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Edited Transcript of ECC.N earnings conference call or presentation 15-Aug-19 2:00pm GMT

Q2 2019 Eagle Point Credit Company Inc Earnings Call

Sep 4, 2019 (Thomson StreetEvents) -- Edited Transcript of Eagle Point Credit Company Inc earnings conference call or presentation Thursday, August 15, 2019 at 2:00:00pm 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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* Christoph M. Kotowski

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

* 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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Good day, ladies and gentlemen, and welcome to the Eagle Point Credit Company Inc. Second Quarter 2019 Financial Results Conference Call. Today's conference is being recorded.

At this time, I'd like to turn the conference over to Garrett Edson, Senior Vice President, ICR. Please go ahead.

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Garrett Edson, ICR, LLC - SVP [2]

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Thank you, Keith, 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 includes forward-looking statements or projected financial information that involve risks and uncertainties that may cause the company's actual results to differ materially from those projected in such forward-looking statements and projected financial information. For further information on factors that could impact the company and the statements and projections contained herein, please refer to the company's filings with the Securities and Exchange Commission.

Each forward-looking statement and projection of financial information made during this call is based on information available to us as of the date of this call. We disclaim any obligation to update our forward-looking statements unless required by law. A replay of this call can be accessed for 30 days via the company's website eaglepointcreditcompany.com.

Earlier today, we filed our form N-CSR, half year 2019 financial statements and second quarter investor presentation with Securities and Exchange Commission. Financial statements and our second quarter investor presentation are also available within the Investor Relations section of the company's website. Financial statements can be found by following the Financial Statements and Reports link, and the investor presentation can be found by following the Presentation 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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Thank you, Garrett, and welcome everyone to Eagle Point Credit Company Second Quarter Earnings Call. If you haven't done so already, we invite you to download our investor presentation from our website, which provides additional information about the company, 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 second quarter, then we'll turn the call over to Ken, who will take us through the second quarter financials in more detail. I'll then return to talk a little bit more about the macro environment, our strategy and provide updates on our recent activity, and of course, we'll open the call to questions.

During the quarter, our portfolio continued to generate strong, recurring cash flows. Recurring cash flows totaled $1.05 per weighted average common share and that's in excess of our common distribution as well as interest and other expenses that the company faces. While retail loan mutual fund outflows continued in the quarter with approximately $9 billion of outflows, we believe pressure from those force sellers was offset by demand for loans from other institutional investors both in the form of CLOs and through separately managed accounts. Indeed, despite the retail outflows for the first half of 2019, the Crédit Suisse Leveraged Loan Index delivered a positive return of 5.4%. Through August 8, the total return on that index is now over 6%.

During the quarter, we issued $35.5 million of new common stock via our ATM program, capturing approximately $0.23 of NAV per common share, and this NAV accretion obviously benefits all shareholders. At the end of the quarter, we redeemed half of our Series A Term Preferred Stock, these are our ECCAs, which brought us back into the range, where we generally expect to operate the company from a leverage perspective over the long term. The As were our shortest maturity and represented the highest cost of financing on our balance sheet.

Corporate credit expense within our portfolios remains low. While the lagging 12-month default rate ticked up a bit quarter-over-quarter to 1.34% as of June 30, that's up from 93 basis points as of March 31, the default rates in corporate credits and we remain near historic low levels. Overall, during the quarter, our NAV felt slightly approximately $0.25 per share from the first quarter 2019 levels. We highlight, however, that short-term changes in the -- in our NAV don't typically -- don't necessarily imply a change in the portfolio of cash flow the way such moves could with the BDC. Rather we expect short-term drops in NAV may actually augur for higher future cash flows in our CLOs as they're able to reinvest principal proceeds from repayments and sales and what can be a buyer's market for loans. During the second quarter, we continued to remain proactive with respect to managing our portfolio.

We deployed approximately $60.9 million of gross capital into new investments. The new CLO equity securities added to our portfolio continues to have a higher weighted average effective yield than the weighted average of our overall portfolio of CLO equity securities. And during that quarter, 3 of our loan accumulation facilities were converted into CLOs. For the second quarter, we generated net investment income and realized capital losses of $0.07 per common share. This included an unusually high realized loss driven principally by the accounting treatment of a CLO that undertook a call and roll transaction.

Beyond this call and roll, which I'll explain in more detail shortly, other realized losses were related to the repayment of the ECCA preferred stock and certain sold and called investments. Importantly, the vast majority of the GAAP realized losses were already reflected in the company's NAV as unrealized losses. On an NII only basis, we generated NII of $0.36 per common share, modestly higher than the first quarters' total NII per share. To expand upon this call and roll transaction, which drove the majority of the company's realized loss, a CLO where the company was invested had contemplated a reset transaction. Unfortunately, certain other investors in the equity class of that same transaction were uncooperative with the planned approach. Those investors did not benefit from the company's preferential economics in the transaction, which we believe may have impacted their view.

As a result of this non-cooperation from other investors, the collateral manager was forced to unwind the old CLO vehicle and move the loan portfolio into a new legal entity. While the underlying portfolio was substantially the same before and after, the new vehicle was a new legal entity with a new CUSIP, and the company had to treat the exit from the old vehicle as a realized loss. Economically, the reset done in the form of a call and roll made tremendous sense in our view and the resulting accounting treatment of our realized loss is something that simply falls out of the right economic decision. Indeed after giving effect of this call and roll, the effective yield on the transaction has increased from 9.6% to 15.6%, as a result of these actions. So we're very pleased with that outcome, the accounting kind of falls out of it.

And 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 distributions, we also evaluate the recurring cash flows that we received from our investments and our estimates of taxable income for each fiscal year. I want to highlight again that it is taxable income that sets the floor in our common distribution. Further, recurring cash flows from our investment portfolio exceeded our expenses and common distributions, once again, during the second quarter, just as they did in the first quarter and have historically.

Based on current market conditions and our current portfolio, the company expects to continue its monthly distribution of $0.20 per common share for the foreseeable future. As I mentioned earlier, during the quarter, we deployed approximately $60 million of capital on a gross basis both in the primary and secondary markets, and we received $36.8 million in proceeds from the sale of investments. We added 4 primary CLO equity positions for the quarter, which includes the conversion of 3 loan accumulation facilities. The new CLO equity investments that we acquired had a weighted average effective yield of 15.36% at the time of investment, this level is well above the June 30 weighted average of our overall portfolio of 13.49%.

That weighted average, of course, excludes call to CLOs that are being liquidated. This continues to demonstrate our ability to source accretive investments through our advisers' investment process. During the quarter, we made a decision to begin recasting all of our CLO equity positions effective yields on a quarterly basis. Previously, each position was recast either annually or upon a specific event, such as a reset add-on purchase or partial sale.

Now moving forward, we will be recalibrating the entire portfolio's effective yield each quarter. We believe this evolution to a more frequent effective yield recasting will provide investors with even greater information about our portfolio. Whereas a static CLO -- a static portfolio of CLO equities weighted average remaining reinvestment period would decay one quarter -- each calendar quarter across our entire CLO equity portfolio, the weighted average remaining reinvestment period remained flat versus the prior at quarter end. The weighted average remaining reinvestment period flat at 3.2 years is due to our continued reset or call and roll activity and proactive portfolio management, which is a meaningful value add provided by our advisers' overall investment process. Minimizing decay in the weighted average remaining reinvestment period is an important part of our risk mitigation strategies.

As of June 30, the weighted average effective yield on our CLO equity portfolio, excluding called investments, was 13.49%, and that compares to 13.58% in the prior quarter and 14.14% as of June 30 of the prior year. The relatively stable weighted average effective yield quarter-over-quarter reflects the recalibration of the effective yield of our entire CLO equity portfolio and was aided by the increase in the weighted average loan spread on the loans held within our CLOs. The weighted average loan spread moved from 3.53% up to 3.57% during the quarter. As we've noted on previous calls, the weighted average effective yield includes an allowance for future credit losses. A summary of the investment by investment changes and expected yields are included in our quarterly investor presentation.

In July and so far through August, I guess, measured through August 8, we've deployed $9 million of gross new capital into investments. Overall, we believe the economy is holding relatively steady despite the recent macro volatility and given the low number of defaults we continue to see in the corporate loan market, we remain favorable on the overall market and our portfolio. After Ken's remarks, I'll take you through the current state of the corporate loan and CLO markets in more detail and share some of 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. We'll review the second quarter in a bit more detail. For the second quarter of 2019, the company reported net investment income and realized capital losses of approximately $1.7 million or $0.07 per weighted average common share. This compares to net investment income and net realized capital gains of $0.36 per common share in the first quarter of 2019 and net investment income -- and net realized capital losses of $0.34 per common share in the second quarter of 2018. The company's NII net of realized capital losses for the quarter ending June 30, consisted of NII of $0.36 per weighted average common share, offset by realized capital losses of $0.29 per weighted average common share. Realized capital losses for the quarter reflected $0.15 per share resulting from the accounting treatment of the CLO that undertook a call and roll transaction versus a traditional reset.

$0.02 per share of a nonrecurring loss related to the acceleration of unamortized issuance cost associated with the partial redemption of a Series A Preferred Stock and $0.12 per share related to losses from the disposition of investments and a write-off of a residual amortized cost of called CLOs. While the majority of the realized loss is due to the accounting treatment specific to investment action, we highlight that the bulk of the realized losses are already reflected in our NAV as an unrealized loss. Further, even after taking into account the $0.29 per share realized loss in the second quarter of 2019, the company has recorded realized net capital gains of $0.09 per share since we went public in 2014.

When unrealized portfolio depreciation is included, the company recorded GAAP net income of approximately $1.6 million or $0.06 per weighted average common share for the second quarter of 2019. This compares to net income of $1.93 per common share in the first quarter of 2019 and net income of $0.44 per common share in the second quarter of 2018. Just a reminder that our short-term cash flow generation is largely unaffected by the unrealized appreciation or depreciation we record at the end of each quarter. The company's second quarter net income was comprised of total investment income of $17.3 million, partially offset by total expenses of $8.4 million, net realized capital losses on investments and extinguishment of debt of $7.2 million and net unrealized appreciation or unrealized mark-to-market losses on investments and liabilities at fair value of $0.1 million.

At the beginning of the second quarter, the company held $1.3 million of cash net of pending investment transactions. As of June 30, that amount was $13.4 million. As a result of deploying $60.9 million in gross capital during the second quarter, there was an additional amount of capital that only generated income for a portion of the quarter, which we expect to generate full income going forward.

As of June 30, the company's net asset value was approximately $347 million or $13.45 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 company's NAV as of July 31 was between the range of $13.02 and $13.12 per share of common stock.

Non-annualized net gap return on common equity in the second quarter was approximately 1%. The company's asset coverage ratios at June 30 for the preferred stock and debt as calculated pursuant to Investment Company Act requirements were 304% and 519%, respectively. These measures above -- are above the statutory minimum requirements of 200% and 300%, respectively.

As of June 30, the company had debt and preferred securities outstanding totaling approximately 32.9% of the company's total assets less current labilities. This is within our target of generally operating the company with leverage in the form of debt and our preferred stock within the range of 25% to 35% of total assets. This is down from 37.4% as of March 31 and was driven by raising accretive equity capital at a premium to NAV and redeeming half of our existing Series A Preferred Stock at par at the end of June.

Beyond proactively managing the company's investment portfolio, we're also very focused on the right-hand side of our balance sheet. We seek to optimize our cost of capital, maximize flexibility and maturity profile afforded to us by our preferred stock and unsecured bonds.

With the redemption of half the Series A Preferred Stock, the weighted average maturity of the company's debt and preferred stock now stands at 7.5 years. While the company is not a BDC, it is often compared against BDCs, and we believe the maturity of our financing compares very favorably to the weighted average financing maturity of most BDCs. Moving on to our portfolio activity in the second quarter through August 8, investments that have reached their first payment date are generating cash flows in line with our expectations. In the third quarter of 2019, as of August 8, the company received recurring cash flows on its investment portfolio of $26 million or $0.98 per common share. This compares to $26 million or $1.05 per common share received during the full second 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 second quarter, we paid 3 monthly distributions of $0.20 per share of common stock as scheduled. On July 1, we declared monthly distributions of $0.20 per share of common stock for each of July, August and September. Based on current market conditions and the company's investment portfolio, the company currently expects to continue its monthly distribution at $0.20 per common share for the foreseeable future. We note that the ability of the company to declare and pay distributions is subject to a number of factors, including the company's results of operations. In terms of our at-the-market offering program in the second quarter, the company issued approximately 2.1 million shares of its common stock at a premium to NAV for total net proceeds to the company of approximately $35.5 million. The second quarter issuance resulted in NAV accretion of approximately $0.23 per common share.

I will now hand the call back 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 first take everyone through some of the macro loan and CLO market observations that we've got and how they might impact our company, and I'll touch a little more on our recent portfolio activity. As I mentioned earlier that through June 30, the Crédit Suisse Leveraged Loan Index generated a total return of about 5.4%, tracking ahead of where the index was at the same time last year. Loan retail fund outflows continued during the quarter. JPMorgan data shows outflows totaling about $9 billion, although that was offset by demand from other institutional investors, we believe. Given that most loans are trading at or below par, there continues to be minimal refinancing or repricing activity in the loan market at present. This has led to a nearly complete and certainly very welcome halt to the market-wide loan spread compression trend that have -- we'd experienced over the past few years.

As I mentioned earlier, on a look-through basis, the weighted average spread in our loan portfolio, increased 4 basis points from March. The total amount of institutional corporate loans outstanding was about $1.2 trillion as of June 30, and that's about a 1% increase from the end of the first quarter according to data from S&P Capital IQ.

As you're certainly aware, in July, the Fed cut rate by 25 basis points as was widely expected in the market. Lower rates, all else equal, is a credit positive event for corporate borrowers as all of our borrowers are floating rate borrowers and their interest expense falls as a result of lower interest rates. Loan defaults continue to remain well below historic averages. The 12-month lagging default rate was 1.34% according to S&P and even with the ups and downs in loan prices that we've seen since October 2018. Importantly, the percentage of loans that trade at stressed or distressed prices have not meaningfully increased, which indicates that the market is not foreseeing broad-based credit issues at this time. We continue to expect default rates to remain below long-term averages over the near to medium term. I mean this is due to minimal and pending maturities before 2022, a growing U.S. economy and the large majority of the market consisting of covenant-light loans.

We're mindful of the short-term uncertainty brought about by rapidly shifting positions on trade tariffs but do not expect those to be long-term factors. When greater loan price volatility presents itself, we believe the company and its investments are well-positioned to go on the offense and take advantage of those lower loan prices given the benefit of our long term, locked-in-place,

nonmark-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 technically-driven loan price volatility without an increase in defaults can be extremely attractive.

In the CLO market through June 30, we saw $65 billion of new CLO issuance along with $11 billion of resets and $13 billion of refinancings. For the full year of 2019, our adviser continues to expect about $100 billion of new issue volume but now has lowered outlooks for resets and refinancings to $20 billion and $30 billion, respectively. We continue to direct -- selectively direct additional resets and refinancings 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 the CLO equity in our portfolio. In our investor presentation, you can see specifically which investments have been refi-ed, reset or in some cases both. As a result, we expect our overall CLO equity cash flows to increase over time with less of an impact of the one-time reductions associated with resets and refis. The benefits of our prior refi and reset activity can also be seen in our weighted average AAA spreads on our CLOs. As of June 30, the weighted average AAA cost within our CLO equity portfolio was approximately 122 basis points. This compares to a market level of about 135 basis points at quarter end. And our weighted average AAA cost continues to be meaningfully in the money today.

As always, our advisers' deep CLO investing experience provides us with a notable advantage as we seek to generate additional value for our portfolio and our stockholders. I mentioned earlier we've deployed about $9 million in gross capital across CLO equity so far in the third quarter, and we have dry powder available as we see opportunities in both the primary and secondary markets.

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

To sum up, we believe we had a solid quarter for the second quarter of 2019. We received recurring cash flows on our portfolio in excess of our common distributions, interest and other expenses, deployed approximately $61 million of capital into new investments, the new CLO equity positions that we purchased had effective yields well above the portfolio's weighted average effective yield, and finally, we continue to raise new equity capital at highly accretive terms, delevered and increased the weighted average maturity of the company's financing.

Given the low loan default rates that we're experiencing, we remain comfortable with the overall environment from a longer-term perspective. As a result, we have the strong opportunity to use our advisers' strength to create additional value for our portfolio over the longer term. We also continue to utilize our advisers' strength and selectively direct additional resets and refis, which we'd expect to increase future cash flows to our CLO equity securities. And as loan spreads hopefully continue to widen, we believe the effective yield on our CLO equity portfolio will begin to rise as well.

We continue to be proactive in the management of both the assets and liabilities of the company to create additional long-term value for our shareholders. With that, we thank you for your time and interest in Eagle Point. Ken and I will now open the call for questions.

Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll take our first question from Chris Kotowski with Oppenheimer.

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Christoph M. Kotowski, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [2]

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Yes. Two things. One is you said on the call that you expect to continue the $0.20 distribution. In the past, you had also said that you expect to cover it out of taxable income and you'd kind of provided a reconciliation between the taxable and the GAAP income. And I wonder if you could do that again? Do you still expect to cover the distribution for 2019 out of taxable income? And can you kind of somehow reconcile taxable income with the GAAP income that we see? First.

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

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Sure. That's a spot-on question. There are -- we're going to get probably just a little deep into the weeds here with the answer. The short answer is, no, based on our current expectations, that could still change. However, the reason for that is an unusual kind of a nonrecurring event that that's happening within the portfolio. CLO equity -- and I'm going to get into a little bit of weeds, but bear with me, CLO equity can be created in partnership format or PFIC format. We have determined that the company, the ECC is better off holding its equity in PFIC format, which gives it the ability to deduct certain capital losses against ordinary income within that same CLO, very unusual provision in the tax code to be able to take capital against ordinary.

We have been slowly -- or not slowly, it has been slower than we'd like, although we have been vigorously converting, and it's been certainly several dozen -- well over a dozen probably, 2 to 3 dozen, significant number of partnership to PFIC conversions within our portfolio. The economics of the securities are identical, but there's -- we bake in, when we create CLOs, the ability to have a one-time conversion from partnership to PFIC which the company has been undertaking. As a result of that conversion, a significant number of CLOs will now have -- or a significant number of our holdings will have a tax year that ends on December 31.

You'll recall the company's tax year ends November 30. And what this is going to have the effect of doing on a one-time -- or I guess on a permanent-shift basis, is move a portion of taxable income to the following year. And then in the tax year, that money will continue to be shifted forward, it's like kind of a permanent shift by virtue of changing these investments from partnership to PFIC. We went in, studied and when we looked at the portfolio without giving rise to these -- ignoring the impact of these conversions, frankly taxable income was in line with our expectations, which was in the, I don't know if we put a specific number, but in the 240 zip code.

As a result of this partial deferral taxable income at present, we expect to be below 240. But we would expect that additional income would just be picked up next year and closer to a 240 run rate in the following year. So a little bit of a long story. One-time change in the portfolio, which makes sense for us to do is causing a deferral of income. Had we not made that change, we believe taxable income would have been right around 240.

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Christoph M. Kotowski, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [4]

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Okay. And PFIC, P-F-I-C, what does that stand for?

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

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Yes. Passive Foreign Investment Corporation. And if you look at our schedule of investments, you'll see some investments are called sub-notes and others are called income notes. In general, although not exclusively, sub-notes are partnership pieces and income notes are PFIC pieces. That's not a 100% rule, but it's a good guideline.

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Christoph M. Kotowski, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [6]

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Okay. And then, I guess, talk a little bit about the NAV volatility. I mean if you look quarter end to quarter end, you started at $13.70 the share issuance, added $0.23 and then you ended $13.45 so that's a -- kind of like a $0.48 erosion. And I guess -- and it's even odder if you look April -- in April, I think you said $14.33 to $14.30 -- $14.43, and end July, you're down in NAV to $13.02 to $13.12. That's kind of a 9% decline in a 3-month period, where the visible loan price index is that we can see it kind of didn't move that much. Now what accounted for that decline in NAV?

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

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If anything, we have -- certainly loans were up broadly, they weren't down meaningfully during that period. On a broad level, and this is a macro statement about the overall portfolio, any individual position can vary widely and can vary -- and have different things going on. Broadly, the market -- CLO equity market, shifted to a bit of a wider discount rate towards really the last 3 months if you look at May, June and July where the marks on the positions were reduced in line with what the current market value is for CLO equity. Broadly that -- the yield has -- that investors are demanding, including ourselves, has moved a little bit wider so unlike quite a few BDCs, which just -- in many cases, just leaves things at par unless there's a big shock downward. As you know, we vigorously mark the portfolio to market every single month. The principal change was due to increase in discount rates.

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Operator [8]

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We'll take our next question from Mickey Schleien with Ladenburg.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [9]

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So I'm going to apologize for a long-winded question, it sort of follows up on the last question. Tom, we've seen that CLO equity cash flows have remained very good at 20% or even more from doing the numbers right for this quarter. And as you pointed out, that's probably due mostly to defaults remaining low. And I do see that your cash flows are more than covering your distribution and expenses. But those cash yields are a lot higher than the average estimated yield of, let's call it 13.5%. And we know that takes text into account a lot of assumptions, but I suspect the one that's been moving around the most lately is the forward LIBOR curve.

So like you said, CLO equity investors are taking all of that into account and applying a higher discount rate to the projected cash flows, and we're getting these more depressed prices, which looks like it continued into July. And again, I'm sorry for the long-winded question, but something's got to give, right? Because over a CLO's life, the cash yield and the estimated yields would converge, everything else remaining equal. And you alluded to this possibility, I think, in your prepared remarks. So based on your experience, when we're late in the cycle, which we appear to be now, how do CLO equity cash yields and estimated yields track in relation to one another?

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

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Let's see, good question. The way that -- let me just -- let me start with this for a minute and then -- you have a long-winded question, I have a long-winded answer. The way CLO equity is valued in the market today when it's lightly seasoned and relatively new, it's much more of an NPV or present value of cash flows at a discount rate assessment. And the discount rate that the markets demanded has gone up.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [11]

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You mean the CLOs that are terminal value, right?

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

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Correct versus where I'm going is as CLOs are more seasoned than let's say CLOs at the end of its reinvestment period or even past it, in general there, the market is going to value CLO equity much more on a liquidation value basis, not an NPV basis.

What can happen, as you get to those later stages, you can see distorted effective yields, sometimes much higher, sometimes much lower, depending on is it over such a short period of time, if it's marked a few points above or a few points below NAV, you can see some pretty wacky distortions. To part of your question on cash flow and late in the cycle, one of the things that's important to appreciate is, let's say 1 loan defaults in a CLO so long as it doesn't trip any OC Test or things like that in the CLO, the actual impact on the ongoing or recurring CLO equity cash flows is quite modest. Let's say that loan was $100 loan, it defaults, maybe you get $0.60 or $0.70 back as a recovery. That $0.30 or $0.40 realized loss is something that comes out of the terminal value well in the future. The recovery on that loan is reinvested and that recovery -- that new investment amount continues to generate cash flow. So when you stress a CLO with higher or lower default rates, what you'll see is the cash flows the recurring cash flows, don't move around that much. It's much more a change in the terminal value or reduction if we had a high amount of defaults.

Of course, if we had a high amount of defaults, our expectation is the price of loans would fall, and the reinvestment opportunity presented to CLOs would be that much better, although you wouldn't see that in the ultimate -- manifest itself in the ultimate liquidation value of the CLOs until such later time as loan prices recovered. So long story short, you could see yields move around more than cash flows in general for light to medium season deals.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [13]

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And directionally, it sounds like you're saying there's a chance that we'll actually see your effective yields -- your weighted average effective yield on the portfolio increase further?

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

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We did drop a little bit quarter-over-quarter. But where we're looking right now, to the extent, loan spreads gets -- we're not popping the champagne over 4 basis point increase in weighted average loan spreads. But maybe we should pop the champagne just for the lack of reduction in weighted average loan spread, which is something, if you look back to probably 8 of our last 10 calls, you would have heard us lament about spread compression. Right now, at least that does not seem to be a factor in the market. And the repricing activity on loans is close to zero as I recall seeing it in some time. So to the extent the market continues with loans trading in this kind of 98 to 100 band, that augurs for the opportunity for the CLOs to actually increase their loan spreads, which is good news for us.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [15]

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Okay. Tom, you've obviously -- and your team have been investing in this segment for a long time. When you look at past cycles, where do CLO -- when do CLO equity investors typically become more optimistic about the outlook? In other words, right now, they're pessimistic, it looks like we're in the early stages of a down cycle. We've had down cycles before, when do they get more optimistic as that process continues?

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Thomas P. Majewski, Eagle Point Credit Company Inc. - CEO & Director [16]

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That's a good question. I'm trying. Yes, I know. I'll say it's different this time in the -- if you compare, and this is some broad generalizations, the investor base in CLO equity today versus the investor base in CLO equity 12 to 14 years ago, kind of from 2005 to 2007. There are certainly many more longer-term stickier vehicles like ourselves in the market, and obviously you can see in our Form ADV, beyond ECC, we manage CLO equity through other private vehicles with -- that are, we believe, well-equipped to handle not short -- not hot money in that complex. So at this point, I think broadly, we have a different type of investor holding a lot of the CLO equity market.

When do people get more optimistic? It's hard to say for sure. There can be both economic factors, frankly, and technical factors that drive market discount rates. There's not one particular thing that I could say boy, if this happened, you'd see discount rates tighten and prices go up. In different classes of securities, earlier this year -- this is talking about CLO debt, we saw AAAs widening while BBs were tightening for a period of time. And frankly that was due to some technical factors of some new money came into the BB market, which seems to push things wider, and the AAA market had a few people go to the sidelines for a little while, which pushed things wider there and while BBs closer to credit risk were actually tightening. So there can be idiosyncratic things that affect as well. So I guess, so demand in that case can move around a bit. I don't have a silver bullet though as to what would be the change.

The NAV, and I know this confuses people who are -- many people and you've done a lot of work trying to get your head around this, Mickey, we compare a NAV of a vehicle like ours or other CLO equity vehicles versus the stability -- a potential stability of a NAV and a BDC. It really just is an apples to oranges thing. And this is why we provide investment by investment cash flow and income recognition. At the end of the day, you can see exactly what's happening on each position. And I don't think you'll see material decay in cash flow really across any of our position. So if discount rates widen or tighten by 100 basis points in the next quarter, absent some other news, that onto itself wouldn't cause me alarm or excitement.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [17]

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Okay. I understand. Tom, one of the idiosyncratic things that I've heard about and read about a little bit is, after the change in the risk retention rules, there've been some CLO managers who apparently price their deals with lower implied returns for their equity tranches, basically to get their deals done because they wanted to price the deals. So how prevalent has that trend been? And what's been the impact on the CLO equity market from that?

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

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Yes. So what you're getting at there, there are some CLO collateral managers who raised captive pools of capital that allowed them to direct -- to basically take the equity in their own CLOs into those vehicles that they controlled. To be 100% clear, there is no affiliated collateral manager in any ECC investment. And frankly, that's a key tenet of our overall advisers' platform is that from time to time and invariably it comes up, there can be a conflict between ownership meaning equity and management. Both at the -- that can come up at the creation, like should we do the deal or not, and then at the, should we call the deal or not. So everything in ECC has a third-party collateral manager. That said, a number of those funds printed -- a number of those third-party funds whether they're -- it's a captive to a particular collateral manager, have printed CLOs that in our opinion are at off-market levels. We can't control what those folks do with their money.

Certainly those are not the type of CLOs we're investing in. It doesn't have that -- it doesn't have that big of a distortion on the equity market, and that equity typically just gets buried away in some other fund. So that much is okay against that some of those firms might -- this is kind of a consequential thing, might just print to print even if they have to push the AAA market or AA market wider in CLOs, which could have an adverse effect if our deal is the next one going. We obviously track spreads, and we make the decision when to convert a loan accumulation facility to a CLO when we think it's best, not by virtue of -- not focused on the management side of things.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [19]

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I see. And I appreciate your time, but I do have a couple more questions given how volatile everything is. I see that the weighted average CCC bucket in your portfolio, it increased a little bit. At the 5.2%, it's still quite below the 7.5% sort of typical limit. How concerned are you that managers are filling their single B allocations, either proactively or through some of the downgrades that we've seen, which eventually could cause them to breach the CCC limit? And is that a meaningful factor that CLO equity guys are thinking about?

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

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Yes. So just to kind of recap, the way that CCC buckets work, typically in a CLO and every terms in any CLO can vary, but broadly you should think of it, once there are more than 7.5% CCCs in a portfolio, there's a haircut to the numerator of the OC Test related to a portion of the loans as CCC-rated loans in excess of 7.5%. So if a CLO is at 7.49%, that doesn't even matter. CLO all of a sudden goes to 7.51%, you're going to take a haircut on that 0.01%, and obviously it goes up and up and up from there. The -- invariably as CLOs season, you do see a little bit of CCC -- a little downward migration, very few of those -- some CLOs will start with 1% or 2% CCCs maybe a little higher in 1 or 2 cases. But that's kind of a bucket more contemplated for migration. And indeed a nontrivial amount of loans are rated B3, which all else equal could suggest they could get to CCCs sooner than later. Let me look at our portfolio distribution just to be -- get on a point here. Bear with me one second, I'm just looking through the -- this quarterly deck.

I'm just looking for -- do we have a ratings distribution? Here we go. Sorry, I found it on a different thing. This is on -- if you look at our monthly tearsheets, you'll see the bulk of the portfolio, and these come up on the website, and we'll have the July month end tearsheet up on the website later today. You'll see the bulk of the portfolio is single B rated. If you use the S&P ratings, that would be B2 equivalent on a Moody's scale. If you would have a look at a similar chart broadly in a CLO 10 or 12 years or 12 or 14 years ago, you'd probably see it a little more evenly mixed between B plus and B versus where we are right now. So that's certainly one thing that is a shift. But what I'll say is good collateral managers are pretty proactive in, I'll say -- what I call managing or foreshadowing downgrade risk. One collateral manager in particular that I know actually has a feature in their system, where the analysts ascribe a probability of falling to CCC, 3 months out, 6 months out, a year out. And what that one issuer has said as well they often don't get it right on a name by name basis, their outlook in aggregate across their portfolio turns out to be pretty darn accurate.

So a good CLO manager is going to keep their eye on that in a pretty big way. A, B, even if we breach the test though, let's say we won over 7.5% in any CLO, we have on our overall junior OC cushion right now, 4.37 points on a weighted average basis of cushion before the OC Test for the trip. So we could take a lot of CCC migration before there'd be any risk of impacting cash flows. Ultimately CCCs do portend for high credit risk, against that the collateral managers in our portfolio, we believe are some of the best in the market. And we're going to make -- we believe they're in aggregate making the right decision should they sell or liquidate a name, crystalizing a loss potentially or is it better to hold.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [21]

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I appreciate. That's good to understand. One last sort of housekeeping question. What were the factors the external manager considered in deciding to waive some of the incentive fees? And can that waiver be recaptured?

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

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So no, it can't be. What it -- what we did, and this kind of just falls in the right-thing-to-do bucket, when we called half of the As, the half of the unamortized original issuance expense becomes a realized capital loss. Had we just let the -- had we let the As run out, that would've been above the line and would have reduced our incentive fee because it would have been treated as interest expense. But then when you prepay it, it goes below the line. So the spirit of the deal is that's -- it's not what the letters say, but the spirit of the deal is that should be interest expense so we took a voluntary waiver related to 20%.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [23]

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I remember, and you've done that in the past, I think.

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Thomas P. Majewski, Eagle Point Credit Company Inc. - CEO & Director [24]

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We did that last time -- in Q2 of last year. That's just the right thing to do.

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Operator [25]

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(Operator Instructions) We'll take our next question from Ryan Lynch with KBW.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [26]

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Just a couple of questions I had today. It sounded like in your prepared remarks, you were pretty favorable on the overall market in your portfolio. It sounded like low default rates currently has you with that opinion. Just wanted to know how do you square that with -- if I look at Slide 34 from your presentation where it shows annual revenue and EBITDA growth from below investment-grade companies, and there's pretty meaningful deceleration in growth over the last several quarters. So how do you square being kind of pretty positive on the outlook versus the slowdown of that that's clearly being showed in some of these portfolio of companies?

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

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Yes. Very good question. This chart used to be up, up and away, and now it's kind of fizzling. And what does that mean? Obviously, this is an average, yes, and some companies are doing much better, some are doing worse than the average. We attribute a non-trivial amount of the increase -- the super strong performance of a year-or-so ago due to kind of a one-time acceleration of earnings and corporate activity due to the tax changes. We're kind of more normalized now and then overlay a little bit of a trade tariff uncertainty that I talked about. If anything, it's probably slowing some degree of capital spending by companies at this point, you certainly don't want to build a factory predicated on getting some raw material from a faraway place and now all of a sudden, there's a 25% duty on it.

The overall impact of the tariffs, even if it's one of the things that's been a popular headline, $300 billion of goods subject to 25% tariff, that's -- did the math -- sorry, it was $75 billion against a $20 trillion economy, it's a rounding error, but it certainly gets a lot of attention, it can move the equity market significantly. And if you're one of the people whose raw materials are subject to such a tariff, that's going to change how you behave. So I think we had a little acceleration last year due to the tax changes. And I think we're kind of at a more normalized level, and then hurt a little bit by some of the tariff uncertainty. We don't think that's a prolonged situation. That's our opinion. Obviously, we could be right or wrong on that. But we think those are kind of the 2 factors driving into the trend that you see on that chart.

Then maybe part B of that overlay, the maturity wall, which is pretty far out and overlay covenant light. And I said that certainly this time last year, we might have been talking -- last October, the market was talking about forward rate increases, we certainly have a much more dovish Fed. So overlay, not a lot of near-term maturities, overlay covenant light, which as long as companies keep paying their interest, there's not going to be a lot of technical defaults and overlay of Fed, which certainly over the last 10 months, has a more dovish feel to it, kind of all factor into our outlook.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [28]

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Okay. That makes sense. And then I had a question, want to kind of follow up on some of the earlier discussion regarding the dividend. So kind of forgetting about GAAP versus taxable income with the dividend at the moment. If I just look at your current NAV today, and I look at what is that dividend yield in your current NAV, it's about 18%. So if you run the math on that, you're going to be required, at least the way that I run it, you're going to need about an 18% to 19% portfolio yield to earn that, at least when I'm just looking at the GAAP standpoint. Your effective yield today is 13.5%.

And I know you're taxable yield is likely much higher than that. But going back and looking at that math to earn an 18% dividend yield on that NAV, you need to have about an 18% to 19% yield in your portfolio. So do you expect this effective yield from a GAAP standpoint to rise significantly higher in the future to kind of maybe more match that taxable yield? And then just kind of from a higher level broader standpoint, 10,000 view standpoint, is it reasonable to expect Eagle Point to pay and earn an 18% ROE and dividend yield on NAV given the current environment, given -- the third year treasury rate at 2%.

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Thomas P. Majewski, Eagle Point Credit Company Inc. - CEO & Director [29]

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Another very good question. One things to factor in mind, first off, is the price of the securities can move around a fair bit without a significant change in fundamental underlying cash flows just as markets ebb and flow and people demand wider and tighter discount rates. So would the NAV move the dollar up or down in the next quarter due to changes in discount rates? Yes, so -- the market discount rate. So first kind of take that as a -- just as a factor in your mind. I know I -- what I don't think is if our weighted average effective yield is in the mid-13s right now, I don't see it moving up 500 basis points in the very near term.

If you look back over history, you'll see probably the peak was in the mid- to high-17s maybe 2.5, 3 years ago, something like that. So that's a factor that's out there. And then I haven't done the math recently to get to the numbers you're talking about, mindful though that I agree with the direction you're looking at, although I don't know that specific quantum. Where we look right now, our expectation is frankly for lower corporate defaults that our models contemplate. So that should be a mitigating factor to the extent the price of securities moves up due to simply discount rates tightening, you'd expect the price of net bogey that you're calculating would, just by definition, fall frankly in that you're working up a higher denominator.

So I don't have a perfect answer for you because I don't have a crystal ball as to where the price of securities will be. The things we look at, we talked about taxable income, we gave you the -- we answered the earlier question about the shift due to the PFIC conversions, which makes all the sense in the world. But it has the -- I guess, the benefit of deferring some taxable income a year, but we don't see the yields on the book going up 500 basis points in the very near term.

Against that cash flow from the portfolio has been well in excess of the yields of the distributions that we've been paying. So it's a mélange of all of those. I don't have a definitive answer as to are we going to see that happen. Well, like I say we're not going to see that happen at the near term. Although what we -- a little different than a typical BDC, here, I think you have to kind of look at all the different factors going on within our portfolio. I was going to say gash -- GAAP, cash and tax and put the 3 of those together, which is ultimately really the medley of all those is what's driving our distribution policy with an overrunning floor of taxable income.

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Operator [30]

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And ladies and gentlemen, we have no further questions in the queue at this time. I would like to turn the conference back to Tom Majewski for any additional or closing remarks.

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Thomas P. Majewski, Eagle Point Credit Company Inc. - CEO & Director [31]

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Great. Thank you very much. We appreciate all the questions and thorough Q&A from call participants and everyone's continued interest in the company. To the extent people have further conversations or questions you like, feel free to reach out to either Ken or myself. And I look forward to speaking to everyone again on the next quarter. Thank you very much.

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Operator [32]

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Ladies and gentlemen, this concludes today's conference. We appreciate your participation.