Eagle Point Credit Company (ECC) Earnings Call Transcript & Summary

Greetings, and welcome to Eagle Point Credit Company's Fourth Quarter and Year-End 2020 Financial Results. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Garrett Edson of ICR. Thank you. You may begin.

Thank you, Rob, 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 matters discussed on this call include forward-looking statements or projected financial information that involve risks and uncertainties that may cause the company's actual results to differ materially from those projected in such forward-looking statements and projected financial information. Further information on factors that could impact the company and the statements and projections contained herein, please refer to the company's filings with the Securities and Exchange Commission. Each forward-looking statement and projection of financial information made during this call is based on information available to us as of the day 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 NCSR, our full year 2020 audited financial statements and our fourth quarter investor presentation with the Securities and Exchange Commission. Financial statements and our fourth 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 presentations and events link. As a reminder, Eagle Point Income Company will also be holding its conference call this morning at 11:30 a.m. eastern time. Web link for that event can be found at the Investor Relations section of www.eaglepointincome.com, or you can dial in by calling (877) 407-0789 and reference conference ID 13715044. I would now like to introduce Tom Majewski, Chief Executive Officer of Eagle Point Credit Company.

Thank you, Garrett, and welcome, everyone, to Eagle Point Credit Company's fourth 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. For today's call, I'll provide some high-level commentary on the fourth quarter, the full year 2020 and some recent events. Ken will then walk us through the fourth quarter financials in a little more detail. I'll then return to talk about the market environment, our strategy and provide some other updates on recent activity. And of course, we'll be happy to open the call to your questions at the end. Simply put, we believe 2020 validated our approach to investing the company's assets and managing the company's liabilities. We make investments that, frankly, some in the media have panned after the depths of a pandemic and a double-digit decline in GDP, the company generated an ROE just shy of 20% last year. We had no forced sales. We had no liquidations. To the contrary because of how the company and our investments were structured, most of the time we were on the offense buying when others were forced to sell. Our NAV ended 2020 higher than where it began the year. We're even able to take advantage of market dynamics to buy back a portion of our own debt at deep discounts during the year. While there is risk in all investments, we believe our performance in 2020 is an excellent case study as to how our portfolio can handle economic stress. Looking to 2021, by a number of important measures, the year is already off to a very good start. Recurring cash flows received on our portfolio in January '21 were $30.7 million, this is up from Q4, and even more notably, it's 21% greater than our collections in January of 2020. Our NAV went up again during January to begin between $11.95 and $12.05 a share at the midpoint, and this represents a 7% gain from where the NAV stood as of December. Not a single company in the U.S. syndicated loan market defaulted in January, truly remarkable. And through Friday, only one borrower, a retailer that had been trading at distressed prices long before anyone knew what COVID was, sought bankruptcy protection so far in February. So the default cycle is close to nonexistent so far in 2021. We remain mindful that COVID is still with us, and frankly, uncertainties remain, but it appears there are far more tailwinds today than headwinds. And we could be in the early stages of the next expansionary period. Our net investment income for the fourth quarter was $0.24 per share, in line with our common distribution level. If you look through our quarterly investor deck, you'll see we also had a reversal of some previously accrued income principally related to CLO debt. Without that, NII would have actually been $0.02 higher. During the quarter, there were certain holdings in our portfolio that were already marked down to fair value, where we determined that any future cash flows were either to be nonexistent or de minimis. Several of these investments were seasoned CLOs that unfortunately ended the reinvestment periods during the depth of the COVID uncertainty or were 2014 vintage CLOs that had heavy energy exposure and suffered losses a few years ago. We decided to write them off, moving from an unrealized gain/loss to a realized loss for these positions. Because we fair value our investments regularly and mark our books accurately, these amounts have largely been factored into NAV already. So despite the optical realized loss, there wasn't a meaningful impact on our NAV. You could think of this really as an accounting reclassification moving from one category to the other. Thus, for the quarter, we had NII less realized losses for a loss of $0.80 per common share. Along with our NII performance, we've been able to find attractive CLO opportunities in both the secondary and primary markets. During the quarter, we've deployed over $10 million in net capital, including 5 secondary and 2 primary CLO equity purchases. The new CLO equity we have repurchased had a weighted average effective yield of a little over 19.25%. And the 2 primary purchases were conversions of existing loan accumulation facilities that we held. Beyond the positive trends in our cash flows and earnings, we continue to maintain a very solid balance sheet. We have no financing maturities prior to October 26. All of our financing is unsecured, and we have no repo style financing or unfunded revolver commitments. Going through the depths of the COVID uncertainty earlier in 2020, the company's balance sheet proved to be a very steady hand. Frankly, our balance sheet even provided us with opportunity through the debt buybacks we executed. We made [ amount of ] $1 million for our shareholders through those buybacks. When I was writing the script, originally, I was going to say we were lucky how our balance sheet was structured. However, I think it's really more accurate to say that it was good planning that put us in a very fortunate position that we were in, during the depths of the market. Looking forward, pro forma for January's performance, we're actually closing in on the low end of our long-term leveraged band. We have ample dry powder, just shy of $30 million in the bank as of February 9, allowing us to continue to be on the offense. Earlier this month, we declared common distributions of $0.08 a month for April, May and June, that's keeping with the rate we've been at for the last few quarters. As we've also done, I want to highlight the value of the right side of our CLO equity portfolio's balance sheets. Within each of the CLOs, we continue to believe our portfolio could withstand a prolonged recession and frankly, thrive in it. This is not because we're blind to defaults, but we're very mindful of the value that can be created through reinvesting within our CLO structures. We saw some of this play out last year. The money to reinvest within a CLO comes from relative value sales and repayments on loans. You may be surprised to know that after the start of the pandemic, kind of beginning on April 1 through the end of the year, 12% of the loan market prepaid at par. Many of our CLO collateral managers during the depths of the crisis were able to use these par paydowns to reinvest in high quality loans, which were at the time, trading in the 80s and 90s. This had the effect of building par and offsetting other losses that might have needed to be taken. A key metric to evaluate our reinvestment optionality is how much reinvestment period we have left in our portfolio. At year-end, our equity portfolio's weighted average remaining reinvestment period stood at 2.4 years. This allows our CLOs to continue to be on the offense in volatile markets. This measure was 2.9 years at the beginning of 2020. So despite the passage of a year's time through our proactive management, our portfolio decayed by only half a year. With the CLO reset market open as it is today, frankly, we have a path to potentially lengthen the tenor of a number of investments that we already have in the ground. I also want to highlight something on our schedule of investments that's new and a bit unusual for us. If you look at the SOI, you'll see we have approximately 679,000 shares of common stock in McDermott Internationa. McDermott is a design and construction firm for the energy industry. Not something we normally have on our SOI. One of the things you may have heard about over the last 2 years relates to restructurings of bankrupt companies, which are designed by the distressed fund community to be unfriendly to CLOs. McDermott is a prime example of that. In this case, as part of the workout, lenders were given the option to buy common stock at $0.50 a share, kind of post bankruptcy common stock. Yet the stock was trading around $0.85 at the share at the time. So this was a very valuable option. Unfortunately, due to restrictions within CLOs, while CLOs can typically receive and hold common stock as part of a workout, they can't write a check to purchase common stock, and in this case, the restructuring was set up in such a way by people who knew CLOs couldn't write that check. As we became aware of the situation, we contacted our CLO collateral managers and said since the CLOs couldn't take advantage of the situation, we would. Most -- unfortunately, not all, but most of the collateral managers were very cooperative and we bought several blocks of the McDermott stock that was assigned to the CLOs that ECC was the owner of. We promptly sold enough stock in early January to cover our cost basis but have held on to the balance. Now we're sort of working with house money would be a good way to think of it. We're still evaluating what to do with this holding, but since we sold enough to cover our costs already, we can be more opportunistic with the remaining position. In this case, the amounts involved aren't tremendously large. Nevertheless, it's an important statement to the market for CLOs not to be pushed around. CLOs own the majority of the loan market. And by definition, they have the heft and scale to drive things. And when the -- particularly when the CLO market works in unison. We've seen several examples over the last year where the CLO market ultimately had the upper hand over distressed investors. The best solution, of course, is not to get involved with companies that go through restructurings, but it's inevitable in our business. And you can be confident that we'll seek to use any tool available to us to capture value for the company, and this is a prime example. There's one other item that's slightly unusual that I also wanted to highlight is in the good news category. We finalized our taxable income for 2020, and it looks like roughly 80% of our common distributions from last year will be treated as a return of capital for tax purposes. While we had nearly a 20% ROE, that's for GAAP purposes, the taxable income on your 10.99 will reflect only about 20% of the cash distributions you received last year. So those distributions perhaps were a little greener, so to speak. While cash flow is the most important part of investment -- our investment program, there's also GAAP earnings and tax measures, which are important to understand. In my experience, there's never been a year for CLOs where cash, GAAP and tax all equal to each other. They each workout -- they each work under different rules. And while in aggregate for the life of an investment, it will ultimately all tie out in any given year, things can and will vary. And in the case of 2020, they vary widely. Of course, nearly all investors want to pay as little tax as possible, so we consider this good news. What gave rise to the low taxable income was principally trading activity within our underlying CLOs. Within PFIC or Passive Foreign Investment Corporations, which many CLOs are, capital losses can be offset against interest income. This is a fairly novel provision of the U.S. tax code and one that worked tremendously to our advantage last year. To give an example, let's say, a CLO bought a loan at par a few years ago, and sold it last year at 85 in the uncertainty around COVID. That CLO used the sale proceeds [ and bought a ] different loan that they might have liked better also at 85. In this example, the CLO would have reported a loss for the 15 related to the first sale, and it wouldn't have to pick up much income related to the buy at 85, might be a little bit of accretion income, but they don't have to pick up the full 15 as income right away. So of course, there is no free lunch. And if that new loan pays off at par in 2021, we'll have to pick up roughly [ $15 ] of gain as taxable income this year. So where we sit today, we don't expect 2020's low taxable income scenario to repeat itself in 2021. One of the things I've said in the past is that taxable income provides a floor on our distributions, which it functionally does due to RIC rules governing taxable income distributions. But importantly, it doesn't serve as our only guidepost for distributions, and I want to make sure investors are very aware of that. A fortunate year last year. We likely will see a higher tax bill coming in 2021. Since the time of our IPO in 2014, through the end of 2020, our -- on average, our common stock has traded at a double-digit premium to NAV. That's something we've been quite proud of over time. Ken and I are keenly aware that where we stand today, our stock is at a single-digit discount to NAV. We have some ideas as to why. But thankfully, know that there are a number of levers available to us to help address the share price. We can share more details on our plans and approach when appropriate, but please know that Ken and I are highly focused on the share price of the stock. After Ken's remarks, I'll take you through the current state of the corporate loan and CLO markets and then share a bit more on our outlook for 2021. I'll now turn the call over to Ken.

Thanks, Tom. For the fourth quarter of 2020, the company recorded net investment income of approximately $7.5 million or $0.24 per share. NII realized losses for the quarter resulted in a net loss of $0.80 per share. As Tom mentioned before, the bulk of the realized loss had already been factored into NAV, and this was effectively an accounting reclassification of an unrealized loss to a realized loss, as the impact of COVID eliminated any last hope of future cash flows from these investments. This compares to net investment income, net of realized losses of $0.23 per share for the third quarter of 2020, and net investment income, net of realized losses also of $0.23 per share in the fourth quarter of 2019. When unrealized portfolio appreciation is included, the company recorded GAAP net income in the fourth quarter of approximately $95 million or just about $3 per share. This compares to GAAP net income of $1.40 per share in the third quarter of 2020 and a GAAP net loss of $0.47 per share in the fourth quarter of 2019. Just as a reminder, 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 fourth quarter GAAP net income was comprised of total investment income of $14.5 million and unrealized mark-to-market gains of approximately $121 million partially offset by realized losses of $33.3 million and expenses of $6.9 million. As of February 9, we had $29.5 million of cash on hand, net of pending settlements. As of December 31, the company's net asset value was approximately $362 million or $11.18 per share. Management's unaudited estimated range of the company's NAV as of January 31 was between $11.95 and $12.05 per share, which at the midpoint is a 7% increase compared to December's NAV per share. The company's asset coverage ratios at December 31 for preferred stock and debt calculated pursuant to Investment Company Act requirements were 354% and 534%, respectively. These measures are comfortably above the statutory requirements of 200% and 300%, respectively. As of December 31, the company had debt and preferred securities outstanding totaling approximately 28.3% of the company's total assets less current liabilities, which is within our range of generally operating the company with leverage between 25% to 35% of total assets under normal market conditions. Based on the midpoint of January's NAV estimate, this measure stood at 27.5%, approaching the low end of our range. Moving on to our portfolio activity in the first quarter through February 9, the company received recurring cash flows on its investment portfolio of $30.7 million or $0.95 per share. This compares to $27.6 million or $0.87 per share received during the full fourth quarter of 2020. Consistent with prior periods, we want to highlight that some of our investments are expected to make payments later this quarter. During the fourth quarter, we paid 3 monthly distributions of $0.08 per share of common stock and are paying the same amount for each month in the first quarter. Additionally, in February, we declared common distributions for each of April, May and June also in the amount of $0.08 per share. Through our aftermarket offering program in the fourth quarter, the company issued approximately 598,000 shares of its common stock and approximately 30,000 shares of its Series B term preferred stock for total net proceeds to the company of approximately $6 million. During the first quarter, through February 9, the company has issued approximately 242,000 additional shares of its Series B term preferred stock for total net proceeds to the company of approximately $6 million. I will now hand the call back over to Tom.

Great. Thank you, Ken. Let me take you, everyone to walk through on where we see kind of the macro loan and CLO market and touch a bit further on our recent portfolio activity. In the face of a very difficult economic climate for much of 2020, the Crédit Suisse Leveraged Loan Index generated a total return of nearly 3%. This was the index's 27th year of positive returns out of its 29 years of existence. And when you consider these are typically speculative grade credits, these loans -- these are the loans that generate the raw materials within our CLO that generate the cash flow, spanning nearly three decades. A 90% success rate in investing, in our view, is very, very good. And this is what generates the cash that flows into our CLOs. Thanks to the rally in loan prices over the last few months, according to data from S&P, a little more than 1/4 of the loan market is actually trading above par at the end of January. Despite the ongoing improvement in the loan market, the significant majority of loans still trade at discounts, even if more modest today, and we believe there continue to be opportunities for our CLOs to reinvest and build par through buying loans at discounted prices, both in the secondary market and new issue loans with OID. Our CLO equity investments should be well positioned to continue generating strong cash flows as we enter what we believe to be the early innings of the next expansionary period. Retail loan outflows continued early in the fourth quarter with total outflows for the quarter of a little over $0.5 billion. That trend reversed in December of 2020, with retail inflows picking up and investors became more and more focused on the risks of investing in fixed rate bonds. Frankly, December was the first monthly inflow to loan funds in some time, and that trend has continued into 2021. On a look-through basis, the weighted average spread in our portfolio increased slightly from 3.59% in September to 3.61% at the end of December. Frankly, we might see this trickle down a little bit in the coming months as demand for loans remain strong. As I noted on our last call, an increasing number of loans in the market now include LIBOR floors, which further increases our interest collections when short-term rates are as low as they are at present. The trailing 12-month default rate at the end of December stood at 3.83% according to S&P Capital IQ, well below what was initially feared by many at the onset of the pandemic. While many of the borrowers that defaulted in 2020 were actually on thin ice before the onset of COVID and thus COVID just accelerated the fall process for these weaker borrowers, there were some COVID-related defaults ultimately. Notably in January, as I mentioned earlier, there were 0 defaults or distressed transactions in the U.S. and only one company has filed so far in February through Friday of last week. We still expect additional defaults in the coming months. The most dealer research desks are forecasting 3% to 3.5% default rate in 2021, certainly much better than initially anticipated. However, when you look at the loan market, only about 2% of the market is trading below 80, so frankly, perhaps there is some potential upside to those default forecast, too. By definition, they're sort of assuming every -- every loan below 80 defaults and a bunch of others do. Maybe that's too conservative, time will tell. While defaults may continue at slightly elevated levels in the short term, we believe the corporate default rate will remain lower than it otherwise would have, frankly, had more of these loans [indiscernible] had financial maintenance covenants. Also, corporate liquidity has been continually strengthened through both ability to access on the bond and loan markets, and this provides additional buffers for companies against future economic setbacks. The company's default exposure as of year-end stood at about 1.24% and certainly well below the trailing 12-month default rate. Further, only about 11.7% of our loans and our underlying portfolios mature prior to 2024, providing the significant majority of our corporate borrowers with years and years of runway before their debt is due. And just about 3% of our portfolio is trading below 80 at present. Our portfolio's weighted average junior OC cushion, this is on a CLO by CLO level weighted average, it's about 1.84% as of December, and that's up from 1.12% at the end of September. But still below where it was on a pre COVID level, reflecting that some CLOs did lose par during the year. I do note that many of our largest holdings have significantly greater OC cushion than the average. In the CLO market in 2020, we saw about $93 billion of new issuance, which when you consider the environment through much of 2020 is really very good performance. We also saw $11 billion of resets and $20 billion of refis. Most of those were kind of anchored at the very beginning and end of the year, as spreads were wider in the middle of the year. For 2021, Eagle Point, our adviser expects about $100 billion of new issuance volume, about $60 billion of resets and about $75 billion of refinancings. With the market continuing to have plenty of liquidity and rates having to start really reflect more of an inflationary view here in 2021, we're watching this closely. We think there'll be plenty of reset opportunities and refi opportunities for us. And with many companies having ample liquidity, even if rates do rise, we certainly don't anticipate many inflation-driven defaults in 2021. CLO debt spreads have tightened significantly since the beginning of the year. While it feels like junior mezzanine might have reached a resistance point lately, the demand for floating rate AAAs and AAs continues to feel quite robust. You might have read in the media that some of the large Japanese AAA players are on the sidelines. Something interesting about the way many of those investors behave is they often take all or nearly all of the AAA class when they invest. The AAAs in some of the recently issued CLOs off of our platform have had much more broadly syndicated investor books, sometimes with 10 or more investors in the AAA class. We think this is very good for the market, and it allows for many more investors to participate. Frankly, AAAs are often well oversubscribed these days. Taking advantage of this debt demand, as I mentioned a minute ago, we're actively working on resets -- resets and refinancings of quite a few of our CLOs in the portfolio for the first half of 2021. We have a calendar slated out for quite some time. More recently, AAAs have tightened roughly to the 105 level, maybe even seen 1 or 2 prints inside of that. This provides our CLOs with ample opportunities to pay off the old now expensive AAAs and issue new tighter paper. 98% of our equity positions by market value that were scheduled to make payments in January did so. Think about this less than 1 year after one of the largest crisis we've seen in a long, long time, 98% of our CLO equity is paying current distributions. Our recurring cash collections in January of 2021 were 21% greater than our recurring collections a year ago in January 2020. If you've followed us for a while, you're certainly aware that the marks can move around on our portfolio, no question about that. But for the vast majority of our portfolio, the cash just keeps coming, and that's the name of the game here. To sum up, our portfolio generated a GAAP total return or ROE of nearly 20% last year. Cash flows on our portfolio continue to increase in January 2021, with cash flows higher than they were a year ago. Our balance sheet remains strong, and we have no debt maturities for nearly 6 years. We've got just shy of $30 million of dry powder available, demand for floating rate assets, what we own is increasing and more and more investors are shifting out of fixed rate bonds into floating rate paper, be it loans, CLO debt, even CLO equity. So we've got what the market wants. And we know where our stock has historically been and where it is now. And Ken and I have several tools available to use on this front and know that we're focused there. While certainly not a straight line, which would have been a lot easier, 2020 proved to be a very good year for the company. 2021 is off to a strong start, and it feels like we're in the early innings of a new expansionary period. We're continuing to closely manage our investment portfolio, and frankly, we're quite confident in the future. We thank you for your time and interest in Eagle Point. Ken and I will now open the call to questions.

[Operator Instructions] Our first question comes from Mickey Schleien with Ladenburg Thalmann.

Tom, a high-level question. I want to ask how you feel about the loan market equilibrium when you think about the very high level of CLO warehouses that are in place versus the level of M&A and LBO activity? You mentioned the level of loans trading at a premium in the market, and that may indicate prepayment risk. And as you show on your presentation on Page 18, loan spreads are still above their long-term average. How do you feel about the risk that loan spreads would -- could decline more quickly than the CLO's ability to refinance their liabilities?

Good question. And you're dusting off your notes from Q1 of 2018, if I were to suspect, where we saw both spread compression and to a lesser degree, we saw loans tighten, and we saw CLO debt tightening more slowly. This time, as we look at where the loan market is, we are seeing some tightening. And I alluded to, we're not crazy to think that weighted average spread will trickle down a little bit. I don't think it behaves as rapidly. If you look at that chart on 18, this is our current outlook. If you look at the compression from '16 to '18, going from 391 to 348, and this is market-wide data, we don't anticipate something like that playing out. Frankly, of those loans at premium, certainly, a fair number of them have still in soft call provision where they would have to pay a prepayment penalty to do anything. That said 1 or 2 loans have opted to pay the prepayment penalty, which, I guess, gets paid through to CLOs, at least, which is nice. The key difference this time, I don't think we're going to see as much repricing as we did in, certainly, '17 and '18, we will see some. A key difference, though, is on the right side of CLO balance sheets, I think the market is in much better shape and has the potential to tighten even greater. We started the year with AAAs kind of in around 130 area. And deals are kind of getting done around 105 area. This is just at the AAA level today. And some of that -- I guess, a couple of things. When you have some of those large players who come in and just take the whole class, it's hard to get a lot of pricing tension when you're just dealing with one guy. We've seen deals, 1 CLO, we were involved in earlier in January, we went out with AAAs, kind of talked at 120, low 120s, we ended up pricing it at 114 markets coming even since. But that kind of movement really is very unusual in the CLO market. But that's attributable to that deal had over 10 different investors in it. And that gives the syndicate manager strength -- and I don't think anyone was more than $60 million on, say, $300 million class that gives the syndicate manager strength to be able to kind of flex things tighter. At the same time, we have 2 other market trends. It's not an extreme view. It's a pretty common view to think right now, rates are going up. While we think 3-month LIBOR probably stays low for longer, the longer end of the curve, 5, 10, 20 year stuff certainly keeps trickling up. So if you're someone who's got to buy structured products, buying fixed rate CMBS or autos and things like that, frankly, there's a lot of paths to downside versus the CLOs, at least you don't have any substantive rate risk in your portfolio. And then the final variable, which we think augurs favorably is, there's far less captive or risk retention capital in the market today. And roll the clock back to 2017, '18, that would -- while the majority of CLOs were made compliant using vertical risk retention, that was where the sponsor took 5% of every class, maybe 40% to 45%, give or take, of those CLOs were taking -- using horizontal retention, where all the retention capital was put in the equity. And to be polite, what I would say is much of that capital was, shall we say, return insensitive in that often cases, there is a conflict of interest in that, the collateral manager decides when to print using just calling down LP money that has the added benefit of starting their fees when they print a CLO. So we saw a lot of CLOs get printed in '17 and '18 that, in our opinion, probably were too tight of a return profile. And -- but that had the effect of creating so much AAA supply that AAAs didn't tighten anywhere near as much as they have lately. So that's largely history in the rearview mirror. So net, we've got a loan universe that's probably going to behave more slowly. They've got more lockouts. If anything, they're more focused on lengthening tenor than cutting cost in general as a borrower. There will be exceptions. We've got a driving force into floating rate product, and then we have much more disciplined issuers with third-party, profit-oriented capital investors like ourselves driving issuance. So I think those 3 things will help. And then when we look into our portfolio, if you look through way back in, let's see, Pages 25 and 26, you can see the vast majority of our portfolio is out of the non-call period at this point. And that's very, very good. We've spent a lot of time mapping refis and resets, whatever makes sense to do or calls, in some cases, of each of these investments. And whereas in 2017 or '18, I would have said, a fair number of our CLOs are still in the non-call period. Our weighted average non-call period across our portfolio is only [ 0.2 ] of a year right now. So that means we've got a lot more flexibility when we're managing the right side of CLO balance sheets. So hear you loud and clear, compression was something we lamented a lot in 2017 and '18. I think there's some pretty strong facts to suggest it won't reoccur anywhere near it did 2 to 3 years ago.

Thank you for that, Tom. That's very helpful. And it actually has generated a follow-up question for me. If anything, if we look at the market today relative to a few years ago, CLOs on a relative basis so representing even a larger share of demand, do you think CLOs are large enough portion of the market to actually dictate terms? In other words, they'll look at the arbitrage and accept a certain level of spread compression relative to where they think they can price the liabilities. And obviously, they want to keep the arbitrage in place. Is that effect strong enough to sort of mitigate the spread compression amongst loans?

I wish. That unto itself is not, frankly, in my opinion, in that -- while, if you look at our data on Page 15, CLOs control, 62% of the loan market. You think we could just dictate terms. It's a law of large numbers and that there's often 100 to 200 different players in a given loan. And invariably, one of them -- more than one of them has to act a little more keenly than the others. So while it's good that we have such a big position, and I think that's more helpful in workouts because there are so many folks in the -- hitting the buy button or considering things, sadly, I don't think we are able to act in unison to drive terms. The one thing I will say, which will be better this time, and we've seen it already, is the folks buying CLO equity are much more like us today and far less in the way of risk retention or captive funds. And when we start buying loans into a loan accumulation facility, we print when we want to, not because we want to turn on the collateral manager fees. So the community of investors that's supporting CLOs today is much more profit-oriented than some of the capital that was chasing deals a few years ago. So the thing I think that will be the disciplined gating factor to not having a mismatch frankly is the behavior of equity investors, which I think the market is much better positioned where we sit today.

I understand. Tom, your portfolio is now marked above pre-pandemic levels when we look at fair value versus cost. And the portfolio's cash flows increased sharply in the fourth quarter and are also back to pre-pandemic levels on a per share basis. But your average GAAP effective yields really haven't improved. What accounts for that divergence? And does that reflect some pessimism on your part in terms of valuation?

No. The -- there's always a bit of a lag between -- we reset the effective yields every single quarter at this point. There's a -- in fairness, there's a bit of a lag between how things get projected. We would refresh the assumptions each quarter, and you can see that in our financial statements. One of the challenges, the -- if anything, to be critical of ourselves, perhaps our default assumptions are overstated in the near term, if I were to be critical. Obviously, we like to be conservative on that. And to the extent defaults don't happen, if we continue with one default every 6 months or every 6 weeks, that's certainly a much more tolerable pace. I could see some path to further upside in the effective yields, but it moves around a little more slowly than all else equal, we would like it to. Maybe it reflects a little conservatism, but not pessimism.

Okay. A couple of simpler questions, Tom. Do you believe it would be economical for you to redeem the 2027 notes and upsize them to increase your balance sheet leverage back towards the center of your target?

Certainly, we're mindful of where we are in leverage versus our target, and we are comfortably below it. As we look across other 40 Act Vehicles, notably BDCs, all the cool kids have been issuing left, right and center. So we're mindful the market seems open. One thing we're also mindful of is, I don't think there's been a deal done longer than 5 years. And right now, all of our paper outstanding is original 10-year tenor. So as we kind of balance and everything actually becomes callable, one of them is callable already. The Xs, I think, run off a non-call in April and the Bs actually run off non-call later this year. So we have tremendous optionality over our debt, whether we issue new bonds or preferreds or refinanced stuff, we grapple with all of those things. Mindful your colleagues in banking like to charge a few points to issue those deals as well. On a 5-year deal, the tenor over which you're amortizing that cost starts to get a little punitive. So we're looking at all different options and issuing debt or preferred is certainly one of the levers in our tool chest. To the extent we did that and invested at a higher rate, that would obviously be accretive to NII.

I understand. I have one more question. My last question. Besides capital allocation, was the decision to take the realized losses this quarter also driven in any way by tax? And what is the outlook for return of capital in terms of your distributions going forward?

Sure. So no, so a -- the realized loss was purely an accounting reclassification. The positions have been -- hopefully, everyone is comfortable we fairly mark our book. The positions had been fairly marked going into year-end, anticipating little or no future cash flows from any of these investments and just kind of the reality of assessing the portfolios, where some of them -- and this obviously is the benefit of a large diverse portfolio. There will be a few challenged names that pop up. Whereas at the beginning of the year, you could at least make a credible argument on some of them, having some further value. Kind of post-COVID -- everyone took a little pain in COVID, some more than others. If CLOs were late in life, in some cases, we just decided it wasn't -- you couldn't make a credible case. So that was something we rolled out. But it really was just an accounting reclassification, moving from one bucket to the other. We already took the unrealized loss, so that's why there was essentially no NAV impact from this. That doesn't -- but we didn't actually sell the securities. We still hang onto them. I mean, in theory, they could phoenix, we wouldn't bet on it. So that didn't trigger any sort of tax consequence onto itself. The bulk of the sheltering of taxable income related to activity and frankly, stuff that we help encourage. And I think we always try and -- I think many of the collateral managers we invest with appreciate we have a heightened sensitivity and knowledge around tax. A lot of the trading activity in CLOs last year really proved to shelter a lot of interest income. So we've got gobs and gobs of cash because there were some realized losses. Even if they were just relative value trades, we sheltered the vast majority of income last year. I think there will be far -- where we sit today, assuming market conditions stay similar to where they are, I think there will be far fewer realized losses this year within CLOs and potentially realized gains, which could flash through a significant amount of income up to ECC. It's -- of all the -- we know GAAP tax and cash will equal over the life of a CLO. We have that -- that's probably the most read, downloaded report on our website from 2015. What I don't -- what we had not figured out, and I can tell you why, and no one has, is accurately modeling taxable income into the future in that we -- a big driver of that is collateral manager behavior. And I don't -- I can't say accurately exactly what buys and sales we'll be doing in the fourth quarter of 2021, which would have a big impact. Safe to say where we sit today, it looks like taxable income should be up year-over-year. It could be meaningful. In theory, it could be above the distribution level, frankly, but it's too soon to tell.

Next question comes from Randy Binner with B. Riley.

So I -- just on the reclass for the realized loss. What exactly are the buckets that those items moved from? And two, was it -- I understand that you already marked them, so there was already an unrealized loss. Was it then move from held-to-maturity or available-for-sale? I'm just trying to understand the mechanics of where the reclass was?

Ken, do you mind driving on that a little bit, maybe where we can see it on the balance sheet?

Sure. So it really is just a reclassification of categories. And if you go to our income statement on the annual report, page 19, the -- and you'll see that the 2 largest buckets, one is net realized gain/loss of $37 million. And then there's a net change in unrealized appreciation of $61 million at the bottom of the income statement. All that happened, and then this is a net amount is the unrealized loss. And the net change in unrealized appreciation, depreciation moved into a realized bucket on the income statement. The other thing to be mindful of is, I would say, this goes from like kind of below the line is an unrealized event to above the line as a realized event, meaning that it's being noted through our earnings per share. But on the face of the balance sheet, just went from unrealized to realized, and it is being reported as our -- as part of our earnings per share for the quarter.

Okay. And then -- so yes, so when you say buckets, you're saying unrealized or realized, which is fine. So I was just curious if you were saying it was more like held-to-maturity to available-for-sale or something like that? And it's not the case.

No, that was just -- correct. It's just an accounting line item.

I mean everything is available for sale for you all, right? I mean, do you have some that's held for maturity?

No. It's all available for sale.