So all of the recurring cash flows with one exception, I’ll come to are — is 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 it’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, and then the cash is what pays the bills.
Cash is what we distribute to shareholders. That’s the most important tax GAAP — cash money in the bank is always the — 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. And old banks speak, if you worked at say, Bank of New York a few years ago, you’d call that a loan loss reserve.
Steven Bavaria: Right.
Tom Majewski: For variable interest entity accounting, VIE accounting, we take a reserve for losses. We disclosed a lot of this in our financial statements, but you can see we typically get default rates up to 2%, 2-plus percent. Right now, we have 40 basis points of default exposure. So we are taking reserves for future losses. And very rarely do defaults haven’t 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 — 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.
Default principally reduces the terminal value of a CLO, but that could be five, seven years from now, and 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 that could go back up tomorrow, but that’s the big driver.
Steven Bavaria: So the NII actually is net of a loan loss reserve?
Tom Majewski: Cool. That’s a fair way to think of it, yes.
Steven Bavaria: Okay. 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?
Tom Majewski: Yes. We’re not taking loan principal payments and distributing those.
Steven Bavaria: Perfect. Okay. That’s really good news. You know — and the answer is the question, a lot of retail investors have been asking me, frankly. And I’m glad I have the –
Tom Majewski: The number one thing we look at recurring — can 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 will go with cash over the other two all day long and maybe keep tax as low as possible. But that’s — 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. And hopefully, Matt Bankers will call us back about a 10-year deal
Steven Bavaria: Yes. That’s great. Okay. Thanks.
Ken Onorio: Appreciate it, Steve. Thanks so much.
Operator: 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.
Tom Majewski: Great. Thank you very much, everyone for joining. Both Ken 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. Ken and I will be available if anyone has any follow-up questions later today, and we appreciate your time and attention. Thank you.
Operator: Thank you. This concludes today’s conference call. You may disconnect your lines at this time. Thank you for your participation.
