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Edited Transcript of ECC.N earnings conference call or presentation 19-Nov-19 3:00pm GMT

Q3 2019 Eagle Point Credit Company Inc Earnings Call

Nov 27, 2019 (Thomson StreetEvents) -- Edited Transcript of Eagle Point Credit Company Inc earnings conference call or presentation Tuesday, November 19, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Kenneth P. Onorio

Eagle Point Credit Company Inc. - CFO & COO

* Thomas P. Majewski

Eagle Point Credit Company Inc. - CEO & Director

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Conference Call Participants

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* Mickey Max Schleien

Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst

* Ryan Patrick Lynch

Keefe, Bruyette, & Woods, Inc., Research Division - MD

* Garrett Edson

ICR, LLC - SVP

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Presentation

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Operator [1]

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Greetings, and welcome to the Eagle Point Credit Company Inc. Third Quarter 2019 Financial Results Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Garrett Edson, Senior Vice President, ICR. Thank you. You may begin.

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Garrett Edson, ICR, LLC - SVP [2]

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Thank you, Michelle, 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 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. 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-Q, third quarter 2019 financial statements and third quarter investor presentation with the Securities and Exchange Commission. Financial statements in 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 Tom Majewski, Chief Executive Officer of Eagle Point Credit Company.

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Thomas P. Majewski, Eagle Point Credit Company Inc. - CEO & Director [3]

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Great. 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, including information about our portfolio and the underlying corporate loan obligors.

As we've done previously, I'll provide some high-level commentary on the third quarter, then turn the call over to Ken, who will take us through the third quarter financials. I'll then return to talk about the macro environment, our strategy and provide updates on our recent activity. And of course, we'll open the call to your questions.

The third quarter overall saw an increase in yields demanded by investors to invest in CLO equity. This was coupled with downward price movement in corporate loans, particularly those rated B. Against that, recurring cash flows from our investment portfolio remained robust during the quarter. The company received recurring cash flows of $1.02 per weighted average common share, which is in excess of our distributions and expenses. Our NAV moved lower during the quarter as CLO equity valuations were pressured by those wider yield demands and lower loan prices.

During the quarter, our NAV fell by $2 a share. As we've noted previously, however, short-term changes in NAV typically don't imply a change in our portfolio cash flow the way such moves could with a BDC. As Ken will elaborate on later, recurring cash flows received from our portfolio so far in the fourth quarter have actually exceeded the total recurring cash flows received during the third quarter.

Despite the recent price movements, we continue to believe that there's no fundamental issue with the corporate loan market or the company's portfolio. Frankly, we believe the drawdown during the quarter was principally driven by a market-wide repricing of risk, not an increase in risk.

Indeed, to that end, corporate loan default rates remain near historic lows, and a few are predicting significant increases in defaults in the near term. The lagging 12-month default rate actually decreased on a quarter-over-quarter basis, down to 1.29% from 1.34% as of June 30 as reported by S&P.

As a reminder, periods of loan price dislocation keenly underscore a key advantage offered by CLOs in such an environment that we have locked in long term non-mark-to-market financing. The locked-in financing of a CLO provides us with stability and allows many CLOs to profit by reinvesting principal pay downs from loans in their portfolios into new additional loans typically at lower prices and/or with wider spreads. In other words, we view the long-term debt of the CLOs in our portfolio to be more in the money in volatile markets like these and like those of 2008.

To put some numbers on this, the weighted average spread of the AAAs issued by our CLOs in our equity portfolio is 121 basis points. Today, many new CLOs are issued with AAAs in the mid-130s, so the debt in our CLOs is in the money, which is beneficial for the company.

While retail loan mutual funds continued during the quarter with approximately $8.5 billion of outflows per JPMorgan, we believe the pressure from those 4 sellers continues to be partially offset by demand from loans -- for loans from institutional investors. Indeed, despite the retail outflows through September 30, the Crédit Suisse Leveraged Loan Index has delivered a total return of 6.39%.

During the quarter, we issued $22.3 million of new common stock via our ATM program, capturing approximately $0.19 per common share of NAV accretion. That NAV accretion, of course, benefits all shareholders.

In the third quarter, we continue to remain proactive with respect to our portfolio. We deployed approximately $24.6 million in gross capital and to new investments. The new CLO equity added to our portfolio continues to have a higher weighted average effective yield than the weighted average for our overall portfolio of CLO equity securities. During the 2 -- during the quarter, 2 of our loan accumulation facilities were converted into CLOs.

For the third quarter, we generated net investment income of $0.37 per common share, modestly higher than last quarter's NII per share.

While several quarters -- while for several quarters we have generated GAAP net investment income below our distribution level, principally driven by lower GAAP portfolio yields on our CLO equity, when determining our common distribution, we also evaluate the cash flow we received from the investments and our estimates for taxable income during each fiscal year. I again want to highlight that it is taxable income that sets the floor on our common distribution. Further, recurring cash flows from our investment portfolio exceeded our expenses on common distributions once again during the third quarter just as they did in the prior quarter and have historically.

As mentioned earlier, during the quarter, we deployed approximately $24.6 million of capital on a gross basis and received $11.8 million in proceeds from the sale of investments. We added 2 primary CLO equity positions for the quarter through the conversion of loan accumulation facilities. We also took advantage of selective opportunities in the market and refinanced 2 CLOs during the quarter.

The new CLO equity investments that we acquired had a weighted average effective yield of 16.38% at the time of investment. This level is well above the September quarter end weighted average yield of 13.38% of our overall CLO equity portfolio based on amortized costs and excluding called CLOs. This continues to demonstrate our ability to source accretive investments through our adviser's investment process.

Whereas a static portfolio of CLO equities weighted average remaining reinvestment period would decay 1 quarter during each quarter of the year, across our entire CLO equity portfolio, the weighted average remaining reinvestment period ticked down just slightly versus the prior quarter to be 3.1 years as of September 30 versus 3.2 years at the end of second quarter. This is due to our proactive portfolio management, which is a meaningful value-add provided by our adviser.

As of September 30, the weighted average effective yield on our CLO equity portfolio, based on amortized costs and including -- excluding called investments was 13.38%, which compares to 13.49% in the prior quarter and 14.07% as of a year ago. The relatively stable weighted average effective yield over the quarter reflects the recalibration of the effective yield on our portfolio for each investment and was aided by an increase in the weighted average spread on the loans held by our CLOs from 3.57% to 3.59% during the quarter.

When evaluating our portfolio at current market levels, however -- this is interesting, I believe. The weighted average expected build on our CLO equity portfolio actually increased to 24.07% as of September 30 versus 18.85% as of the prior quarter. This is taking those same cash flows but discounting them back to the current market level for the positions, not the amortized cost. This increase is principally due to the unrealized mark-to-market loss during the quarter and reflects the wider yields demanded by investors during the quarter that I referred to earlier. For investors evaluating the company's portfolio yield based on the fair market value of our portfolio, this is a very important metric to understand.

As noted on previous calls, the weighted average effective yield includes an allowance for future credit losses as well. A summary of the investment-by-investment changes and expected yields are included in our quarterly investor presentation.

In October and through November 12, we've deployed $9.5 million of gross capital into new investments. Overall, despite the price movement in our portfolio, the economy remains reasonably robust. And given the very low number of corporate defaults that we've seen, we remain favorable on the overall market in our portfolio.

After Ken's remark, I'll take you through the current state of the corporate loan and CLO markets and share our outlook for the remainder of 2019. I'll now turn the call over to Ken.

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Kenneth P. Onorio, Eagle Point Credit Company Inc. - CFO & COO [4]

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Thanks, Tom. Let's review the third quarter. For the third quarter of 2019, the company reported NII and realized capital gains of approximately $9.9 million or $0.37 per common share. This compares to NII and realized capital losses of $0.07 per common share in the second quarter of 2019 and NII and realized capital gains of $0.41 per common share in the third quarter of 2018.

Company's NII and realized capital gains for the quarter ending September 30 consisted mostly of NII of $0.37 per weighted average common share as realized capital gains were nominal for the quarter. When unrealized portfolio depreciation is included, the company recorded a GAAP net loss of approximately $42 million or $1.59 per weighted average common share for the third quarter. This compares to net income of $0.06 per common share in the second quarter of 2019 and net income of $0.50 per common share in the third quarter of 2018. Just a reminder that our short-term cash flow generation is largely unaffected by unrealized appreciation or depreciation in our portfolio.

The company's third quarter GAAP net loss was comprised of total investment income of $17.8 million and net realized capital gains of $0.1 million, which was more than offset by net unrealized depreciation or unrealized mark-to-market losses of $52.1 million and total expenses of $8 million.

At the beginning of the third quarter, the company held $13.4 million of cash, net of pending investment transactions. As of September 30, that amount was $27.4 million, providing the company with dry powder as our adviser seeks investment opportunities. As of September 30, the company's net asset value was approximately $311 million or $11.45 per common share.

Each month, we publish on our website an unaudited management estimate of the company's monthly NAV as well as quarterly NII and realized capital gains or losses. Management's unaudited estimate of the range of the company's NAV as of October 31 was between $10.06 and $10.16 per common share.

Nonannualized net GAAP return on common equity in the third quarter was an approximate loss of 12%. The company's asset coverage ratios at September 30 for preferred stock and debt as calculated pursuant to Investment Company Act requirements was 283% and 483%, respectively. These measures are above the statutory minimum requirements of 200% and 300%, respectively.

As of September 30, the company had debt and preferred securities outstanding totaling approximately 35.3% of the company's total assets less current liability, slightly outside of our target of generally operating the company with leverage in the form of debt and/or preferred stock within a range of 25% to 35% of total assets. This number has increased from 32.9% as of June 30, primarily driven by the recent unrealized portfolio markdowns which were partially offset by raising accretive equity capital at a premium to NAV.

Moving on to our portfolio activity in the fourth quarter through November 12. Investments that have reached their first payment date are generating cash flows in line with our expectations. In the fourth quarter of 2019, as of November 12, the company received recurring cash flows on its investment portfolio of $29 million or $1.05 per common share. This compares to $27.1 million or $1.02 per common share received during the full third quarter of 2019. Consistent with prior periods, we want to highlight some of our investments are expected to make payments later in the quarter.

During the third quarter, we paid 3 monthly distributions of $0.20 per share of common stock as scheduled. On October 1, we declared monthly distributions of $0.20 per share of common stock for each of October, November and December.

In terms of our at-the-market offering program, in the third quarter, the company issued approximately 1.3 million shares of its common stock at a premium to NAV for total net proceeds to the company of approximately $22 million. This third quarter issuance resulted in NAV accretion of approximately $0.19 per common share.

I will now hand the call back over to Tom.

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Thomas P. Majewski, Eagle Point Credit Company Inc. - CEO & Director [5]

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Great. Thank you, Ken. Let me take everyone through some of the macro loan and CLO market observations and talk about how they might impact our company. And then I'll also give a bit more color on recent portfolio activity.

As I mentioned earlier, through September 30, the Crédit Suisse Leveraged Loan Index has generated a total return of 6.39%, tracking ahead of where it was at that time last year. Loan retail outflows continued during the quarter, with the outflows totaling approximately $8.5 billion, though that demand was made up for, we believe, with -- that selling was made up for with demand from other institutional investors.

A bit of a trend change in the market and we're now seeing about 33% of loans trading at or above par, and we have seen a small amount of loan refinancing or repricing activity. Despite that, as I mentioned earlier, we experienced the second straight quarter of slowly rising loan spreads in our portfolio. On a look-through basis, the weighted average spread of the loan portfolio increased 2 basis points, up from 357 in June to 359 at the end of September.

The Fed has now cut rates by 25 basis points 3x in the last 4 months. As we've noted before, lower rates is a credit-positive event for corporate borrowers with floating rate debt as their interest expense then fall. Loan defaults continue to remain well below historic averages. The lagging 12-month default rate as of the end of September was 1.29% according to S&P. Against that, the percentage of loans trading at lower prices has also increased a bit with approximately 11% of the market trading below 90.

I've said the market overall doesn't appear to be foreseeing an impending recession. And certainly, many dealer research desks are forecasting default rates for 2020 of between 1.5% and 2.5%. We continue to expect default rates to remain below long-term averages over the near to medium term due to minimal impending maturities before 2022, a growing U.S. economy and the large majority of the loan market consisting of covenant-light loans.

We remain mindful of the short-term uncertainty brought about by ongoing trade tariff negotiations, but do not expect those to be long-term factors and remain hopeful that a Phase 1 deal will be signed soon. With the 2020 being an election year, that could also bring some surprises.

When greater loan price volatility presents itself, we believe the company and its investments are well positioned to go on the offense to take advantage of those lower loan prices given the benefit of our long-term locked-in-place, non-mark-to-market financing inherent in our CLOs and the company's long-term balance sheet.

From our perspective as long-term CLO equity investors, an environment of loan price volatility without a meaningful increase in defaults over the near to medium term is extremely attractive. In the CLO market through September 30, we saw $90 billion of new issuance this year along with $15 billion of resets and $21 billion of refinancing. For the full year of 2019, our adviser continues to expect at least $100 billion of new issuance volume, approximately $20 billion of resets and $30 billion of refinancing.

We are continuing to selectively direct additional resets and refinancings of CLOs in our portfolio, though at a slower pace than prior quarters, principally due to the fact that we've already reset or refinanced the vast majority of our CLO equity portfolio at this point. We did direct 2 refinancings during third quarter and expect to be selective with additional refinancings and resets in the near term. As a result, we expect our overall CLO of equity cash flows to increase over time without the consistent impact of the onetime reductions associated with resets or refinancings that we saw over the past few quarters.

The benefits of our prior refi activity can be seen in our weighted average AAA levels. As of September 30, as I mentioned earlier, the weighted average AAA cost within our CLO equity portfolios was 121 basis points. This compares to a market level of 134 basis points at quarter end. Our weighted average AAA cost continues to be meaningfully in the money today. As always, our adviser's deep CLO investing experience provides us with a notable advantage as we seek to generate additional value for our portfolio and our stockholders. We have dry powder available as we see attractive opportunities in the primary and secondary markets.

Beyond seeking to maximize the value of our CLO -- existing CLO investments and looking to be opportunistic with respect to the CLO price dislocation that we've seen lately, we continue to maintain solid visibility on our new investment pipeline for the next few quarters as well.

To sum up, we continued in the third quarter to receive recurring cash flows on our portfolio in excess of our common distribution, interest and other expenses. Recurring cash flows in the fourth quarter were greater than -- so far in the fourth quarter, were greater than received during all of the third quarter. Loss adjusted weighted average effective yield on our CLO equity portfolio, implied by the current fair value, current marks on our portfolio, is 24.07% as of September 30. And we continue to raise accretive equity capital during the quarter.

Given the low continued default rates being experienced, we remain very constructive on the overall macro environment from a longer-term perspective. As such, we maintain a strong opportunity to utilize our adviser's strength and create additional value for our portfolio.

We will also continue to selectively direct resets and refinancings, which we would expect to increase future cash flows to our CLO equity securities. And of course, we'll be very proactive in our management of the company, creating value for our shareholders.

We thank you for your time and interest in Eagle Point. Ken and I will now open the call to your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Mickey Schleien with Ladenburg Thalmann.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [2]

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Tom and Ken, I'm going to ask you to indulge me a little because my first question is a little long-winded. But I'd like to start off by asking about the quality of the collateral. Your presentation shows that revenues and EBITDA growth has slowed sharply for borrowers in general. And we now have almost 30% of leverage of loans rated B- or B3. So there's this persistent concern in the market that these ratings on these loans could decline even without a recession because a lot of that trend has been due to aggressive acquisition strategies or perhaps poor deal terms or maybe business models that aren't working very well. Since CLOs own over half of all leverage loans, obviously, that trend could put the typical 7.5% CCC Test at risk. And I do see that your portfolio is already at 6% in CCC as of October. That compares to 4.9% at the beginning of the year.

So I'd like to ask you, what is the sensitivity of the portfolio's cash flows and your NAV to this test being broken?

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Thomas P. Majewski, Eagle Point Credit Company Inc. - CEO & Director [3]

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Good question. So you hit on a couple of points there. Probably the first number, let me draw everyone's attention to, is on Page 26 of the investor presentation which lays out a number of metrics. But among them, the weighted average over collateralization ratio, junior OC cushion, the fifth column from the right, you'll see that's 4.33%. As we look at CLOs -- and obviously, that's an average. Some are higher, some are lower, but mostly the vast majority are clustered right around the average.

What happens in a CLO, if there were to be an increase in CCCs over 7.5%, is there would be a reduction in the numerator of the OC Test such that -- and while every transaction varies slightly, broadly, how I would encourage you to think of it is the lowest priced CCCs get a reduced carrying value in the numerator of the OC Test. So if you have -- let's take some examples. If you had 10% CCCs and they were all trading at 60 cents on the dollar, let's say, you would take a 40% haircut on 2.5% of your CCCs. To do my math, that would be 1%, I guess, reduction in the numerator side of the OC Test, which would reduce that 4.33% if that happened uniformly across all CLOs to 3.33%. So we could sustain a nontrivial increase in CCCs, holding all else constant, without necessarily impacting the current cash flows on the weighted average of our portfolio.

Now when I said, though, in there is one thing is holding all things constant, and that's obviously a highly simplifying assumption. There's 2 things to highlight around this. The OC Tests are interesting all the time, but they only matter on 4 days of the year, on the payment determination date. So even if a CLO were to fail its OC Test on an interim basis during a period, that's nice but doesn't do anything. It's only calculated with any effect on the determination date for the quarterly payment.

And one of the things that's very important to remember in the CLO, and typically any CLO, is the ability to build par through discounted purchases and relative value trading. And what that means is typically in a CLO, any loan purchased in the 80s is going to get 100 cents on the dollar credit in the OC Test. So if you own a loan that may be traded to $0.95, you could sell that by a different loan that's trading at $0.85, all of a sudden, you've built 10 points of par related to that loan.

And where I go with all of this is it's a very manageable test. Not saying we couldn't have downgrades that ultimately trips some CLOs for a period of time. But what we've seen in many of the collateral managers that are in our portfolio, frankly, didn't miss payments to the equity during the '08, '09 cycle. Some have track records going back even further, in many cases, without the same payment. I'm not saying that none have and some in the portfolio had missed payments. But a very high concentration of them, frankly, hadn't missed payments through the '08, '09 cycle. There, there were certainly significant amounts of CCCs and a greater -- and a great amount of defaults. But through managing the portfolio and other discounted purchasing, they were able to keep those CLOs on site.

So as we look forward, you also pointed to slowing revenue and EBITDA growth. Let me kind of talk about that, and that is an interesting one. Indeed, many companies are bought, assuming by private equity sponsors with charts that go up into the right. No one ever has a chart that goes down to the right in terms of revenue and revenue and EBITDA. And we are seeing it slow to some -- the rate of growth slowing versus where it was a year ago.

In our opinion, and this is a broad statement, not specific to any one credit, although representative, we believe, the rates we saw -- the rates of growth we saw a year ago were driven, frankly, by maybe a shorter-term initial stimulus from some of the tax changes that went into effect in the beginning of 2018 on both changes in tax rates, depreciation and also very importantly, changes in code, which encouraged investors who had large amounts of cash, the proverbial Microsofts and Googles, large amounts of cash offshore to repatriate that money, which ultimately circulated through the economy in the U.S., be it through share buybacks, increased dividends or any number of measures those companies use.

That provided, in our view, an increase or a kind of a onetime bump up during 2018, which is now slowing. And frankly, we see further slowing due to the tariff uncertainties that I talked about. While the aggregate amount of all of the tariffs that are bantered back and forth are -- while they're big in the dollars in the hundreds of billions, when compared to a $20 trillion approximate GDP of the United States, these are relatively small sums. However, the uncertainty that creates for business very -- it takes a little bit more guts to build a new factory if it's predicated on a raw material coming from overseas, could be anywhere in the world, frankly. And we think we have -- so we think that has caused a further slowdown in CapEx, which has slowed some of the revenue growth of some of our companies and that many of our companies provide the services and products that are used for larger companies in their CapEx initiatives.

So we don't see it as a wholesale slowdown as much as just returning to normal and then a little bit of pressure downward from some of the trade uncertainties against that. If you look at interest coverage, we should have that chart in here as well. If you look on the prior -- on Page 33, if you look on the top-right corner, this is of all loans that are publicly reporting, which is $200-and-change billion worth of loan, you can see interest coverage. EBITDA versus interest as of the second quarter was 4.7% -- 4.7x. So companies have quite strong current cash flow or current EBITDA to service their debt. Frankly, lower and lower interest rates, holding all else equal, would increase that ratio.

So when we look at a loan universe that's principally covenant light, so taking technical default off the table for many of those companies, and you look at this chart on the top right showing high-4s interest coverage multiple, we think the likelihood of companies missing payments on loans remains quite low. The slower growth that you pointed out could accelerate the rate of downgrades to CCCs. However, hopefully, we illustrated that we have plenty of OC cushion in the deals onto themselves. And then finally, the way the tests work around these OC Tests, it's something that can be managed quite well by collateral managers. Long-winded question, long-winded answer. I hope that was helpful.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [4]

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I appreciate that, but it's really helpful. And I do want a follow-up. And in the sense that at the very end of your answer, you're reiterating that all else equal, the cash flows look to be stable. And I know all else equal never is really true, but it's the best we can do at the moment. So if cash flows look to be at stable, let's say, for the next few quarters, I'm trying to still reconcile that, Tom. And I keep coming back to this every quarter with where CLO equity is trading.

Clearly, the market's concerned about something. And I understand that the primary markets are not working very well right now because the ARB is not very good. I understand that there hasn't been a lot of secondary volume, and bid-ask spreads have widened. So you're marking to a market that's not working really well, and that's a factor. But it's a deep enough market to still raise the question, what is it that these folks that are investing in CLO equity are worried about that is requiring you to mark down your NAV so much?

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Thomas P. Majewski, Eagle Point Credit Company Inc. - CEO & Director [5]

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That is the best question. Broadly, what we've seen is within most fixed -- many fixed income markets, the bottom part of the band of investments has traded the worst this year. And an example I'll give you -- but even within the loan market, BBs remain quite keenly bid. And frankly, now we're seeing 1/3 of the market as of quarter end trading at a premium. That's up from where it was earlier in the year, but year-end, it was probably less than 5% we're trading at a premium. But many of those loans, BB-rated, are now at a premium, versus B-rated loans, the price has fallen by several percent.

Similarly within CLOs, BBs today are wide to where they were at year-end, while BBBs are tighter that we're not -- or tighter than where they were at year-end. So you have this dichotomy of products moving in other -- within the same structure moving in opposite directions relative to year-end. CLO equity yields have widened significantly, hundreds and hundreds of basis points.

It's the -- the fear of investors, I would presume, have is that there's an interruption in the cash flow spending. If you believe the cash flows are quite consistent, in which, in our experience, they have been, the 24% loss adjusted yield based on our current mark, to me, is attractive. That's obviously predicated on those cash flows continuing.

Some investors see the price of loans moving and the liquidation value of CLOs moving down to the extent prices of loans fall. That, I think, some people in the market give too much credit to. We're very much cash flow-oriented. And our objective with essentially every CLO equity investment we put in the ground is to get all of our money back during the reinvestment period from operating cash flows just from free cash flow, and then we'll figure out the optimal strategy for the end-of-life based on the market conditions at that time. One of those strategies is do nothing and just let the investments sit there. Every loan will either default or pay off at par during the life of a CLO.

So we think there is some greater fear in the market of a significant CCC downgrade. Not a lot of people are talking about a big pickup in defaults. I'm sure some feel that way, but not many. So the thing that I think many would presume could hurt the cash flows or impair them would be a big, big spike in CCCs and I think some investors are unduly drawn to the drop in loan prices and kind of the embedded NAV decline within each CLO. In our opinion, those are all interesting to look at. However, the certainty of the continuation of the cash flows that we see, obviously, there's -- nothing can be certain. We see the cash flows based on the amount of OC cushion and the way the tests actually work with the ability to manage them through discounted purchases being quite high.

Divergent views obviously make a market. We have dry powder. I wish I could buy more investments that are weighted average effective yield of where we have the portfolio marked. We're actively scouring the market for them. Sadly, a lot of people who own the positions don't want to sell them, including us. We wish there were more to buy.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [6]

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Yes. That's consistent with what I'm hearing, Tom. And just one last question, sort of housekeeping. When you recast your estimated yields -- or I should say when you make your estimated yield assumptions, what sort of assumptions do you make for the CCC bucket degradation? Is that part of the math?

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Thomas P. Majewski, Eagle Point Credit Company Inc. - CEO & Director [7]

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That's not a specific input actually into our -- into the models. The OC Test is captured -- the changes in OC Test and potential interruption is captured throughout realized losses occurring every single year in our model. One of the things we stressed for investment, making investment decisions, is increases or decreases in CCCs. But a spike in CCCs is not included in the base case of our forecast for any given CLO, although it's for the effective yield determination because it's a binary thing. Ultimately, either they're on or they're off. It's a judgment on our part of looking at a CLO and its underlying loan portfolio if that's going to become a problem. So it's something we look at for sensitivities, but it's not reflected in the base case.

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Operator [8]

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(Operator Instructions) Our next question comes from the line of Ryan Lynch with KBW.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [9]

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First one, just wanted to talk about the environment right now and what we've really seen over the last year in CLO equity. You mentioned default rates are continuing to remain pretty low. But there is some slowdown in leverage loan, revenue and EBITDA growth, which could be signaling and could create some worry about, like you said, defaults picking up in the future.

We saw in the fourth quarter of last year, your guys' portfolio get marked down, unrealized and realized, about $93 million. And it only recovered about $37 million in Q1. So it didn't fully recover from that kind of partial temporary dislocation that we saw in the market. It never really came back. And then we've seen some more markdowns in the second and third quarter of this year. And then again, in the fourth quarter, quarter-to-date, you guys had some more markdowns in the CLO portfolio.

So do you think that -- I guess, do you feel that these are more temporary markdowns in the portfolio? Or is the -- and that the CLO equity could potentially recover sometime in the future? Or is the market potentially correct and that the appropriate risk in CLOs widening out those yields is appropriate and going to stay at these big wide discounts, and so your guys' portfolio value is not really looking for a meaningful recovery anytime soon?

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Thomas P. Majewski, Eagle Point Credit Company Inc. - CEO & Director [10]

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I certainly wouldn't say it's never going to recover. I can't say it's going to recover tomorrow either. These -- the price of any security or any fixed income security is a function of the yield that investors demand. The yields -- and if you look in our financial statements in the assumptions section for the level 3 assets, which is the CLO equity, we have -- and this is the first time we've used the weighted average effective yield based on fair value, that 24% number in the call because it's important to -- we should have highlighted it sooner. But if you go back to our prior quarters, you'll see that number in there in the footnotes to the financials here where we talk about the default rate assumptions and things like that.

We've seen what is, in our opinion, a repricing of risk. We haven't seen a substantial increase in risk, in our opinion, and remain quite firm in our belief and expectation that the cash flows on these securities are going to keep coming quite strongly. Frankly, you have cash-on-cash quarter-over-quarter, and we've not even gotten all the way through the quarter, is up, which is certainly different than -- the corporate defaults are down, which is certainly different than what we're seeing from the widening of yield. And our mark-to-market is substantially due -- the mark-to-market losses is substantially due to a widening of yield that investors are demanding.

Kind of building on Mickey's question before, that means either some people think the cash flows aren't going to continue. It's as simple as that. I mean that's got to be the reason people are demanding yields in this kind of context. And will some CLOs miss payment? Sure. We don't see that broadly happening across the market, however. And frankly, we view this as an attractive opportunity to deploy capital. We have more cash on the balance sheet, all else equal, than I'd like, frankly, and that we continue to scour the market. But these are, frankly, quite attractive buying opportunities. I wish there were more willing sellers in the market.

We have this oddity of spreads. Our yields are wider on little to no volume, which I admit is a frustrating thing sometimes as an investor in the market. But we've -- I've worked with this asset class 20 years. We've seen this happen any number of times over the last 20 years where yields widen against that. Quite a few of the collateral managers in our portfolio have never missed a payment to the equity. I look at one of the -- our original investment here at Eagle Point was a platform from -- called Octagon. They missed 1 payment, I believe, in 1999 and hadn't missed a payment on 40 other CLOs in the intervening 20 years through a lot of default cycles, through big CCCs. So in our opinion, sometimes, the baby gets thrown out with the bathwater, and that's what we feel is happening in the market right now.

What we would encourage investors to do is form a view on the certainty of the cash flows. We've got 4.3% OC cushion. Ramp up defaults if you think defaults are going to go up next year or ramp up, downgrade, and then also bake in some provision for discounted purchases and some of the par builds you can recover through buying loans in the 80s and 90s, which all count as 100 in the numerator. You'd have to be, in our opinion, pretty draconian to see these cash flows stop, although divergent views obviously make a market.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [11]

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Yes. That's helpful. Well, on that point, obviously, the market could be proved out to be right or wrong. But the market, I guess, is what it is today. And quarter-to-date in the fourth quarter, there's been some additional markdowns in your portfolio which has negatively impacted your NAV. And we estimate that it's increased your debt and preferred equity over your current equity to about 0.6x above your kind of the upper end of your target range. You guys are now running with higher leverage above your target range, at least quarter-to-date, holding all else equal.

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Thomas P. Majewski, Eagle Point Credit Company Inc. - CEO & Director [12]

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Could you explain the 0.6? I don't...

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [13]

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Yes. The 0.6x debt plus preferred equity over your equity, which would be above your guys' current asset target range.

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Thomas P. Majewski, Eagle Point Credit Company Inc. - CEO & Director [14]

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We were at 30 -- Ken will...

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Kenneth P. Onorio, Eagle Point Credit Company Inc. - CFO & COO [15]

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So I think on the -- are you referring to the 25% to 35% range?

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [16]

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Yes. Which would equate to a debt-to-equity of 37% to 55%, the asset coverage. I'm just converting your asset coverage to a debt-to-equity.

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Kenneth P. Onorio, Eagle Point Credit Company Inc. - CFO & COO [17]

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Yes. So we would be 38% on that range, should we build in the October drawdown.

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Thomas P. Majewski, Eagle Point Credit Company Inc. - CEO & Director [18]

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Yes. So we are a hair over 30 -- calculating it the way we present it, we were a hair over 35% at quarter end. And then as of the management estimate of October month end NAV, we were 38-and-change percent. So about 3% outside our band, 3-and-change percent. We have been outside our band once before, frankly, due to mark-to-market moves, and it did move back. We're certainly at -- we have not added any leverage of -- actually, we've taken a little off the table with the partial redemption of the As earlier this year. But the leverage has moved around just due to the change in the portfolio value.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [19]

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So are you comfortable then operating outside of the range if these trends do continue? Or what is the plan going forward?

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Thomas P. Majewski, Eagle Point Credit Company Inc. - CEO & Director [20]

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We certainly -- when we size that range, it's a judgmental range based on where we could see a potential change in value in the portfolio relative to the statutory limits that we're subject to. Our goal is to keep the company within that range in general. We're comfortable where it sits right now. You'd have to have a very further -- a very significant further drawdown to see those breach any of the statutory limits, which is why we set it where we do. Other vehicles may use more leverage, frankly, than we do. We think we've kind of got the right balance to be able to manage reasonable changes in the market.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [21]

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Okay. And I know you guys also have the ability to issue equity, longer ATM to obviously help out the leverage range. I'm just curious, I know you guys issued some shares this quarter. How are you guys looking at that? With a roughly a 16% to 17% dividend yield, 17% today, probably closer to 16% prior to today, how are you guys looking at issuing equity with a 16% required dividend yield with your guys' fee structure, with the expenses, G&A costs? How do you guys make that math work with the weighted average portfolio yield of 13.8% or even with the new CLOs acquired at 16.4% given the leverage that you guys have and the cost structure?

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Thomas P. Majewski, Eagle Point Credit Company Inc. - CEO & Director [22]

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Yes. No, it's a very good question. When we look at the weighted average cost of capital within the company, you can't just include the equity distribution rate. You need to look at the overall capital structure, both including the debt and preferred stock. Obviously, we don't charge a management fee on the roughly $100 million of assets purchased with the debt tranches with the Xs and Ys.

So when I look at our all-in cost of capital, the rough math I use is 15% debt, 15% preferred and 70% equity, just to kind of take it out there, which puts us at the 30%, the midpoint of our range. When you factor in the far lower cost and that the debt doesn't attract any management fee, our all-in cost of capital is lower than just looking at the common equity straight up.

Obviously, we can't issue $0.70 of common, $0.15 of preferred or $0.15 of debt in any given day. It moves around in batch mode. But when we look overall at what our cost of capital is, where we're raising the capital and where we're investing it, it's putting the blended cost of capital together. If we use just the common equity costs, you'd probably never do anything. All you do is issue debt all day. But obviously, that wouldn't necessarily be a prudent way to run a company either. So I'd encourage you to look at it on a selective basis.

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Operator [23]

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Our next question comes from the line of [Stephen Bavaria] who's a private investor.

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Unidentified Participant, [24]

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At the risk of oversimplifying, I'm curious about what seems to be almost a kind of inverse relationship at times between your mark-to-market value of your NAV and what I'd call the economic value of the company. And I guess what I mean by that is if your equity -- if your assets -- if the market value of your assets drop and the market value -- and your liabilities, obviously, stay the same, and by definition, the value of your equity is -- your NAV, your market value will drop as well.

But if in fact, if I understand things correctly, if you're -- the repayments of principal you received that you're able to reinvest during the reinvestment period, you can actually now reinvest those in healthy assets with cheaper prices where you're locking in a better yield and a capital gain when they repay at par, it would seem that your economic value has actually increased as a result of the underlying loan market, secondary market drop. So there's almost a kind of inverse relationship there, and I'm sure that's confusing at least to many investors out there. Am I -- is that roughly correct even though I may be oversimplifying a bit?

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Thomas P. Majewski, Eagle Point Credit Company Inc. - CEO & Director [25]

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Yes. That is correct. There's a few things going on. So our CLO debt that we're -- we've issued within each CLO is in the money. Our weighted average AAA is 121 versus a 130-something market. And we just showed the AAA, but if you look at all the classes, many of those are in the money versus where we could issue today. Loans in general are -- many loans are at cheaper prices. Over 11% of the market is trading below 90. The market, we don't believe and we don't know anyone who's predicting an 11% default rate, even a 5% default rate, assuming those were to default over the next 2 years. So that suggests that, indeed, there are some cheaper loans out there.

Now 1/3 of the market is trading at a premium as well, so it is a bit of a bifurcated market. But when people look at CLO equity, we think an error many investors make. They look at the price of the loans, they don't factor in the in-the-moneyness of the CLO debt. So that's kind of one mistake, I think, some investors make when they look at the market.

And then second, we're seeing, for better or worse, the discount rates, some yields on CLO equity are widening. So you have right now, with loans, at least the B-rated loans down, you have a lower terminal value that many people are assuming, including us, because we assume the loans either pay off at par or are sold around where they're valued today. You have a lower terminal value and a market using wider and wider yields or discount rate in spite of those cash flows are pushing down the values. And we're literally -- and we use that number, that 24%-plus number, which is the weighted average loss adjusted effective yield on our portfolio based on the current market value.

I wish I could buy more stuff at that price in our portfolio. That's, to me, an attractive opportunity. As we stress our investment, while it's not impossible for the cash flows to be suspended for a period of time, most of the collateral managers -- many of the collateral managers in our portfolio, and I believe most have not -- didn't miss a payment through the '08, '09 cycle. And that shows there's many, many ways to manage these structures prudently through times of volatility. Even if the payments were to get cut off, the only consequence is money that would have come to us is used to repay the AAA. That's not what we want to do. You don't want to pay down your lowest cost debt, which is in the money in our favor on that day. But even if that were to happen, there's not a requirement to sell any assets to do so. You'll just be using operating cash flows. As the test cure, the equity cash flows would turn back on.

So the consequence is certainly not great but it is by no means catastrophic if you were to fail one of those tests on the CLO. But broadly, where we look at this, we see the portfolio as very attractively priced. The market, in our opinion, is exaggerating some of the downgrade risk and the yields that are being -- that are used for pricing these securities. While their fair market value, in our opinion, are cheap relative to fundamental value.

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Operator [26]

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There are no further questions at this time. I'd like to turn the call back over to Mr. Majewski for any closing remarks.

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Thomas P. Majewski, Eagle Point Credit Company Inc. - CEO & Director [27]

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Great. Thank you again very much for everyone's participation. May we live in interesting times, these certainly are they. We hope you've gotten a good flavor of kind of how we're looking at the portfolio and the stresses that we run. If you have any further questions, please feel free to follow up with Ken and me directly, and we appreciate your interest in Eagle Point Credit Company.

One last bit. There is a call at 11:30 for Eagle Point Income Company, which is a new vehicle also brought by our adviser. We'll be having a third quarter earnings call later this morning. We'd encourage anyone to attend. Thank you very much.

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Operator [28]

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Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.