Eagle Point Credit Company, Inc. (NYSE:ECC)
Q3 2016 Earnings Conference Call
November 16, 2016, 11:00 AM ET
Thomas Majewski - Chief Executive Officer
Kenneth Onorio - Chief Financial Officer
Ryan Lynch - Keefe, Bruyette & Woods, Inc.
Christopher Testa - National Securities Corporation
James Young - West Family Investments
Good morning. My name is Mike and I will be your conference operator today. At this time, I would like to welcome everyone to the Eagle Point Credit Company Q3 Update Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]
I would now turn the call over to Thomas Majewski. You may begin you r conference.
Good morning and welcome everyone to the Eagle Point Credit Company’s third quarter earnings call. This is Thomas Majewski and I’m the Chief Executive Officer of Eagle Point Credit Company. I’m joined this morning by Ken Onorio who is the Company’s Chief Financial Officer.
I would like to ask Ken to provide a discussion regarding forward-looking statements before we begin.
Thank you, Tom. This is Ken speaking. 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, eaglepointcreditCompany.com.
Earlier today, we filed our Form NQ and third quarter financial statements with the Securities and Exchange Commission. The financial statements and our third quarter investor presentation are available also available on the Company’s website. The financial statements can be found by following the Financial Statements Reports quick link and the investor presentation can be found by following the Investor Presentation and Portfolio Information quick link on our website.
I would now like to hand the call back over to Tom.
Thank you, Ken. For today's call, Ken and I plan to address seven topics with our participants. The first item will be going over the Company's third quarter 2016 financial results. The second item will be the Company's investments activity during the third quarter.
The third item will be recapping the Company's capital markets activities during the quarter.
For the fourth item, we will provide an update on the fourth quarter 2016 portfolio activity through November 11th and management’s preliminary estimate of October 2016 NAV per share of common stock.
The fifth, item we will cover is a recap of the Company's recent issuance of Series B Term Preferred Stock. The sixth item will be a broad update on the bank loan and CLO markets and then the seventh item will be an update on the Company's estimated taxable income and our plan for special distributions.
Ken, would you begin by walking us through the third quarter results, please?
Sure, Tom. We will begin with the Company’s third quarter results. During the period from July 1 to September 30, 2016, the Company recorded net investment income and realized capital gains of approximately $8.2 million in the aggregate or $0.54 per common share.
This was comprised of $7.7 million of net investment income and $0.5 million of realized capital gains. This compares to net investment income and net realized capital gains of $0.57 per common share in the second quarter of 2016 and $0.51 per common share in the third quarter of 2015.
When unrealized portfolio appreciation is included, the Company reported net income of approximately 42.4 million or $2.80 per common share for the third quarter of 2016. This compares a net loss of $1.81 per common share in the second quarter of 2016 and net loss of $2.20 per common share in the third quarter of 2015.
The Company’s third quarter net income was comprised of total investment income of $13.7 million, net unrealized appreciation or mark-to-market gain of $34.2 million and realized capital gains on investments of $0.5 million, offset by total expenses of $6 million.
We would like to highlight that total investment income and realized gains in aggregate increase in absolute dollar terms during the third quarter versus the second quarter. However, the per common share amount of net investment income in realize gains felt $0.03 in large part due to the drag associated with deployment of proceeds from the Company's stock and debt issuance since May of this year. Nonetheless capital deployment remains on piece with our expectations.
While the Company held only $21.5 million in cash, net of pending investment transaction on September 30, and meaningful amount of the Company's investments made during the third quarter or late towards a final part of the quarter. These investments have only just started to generate income for our Company.
As of September 30, the Company’s net asset value was approximately $255.4 million or $16.66 per common share. As of September 30, the closing trading price of our common stock was $17.16 per share, reflecting 3% premium to NAV on such date. As of November 15, the Company’s closing common stock price was $17.20 per share.
The total return to our common stockholders for the quarter ending September 30, 2016 was 10.3%. This assumes that distributions received during the period were reinvested at prices obtained by the Company’s dividend reinvestment plan.
The Company's asset coverage ratios at September 30, were preferred stock and debt as calculate pursue to investment Company act requirements was 338% and 595% respectively. These measures are above statuary minimum coverage requirement of 200% and 300% respectively as of quarter end.
On prior calls, we discussed management expectations are under current market conditions of generally operating the Company with leverage in the form of debt or preferred stock within a range of 25% to 35% of total assets. As of September 30, the Company had debt and preferred securities outstanding which totaled approximately 30% of the Company's total assets less current liabilities.
On October 31, we paid a distribution of $0.60 per share of common stock for the quarter ending September 30, 2016. As with prior quarter the September 30, net asset value reflects an accrued liability for this distribution.
I’ll now ask Tom to provide a recap of the Company's investment activities during the third quarter.
Thanks Ken. The third quarter was an active period for the Company; broadly, the quarter was marked by a strong rally and credit markets. We saw at the capitalize on that strength through a variety of portfolio activities.
During the third quarter, the Company deployed a total of $52.2 million into new investments. This consisted of one new primary CLO equity investment where Eagle Point was involved in the initial negotiation of the transaction and a series of secondary market CLO equity investments.
The Company also made several investments in loan accumulation facilities during the period setting up CLOs expected in the future. The CLO that we purchased in the primary market was structured to the risk retention compliant principally using the vertical approach.
In that transaction, an affiliate of the collateral manager purchased some of each class of securities issued by the CLO; that same entity also made a larger additional co-investment in the equity tranche alongside of us and one other investor.
The weighted average loss adjusted effective yield of the CLO equity investments made by the Company in the quarter was 20.16% as measured at the time of investment. In general, the Company invests with a long-term mindset. However, there were instances where we saw market demand at very strong prices.
During the quarter, we opportunistically sold securities into the strength. Our sales broadly fell into three categories; the first is where we have several sales of minority equity securities where net of those sales the Company still [benefitted] (Ph) from an Eagle Point held majority interest in the equity tranche.
Second category, where we had one sale was the sale of purely a minority equity interest where Eagle Point was not involved in the majority and then in the third case, we sold one debt security. Across these sales, we realized $0.5 million in net gains versus amortized costs for approximately $0.03 per common share.
One of the attributes of CLO equity that we find attractive is the refinancing optionality given to it by the senior tranches. With the demand for CLO debt tranches strong during the quarter, one of the CLOs owned by the Company was refinanced and another was reset.
In the case of the refinancing, this was the CLO that the Company purchased in the secondary market late in the second quarter. When we purchased the investment, while we believe the investment was attractive onto itself; part of our thesis that we could build additional equity value through refinancing of the senior tranches.
We worked with the bank to arrange the refinancing over the summer; this refinancing lowered the CLOs future financing costs while keeping all other terms of the transaction the same. We fully expect these lower prospects of cost to increase the value and future yield of the CLO equity security that we hold, holding all else equal.
In a separate transaction, the CLO owned by the Company completed what is known as a reset; in a reset in addition to changing the spreads on the CLO debt tranches, the reinvestment period, non-call period and maturity date of the CLO are also typically extended. We also believe our investment in this CLO was made more valuable as a result of the reset.
Actions like these take significant time and effort to complete. The benefit of lower costs and increased optionality that are newer to the Company are a result of our private equity like approach to investing and our advisors’ proactive investment process.
Reflective of all of this portfolio activity, as of September 30, 2016 the weighted average effective yield on the Company's CLO equity portfolio was 17.27%, this compares favorably to a weighted average effective yield of 17.03% as of June 30 and 16.65% as of September 30, 2015.
Importantly, we highlight that the effective yield of the Company's CLO equity investments include a provision for future credit losses. Additional information regarding the Company's portfolio in the underlying loan of obligors can be found in the Company's regular quarterly investor presentation, which is available on our website.
The presentation includes portfolio level information, which we believe it's helpful for stockholders under continued evaluation of the Company and we encourage everyone to download and read the presentation.
Overall, we remain very pleased with the Company's portfolio and believe the portfolio’s cash generating capacity remains strong. As an illustration of the portfolio is cash flow generating capacity to-date, in our quarterly presentation, you will see the ratio of cash received in the third quarter to GAAP income accrued during the second is 199%. All cash flow in excess of accrued income is treated as a return of capital for GAAP purposes in the Company's books and records.
I’ll now hand the call back over to Ken.
Moving on our third agenda item, the Company competed two successful offerings during the third quarter. In August, the Company priced a follow-on offering of 10 million of its series 2020 notes, which resulted in net proceeds of $9.9 million after payment of estimated offering expenses.
In September, the Company issued 201,000 shares of its common stock at $17.45 per common share; this resulted in net proceeds of approximately $3.4 million after payment of estimated offering expenses. The shares were issued at a premium to NAV.
Both offerings institutionally placed directly by the Company with no apparent impact market price of the securities. By virtue of being direct placement, the Company did not bear underwriting expenses or commissions in connection with the offerings, assuming market commission rates; this resulted in savings to the Company of approximately $300,000 to $400,000.
To adjust the fourth agenda item, I will provide an update on the Company following the September 30, quarter end. Investments at our reset first payment date and are generating cash flows in line with our expectations.
In the fourth quarter of 2016, as of November 11, the Company has received cash flows on its investment totaling $20.8 million, or $1.36 per common share. This compares to $21.6 million of total cash flow received during the third quarter of 2016.
We highlight that some of our investments made payments later in a quarter as of November 11, those other investments had not yet reached their payment date.
During the fourth quarter, as a relative value in the market has shifted in favor of new issued transactions, our investment focus has migrated in the same direction. On October 1st, through November 11th, we made gross new investments totaling $56.7 million, which includes one new CLO equity investment and several loan accumulation facility add-on purchases.
We also converted two existing loan accumulation facilities into new CLOs and sold assets opportunistically into pockets of market strength. Whereas on September 30, the Company had $21.5 million of cash, net of investment activity and other cash flows; on November 11th, the Company had approximately $17.3 million of the cash available for our investment.
As a normal course of business, we published an unaudited management estimate of the Company’s monthly NAV and quarterly net investment income and realized capital gains or losses.
Last week we published a range with respect to management's unaudited estimate of the Company's NAV as of October 31st of $17.18 to $17.28 per common share of stock. This reflects the continued increase in the market value of our investments.
I would now like to hand the call back over to Tom.
Thanks, Ken. Next I would like to recap the Company's capital market activities after the end of the third quarter; on October 11th the Company closed an underwritten public offering of 1.2 million shares of 7.75% Series B Term Preferred Stock due 2026 where securities were sold at a public offering priced at $25 per share.
This resulted in 28.5 of net proceeds to the Company after payment of underwriting discounts and commissions and estimated offering expenses.
In late October, the underwriters fully exercised the green shoe and purchased an additional 180,000 shares of the Series B Preferred's. Exercising the shoe resulted in additional net proceeds to the Company of approximately $4.3 million. In total, the Company issued 1.38 million shares of the Series B Term Preferred Stock.
The Series B Term Preferred trades on the New York Stock Exchange under ticker ECCB, similar to our Series A Term Preferred Stock, the Bs also pay a monthly dividend, which we believe to be an attractive feature. As of November 15th, the Series B Term Preferred Stock is trading at $25.70 per share. We were very pleased with the most recent offering.
Looking at the big picture, the Company was able to issue 10-year preferred stock at the same 7.75% rate as our seven years, Series A Preferred Stock that we issued in May 2015. We believe this signals that the Company's standing in the investor market continues to grow and we are pleased to be able to issue longer dated preferred stock.
On a pro forma basis to account for this offering, the Company has debt and preferred securities outstanding totaling approximately 35.9% of its total assets, less current liabilities as of September 30th. The Company plans to use the net proceeds from the offering to acquire investments in accordance with its investment objectives and strategies and for general working capital purposes.
I would also like to share some thoughts on how we manage the Company both from the deployment and a capital raising perspective. And important part of our advisors investment strategy is to continue to enhance vintage period diversification of the Company's CLO portfolio.
While the Company generates cash flow in excess of investor distributions and expenses and its cash flow is available to be reinvested, additional capital raises allow the Company to further execute on its vintage diversification strategy where most if not all of our post IPO raises. The respective offering document indicated that we expect to deploy the capital raised within two to six months of the offering.
To-date and understanding that we are still in the process of deploying proceeds from our Series B Preferred Stock, we have met those targets and believe each raise we have undertaken has been accretive to the Company as they have allowed the Company to exercise its investing power on a regular basis and grow its earning potential.
That said, nearly any capital raise will include a cost in the form of a short-term drag on earnings per share. A good example of this, was found on the most recent quarter, while in absolute dollar the total investment income and realized gains increased, net investment income and realized gains fell on our per common share basis.
When we evaluate the possibility of issuing securities, we factoring some flexibility on our anticipated pace of deployment and accordingly the potential cost of the drag, this is a very important discipline. For example, if we were to invest [too peacefully] (Ph) such actions could ultimately with need to a reduction in portfolio quality over the long-term. This is a trade of that; we believe is generally not in the best interest of the Company.
I’ll now move on to CLO and loan market developments. The market really that began earlier this year continued during the third quarter. The Company's NAV per common share increased by 15.2% during the quarter. That upper trend continued by an estimated 3.4% in October.
Despite potential headwinds from uncertainties including Brexit and the recent U.S. election, demand for dollar denominated floating rate assets remains strong from many investors around the world.
Continued investor demand for yield helped boost prices of many CLOs securities as well. This demand was underpinned by the consistent cash flow that the securities generate coupled with an improved outlook for corporate credit as reflected in increased loan prices among other things.
Bank loans have move strongly since there February lows to Credit Suisse leverage loan index has returned 8.28% year-to-date through October to help frame the market perspective on credit, whereas on February 29th, less than 1% of the loan market was trading above par according to Credit Suisse. By that same measure over 43% of the loan, market was trading at a premium at the end of October.
New issue institutional loan volume increased to $106.8 billion during the third quarter from the 87.3 billion reported in Q2, according to S&P Capital IQ. LBO and M&A deals represented approximately 41% of the institutional volume during the quarter with the bulk of the remaining issuance coming from refinancing and recapitalization activity.
Loan market technical continue to move in favor of issuers aided by strong demand for loans including from CLOs and retail firms. According to S&P Capital IQ, retail loan funds that report weekly deliver had nine consecutive weeks of inflows through September 28th, those inflows totaled approximately $2.1 billion.
The net effect of the new loan supply and repayment activity resulted in the slight decrease of the amount of loans outstanding to $882 billion at the end of Q3 from $886 billion at the end of Q2. Regardless of the small move, this enlarged market provides ample opportunities for our CLOs to continue to reinvest.
Corporate defaults an area of significant concerns for many investors less than a year ago had remained low indeed according to S&P Capital IQ the trailing 12 months loan default rate was 1.95% through September 2016.
For the nine-months ended September 30, US CLO issuance totaled $46.1 billion according to S&P Capital IQ. Q3 issuance alone totaled $19.9 billion and outpaced the $8.2 billion issued in Q1 and the $18 billion issued in Q2. In October, CLO issuance remained strong with approximately $8.4 billion of volume bringing year-to-date issuance to over $54 billion.
Following the strong demand for secondary AAAs earlier this year, we observed an increasing demand from primary AAA buyers during Q3. Spreads from new issued AAAs reached to mid-140s for top issuers; with a few issuers even printing in the low 140s. There continue to be strong demand from domestic investors for CLO AAAs, because of their high spread relative to other similarly rated assets.
In addition, we are seeing increased demand from foreign investors; specifically there are several new entrants in the CLO AAA market from non-Japan Asia, which we believe could be quite favorable for prospected AAA spreads overtime.
CLO fundamentals generally improved in the third quarter as the loan market continue to rally. Market wide CLOs reported an increase in the minimum over collateralization cushion during the quarter from 3.98% to 4.05% according to data from Wells Fargo.
Indeed, within the Company's portfolio the weighted average junior OC cushion increased from 4.08% as of June to 4.27% as of September and the Company continues to have on average more minimum junior OC cushion than the broader market.
As evidenced by the low default rates, we remain in a benign credit environment even when commodity related loan losses are included. No discussion regarding investments would be complete today without considering the potential impact of the recent U.S. elections.
Having had a week to reflect upon the election results, while we acknowledge that there are many unknowns, we are becoming increasingly optimistic in our outlook for the U.S. economy. Many of the economic initiatives being publicly discussed by the incoming administration are intended to help stimulate growth and create jobs.
We believe that if effectively implemented, these polices could have the potential to be beneficial to many companies within the United States. To the extent, our CLOs borrowers grow their top and bottom lines that generally augurs for lower instances of defaults.
Pro growth policies may also result in rising interest rates, something already playing out in the medium to long end of the yield curve. CLOs in their underlying assets are typically floating rate would should generally compare favorably to fixed rate corporate bonds and in an upward rate environment.
With nearly any change in regulation however, also comes risk and sometimes unintended consequences. While many companies involved in the construction and infrastructure development industries, could easily be assumed to likely benefit from some of the policy changes being discussed.
Potential changes to the Affordable Care Act could potentially have an adverse impact on some of the companies in the healthcare sector. We continue to monitor sentiment and development in new credit markets and have the ability to make changes in our portfolio, should we believe circumstances warrants.
Okay, this is Ken speaking again. For our final agenda item, we would like to discuss the Company's taxable income and our current analysis of special distributions. As one of the requirements for the Company to be taxed as a [Indiscernible], the Company generally require to pay distributions equal to substantially all of its taxable income within one year of its tax year end. As you may recall, the Company elected a November 30th, tax year end.
The taxable income that Company is required to recognize is primarily based on tax reporting received from its underlying CLOs. On a preliminary basis, the Company estimates its taxable income for the tax year ending November 30, 2016 will exceed aggregate quarterly distribution paid to common stock holders.
At present, management estimates special distributions totaling between $0.75 to $1.25 per share of common stock will be required to meet the tax requirement. It's important to highlight that this estimate remains preliminary and is based slowly on final returns and formal estimates for approximately 60% of our portfolio. The actually distribution requirement will not be known until the Company files it's tax returns next year and it may deviate from our range.
Management expects to target payment of special distributions pertaining to its November 30, 2016 tax year in one or more installments towards the later part of 2017. The Company expects to incur a 4% excise tax on the amount distributed.
The amount of such tax is expected to be reported in the Company's annual report for the fiscal year ending December 31, 2016. A further update on the Company's taxable income and plan for special distributions will be provided on a Company's yearend earnings call in February 2017.
This is Tom speaking again. I would like to thank everyone for their continued interest in Eagle point Credit Company. We believe that Company has had three strong quarters so far this year and are pleased with our positioning going into the end of the year.
Some of the Company accomplishments include earning GAAP, net investment income and realize gains of $1.72 per common share for the first nine-months of the year. We have had three successful capital raises since August, particularly our Series B Term Preferred Stock, which was issued at the same coupon as our Series A Preferred Term Stock, but was the longer term.
We had $2.20 per common share growth in NAV during the third quarter, net of the $0.60 common distribution. And the Company has enabled to be patiently on the offence during periods of price volatility. The new CLO equity investments that we have made in the first nine-months of year has had a weighted average effective yield at a time of investments that is approximately 220 basis points higher than the portfolio of yearend weighted average expected yields.
The Company has ample cash available and our advisors continuing to evaluate attractive new investment opportunities in both the primary and second markets, the Company has positioned well to continue to seek these opportunities.
This concludes management's presentation of Eagle Point Credit Company's third quarter update. At this point, we will open the call to questions and Ken and I will be happy to address any of the questions that our call participants have.
[Operator Instruction] Your first question is from Ryan Lynch from KBW.
Hey good morning thank you for taking my questions. First one, cash received as a percentage of prior quarter’s income accrual was 199%. That was a pretty big increase over prior quarter, you guys cash receive as percentage of the prior quarters accrual which is about 155%, so can just talk about what drove that increase in the third quarter?
Sure, and probably to share some context have to look back over the three quarters of this year to kind of paint a picture of broadly what played out. Obviously each of the underlying investments has lots of things going on, but broadly in the market and which you will in our portfolio; the cash versus accrual was up significantly for the third quarter cash versus Q2 accrual.
And what that reflects and bolder talked back on prior quarter that Q2 accrual as a percentage of Q1 cash also varied. And what we saw was in April the distributions on CLOs came down a bit due to the impact of the rate increase back in December, which in general affects the resets on CLO debt in January, which affects the payments you get in April.
So, it's kind of takes a little bit of a lag; it was until April that we saw the effect of the December rate increase in the actual cash. Why it went back, why the ratio moved more favorably; since then one of the things we saw in the July payments and this is broadly across the CLO market, any individual investment can vary, is a lot of the positioning that was able to be done within the CLO portfolios.
In the first quarter when loans were very cheap and we said earlier, 1% of the market was at a premium, the balance at discounts, many of the underlying CLO collateral managers were able to either build par or increase spread in their portfolios, which manifests itself in the payments collected in the second quarter within the CLOs and are paid to us in early July. Long answer, regards to look back, to see the trend overtime.
No that’s really a helpful color. In the third quarter, you guys had really good net portfolio growth, deployed a lot of capital but it looked like a lot of that capital was in loan accumulation facilities, which means that we didn't really see big uptick in revenue growth versus the amount of capitals you deployed. So generally speaking what sort of timeframe should we be thinking about, how long it takes a typical loan accumulation facility to convert into a CLO equity piece?
I know that each one varies, and it depends on market conditions, but if you just provide some general context around that as well as when you do investment to a new loan accumulation facility. What sort of general returns do you expect to get from that loan accumulation facility? And I know that obviously, as you start ramping up that facility, returns are lower early on versus as you start to ramp it up, returns increase, but generally speaking can you kind of talk about returns from loan accumulation facilities as well?
Sure. Very good question just to answer the life cycle. That one really is answers will vary widely. Some have probably been around for three months or maybe even less; others can be around for over a year; if I had a stereotype or generalized it's probably three to six months as the base case where stuff is around, but they do vary depending on any number of circumstances, how long they are going to be around for. So if you had to pick at default, it's probably somewhere in the three to six months band.
We said during the call that indeed a fair bit of the investment activity occurred later in the quarter; and indeed quite a bit went into ground in September. So two parts, our starting cash and our ending cash to the extends a meaningful amount was invested later in the quarter, a lot that doesn’t start earning until it's invested. And then B, to your point whereas CLO equity is a level earning investment absent of change in expected yield assumptions. The loan accumulation facilities kind of ramp up overtime and the income we record is based on the income accrued.
Loans have many advantages, one of the oddities of them is, the new issue processes or [Indiscernible] is probably a light way to put it. And even if new loan accumulation facility is setup and the collateral manager, commits to a loan that loan might not settle for 20 or 30 days. So there is ultimately a lag at the beginning part of the earnings and it wouldn’t surprise me if some of the new things at the end of the quarter had little to no earnings frankly.
Against that the overall return on loan accumulation facilities is often in the teens or 20s IRR. Obviously there could be higher or lower including negative, but in general that depending on the pace of deployment be ultimate IRR and many of those investments in the market, I think people would say is the teens and 20s. It is a little more back loaded however broadly.
Looking as of September 30th, you will see we have five accumulation facilities open, if you look across in the market, actually we were involved in converting two of these into CLOs already this quarter, and then one other was actually converted into a CLO and we chose not to participate in that one. So this is all stuff you would see just looking at kind of the Bloomberg news feeds. So of the remaining two, those are still in active accumulation note as we speak, but key to a good bit of turnover in those facilities.
Great and then just one final one, you kind of touch on some commentary around the U.S. election, but I wanted to hit on it again with a slightly different question. So obviously, with the election, there is going to be a lot of changes and nobody really knows exactly what is going to happen yet, but we are all kind of trying to speculate and make our best educated guesses.
But one thing that you really think senses you, is that new regulations are going to come out actually going to come out that are actually start peeling back potentially some regulations from bank. And that could potentially mean that banks could start to become more active in lending in the [Indiscernible] market whereas now there has been a lot of regulation to really restrict them. So again, nobody knows what is going to happen, but if some regulations would get pulled back and banks would start to become more active in the leverage loan markets. What sort of impact could foresee that having in issuance of new CLO equities?
Sure probably and obviously this is of speculation. The electoral college hasn’t even worded yet, so who knows. I think we have a good idea who the incoming administration will be, but a lot of things between now and late January when the immigration happens will play out. Certainly one other things that’s been talked about pretty heavily in the popular press has been a partial or complete our repeal of Dodd-Frank, this is just based on media report, who knows what is actually contemplated at this point.
But if that were to occur, when you think about it, really is a couple of things on most notably that could potentially include a repeal of some of the risk retention rules, which are at present scheduled to take effect on December 24th of this year. I noted that the CLO we created in the third quarter was risk retention compliant; using the vertical approach.
But if the rules, if Dodd-Frank wriggle its potential for those regulations to go away, which are all else equal would likely increase unto itself holding all else equal, increase the flow of CLO which as it would be easier for collateral managers to get into the market. And then B, to the extent banks have more interest in actually owning loans, which what banks used to do in the olden days I guess that would probably be a bad fact in terms of if banks bought more loans that would be less supplied in the market.
Broadly, we think of many banks in general as very much viewing the loan origination business as much more of a fee based business then an NII based business. If you look at the percentage of syndicated bank loans owned by banks, in general it's come down overtime while the market size has increased. To the extent, there's additional demand from banks that could potentially reduce the amount of CLOs issued. Although, if I had to make a speculation and this is purely in the speculation category; probably the net increase as a result of the retention refuel would probably outlay any drawback in any slowdown in issuance related to additional bank demand.
The other factor of course is retail mutual funds, we talked about the inflows during the third quarter, in a day where many, many people are talking about rate increases and I think the forward curve is pricing in near 100% looking on Bloomberg, Fed rate hike odds approached 100% in anticipation of Trumponomics on Bloomberg right now. That would suggest more interest in floating rate assets than fixed rate assets, all else equal, so there could be additional inflows into retail loan funds as well.
Great. That’s a great commentary and I appreciate you have given some commentary knowing that everything right now is a speculation given nobody really knows the exact policies are going to replace, but that’s really helpful commentary. So thanks for taking my questions, that’s all for me.
Thanks much Ryan.
[Operator Instructions] The next question is from Christopher Testa from National Securities.
Thanks for taking my questions. Just on the gap effective yields on ArrowPoint, Atlas Senior Madison Park VIII and the [Zeis5] (Ph) CLO equity role well above the effective yield of the total portfolio the prior quarter. Can you explain what is driving the effective yield up, given that the reinvestment opportunities are actually less attractive, is it lower default assumptions, is there something else going on there?
Sure, And you went through a number of them; could you repeat in terms of [Indiscernible]?
Yes, just the ArrowPoint, Atlas Senior, Madison Park VIII, and Zeis5, if I'm pronouncing that one right?
You got it, yes, those are very good. You sound like a CLO guy Chris, I don't know.
Yes. Looking through on each of these, you will see indeed these are amongst some of the higher expected yields in the portfolio. Crescent, Atlas and I guess each of these except for Zeis was a primary market purchase; the other three were secondary market purchases. And these were in some cases transactions that were taken place earlier in the quarter that we were able to buy prior into the rally, but certainly on the last day of the quarter.
Crescent, the dollar price on that equity, my recollection was had a four handle, you have to do the exact math to see it for sure, but it wasn’t 50 and it wasn’t 30, it was somewhere in between. So we are able to buy that at a very low dollar - the Atlas sorry the Atlas. The Crescent is the collateral manager.
The Atlas position, we bought $6.35 million of face at a amortize cost as of $2.7 million and so fairly significant discount to face. As a family Eagle Point does own the majority of that transaction although ECC own just a $6.3 million and you will see the fair value is comfortably above the amortize cost for that position reflecting hopefully a good purchase opportunity for the Company.
A similar thing with ArrowPoint although not quite as good, that one is at a 17.25 expected yield, it's a firm that we know very well, and we know the individuals very well, frankly it's a group that is not as well known in the CLO market perhaps. So there was a bit of value opportunity that we are able to capitalize on that.
And then Sesame Madison Park VIII or Madison park funding VIII, you will see that one is a little higher and it's actually higher than some of the expected yields on some of the other Madison paper we own. Madison VIII just by virtual the number you can tell us an order deal than 14 to 21 also in a portfolio. These guys are in our opinion some of the very, very good collateral managers.
Being a shorter dated piece of paper, I think Madison VIII is past the reinvestment period at this point. The duration is a little shorter than other like new issued CLOs; you can see the due date is 2022, which would suggest it's been around a while at this point. As you get shorter, sometimes you can get some higher IRR opportunities but with the different profile.
Other investments segment in the portfolio you can see at a lower end, a couple notch up or one notch up LCM 18 that came at a 14.29 expected yield that was blocked during the third quarter as well. So there was a wide dispersion of yields, while in general you hit the nail on the head, the reinvestment option on these is less valuable today than it would have been in the first quarter as loans are at fuller and fuller prices.
The flip side that the options over the right side of the balance sheet particularly in refinancing have been things where we have been able to capitalize and go out and actually reset the lower our AAA cost on a number of these CLOs. So nothing in particular about those, each transaction has its own reason for the level, none of the things we talked about their though of any of those have any notable credit concerns or something like that with the yield.
Got it. That’s a great color. Thank you. And thanks for your guidance on the special dividend. So just, I guess looking at this going forward, if we look at the cash distribution per share compared to GAAP NII, the difference is about $2.89 year-to-date per share. And then from second quarter of 2015 to second quarter 2016 the difference is about $3.67. How should we evaluate this going forward and I guess is there a certain way to look at this without going through a whole tax accounting lesson I guess if there is any guidance you could provide?
Well we certainly direct everyone to our GAAP tax cash triple play analysis, which is available on our website which lays out the GAAP tax and cash differences and that's the generic assessment of course. Off the things that drive the taxable income one thing is probably important to isolate is, unrealized mark-to-market is generally not a direct driver of taxable income or loss. So as the securities get more valuable or get less valuable on an intra period basis, we are not a mark-to-market tax payer; so that wouldn't be captured in the taxable income.
So, it's really looking at kind of the realized gains or losses and the net investment income that we report in comparing that number to what we talk about as the taxable income, which is what gives rise to if I just pick to midpoint of the range of a $1 a share potential special distribution. Some of the things that happen and if you look at that presentation we put, you will see the pattern or take a step back at a very high level GAAP, tax and cash income ultimately roughly equals.
There is one or two slight permanent differences, but truly, at the margin in general the sum of the income for GAAP, for tax and your actual profit will be equal. However, in some periods it's skewed one way or the other in favor of GAAP or tax. And for many of the CLOs and Ken noted that 60% roughly of the CLOs have reported or we have kind of third-party estimates from some of the tax preparers for those, we have pretty definitive numbers on some cases final, but we are making an estimate for the other 40.
Many of those CLOs however, we got the tax information earlier in the year that would be what we have to report. Might even been December 31, 2015 dates reports, which are going to drive our tax return for this year. To the extent many credit investors including CLOs in the market I'm sure, some in our portfolio took losses and sold some energy names earlier in the year. Those might not all be reflected if it was at December 31 tax year, so those CLOs would be reflected in next year's taxable income.
So, as we look the portfolio effect, our expectation is it should help balance some of these things, many of the 2015 tax information statements we received were from a period where little losses were actually realized in the CLOs. So taxable income all else equals was higher to the extent, a little bit of losses were actually realized in the underlying portfolio that will help shelter some of it going forward.
It's an imprecise science, because GAAP is kind of a level yield approach and tax is basically cash, realized losses, so it's a little bit of a mismatch and then kind of the spike in credit activity earlier this year probably will exacerbate some of that. So we don't have a more definitive prediction unfortunately, we are still trying to figure out this year which ends in 15 days versus next year. But we do think there is a pretty good portfolio of balancing approach overall.
Great and just touching on your comments on using the affiliate of your asset manager to take the vertical approach to risk retention, which I'm not too optimistic on going away. So assuming that risk retention does stay in place, what is having this part of the affiliate able to do this and finance these tranches, what can I do I guess for seeing the deal flow and improving the deal flow back you see through the follow up?
Sorry, I should offer clarification on the affiliate that purchase, the retention interest in that case was an affiliate of the collateral manager. We think not an affiliate in any way of Eagle Point. And in that entity, the collateral manager has a vehicle that they have set up as we understand it with some of their capital and some side capital in that vehicle is design to provide retention solutions and as I think, the phrase would be like majority.
There is a lot of acronyms, but I believe the phrase they are using to describe it is majority owned affiliate or MOA, which is something here they have a significant interest and others may have an interest and it is well in that box. So an affiliate of the collateral manager bought some up and down in stock and then a little extra in the equity.
Broadly many of the CLOs that we are involved in today, and a number in the portfolio already are design to be risk pretention compliant using the vertical approach, overall for many collateral managers, we believe that are actually be the most efficient approach to participating in the market. If you look at our loan accumulation facilities that we had as of quarter end, one in particular I just highlight.
Barings CLOs 2016-3 and Barings is the firm formally known as Babson, I am saying people with just different name and obviously part of mass neutral ultimately. That CLO has instant price after quarter end and was also done in a vertical retention compliant manner. So in that case, the collateral manager by 5% of everything and then the other 95% of all the securities are free to be sold and traded, and do as you like with them. In retention stay environment, we expect ECC to be most active in transactions with vertical retention.
Great and just last one from me. More of a highly level question. Are you seeing some complacency in the broadly syndicated markets, leverage multiple on average are higher than they were in 2007 although it's more first lien composition. There has been obviously a lot of covenant wide issuance and the economy seems to be somewhat shaky, are you seeing just general complacency or just your thoughts there, would be well appreciated?
We will into the commentary that certainly the trends are going right now in the borrower's favor, unfortunately we like when things are in the lenders favor all else equal. So that’s broadly a trend in syndicated land and middle market. There is lots of investor chasing floating rate and yield base product particularly in the United States, which is underpinning all of that.
That said, there is a couple of metrics to look at, certainly leverage and the points you raised indeed, broad, leverage depending on different market stats is certainly in line with maybe a little above, a little below 2007 levels. Importantly some of the things we look at though are kind of debt service coverage or interest coverage ratios based on a lot of different data that we see in general that stronger right now, that does include the cost of LIBOR floors so the companies are paying where they have floors for some of the potential upcoming rate increases. Against that’s a freight through the sort of short term rates would skyrocket that could have an adverse effect on interest coverage.
Covenant light, indeed I think some in the market would even say if a loan has covenants, you have to ask why in that fair bit of the loan market is covenant light today that's up from perhaps 15% to 20% 10 years ago. I think you would say an all covenanted portfolio is an adverse selection portfolio if nothing else at this point.
What that may mean is all else sequel covenant light takes technical default or either reduces the likelihood of technical defaults for companies, which for CLO equity could be a good fact in that perhaps the companies can make it through what would have otherwise been a technical default and ultimately recover and pay off their loan without having to kind of pay the piper with their lenders.
At the same time perhaps lender not being able to be involved sooner could make problems more severe when they do ultimately happen. So, it kind of cuts both ways, a lot of data shows from the pre-prices era, covenant light loans did fine, but that was a much smaller percentage of the market so we are not sure it's applicable prospectively.
Great, that’s all for me. Thank you for taking my questions.
Next question is from Rob Brock from West Family Investments.
Hi, it’s actually, it's Jim Young. I was curious if you could share with us the characteristics and structural component of the new CLO equity security that you purchased in this quarter. What you found attractive about it? And on the flip side, can you discuss why you declined to participate in the CLO from one of the five loan accumulation facilities that you are involved in. can you give us a sense of what characteristics or structural components of that transaction that you found unattractive? Thank you.
Sure. So, in the CLO where we didn't participate in, we were actually not involved in the loan accumulation facility; and there was an opportunity to get involved in a transaction like a number of the facilities we have opened it was active and buying loans in the first quarter when loans were a lot cheaper than they were today.
In the case of the CLO that we invested in where we weren't in the accumulation facility we were able to come in to that - it's a collateral manager we already have exposure with and know very well and know the team and, so, we have known for years, so we know the team very well. There was an opportunity to get involved in the CLO where the portfolio was coming in at original cost, which is the way most accumulation facilities roll into the CLO but that cost was largely struck back in the first quarter.
So that CLO had an unusually favorable purchase price compared to the broader market where you could rebuild that portfolio today. So that was in our opinion very attractive and in the money buying loans; today at yesterday's price proverbially. So that's what something that was we are very happy to do. As I mentioned during the prepared remarks two of the accumulation facilities on the books at the end of the quarter have converted into CLOs; they have continued to ramp up and are either half closed or are approaching their closing date. We are hoping for a little election volatility, because they still had dry powder, kind of Wednesday morning after the election; didn't get as much as we would like unfortunately.
Of the one we didn't participate in, we only get into these facilities with very, very strong expectation that is going to move above the line to the CLO equity category; in the case of the one that didn't and the CLO has ultimately priced at this point. Our view was that the debt cost for that collateral manager due to a series of reasons that evolved over the past few months. We are going to be higher than would be economic for us to make the returns attractive to us.
So whereas we have invested with that group in the past and certainly we hope to again in the future where we thought their debt -- price was too expensive. So we said [brightly] that’s what we think. They went ahead and I believe they clearly found the capital not from us and have since priced the CLO. The debt cost ultimately were what we thought they would be, so we feel indicated in our decision and we certainly wish them very well with that CLO, it is a great job and I know they will do well. But it had a pretty heavy mill stone out of the gate in our opinion.
There are no further questions at this time. I will turn the call back over to the presenters.
Great, thank you very much. We appreciate everyone's continued interest in the company, certainly the third quarter we are very proud of the strong returns both from a cash flow and mark-to-market perspective in the portfolio. I appreciate the questions kind of getting into line by line on the portfolios as well; we are very hands on as you know certainly with all of the investments in the book.
We look forward to hopefully a strong balance of the year, obviously a lot of uncertainty in the market with the elections still I guess being resolved. The company has ample amount of dry powder available to it to continue to actively pursue opportunities as they come about. We appreciate everyone's interest in the company. Thank you very much.
This concludes today's conference call. You may now disconnect.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: firstname.lastname@example.org. Thank you!