Steven Bavaria: Good morning. Just a quick one. Happy to see how well you’re doing. Congratulations. I see that your GAAP net income covers about three quarters of your distribution. But then you’ve got your recurring cash distributions that really cover — will cover the rest of it, and then some. And the question, I guess, that I get all the time is what’s in that recurring cash distribution number that’s over and above your GAAP income, your net, your NII and your realized capital gains and since the average loan includes an amortization feature, and then a smaller balloon at the end, how much of the routine amortization that’s in loan payments throughout their life, and that flows down through the waterfall to you as equity owners. How much of that amortization of principle is included in the recurring cash distribution? And then what else is in it?
Tom Majewski : So the short answer is none.
Steven Bavaria: Oh, good.
Tom Majewski : With one upside, I’ll come back to but we haven’t had it in a while. So when we talk about recurring distributions that’s proceeds that would be interest waterfall from a CLO. So your point, your description is absolutely correct, that loans have some amortization payments, and then a balloon payment, whatever is leftover at the end, for a CLO during the reinvestment period, with one exception, which I’ll get to, all of that principle stays in the system and goes to buy new loans. And what gets distributed to us, and in that recurring cash flow number is just money that comes to us from the interest waterfall. So let’s say we call a CLO, a topic we’ve talked about earlier, if we were to call one, then we’d also get a principal payment.
We would not include that principal payment from a call in our recurring cash flow number that we described. We would just say what the total cash is, but we always have that recurring number, which is just from the water — the interest waterfall. I did say there’s one exception. We haven’t had this in a while. I mean, just in interest of full disclosure. Early in the life of a CLO, sometimes on the first or second payment date, if there are gains, realized gains in the portfolio above, let’s say we start with a $500 million CLO and the collateral manager is able to create some gains in excess of $500 million, sometimes for the first or second period in a CLO, they can move those gains from the principal account to the interest account and pay it out to us as the equity holders.
But having not been involved in many new CLOs there, sadly we haven’t gotten — I don’t remember the last time we got one of those payments. So that might be the one exception, but the essentially all of the cash flow, all of the cash flows from the interest waterfall and substantially all of that is interest. So to be very clear. So then your question, what’s the difference? What’s the difference? Why are you getting all this interest, but you’re saying your GAAP income is lower? It’s not exactly what we do. But you’ll remember this from your banking days, loan loss reserve accounting. And it’s not exactly what we do. We have this effective yield concept. And what you’ll see — I mean, we publish on a position by position basis, the amount of cash we received on each investment, try and apply — provide a tremendous amount of transparency.
For the vast vast majority of our investments if you look at the effective yield, multiply it times the par amount of what we have, divided by four, you’ll see that would be, you think what we’re getting in cash, we’re actually getting more cash than that. And the difference is that effective yield has a reserve for losses analogous to a loan loss reserve. What’s happening is we model and all the assumptions are in there. But basically, once a CLO is ramped up about 2% defaults per year, we’re not seeing that. The default rate remains well below the long term average. So it might catch up with us. Maybe we’ll have a spike and those defaults will catch up. But right now, what we’re seeing is many CLOs are performing better than our credit assumptions.
In our expectation, we’re not anticipating a default spike. So what we’re using are these recurring cash flows, which is — which touch wood continue quite robustly.
Steven Bavaria: So the recurring cash flow does not include your sort of anticipated loan loss. Although your experience has been that you don’t usually achieve that as much of a loan losses you might kind of mentally or financially reserve for it. And again, I could pack — and loan loss anticipation, a reserve that you would create that that’s not part of your — that’s not a taxable loss, until you actually have the — experience the loss. So you’re required to pay out a certain portion of your pretax income, obviously. So I guess that gets complicated trying to reserve for a loss that you’re not allowed to include in your tax return.
