expect our portfolio cash flows to move higher in the fourth quarter.

I’ll now hand the call back over to Tom for his market insights and updates.

Thomas Majewski : Thanks, Ken. I’ll now update everyone on the trends we are seeing in the loan and CLO markets. Starting off with loan performance, the Credit Suisse Leveraged Loan Index continued to perform well in the second quarter, generating a total return of 1.87% for the quarter and 4.44% for the first half of 2024. The Index continued its trajectory in July with loans up 5.21% through July 31. We continue to believe dealer research desks are significantly overstating overall corporate default risk as the underlying loan borrowers that we see have continued to see revenue and EBITDA growth on average despite the current elevated rate environment. Dealer research desk a default forecast for 2024 are now typically between 4% and 6%.

However, during the second quarter, we saw only six loans actually default, which was the same number as the prior quarter. As of quarter end, the trailing 12-month default rate was 92 basis points remaining well below the historic average of 2.65% and even farther below dealer forecast. As of June 30th, ECC’s portfolio’s exposure to defaulted loans stood at 53 basis points. Also, during the second quarter, approximately 9% of all leveraged loans were at roughly 35% annualized were repaid at par. While there has been some opportunistic repricing activity within the nearly 45% of loans trading at or above par, many loan issuers remain very proactive in tackling their near-term maturities through these repayments and refinancings in an effort to further push out their debt maturities.

We view this as another sign of the loan market’s resiliency. On a look through basis, the weighted average spread of our CLOs underlying loan portfolios was 3.63% at the end of the quarter, and that’s down from 3.74% at the end of the prior quarter. Meanwhile, spreads on debt tranches issued by our CLOs that were locked in two years ago remain unchanged and have the potential to tighten significantly as they roll off their non-call periods later this year and early next. Over the past few days, there has been some softness in the loan market in line with the broader market volatility. The price movement we’ve seen in the loan market has been relatively modest to date. In terms of new CLO issuance, we saw $53 billion in the second quarter of 2024 and $102 billion for the first half of 2024.

This is the fastest pace on record and approximately 82% higher than the new issue CLO volume for all of the first half of 2023. As CLO debt spreads have tightened third-party CLO equity investors, including us, have returned to the new issue market. During the second quarter, we invested significant amounts of capital into both primary and secondary CLO equity as well as other attractive investments. Market-wide CCC concentrations within CLOs stood at 6.6% as of June 30, and the percentage of loans trading below 80 within CLOs in the market was about 5.5%. Our portfolio’s weighted average junior OC cushion was 4.2% as of June 30, which gives us ample room to withstand potential future downgrades or losses. To compare this, our portfolio’s OC cushion remains well higher than the market average of 3.2%.

We continue to believe CLO structures and CLO equity in particular are set up well to buy loans at discounts during periods of volatility and ultimately outperform the corporate debt markets over the medium term as they have done in the past. To sum up the quarter for ECC, we generated net investment income and realized capital gains excluding the write-down reclassification for the quarter totaling $0.31 per weighted average common share, recurring cash flows were solid in the second quarter, both up on a quarter-over-quarter basis and comfortably exceeding our regular common distributions and expenses. We sourced a significant number of attractive new investments, investing $135 million of net capital during the second quarter. Our portfolio’s WARRP of 2.7 years increased during the second quarter and remains significantly longer than the market average.

We expect our WARRP to increase further as our new issue investing in reset activity continues. Our existing regular monthly common distributions and variable supplemental distributions were declared through the end of 2024. We’ve also significantly strengthened our balance sheet through the launch of our non-traded 7% perpetual convertible preferred stock, as well as NAV accretive issuances through our ATM program. We continue to maintain 100% fixed rate financing with no financing maturities before 2028, providing protection from any future rise in rates and locking us into an attractive cost of capital for years to come. Further, an increasing amount of our preferred financing is now perpetual with no repayment date obligated. Importantly, we still see an abundance of primary and secondary CLO equity opportunities and have a robust pipeline of refinancing and reset opportunities under consideration to further enhance the value of our portfolio.

In closing, we are encouraged by the performance in the first half of the year. Our proactive investment approach has resulted in the portfolios significantly greater than market average WARRP, strong OC cushions and high recurring cash flows. We believe our portfolio is well positioned for continued strong performance through the second half of the year. We appreciate your time and interest in Eagle Point. Ken and I will now open the call to your questions. Operator?

Q&A Session

Operator: Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Mickey Schleien with Ladenburg Thalmann. Please proceed with your question.

Mickey Schleien: Yes. Good morning, everyone. Tom, there’s been a leveraged loan repricing wave, which we’re all aware of, that’s been driving down loan spreads. I see that your portfolios weighted average AAA spread is near the market average. So how much of an opportunity do you have left to refinance or reset the liabilities in your CLO equity portfolio to help defend your yields against that spread compression?

Thomas Majewski: Hey, Mickey. Good morning. Excellent question. Couple of things in there. Definitely loan spreads tightening. I forget the exact number, tighter about 10 basis points plus or minus quarter-over-quarter. Flip side of that, of course, defaults very few in a spread tightening world. But to your specific question of how do we manage the right side of our CLO balance sheets, while the average is about the market average. We give you line-by-line detail in the investor presentation. There’s a tremendous dispersion, and I don’t know the exact number. But about half of them are probably above the average. And some of the highest cost CLOs start running off of non-call later this year. So we have been very proactive.

I think we had four resets and two refis in the second quarter. And we continue to be active with those here in the third quarter. And we have an active pipeline. Obviously, market conditions can change at any time. But what I would less focus on the average and more focus on kind of sorting by the highest AAA ones and looking at the non-call dates on those. And those are the ones we’re most focused on, particularly as they run off of non-call.

Mickey Schleien: I appreciate that. Thanks for that clarification. You mentioned that default forecast seemed fairly pessimistic and the ratings agencies have also remained pretty conservative and haven’t seemed to accept, what I – price are decent odds of a soft landing. And they also don’t seem to recognize the amount of capital available to lower quality borrowers. So the downgrade to upgrade ratio is still a problem. That situation can obviously pressure CCC buckets. So how are your portfolio managers dealing with that trend?

Thomas Majewski: Yes. I mean, there’s always too many CCC. As long as there’s one CCC, I guess there’s too many against that. Our CLOs in general have tons of cushion. We provide the average in our deck for both our CCC bucket. Let me just pull up the number here, bear with me. CCCs, this is on, I’m looking at the right deck here Page 28 of the master presentation. 6.37% is the weighted average CCCs, which is, I think, slightly better than the overall market, which is good across our CLOs. Again, there’s an average and a dispersion, you’ll see some of them have higher numbers, others lower. The higher ones are typically later in life and in many cases are amortizing. Against that we also have 4.2% junior OC cushion on a weighted average basis.

And that is very, very powerful in that you’d need to have CCCs on the typical CLO go over 7.5%. And then you start taking a haircut above 7.5% the lower of your market or a stated number in a given CLO. But in general, you could probably cuff it that we could have 15% CCCs on average, give or take before we actually faced interruption on CLO equity payments. Now, if we got to a market where there was 15% CCCs the current markets in the sixes, there’s clearly something going on in the world and a continued downdraft. And what that would suggest is while a non-trivial amount of loans right now are priced at pretty heavy prices, relatively high prices, although coming down a little bit lately. You’d imagine you’d see a draw down in all loan prices, which would then help discounted reinvesting non-CCC loans to help build back bar.

Quite a few of the CLO managers in our portfolio frankly have never missed a payment to the equity through COVID, through the financial crisis, these OC tests are very important. I hope there’s no AAA investors on the call right now, but they only matter four minutes a year. They matter on the end of the – the close of business on the quarterly determination dates. So it’s a known target and good CLO managers have a schedule, they know when they need to be passing that OC test. And the folks we work with have a pretty good knack of doing that. Obviously, who knows what the future brings. But having been involved in CLO management here over the years at Eagle Point as well, those are relatively manageable tests. But we’ve got a better than average portfolio and I think the collateral managers we partner with have a real good knack in maintaining these – of beating these tests, and they really just matter of four minutes a year.

Mickey Schleien: Tom, in terms of the folks you work with, Eagle Point has grown significantly over the years. So I’m curious whether you can still focus on just top tier managers or have you grown to a point where you need to consider tapping into maybe second and third tier managers, assuming the pricing is right to be able to deploy capital?

Thomas Majewski: Yes. So I would say over an extended period of time, we’ve had collateral managers that the market would rank in varying tiers. What we’re focused on at ECC are CLO collateral managers that have the DNA to deliver superior equity returns. On the surface, you’d think all CLO collateral managers want to deliver superior equity returns. The equity investors are the owners or the residual holders. They’re all companies work for the owners. In our opinion, some purportedly Tier 1 CLO collateral managers think of the equity as nice, but not really important. So one of the things our investment process is focused on is, is honing in on CLO collateral managers who have the DNA to outperform for the equity class while respecting their creditors, A.

Then B, while ECC has certainly grown and Eagle Point’s, our overall CLO equity holdings, which are far greater than just what’s in ECC have grown, we still remain what we believe to be a single-digit percentage of the market. The CLO market itself is about a $1 trillion outstanding give or take in just the U.S. The nice thing is, when you look through our portfolio, I’m just looking at that same Page 28 like Octagon, which is a CLO manager. We’ve worked with a bunch. You can see we’ve got 26, 27, 29, 37, 44, 45, so on and so on and so on. All the way up to Octagon 58 and old Octagon 14, our original investment, when back when they used Roman numerals. So the good news is that the chefs we like so to speak, are always in the kitchen and there’s always another one coming.

So sometimes we buy new, sometimes we buy used, depending on what’s better in the market condition. But we’ve not struggled to find access to the collateral managers that we’ve wanted to. And frankly, our continued size and scale has net helped us in that we – in that were in many cases their most relevant equity investor.

Mickey Schleien: That’s very helpful, Tom. Thanks for your time this morning.

Thomas Majewski: Great. Thanks so much, Mickey.

Operator: Thank you. Our next question comes from the line of Mitchel Penn with Oppenheimer & Company. Please proceed with your question.

Mitchel Penn: Thanks so much. Quick question just to follow-up on Mickey’s question. The impact to spread compression during the quarter, you said it was around 10 basis points. Is that – are you taking – is that just the loans that were repriced or is that taking the amount that was repriced and spreading it over the total portfolio?

Thomas Majewski: I had used the number 10 earlier. I said approximately. The exact number is 11 basis points, just to be clear, and good morning. That’s just the weighted average spread of the loans in our portfolio. It doesn’t matter if it was a repricing, if a loan was sold, the loan was bought, whatever, the weighted average spread as of the prior quarter, weighted average spread of this quarter, taking into account all changes in the portfolio, new CLOs, changes in the CLOs and different CLOs that we bought and sold during the quarter as well.

Mitchel Penn: Got it. Because we had heard a higher number mentioned, and I assume that’s just on the new deals or whatever deals repriced, it was a higher number, but then we…

Thomas Majewski: I’m sure some loans reprice 50, 100 basis points tighter.

Mitchel Penn: Got it. That makes sense.

Thomas Majewski: Others may have repriced wider if they were kicking out their maturity. So that’s just overall what our portfolio did in aggregate.

Mitchel Penn: And you said the research guys are like – the Street’s like 4% to 6% default forecast, and you guys thought it was lower. I think, and tell me if I’m wrong, you’re looking at just defaults, you’re not including distressed exchanges. Is that correct? Because distressed exchanges are running over 4% right now.

Thomas Majewski: Correct. So the number we cite and what triggers a D rating, some distressed exchanges do trigger D rating, others don’t. Facts and circumstances vary. Our number is anything, I believe, that’s rated D or fail to pay, which would be immediately rated D. Sometimes distressed exchanges happen below us. Sometimes they do happen at the loan level as well.

Mitchel Penn: Got it. But that would probably be why the Street’s estimating a higher number probably because they’re including those distressed exchanges?

Thomas Majewski: Different dealers include different things in their measures as long as your par is not impaired. I don’t know. I mean, that to me seems like the most important thing. And some distressed exchanges, you do take less par back but in many you don’t.

Mitchel Penn: Got it. That’s all for me. Thank you.

Thomas Majewski: Great. Thanks, Mitchel.

Operator: Thank you. [Operator Instructions] Our next question comes from the line of Matt Howlett with B. Riley Securities. Please proceed with your question.

Matthew Howlett: Good morning. Hey, Tom.

Thomas Majewski: How are you?

Matthew Howlett: Good. Thanks. Thanks for taking my question. Congratulations again. I’ll just start on a follow-up. I mean, how much do you look at these analyst forecast or default rates? I mean, they’ve been dead wrong for a number of years. So just curious like when you look at that stuff, would you say your portfolio is a 50 bps of loan default?

Thomas Majewski: Yes. We don’t really care about it. I mean, it’s just interesting to see. I mean, in 2022, one leading investment bank predicted 11% defaults for 2024. I mean, it’s fascinating, but it doesn’t – yes, doesn’t really make a difference one way or the other. For as long as our loans keep paying, that’s the relevant measure.

Matthew Howlett: Yes. I mean, and that’s why I want to kind of dovetail into my question here. I mean, you have this incredible phenomenon that you have reoccurring cash flows that are way above the dividend, way above what you report for GAAP NII. And this has been going on ever since I’ve been covering the company, I mean, really for several years now. I know at some point, GAAP and cash flow and tax all kind of converge. Just what can you, I mean, tell us about what you really believe is the economic earnings power? Like what metric? What should we look at? Should we just – I’m assuming that we’re not going to get this huge reoccurring cash flows above dividend forever. And otherwise, you’d have to raise the dividend a lot over time. Just walk me through how to think about it because last [indiscernible] I mean, it’s been great. Every since I’ve covered the company, you’ve seen this phenomenon.

Thomas Majewski: Yes, the CLOs generate gobs of cash as a general rule. And even when loans are defaulting, something that’s really powerful and important to remember is the default – let’s say you have a 50 basis point position in a CLO and it defaults. Now let’s just say it’s a total wipeout, a zero recovery. Let’s take the most conservative position here. If that all happens, you get a little bit less interest on an ongoing basis, but your principal loss is five to seven years from now when you ultimately redeem the CLO. And so interest income is far more important in the CLO equity IRR than principal income. Frankly, in many of our investments, we would have a positive IRR even if we never got $1 of principal at the end of the CLO because in many cases, the cash flows – not all cases, but in many cases, the cash flows on an ongoing basis from the CLO frankly outweigh the – greater than the principal we invested at the beginning.

So now along the way, if we have a bunch of those defaults where zero recoveries are very bad recoveries. Again, we’re not predicting zero recoveries. The price of loans is going to be down nearly certainly on that day if you’re having a bunch of those. And that’s what gives us – as long as you’re in the reinvestment period, gives the CLO collateral managers the opportunity to reinvest. So if you look at like the performance of ECC from January 1, 2020 through the end of December 2021, so a 24-month period, our NAV grew somewhere between 25% and 35% during that time frame. NAV grew, and obviously, we continued paying distributions throughout that period, never failed the ACR or anything like that on a measurement date. So CLOs equity is very nice in that, it generates cash flow on an ongoing basis pretty robustly.

When things go haywire, COVID, financial crisis, which you want to have as a long RP so you continue reinvesting. In April of 2020, approximately 2% of the loan market paid off at par. No CFO, like Ken walked in and said, “Hey, why don’t we optionally pay down our debt today?” But the previously announced M&A, remember, I think it was the T-Mobile loan paid off that month. Just stuff keeps happening. If you’re a CLO manager, you’re just opening the mail, getting money at $1 when loans are for sale on $0.80. If you’re in the RP, you’re able to take advantage of that. So that’s the formula that makes this work. The drawback of CLO equity, the prices move around far greater than the fair value, in my opinion. But the very nice thing of it is the cash flow just keeps coming.

And we’ve seen that. We’ll be 10 years public in October of this year. A lot of things have happened and what hasn’t changed is the cash flows continue being very robust.

Matthew Howlett: Yes. So look, in my opinion, it’s a better – in my opinion, that number is more important than the GAAP number. I don’t know. I mean, I know you give…

Thomas Majewski: Cash pays the bills. We don’t send no GAAP dividends. We send out cash dividends. We’re a distribution company.

Matthew Howlett: I’ve covered REITs and funds. I’ve only focused – they’d only give a CAD or a FAD number, and that’s all we really focus on in a given quarter. They almost ignore the GAAP. But certainly, that’s the number that’s just remarkable and really, I think, speaks to the value inside ECC. So congrats on that, and hopefully, you keep it up. The next question, I mean, your capital structure is evolving as you really mature here and grow. Just with the new – with more perpetual and preferred and this non-traded exchangeable convertible note, I mean, how do you feel about targeted leverage? Do you think about that differently as the capital structure evolves?

Thomas Majewski: Obviously, the best financing is financing you don’t have to pay back. So those are – from a common equity perspective, that’s great. We have issued a little bit of the preferred D, which is the traded perpetual via the ATM. From time to time, there’s activity there. The Series AA and AB, which we’re issuing through a non-traded channel, really, really nice. We don’t have any maturities, I think, until April of 2028 at this point. Our target leverage is unchanged between 25% and 35%. And I’ve always roughly thought of that roughly half debt, half equity. It’s moved around a little bit, but that’s always kind of been the benchmark in the back of my mind. I don’t think we – although let me say, with perpetuals in theory, you have a little more wiggle room.

In general, I’ve tried to avoid – or something I’m very proud of, let’s put it this way. We didn’t fail the ACRs during COVID. And that’s something on any measurement date, we passed. And there’s no scientific rule for this other than 30 years of experience in this market and in the securitization markets to say, I’ve never been through a pandemic before, no one had, but kind of gut feel when things get really ugly, really fast, this is kind of what’s going to happen. And that’s honestly how we size that purely based on judgment. Obviously, we know the statutory limits, we have to be within those. But when we’ve sized it, so why – we certainly have more flexibility without worrying about repaying this, the perpetuals. It’s still – we always want to be able – our goal is never to fail the ACR.

So that’s an equal governor on how much leverage we would add to the company. So I don’t see us going above 25% – above that 35% band in normal market conditions. But I certainly love pushing out, taking away the maturity well, how about that?

Matthew Howlett: Yes. No. In theory, someone much a lower discount rate on your – on the cash, on the dividend stream because of it. On that note on that, you can do up to $100 million on that new exchangeable convert series. What are the terms? Can you force conversion or call it when the stock trades over a certain price for a period of time?

Thomas Majewski: So the exact details, I’m going to start here and then maybe Ken will finish. He’s been a little closer to this one. So it’s perpetual and like, so that’s always nice. If people and the conversion – the owner of the security has the conversion option. Any time after four years, they can call us up and say, “I’d like to get rid of my security.” And we have two choices as a company. We can either pay them cash or give them stock equal to the ECC common stock equal – market value of that equals to the par amount of their preferred or $25. So if the stock is $10 a share, we’d have to give them 2.5 shares in exchange for that – new shares in exchange for that $25 of preferred. We can also call it after a certain date. I don’t recall what that call date is, Ken. Five?

Kenneth Onorio: Five years.

Thomas Majewski: Yes. And we can mandatorily repay it if we want after five years. But at 7% perpetual, obviously, we happily have that option. I would struggle to see a scenario where we – in current conditions where we’d exercise that, but it’s nice to have and obviously, if we got off size on the ACR or things like that. And if investors wanted to redeem or convert prior to four years, there’s a penalty [8,6,5,4] or something like that over the first four years. So it’s a great piece of paper for – it’s investment-grade rated for investors who might want to hold it. It’s because it’s non-traded. It sits in people’s accounts. Typically, people just carry it at par. You get a monthly coupon of 7% investment grade-rated, a ton of capital beneath you, really good assets underlying. It’s a nice piece of paper onto itself, frankly, but it’s a great tool for the company to keep a very stable balance sheet. And I think one of the things – I’m sorry?

Matthew Howlett: Is perpetual, did you say?

Thomas Majewski: It is perpetual, but you have a path out after four years, if you want.

Matthew Howlett: Right. While assume…

Thomas Majewski: Cash or stock at our option. But not a lot of things paying 7% on a monthly pay basis that don’t move around, that don’t have really any NAV volatility. So it’s an interesting, very interesting people usually carry at par. So it’s one of those kind of really feels like if someone can invest their cash for four-plus years, it feels like a win-win, win for the person who invests in that security and win for the company because it’s a great and stable piece of financing.

Matthew Howlett: Been a lot of conversion feature, the dividend is that much higher, dividends 15% or something.

Thomas Majewski: They’re welcome, we are always here, we’re welcome to do that. People are welcome to do that. I think if you’re buying the 7%, you’re probably seeking just that. You’re focused more on the stable price on your statement if I had to guess, but we’ll see you in 3.75 years like people do.

Kenneth Onorio: Ken here. Just to clarify the call option, it’s actually two years.

Thomas Majewski: Oh, sorry, even better. Great, I apologize. Yes, because there are other – these are five years, yes.

Matthew Howlett: You can call it at par in two years? I mean, you could be reissuing the stuff at 6% or something in two years. Yes, exactly. Look, same here. Look, congrats on that. And the last question, what is the opportunity, the BB opportunity to sell those at premiums? It’s been obviously a great trade. Just any way to quantify what’s left and what could be sold?

Thomas Majewski: Yes. We still have – everything in the BB portfolio is certainly available for sale, shall we say, to use an accounting term. We bought most of that when BBs were in the 80s and 90s. Just looking at the portfolio here, we are at…

Kenneth Onorio: About 15%.

Thomas Majewski: We’re about 15%. So we – that was as of June month end. We’ll continue – the market softness the last couple of days has probably brought things down a little bit, but through July – we bought this stuff at discounts thinking it would get back to par, close to par. Theory has been correct. I think we mentioned we had $0.03 of realized gains from sales in the quarter last quarter. And we certainly – our goal is to continue reducing that. We increased it when there was some nice convexity and now that the convexity is largely gone, we’re continuing to reduce it. Hopefully, I don’t think we’ll get rid of everything, but ask the team, please get rid of everything.

Matthew Howlett: Well, it’s certainly accretion to bake into our model. Really appreciate it. Congrats. Thanks, Ken and Tom.

Thomas Majewski: Thanks so much, Matt.

Operator: Thank you. Our next question comes from the line of Paul Johnson with KBW. Please proceed with your question.

Paul Johnson: Yes. Good morning. Thank you for taking my questions. I’m just wondering to get your thoughts kind of on how you think broadly on kind of new investments. Obviously, there’s some interplay here between the impacted yield and cash yield on what’s realized over investments. But the cost of equity for ECC has been increasing, that’s targeted and the cost of equity is getting close to 20% yield on – the effective yield on new investments this quarter was around 19%. Give us kind of your thoughts?

Thomas Majewski: How does that math work? No, a very good question, Paul. When we look at our – the bogeys we’re trying to meet, we look at it on a blended basis. And if you just say the distribution rate, I’m just putting a number is 20%, we’re investing at 19%. That’s not a formula for success. Overlay, there’s costs and expenses as well. But just looking at just the raw equity cost obviously is not the full picture. We look at the blended cost of capital on the right side of our balance sheet, which includes stuff that has coupons in the 6s, even those the old perpetuals, the Ds are 6.75% if memory serves. We have other coupons, probably the highest is 8% across the stack. But so we’ve got roughly a little less than 1/3 of the portfolio financed in the 8s.

So the actual cost is an average of the distribution rate on the common, in our opinion, and the attractive debt cost that we have at the top of the stack. Without the attractive debt, our distribution yield would need to be lower, frankly, debt and preferred.

Paul Johnson: Got it. Thanks for that. And then last one just out of curiosity, I mean, just with the development of some liability management exercises in the leveraged loan market, lender-on-lender violence in some of those workout situations. I’m just curious, how was that dealt with, I guess, at a CLO manager level? I mean, obviously, you would assume you’re in a minority position within CLO. How was that dealt with? Or is that just a situation where just basically never comes to fruition because it’s an investment that would probably be exited due to downgrades or whatever?

Thomas Majewski: Yes. A very good question. So the good news, lender-on-lender violence is certainly – that proverbial lender-on-lender violence is certainly down versus where it was one to three years ago. The market’s kind of calmed a little bit in terms of that. It’s not zero but it feels judgmentally to me like it’s less than it’s been in the past, A. And B, while any given CLO, if you think of a CLO as a $500 million CLO, typical position size is 60 basis points or something, a big one, so that’s $3 million. Against that, these collateral managers manage tens of billions of dollars, so some of them might own $100 million, $200 million, $300 million of a loan. So there’s good and bad of that. The bad part is if they wanted to exit the loan, that would take them a little while.

The good part is CLOs own roughly 2/3 of the loan market. That percentage moves up and down a little bit. But directionally, I think that number is accurate. And many of the collateral managers that we work with are some of the largest investors in loans. So while our – any one CLO might be a little pipsqueak of a holder, when you aggregate any given – given many of the collateral managers we work with, you’re going to see they’re really quite relevant in here. And one of the things that happens in the loan market, though, and this is something – this is a bad part. We would it’s still – it’s all worked out over the last 10 years but it’s – if the new loan is issued at 99.5, you have CLOs buy it there, I would say it trades down to 60.

Other distressed funds, purported bad guys come in and buy it at 60, for them, getting out of 80 is a nice win. For us, a recovery at 80 kind of stinks, we just lost 20 or roughly 20%. So one of the things that does cause a problem sometimes you get these people with divergent starting points, the same outcome can be a win or a loss for different people. That said, I think the loan market is getting better at not being intimidated and bullied by distressed funds as much as perhaps used to be. So while there will continue to be some degree of lender-on-lender violence in some situations where the CLO community does get the CLO collateral manager community gets a little outsmarted by these distressed guys, it feels like the tide has been turning in the CLO markets favor for a while now.

Paul Johnson: Very interesting, Tom. Thanks for taking my questions. That’s all for me.

Thomas Majewski: Great. Thanks so much, Paul.

Operator: Thank you. Our next question comes from the line of Steven Bavaria with Inside the Income Factory. Please proceed with your question.

Steven Bavaria: Hi, Tom.

Thomas Majewski: Hey, Steve. Good morning.

Steven Bavaria: Hey. Since typical syndicated loans, partially amortized principal over the term of the loan, at least they did when I was doing them, then with a balloon payment of the unamortized principal at the end at the loan maturity, what is your estimate of – within your recurring cash distributions, what’s your estimate of the percentage of that, that consists of principal payments? And then sort of follow up. To the extent that, that would cause any erosion over time of the ultimate principal of that particular CLO, how much has that been offset through building par, resets, portfolio trading, buying new loans at $0.70 when old ones mature at $0.100, that kind of thing?

Thomas Majewski: It’s an easy estimate, zero.

Steven Bavaria: Zero?

Thomas Majewski: With one asterisk, zero, yes. So within a CLO, I will explain the asterisk. When money comes in to the CLO, there’s a trustee, Wells Fargo Bank or Citibank serves as trustee for the CLOs. When the money comes in, they put it in two accounts. There’s an interest account and a principal account. And the interest is what gets paid out to us is the equity after the AAAs and all the debt holders get paid. The money that comes to us is purely from the interest account. All the principal that comes in, whatever amortization alone makes or sale proceeds or recoveries on defaults or anything goes in the principal account, which is, during the reinvestment period, entirely used for reinvesting into new loans. So even if a loan makes a 1% quarterly amortization payment, that’s going to be trapped in the principal account and not used to pay out current income distributions to the equity.

There is one exception I did mention in asterisk, and this is something called the principal flush. And on one hand, that sounds bad, but if you’re the receiver of it, it’s actually pretty good. In many CLOs on the first and second payment date, if the collateral manager was able to buy the loans cheaper than the targeted price, that savings, let’s say they modeled buying them at 99.75, they bought them at 99.5, that 0.25 point which is left over in the principal account can be reclassified into interest and is paid out as a onetime or 2x special distribution to the equity. That would be the only situation when that occurs. But like randomly on the seventh payment date of a CLO, if some of the loans are amortizing, all that money is trapped in the system and we don’t get any of it.

So all the latter parts of your question kind of go away, frankly, other than that one special distribution at the beginning or one or two to the extent we can buy loans cheaper or have some trading gains early, the balance of the principle stays within the system.

Steven Bavaria: So is there a simple answer to the question then of what accounts for the big difference between your NII plus your capital gains and then the much larger recurring distributions? Yes.

Thomas Majewski: Yes. So you were a banker back when bankers made loans in the old-fashioned days. Loan loss – basically, loan loss reserves. So when we calculate an effective yield on a CLO, there’s a provision for losses baked into there, whether or not those losses actually happen. So we might be getting cash far great. If we’re accruing, I think that was 19.4% was the new purchases this quarter. So those investments on average, Ken is going to book 19.4% divided by four is going to be the income in the third quarter on those. We expect to get more cash than that but we’re taking a reserve for losses along the way. To the extent those losses don’t occur, we might get a little more at the end. To the extent the losses are greater, we get a little less at the end.

Steven Bavaria: And your reserve – as you take that reserve, I assume that’s not part of your pretax income from which you’re supposed to pay, whatever, 90%? So in other words, the losses don’t actually get taken for tax purposes until later on when you…

Thomas Majewski: Until they’re incurred. Yes, yes. So it’s basically accrual accounting for GAAP and cash accounting for tax, I guess, would be a pretty simple way to put it.

Steven Bavaria: Perfect. That’s going to – that’s a question that a lot of people have, and I think now maybe won’t – I don’t. I mean, that really helped a lot.

Thomas Majewski: Yes, I mean the number one. There’s cash, GAAP, and tax. They’ve never equaled in any given period. But over the life of a CLO, absent a few slightly – handful of nondeductible items, cash profit, tax profit, and GAAP profit will equal in aggregate but sadly not in any given quarter.

Steven Bavaria: You put out an explanation of that about five years ago or so.

Thomas Majewski: I think it was nine years ago. I think it was August 2015 or 2016.

Steven Bavaria: Exactly, yes. And it’d be great…

Thomas Majewski: The most downloaded thing on our website.

Steven Bavaria: I’ll go take a look. One other quick question or point is, I don’t know how many of your investors realize that even a 4% default rate, which you would probably never achieve even though that’s being – except in a real recession, after 60% or so recoveries, you’re talking about a loss rate that’s only 1.5% or so. Big difference.

Thomas Majewski: In that direction. And I would also then say, well, Steve, if 4% of the corporate loan market is defaulting every year, what’s the price of loans on that day? It’s probably not par.

Steven Bavaria: Yes. Anyway, thank you.

Thomas Majewski: Every loan that doesn’t default pays off at par – binary outcome.

Steven Bavaria: That’s fine. Thanks a lot.

Thomas Majewski: Appreciate it. Thanks for your time, Steve.

Operator: [Operator Instructions] And it looks like we have reached the end of the question-and-answer session. I will now turn the call back over to Tom Majewski for closing remarks.

Thomas Majewski: Great. Thank you very much for joining. Ken and I appreciate your time and interest in Eagle Point Credit Company. For those interested in Eagle Point Income Company, we invite you to join me, Lena, and Dan at 11:30 this morning. Thank you very much.

Operator: And this concludes today’s conference, and you may disconnect your lines at this time. Thank you for your participation.