Earnings Call Transcript - EIC Q3 2024

Operator, Operator

Ladies and gentlemen, greetings, and welcome to the Eagle Point Income Company's Third Quarter 2024 Financial Results Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Garrett Edson of ICR. Thank you. Please go ahead.

Garrett Edson, Host

Thank you, and good morning. As a reminder, before we begin our formal remarks, the matters discussed on this call include forward-looking statements or projected financial information that involve risks and uncertainties that 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 www.eaglepointincome.com. Earlier today, we filed our third quarter 2024 financial statements and our third quarter investor presentation with the Securities and Exchange Commission. The financial statements and 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 will now turn the call over to Tom Majewski, Chairman and Chief Executive Officer of Eagle Point Income Company.

Thomas Majewski, Chairman and CEO

Thank you, Garrett, and welcome everyone to Eagle Point Income Company's third quarter earnings call. We appreciate your interest in Eagle Point Income Company or EIC. If you haven't done so already, we invite you to download our investor presentation from our website at eaglepointincome.com. This presentation contains detailed information about the company and our investment portfolio. It has been a solid year so far for EIC. We've generated strong net investment income and realized gains and continue to strengthen our balance sheet. CLO junior debt remains in robust demand and we're actively managing our portfolio towards maximizing shareholder returns. Among our highlights for the quarter, the company received recurring cash flows of $13.1 million or $0.76 per share. This compares to cash flows from the prior quarter of $12.4 million or $0.87 per share. The decrease in cash flows per share during the quarter was a result of a significant number of new investments made after their third quarter payment dates. We are now seeing our first payments from those investments in the fourth quarter. The company generated net investment income and realized gains of $0.57 per share during the quarter. Realized gains of $0.08 per share were generated from a number of sales and repayments at par on positions in our portfolio during the third quarter as we were able to realize the convexity of our discounted purchases over the past quarters sooner than expected. In line with the previous two quarters, we paid three monthly common distributions of $0.20 per share during the third quarter and have declared the same monthly distributions through March 2025. Our NAV as of September 30 was $14.90 per share, a 2% decrease from the level at June 30. We continue to strengthen our balance sheet through our at the Market Program or ATM and Committed Equity Finance programs. We issued approximately 2.8 million common shares of stock at a premium to NAV. This generated NAV accretion of $0.05 per share during the quarter. We also realized proceeds of $7.1 million from additional issuances of Series B and Series C term preferred stock via the ATM. Daily average trading volume for our common stock continues to increase with volumes in the third quarter, 29% higher than the second quarter and more than tripling the average trading volume on a year-over-year basis. All of our CLO coupons remain in the double digits and some CLOs have the potential for higher returns if those CLOs are called early. Furthermore, the portfolio closing equity exposure continues to enhance our portfolio's earning ability. As investors focused on the long-term, we remain consistent in our approach to construct a portfolio that can weather any economic and rate cycle. We believe the portfolio is strongly positioned for continued future performance. For additional commentary on the overall market and our recent portfolio activity, I'd like to turn the call over to Senior Principal and Portfolio Manager Dan Ko.

Dan Ko, Senior Principal and Portfolio Manager

Thank you, Tom. We continue to find attractive investment opportunities in junior CLO debt and CLO Equity. EIC continued to capitalize on the elevated rate environment in the third quarter by investing in high-yielding CLO debt and CLO equity. Despite the Federal Reserve's recent rate cuts, we believe floating rate CLO debt still offers an attractive return profile compared to other fixed-income securities. Furthermore, CLO equity is relatively insulated from rate movements because it is principally a spread arbitrage product. All things equal, lower rates should lead to lower defaults of the loans in our underlying CLO portfolios. The Credit Suisse Leverage Loan Index continued to perform well, generating a total return of 2.1% for the quarter and 6.6% year-to-date through September 30th. The index continued its trajectory in October with loans up 7.5% year-to-date as of October 31. We continue to see attractive return profiles in both the primary and secondary markets. In the third quarter, we deployed approximately $90 million of net capital into new investments. The weighted average effective yield of the new CLO purchases during the quarter was a robust 12%. During the third quarter, approximately 6% of leveraged loans market-wide or roughly 23% annualized repaid at par. The prepayments were driven by loan issuers focused on refinancing their near-term maturities in an effort to further extend the maturity profile of their debt. Regarding new CLO issuance, we saw $40 billion of new issuance in the third quarter of 2024 and $142 billion for the first nine months of 2024, still on pace to break the previous record of $187 billion set in 2021. As noted on our prior calls, third-party CLO equity investors including us have returned to the primary market as CLO debt spreads have tightened. We continue to see a large increase in resets and refinancings of CLOs driven large part by tighter CLO debt spreads. Year-to-date through September 30th, we completed four refinancings and one reset of our CLO equity positions, lowering their debt costs in the refinancings by an average of 32 basis points. The reset extended the reinvestment period to five years, thus increasing our portfolio's weighted average remaining reinvestment period, which remains our focus for the CLO equity portion of EIC's portfolio. We continue to expect that refinancings, resets, and calls will lead to some of our discounted CLO BB purchases over the past quarters being repaid at par, crystallizing the convexity in certain of our investments sooner than anticipated. Defaults continue to improve during the year with only three leveraged loan defaults in the third quarter and the trailing 12-month default rate declining to 80 basis points as of quarter-end, remaining well below the historical average of 2.6%. EIC's default exposure as of September 30th stood at 0.6%. We expect default risk to remain low for some time. As we've consistently noted, CLO BBs have withstood multiple economic downturns in the past, experiencing very low long-term default rates. We believe it would take a significant amount of loan defaults well above the historical average and importantly coupled with limited loan price volatility for EIC's portfolio to be permanently impacted by a default wave. Moving forward, we remain well positioned to deploy new capital into additional investments that offer compelling risk-adjusted returns for the Company's portfolio. With that, I will now turn the call over to our Advisor's Chief Accounting Officer Lena Umnova to walk through our financial results.

Lena Umnova, Chief Accounting Officer

Thank you, Dan. During the third quarter, the company recorded NII and realized gains of $9.9 million or $0.57 per share. This compares to NII and realized gains of $0.44 per share recorded for the second quarter of 2024 and NII of $0.38 per share for the third quarter of 2023. When unrealized portfolio depreciation is included, the company recorded GAAP net income of $1 million or $0.06 per share. The company's third quarter net income was comprised of total investment income of $12.5 million and net realized gains of investment of $1.3 million. This was partially offset by unrealized appreciation on certain liabilities held at fair value of $3.6 million, net unrealized depreciation on investments of $5.3 million, and financing costs and operating expenses of $3.9 million. Additionally, for the third quarter, the company recorded other comprehensive income of $2.4 million representing the change in fair value on the Company's financial liabilities attributed to instrument specific credit risk. During the third quarter, we paid three monthly distributions of $0.20 per share and last week we declared continued monthly common distributions of $0.20 per share through March 2025. As of the quarter end, the company had outstanding borrowings from the Revolving Credit Facility and Preferred equities, which totaled 32% of total assets less current liabilities. This is within our long-term target leverage ratio range of 25% to 35% at which we expect to operate the company under normal market conditions. The company's asset coverage ratios at the quarter end for preferred stock and debt, calculated in accordance with Investment Company Act requirements were 316% and 4,965% respectively. These measures are comfortably above the statutory requirements of 200% and 300% of preferred stock and debt. As of September month-end, the company's net asset value was $277 million, or $14.90 per share, compared to $15.24 per share as of June month-end. Moving on to our portfolio activity for the month of October, the company received recurring cash flows on its investments of $15.2 million. Note that some of the company's investments are still expected to make payments later in the quarter. As of October month-end, net of pending investment transactions and settlements, the company had over $21 million of cash and revolver capacity available for investment management. Management's unaudited estimate of the company's NAV as of October 31st was between $14.99 and $15.09 per share. At the midpoint, NAV is up from where we stood at September 30th. I will now turn the call back over to Tom to provide closing remarks before we open it up for questions.

Thomas Majewski, Chairman and CEO

Thanks, Lena. EIC continues to perform quite well and our proactive investment strategy continues to generate significant net investment income. Despite the rate cuts in mid-September and early November, we continue to believe our portfolio is well positioned to succeed in any rate or economic environment. We maintain our view that CLO BBs are one of the most resilient risk asset classes in the market. This is attributable both to their structural protections and underlying collateral. We remain confident that EIC is well positioned to generate compelling risk-adjusted returns for our shareholders. We thank you for your time and interest in Eagle Point Income Company. Lena, Dan, and I will now open the call to your questions.

Operator, Operator

Thank you. The first question is from Matthew Howlett with B. Riley Securities. Please go ahead.

Matthew Howlett, Analyst

Hi Tom, thanks for taking my question. Hey look, congrats on the terrific results here. And I want to talk about the BB market because you are really a unique vehicle out there. What are you seeing? So on acquisitions, can you go over primary and secondary on the prior call? You said there was a big difference on spreads on the equity side. I want to hear about the BB side. And I want to hear about the tiering among the managers. Is there much of a difference these days?

Dan Ko, Senior Principal and Portfolio Manager

Hey Matt, this is Dan Ko here. In terms of spreads, I'd say that despite the recent Fed rate cuts, CLO BB has actually held in pretty well in terms of prices. We've actually seen prices rally despite the Fed rate cuts and these being floating rate CLO debt securities. Now the current cash yields certainly are falling as the base rates are falling. But you have to remember that the spread on CLO BB is a larger chunk of the yield than other floating rate securities so it's a little less impacted there, actually on the overall yield. And then to your question about tiering, we are certainly seeing tiering compress within the Tier 1 and Tier 3 collateral managers out there. But then we're also seeing tiering between new issues and resets as well. So for a new issue portfolio that's being issued today, you have a much cleaner portfolio, no tail in the portfolio, and fewer stressed assets, whereas resets, while obviously, it is nice to have a portfolio in place that already ramped, there are some stressed assets that are in the portfolio. So we do see potentially even a difference of 100 basis points in terms of spreads that we're seeing on new issues versus resets.

Matthew Howlett, Analyst

That's huge. And what about primary or secondary just in general on the double business if it's not a reset if it's a new issue or something?

Dan Ko, Senior Principal and Portfolio Manager

Yes. The convexity we observed in CLO BBs over the past year has largely diminished, as most of the CLO BB asset class has returned to par. While there are some assets still trading at a discount, those may not be advisable to invest in. There are still opportunities to purchase discounted assets, and some compelling options at a premium as well. Currently, there is a more favorable balance in value between new issues and secondary, particularly since secondaries have seen a significant rally.

Matthew Howlett, Analyst

Great. Regarding the discounts you own, specifically the prepay aspect, how much is left in that portfolio and what should be our expectations on the contribution from those prepays going forward?

Dan Ko, Senior Principal and Portfolio Manager

Yes. No, it's a good point. We certainly see the benefits of being able to realize the convexity sooner, and so we take those realized gains, but then you're right. I mean you're losing out on some of the wider yielding stuff. I'd say that a large chunk of the portfolio still consisted of purchases that we made at discounts that we do still see potential for the gains to come through. But in terms of the mark in terms of the NAV, I guess we've already marked those positions kind of at par. So it's really more of a when those, I guess, unrealized gains will be moved to realized.

Matthew Howlett, Analyst

Right. Exactly. I understand. Okay. Now, regarding the portfolio, it's essentially doubled in this unique vehicle that handles these BBs. Can you elaborate on the fact that there have only been 4 basis points of losses, which is remarkably low? It's surprising that more people aren't involved in this, but your vehicle operates efficiently, your cost of capital is decreasing, and your efficiency improves as you expand. Tom, what should the ideal yield requirement be? If you could think like an equity analyst, how should this vehicle be compared to other risk-type vehicles? It appears that your exposure to losses in these BBs is minimal.

Thomas Majewski, Chairman and CEO

Certainly, the historic data that you cite is spot on. The distribution rate kind of pencils out to a high 14s yield right now, which, in our opinion, certainly is way cheap compared to private credit, which is probably the closest comparison. And I don't know what you have a view on a generic dividend yield right now. I'm just pulling up.

Matthew Howlett, Analyst

BDC.

Thomas Majewski, Chairman and CEO

Many private credit managers perform well, but there will always be some challenges. There are typically a few names that are not accruing, but we have no non-accruals in our BB book, as that concept does not apply to us, given our appealing capital structure. We still have some 5% paper maturing in 2026, but the right side of our balance sheet remains very attractive. Additionally, our fee structure in EIC is significantly better than that of a typical BDC. When comparing fees charged by large public BDCs, we are investing in higher-yielding assets that have lower historical loss rates while charging less. However, the distribution return on EIC still shows a substantial difference compared to many BDCs, which should narrow over time. We are pleased with the company's increased volume, which has roughly tripled year-over-year, helping to scale the company. Increased volume leads to more volume; we want our shareholders to have a liquid stock that allows them to buy more and trade actively. We must continue to communicate the resilience of the underlying asset class and the robust cash flows it generates. We believe the premium distribution yield of our stock compared to BDCs is set to compress, but it will take time. EIC has been in the market for a decade, and we are gradually progressing. Our brand has an advantage as we were recognized early. We feel that the distribution opportunity offered by EIC is currently undervalued from an investor's perspective.

Matthew Howlett, Analyst

Yes, I think it's one of the most overlooked yield vehicles out there. Like it's re-rated a little bit, but I mean it's got a long ways to go, and you guys are doing a great job. And on just like the asset class itself, I mean it's only 4% to 6% of a typical CLO, but it's big enough. I mean, it's big enough, you could still double, triple the size of EIC. It's big enough for you guys to grow out.

Thomas Majewski, Chairman and CEO

Yes, the short answer is yes. If we consider the U.S. CLO market to be around $1 trillion, the BB class represents approximately 4%, which amounts to about $40 billion. Our assets are roughly $400 million, so we account for about 1% of that market through this vehicle. However, at Eagle Point, we manage other accounts and vehicles that also invest in CLO BBs. In total, we hold billions of dollars in CLO BBs. This isn't our sole investment in this strategy. The corporate BB market offers substantial opportunities, especially for larger investment-grade entities that typically invest in high-yield bonds, which amount to hundreds of billions of dollars. For a large insurance company managing $100 billion to $500 billion, the $40 billion market may appear too small to warrant serious consideration. They actively engage in single A and AA investments within their CLO strategies. While they certainly hold a lot of BB-rated bonds, the size of this market likely represents a minimal portion of their overall investment landscape. Consequently, we believe there is significant room for growth for EIC, particularly given the structural imbalance in this sector, which plays a vital role in financing a much larger leveraged loan market in the United States. The $40 billion market tends to be overlooked by many institutional investors, not because of quality, but due to the scale of the opportunity. For large life insurance companies, this market may simply be too small to engage with, but we see a lot of capacity for growth in this area.

Matthew Howlett, Analyst

As we analyze the situation, it's clear that as you grow, the company will experience some operating leverage, and your cost of capital continues to decrease. The stock is trading slightly above its net asset value, and your bonds are trading above par as well. All of this indicates positive trends moving forward. Am I considering this correctly?

Thomas Majewski, Chairman and CEO

We agree completely.

Matthew Howlett, Analyst

Yes. It's just an incredible vehicle setup.

Thomas Majewski, Chairman and CEO

Yes, we have the revolver outstanding, which enhances efficiency. We also have preferred stock and this revolver allows us to manage our resources effectively, although it may not always go as planned. We maintain a slightly drawn revolver to facilitate any issuances on the ATM, and we use those funds to pay down the revolver while continuing to invest. Ideally, our vehicle remains fully invested. As of October 30th, we only had a small amount drawn due to incoming payments, and we're committed to deploying capital as quickly as possible. There's still a lot of potential for this vehicle, and we're very happy with the increased volume. A year ago, stock volume was too low, and we hope to increase it further. Despite some rate decreases, the investment opportunities remain very attractive, with every BB in our portfolio yielding double digits. Additionally, we have some CLO equity that supports us further. Overall, we feel confident about our future prospects.

Matthew Howlett, Analyst

I look forward to the market becoming more knowledgeable about EIC, and they will certainly recognize the relative value. I anticipate continued success, Tom. Thank you for answering my question.

Thomas Majewski, Chairman and CEO

Appreciate it. Thank you, Matt.

Operator, Operator

Thank you. As there are no further questions, I would like to hand the conference over to Thomas Majewski for closing comments.

Thomas Majewski, Chairman and CEO

Great. Thank you very much for joining the call today. Lena, Dan and I appreciate your interest in Eagle Point Income Company. We're all around in the office later today if anyone has any follow-up questions. Thank you, and have a good day.

Operator, Operator

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.