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

Greetings, and welcome to the Eagle Point Credit Company Fourth Quarter 2023 Financial Results Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Garrett Edson of ICR. Thank you, Garrett. You may begin.

Thank you, 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. As a reminder, before we begin our formal remarks, the matters discussed on this call include forward-looking statements or projected financial information that involve risks and uncertainties that may cause the company's actual results to differ materially from those projected in such forward-looking statements and projected financial information. For further information on factors that could impact the company and the statements and projections contained herein, please refer to the company's filings with the Securities and Exchange Commission. Each forward-looking statement and projection of financial information made during this call is based on information available to us as of the date of this call. We disclaim any obligation to update our forward-looking statements unless required by law. A replay of this call can be accessed for 30 days via the company's website, eaglepointcreditcompany.com. Earlier today, we filed our Form N-CSR, our full year 2023 audited financial statements and our fourth quarter investor presentation with the Securities and Exchange Commission. The financial statements and our fourth quarter investor presentation are also available within the Investor Relations section of the company's website. The financial statements can be found by following the Financial Statements and Reports link, and the investor presentation can be found by following the Presentations and Events link. I will now turn it over to 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, which provides additional information about the company and our portfolio. I'll start off by saying that the company had both a strong fourth quarter and a great 2023. For the year, we generated a GAAP return of equity of 20.79% and a total return on our common stock, assuming reinvestment of distributions of 18.92%. We believe our portfolio remains well positioned for 2024 and also that our portfolio has room for continued upside. The right side of the company's balance sheet is also positioned very well. Some highlights from the fourth quarter include that our net income and realized capital gains totaled $0.33 per common share. We received recurring cash flows on our portfolio in the fourth quarter of $60.7 million or $0.82 per common share. This exceeded our aggregate common distributions and expenses for the quarter by $0.14 per share. NAV per share, as of December 31 was $9.21, and this is a modest decrease from September 30th, but up 2% for the full year. During the quarter, we paid $0.48 per share of cash distributions to our common shareholders -- distribution with record dates during the year to $1.86 per share. During the quarter, we continued to actively manage our portfolio, opportunistically deploying $34 million in net capital into new investments that we believe will increase the earning power of our portfolio over time. Along with our overall portfolio performance, we continue to prudently raise capital through our at-the-market program and issued approximately 4.5 million common shares at a premium, generating NAV accretion of $0.03 per share during the quarter. As of December 31, the weighted average effective yield of our CLO equity portfolio was 16.7% based on amortized cost, and this is an increase from 16.29% at the end of September. The new CLO equity that we purchased during the fourth quarter had a weighted average effective yield of 22.9%, which should help bolster the portfolio's weighted average effective yield prospectively. The company also had a number of meaningful subsequent events that I would like to highlight. We estimated our NAV at January month end to be between $9.22 per share and $9.32 per share, and that's an increase from year-end. Along with our regular monthly common distributions of $0.14 per share, we also declared additional variable supplemental distributions of $0.02 per share for aggregate monthly common distributions of $0.16 per share through the end of June 2024. I also want to highlight that inclusive of the January 31 distributions, we've now crossed an important milestone, and the cash distributions paid to our shareholders have now totaled $20.15 per share since our IPO in 2014. This means a shareholder, who invested in our IPO less than a decade ago has now received over 100%, a full return of invested capital of our IPO price in the form of cash distributions, while still owning their shares in Eagle Point. We are immensely proud of this milestone and the value that we have created for shareholders. During the first quarter, we were also pleased to be able to further strengthen our balance sheet, raising an additional $47 million of net proceeds through the issuance of a new Series F term preferred stock due in 2029. Consistent with our long-time strategy for operating the company, all of our financing remains fixed rate, and we have no financing maturities prior to April 2028. In fact, some of our preferred stock financing is even perpetual with no set maturity date. We continue to focus most of our investment efforts in the secondary market during the fourth quarter, as the yields and convexity available in the secondary market offered in our view, better risk-adjusted returns than the primary market. We remain focused on finding opportunities to invest in CLO equity with a generally longer reinvestment periods remaining. As a result of our consistently proactive portfolio management, as of December 31, our CLO equity portfolio's weighted average remaining reinvestment period or WARRP stood at 2.4 years, well above the market average of 1.6 years. As we have consistently stated, we believe keeping our weighted average remaining reinvestment period as extended as possible is our best defense against future market volatility. With a notable increase in demand for CLO AAA bonds, we're starting to see a pickup in reset and refinancing activity within the CLO market. We expect to be active in completing resets and refinancing were attractive in order to further increase our portfolio's weighted average remaining reinvestment period and potentially lower our CLOs cost of debt. For the first time in a while, we're also seeing an increase in attractive new issue CLO equity opportunities, several of which we're pursuing. Before turning the call over to Ken, I'd like to take a moment to highlight Eagle Point Income Company, which trades on the New York Stock Exchange under symbol EIC. EIC primarily invests in CLO junior debt. For the fourth quarter, EIC generated net investment income of $0.56 per share, excluding non-recurring expenses, once again exceeding its common distributions for the quarter. Given our continued confidence in EIC's portfolio, we recently raised its monthly common distribution by 11% to $0.20 per share. This is the highest distribution in the company's history. EIC has performed very well over the last few years, and we believe remains well positioned to continue generating strong net investment income. We invite you to join EIC's investor call at 11:30 a.m. today after this call and to visit the company's website, eaglepointincome.com, to learn more. After Ken's remarks, I'll take you through the current state of the corporate loan and CLO markets. I'll now turn the call over to Ken.

Thanks, Tom, and thanks, everyone, for joining our call. I'll start off by reporting for the fourth quarter of 2023, the company recorded net investment income and realized gains of approximately $25 million or $0.33 per share. This compares to NII and realized gains of $0.35 per share in the third quarter of 2023 and NII less realized losses of $0.29 per share in the fourth quarter of 2022. When unrealized portfolio appreciation is included for the fourth quarter, the company recorded GAAP net income of approximately $27 million or $0.37 per share. This compares to GAAP net income of $0.93 per share in the third quarter of 2023 and GAAP net income of $0.17 per share in the fourth quarter of 2022. The company's fourth quarter GAAP net income was comprised of total investment income of $39.4 million, net unrealized appreciation on investments of $10.1 million and realized capital gains of $0.2 million, partially offset by expenses of $14.1 million, net unrealized appreciation on certain liabilities held at fair value of $8 million and distributions on the Series D preferred stock of $0.5 million. Additionally, for the quarter ending December 31st, 2023, the company recorded an other comprehensive loss of $1.2 million. The company's asset coverage ratios at December 31 for preferred stock and debt calculated pursuant to Investment Company Act requirements were 371% and 551% respectively. These measures are comfortably above the statutory requirements of 200% and 300%. Our debt and preferred securities outstanding at quarter end totaled approximately 27% of the company's total assets less current liabilities. This is towards the low end of our target range of generally operating the company with leverage between 25% to 35% of total assets under normal market conditions. Last week, we declared distributions for the second quarter, in line with our recent distributions. We will continue to review our variable supplemental distribution on a quarterly basis. Moving on to our portfolio activity this year through February 15th, the company received recurring cash flows on its investment portfolio of $50.4 million. This is below our fourth quarter recurring cash flows, as there were higher loan prepayments in the fourth quarter of 2023, which caused a short-term buildup of cash on some of our CLOs. In addition, some semiannual paying loans and bonds in our CLOs underlying portfolios will not make payments again until the second quarter of 2024, which also contributed to the decline in cash flow. As these items are generally timing related, we expect portfolio cash flows to be higher in the second quarter, all else equal. I will now hand the call back over to Tom.

Thanks, Ken. I'll now update everyone on the loan and CLO markets. In 2023, the Credit Suisse Leveraged Loan Index generated its best performance in nearly 15 years. It was actually its second-best performance on record with a total return of 13.04% for the full year. The Index has continued its positive performance into 2024, and as of February 15th, loans were up about 1.14%. During the fourth quarter, we saw only 4 leveraged loan defaults, and that's down from 6 in the prior quarter. As of year-end, the trailing 12-month default rate stood at 1.53%, remaining well below the long-term historic average of 2.7%. While some research desks believe the default rate will rise modestly in 2024, nearly all were completely wrong in 2023, and we believe the typical loan borrower has far more tools in its toolkit to manage their balance sheet than the average researcher gives credit to. While defaults may actually increase in 2024, we don't expect to spike and believe many forecasters will again miss the mark. During the fourth quarter, approximately 5% of all leveraged loans or about 21% annualized repaid at par. This represents a modest quarter-over-quarter increase and importantly, provides our CLOs with valuable par dollars to reinvest in today's discounted loan market. With a large number of high-quality issuers continuing to trade at discounted prices, CLO collateral managers remain very well positioned to improve underlying loan portfolios through relative value trading in the secondary market. Loan repayments make this even easier. Additionally, most loan issuers remain very proactive in tackling their near-term maturities in an effort to further extend the term of their debt. Some borrowers even offer lenders a higher spread and new OID in order to lengthen out their maturities on their newly refinanced loans. As a result, our portfolio continues to have numerous opportunities to build par and increase our weighted average spread, which in turn increases the excess spread we receive on our CLO equity portfolio. On a look-through basis, the weighted average spread of our CLOs underlying loan portfolios was 3.79% at the end of the year. This is comparable to September, but is a healthy 21 basis point increase over the last 21 months. Meanwhile, spreads on debt tranches issued by our CLOs that were locked in 21 months ago remain unchanged and actually have the potential to tighten if we're able to refinance or reset our CLO debt. CCC concentrations within our portfolios stood at around 7.4%, as of December 31, and the percentage of loans trading below 80 stood at around 4.5%. Our portfolio's weighted average junior over-collateralization cushion was 4.28%, as of December 31. This gives us ample room to withstand any potential downgrades or losses. Our portfolio's OC cushion remains much higher than the market average, which stood at 3.31% at the end of the year. In terms of new CLO issuance, we saw $32 billion of issuance in the fourth quarter and $116 billion for the full year, once again, eclipsing the $100 billion mark. We believe that over 80% of the volume in 2023, however, was backed by captive CLO funds, which are generally less return sensitive than investors like us. 2024 has started off strong with a very active January for CLO issuance, as AAAs tightened significantly. While secondary CLO equity can [indiscernible] CLO equity arbitrage has improved enough that the company has invested in a number of attractive new issue CLOs during the first quarter. We haven't done much of that in some time. As we've consistently noted, its environment of loan price volatility, where we believe CLO structures and CLO equity in particular, are set up well to buy loans at discounts to par with very stable financing structure using par paydowns from other loans to outperform the broader corporate debt markets over the medium term, as they have in the past. I'll conclude the call with the following highlights. We generated net investment income and realized capital gains for the quarter of $0.33 per weighted average common share. We continue to receive robust cash flows on our portfolio in the fourth quarter that exceeded our common distributions and expenses. We sourced a number of new investments with very attractive yields, investing $34 million of net capital during the quarter. Our portfolio continues to maintain a weighted average remaining reinvestment period that's significantly longer than the market average. Our existing regular monthly common distributions and our variable supplemental distributions were declared and continued through June of 2024. We further strengthened our liquidity position, generating NAV accretion of $0.03 per share through our ATM program. And in the first quarter, we generated $47 million of net new capital from the issuance of the Series F term preferred stock. As of February 15th, we had about $52 million of cash available to deploy into new investments, and we've been very active in sourcing investments with which to apply our dry powder. Importantly, we continue to maintain 100% fixed rate financing with no financing maturities before 2028 and this gives us protection from any further increase in interest rates and locks us into an attractive cost of capital for many years to come. We have a strong pipeline of primary and secondary CLO equity investments that we're evaluating. In addition, we're carefully looking at many CLOs in our portfolio and evaluating the possibility to refinance or reset them, which, if successful, would lock additional upside in our portfolio in 2024. We believe the company's investment portfolio continues to be very well positioned given our proactive management. The portfolio's weighted average remaining reinvestment period, its strong OC cushions and its high recurring cash flows, remain opportunistic and proactive, as we manage our investment portfolio always with a long-term mindset. We thank you for your time and interest in Eagle Point. Ken and I will now open the call to your questions. Operator?

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

Tom, I wanted to ask you, how do you see the potential to call deals that are beyond the reinvestment period and now rotate that capital into the primary market since you're seeing the economics there starting to make more sense?

Very good question. Kind of 2-pronged to that. Certainly, later in life CLOs get a healthy review from us, the range of outcomes that we can do either CLOs at the -- past the reinvestment period or even with a year or less to go. Our menu of options are polled, sell, call, reset or refinance. Selling obviously takes care of it, calling it, you get what's left over, refi, just lowers your cost, reset gives you the potential to lengthen reset with a whole new reinvestment period. With the AAA market having come in significantly over the last 3 months to 6 months, and the price of loans, while still trading at discounts up a bunch, that optionality has come more into play, whereas we conducted very few calls and resets last year, it wouldn't surprise me to see that activity pick up. And we're certainly actively looking at it across a number of investments right now. 1 or 2 maybe just lowering the AAA spread and just doing a refi, frankly, a couple of resets are being considered. What we do with the proceeds is it might be to going into the new issue market. We have done a small number of new issues this year, but there's still plenty of attractive secondary opportunities as well. So the good news is the optionality embedded in CLO equity is more in the money today, be it through a call or a reset or refi than it was the last time we spoke. And while the secondary market has certainly moved up since the end of the third quarter, we had a good -- a very nice fourth quarter. There's still attractive opportunities there. And now we have the added opportunity to invest in the primary market. The primary market is typically bigger tickets. You can buy secondary pieces. It's sometimes hard to deploy $10 million in proceeds in the secondary market. It's possible, but it's limited versus new issue majority investing. Obviously, you can get more capital in the ground. There's a bit of an inverse yield curve in the CLO market. If you think about like what a typical treasury curve looks like when you or I might have been students at school, the low rates are -- the short rates are low, the 30-year was high and there was some sort of slope around that. CLO equity yields are almost inverse to the remaining reinvestment period and that's something that's brand new with a 5-year reinvestment period or something like that might have a mid- to mid-upper teens yield versus something with 1 year left might have a 25% yield than a generically loss adjusted. So it's kind of inverse the more time you have on your reinvestment period, the less yield you're going to get in general, but the more optionality you have. So as we look, we continue to consider what to do with every single investment, roll the clock back a year or 2 ago, we kind of thought of things as refi, reset mania here, and we did dozens of them. Last year, again, very few. But this year, it looks like that option is more in the money, and I suspect we'll get -- continue to get things done in that space.

Tom, that's very helpful. And if I could just follow up with one question. What do you believe is driving [indiscernible] very much out of whack last year. Is it new entrants or old entrants coming back into the market or a reassessment of risk or a combination of all the above? What's -- how would you characterize all of that?

It's a couple of things. Not so much reassessment of risk, but we're seeing some older buyers, who might have been off coming back online, both U.S. banks and Asian banks, in particular. We are seeing some new entrants into the market. And then a stat that's often overlooked, the -- a significant portion of the CLO market, the last number I saw was around 40%, but that might be a tiny bit dated, is actually outside the reinvestment period. And depending on how proactive the collateral managers are assuming they're not very proactive, then indeed, what's happening is people hold those AAAs are getting paid down and factored down. And to the extent there's resets, refis and calls, they're getting their AAA money back. Some are actually -- some of the AAA buyers are seeking to increase their exposure. Some are frankly just seeking to maintain it and if they're getting called or paid off in a refi or reset they need to redeploy. So one banker described to one of our partners that there's very, very strong demand for AAAs. This was a couple of weeks ago, but we're definitely seeing it across the market with a number of prints in the [ 1 50 ] area levels that 3 months to 6 months ago, we would have loved to have gotten to.

Our next question is from Matt Howlett with B. Riley Securities.

When we look at the forward curve when we look at the potential for the Fed to cut at least 2x, I think the market is projecting even a little bit higher than that. And then look out in '25, can you walk us through how we should think about GAAP NII and more importantly, cash flows. I mean, obviously, on one hand, you get the floating rate reset downward, but on the other hand, you could do these resets, you [indiscernible] that opportunity could increase, you obviously could issue debt cheaper. How should we think about it declining, now it just looks like it's a matter of time, a declining rate environment for ECC and would you take up leverage? Just walk me through like how you guys are thinking about it and how we should think about it from a modeling standpoint?

Yes. The short answer is it's much to do about nothing in my opinion. While all we do is we're a borrower and a lender all with interest rates in the old days LIBOR now SOFR, largely cancels each other out in a CLO. So loans, we went from 0, basically 0 or near 0 rates a couple of years ago at around 5% rates today. You can see the equity cash flow, if you look at it over time in our portfolio, didn't adjust it by share count or whatever other stuff like that, it doesn't even move that much and that the bulk of our that income distributions that come to us as CLO equity holders is simply the difference in the spread on the loans versus the spread on the liabilities. Increases in rates have the potential to increase defaults for companies because they have to pay these higher rates, although, as you heard, there's 4 companies out of 1,400 or something like that in the portfolio, defaulted is not a -- is not a default situation is down from [ 6 over ] the prior quarter or whatever it may be. So there's a little bit of drag there. Probably the best thing going on is the ability for us to start refi-ing and resetting. That's the thing that's going to drive increases in cash flows on the existing portfolio, where we can rip out costs on the right side of CLOs balance sheet. The -- now the flip side, 1 or 2 loans have repriced as well, but that's really the exception. If we think back to like 2017, we saw loan repricing wave. That was bad news for us and loans were getting repriced faster than we could reset and refinance our CLOs. Today, there's a very small amount of loan activity on repricing, more activity and optionality for us on the right side of our balance sheet. So those are things we like. Would we take up leverage? Not particularly. I mean, we seek to operate the company within the 25% to 35% band. We've been consistent with that message probably since 2015 when we added the first ECCAs, which we paid off a long time ago, I remember those. We were a little below the target. We got the [ apps off ] earlier, might have even been, you or one of your colleagues, who suggested we do something like that, although it might have been in the works on the last call. But we got the [ apps off ] and that's a good piece of paper for us. And if you read in the financials, it's not that deep of a market. We do continue to issue a little bit of the Series D perpetual preferreds via the ATM as well. Those are kind of trading, just looking at the screen right now, around low to mid 8s type yield. So that's obviously very attractive and we can kind of drip that in as we need it. So we're fixed income investors, but the biggest thing that's going to drive is getting our effective yield up and the things that get our effective yield up are getting our CLO debt costs, as low as possible for our existing portfolio and continuing to put in very attractive new investments on the balance sheet, as capital comes in and cash flow on our portfolio comes in.

And you have a 2-year [ non-call ]

[indiscernible] probably won't matter.

Right. No, look, it makes -- look, one thing we're [indiscernible] certainly couldn't matter you look at Eagle Point, ECC is 15% -- 18%-plus yield rates are going lower. That's going to be more apparent to a lot of people earning that were -- [ 125% ] of their money market [ isn't really ] might take some cash off the sidelines and buy your stock. And that's where I want to go with the next question on -- you have this, it's just -- we always sort of thought that the excess cash flow over the dividend, think of what was the $0.14 over dividend expenses this quarter. I mean at some point, it was going to come down, but it's sort of like a -- it's just the gift that keeps on giving. It's a high-class problem. You just have this every quarter, almost like clockwork, and maybe you don't expect it forever. But my question is, how -- at some point, did you have -- you're going to have to pay a special, do you want to pay a special dividend? Do you just rather pay an [ excess X ]? Do you have to pay it? Just walk me through how you had the supplemental, which is great. But at some point, you have to true everything up because of this just bonanza that's happening with your cash flow for longer -- higher for longer?

Yes. And again, we're probably of the higher for longer type here, but again, that's not going to be the big driver the -- for us. The way we've looked at this, we've evolved our thinking as we learn how to -- we're 10 years -- it's our 10th year anniversary, I guess, in October, it will be a decade. We've kind of gotten our sea legs, Ken and I, I remember back in probably 2017, we declared a special distribution for the first time and maybe it was $0.50 distribution. I don't remember exactly what it was, but it was in that context. And the stock went up $0.50 at x day. And for the person, who bought that stock at 3:59 p.m., I had no idea it was a bit of a windfall or just -- I mean, in that case, just distributing cash back to the shareholders. But -- so we kind of came to the view, we did specials a couple of times. It became very predictable what would happen, but it didn't, in our opinion, reward long-term shareholders. Obviously, you got money to long-term shareholders, but there was some benefit of invariably, someone got a lucky break, and some guys sold the stock at 3:59 p.m. the day before as well. So what we've gone to is more of this kind of dripping the supplementals out when we need to. We think a $0.14, as the base distribution right now. We've been doing the [ attitude ] to deal with spillover income, but to kind of reward people over a longer period of time. We reevaluate this based on taxable income every single quarter. Obviously, when the Board met last week, we extended it through the end of June. But even without that, even at $0.14, we think the stock is still a very attractive high earning, high cash flowing stock to own in a portfolio. But I think we're going to broadly get away from big chunky specials and when we have taxable income needs because we do have to pay out substantially all of our taxable income we'll try to trickle it out more of how we've been doing lately than do those big blocks.

Great. I appreciate that. And look, it's high -- no one's complaining. It's a high enough yield there...

Yes. No one's ever complained. And the number of happy messages I get when we do a special is great. But we're a long-term player. We want to reward long-term shareholders. And the best way to do that, we think is a drip, not a splash.

Great. And the last one, the new issue market, you made some just comments on that. I mean, what do the -- what -- I know, you're primarily looking at the secondary market, but what are the expectations in '24 for M&A and new issue? And what's the new kind of what's in vogue now with new CLO deals? Are they -- anything interesting about them structural-wise, is it something that might be interesting, that's new? Just give us an update on what your expectations.

Yes. So most of the market last year, I think we said this in the prepared remarks, our estimate is about 80% of the market was taken by captive investors, where the collateral manager was the person, who turned up at the table with the majority of the equity. It might be their own money, it might be client money, who knows where. But the person, who leaves with management fees was the person, who turned up with the equity debt. We did a very small number of CLOs last year on a new issue basis and very close to 0 or no refis or reset. That said, it's -- that universe has changed significantly. And even so far this year, we have done a number of new CLOs at Eagle Point, where we've been as a firm, the majority equity investor. And some of that is attributable to -- we have a handful of loan accumulation facilities on our books. So I'm looking at the portfolio, we've got about 1.4% of the portfolio based on the January tear sheet in loan accumulation facilities. Those are basically tickets. So whenever it's a good time to do a CLO, everyone wants to do a CLO and when it's a bad time no one wants to do when it seems. What we do is with the collateral managers that we know we're going to want to be working with when the market is right, we'll keep a small amount of loans. We'll have all the paper set, all the economic terms agreed. And if loans dip, they can buy some, if loans go up, they can sell some. But we've kind of got the tickets punched so that when it makes sense to do new CLOs, we got everything -- we're -- people are, oh, my goodness, it's a great idea. Let's try and figure it out. We've got all the groundwork laid out. So I think we're going to see an increase in third-party new issue CLO activity this year, which suggests that the returns are pretty good. M&A activity probably picks up. But even without that, there's still the loan market of $1.3 trillion, $1.4 trillion, depending on whose numbers you look at. And while CLOs make up a significant part of the -- usually, the majority of that, whether we're buying new loans or secondary loans, there's usually always enough loans to buy to get into CLOs. But I would expect to see us doing more on the new side and more on the refi and reset side, which is just unlocking value in our existing portfolios.

Great. Well, congrats on the 10-year anniversary, the growth is tremendous, should be over $1 billion market cap in no time. And congratulation, look forward to another great year.

Thank you much. And we got -- we shared shareholders got their full IPO price back, as of January 31. We're $0.01 short, as of December, but that's the way it's supposed to be, and we hope to get another $20 back to people, no assurances, obviously, but we'll try as soon as we can. So...

[ You made a ] lot of people happy. It's a tremendous accomplishment.

Our next question is from Steven Bavaria with Inside the Income Factory.

Just a quick one. Happy to see how well you're doing. Congratulations. I see that your GAAP net income covers about 3/4 of your distribution, but then you've got your recurring cash distributions that really cover -- will cover the rest of it and then some. And the question, I guess, that I get all the time is what's in that recurring cash distribution number that's over and above your GAAP income, your NII and your realized capital gains. And since the average loan includes an amortization feature and then a smaller balloon at the end, how much of the routine amortization that's in loan payments throughout their life and that flows down through the waterfall to you, as equity owners. How much of that amortization of principal is included in the recurring cash distribution? And then what else is in it?

So the short answer is none.

Good.

With one very -- with one upside, I'll come back to, but we haven't had it in a while. So when we talk about recurring distributions, that's proceeds that of the interest waterfall from a CLO. So your point, your description is absolutely correct that loans have some amortization payments and then a balloon payment whatever is left over at the end for a CLO during the reinvestment period with one exception, which I'll get to, all of that principle stays in the system and goes to buy new loans and what gets distributed to us and in that recurring cash flow number is just money that comes to us from the interest waterfall. So let's say, we call a CLO is a topic we've talked about earlier, if we were to call one, then we'd also get a principal payment. We would not include that principal payment from a call in our recurring cash flow number that we described. We just say what the total cash is, but we always have that recurring number, which is just from the water -- the interest waterfall. I did say there's one exception, we haven't had this in a while. Let me just -- interest of full disclosure. Early in the life of a CLO, sometimes on the first or second payment date, if there are gains, realized gains in the portfolio above, let's say, we start with a $500 million CLO and the collateral manager is able to create some gains in excess of $500 million, sometimes for the first or second period in a CLO, they can move those gains from the principal account to the interest account and pay it out to us, as the equity holders. But having not been involved in many new CLOs, they're sadly, we haven't gotten -- I don't remember the last time I got one of those payments. So that might be the one exception, but essentially all of the cash flow. All of the cash flows from the interest waterfall and substantially all of that is interest, so to be very clear. So then your question what's the difference, right? What's the difference? Why are you getting all this interest, but you're saying your GAAP income is lower. It's not exactly what we do, but you'll remember this from your banking days, loan loss reserve accounting, and it's not exactly what we do. We have this effective yield concept. And what you'll see, I mean, we publish on a position-by-position basis, the amount of cash we received on each investment, trying to provide a tremendous amount of transparency for the vast, vast majority of our investments, if you look at the effective yield, multiply it times the par amount of what we have divided by 4, you'll see here that would be -- you think what we're getting in cash. We're actually getting more cash than that. And the difference is that effective yield has a reserve for losses analogous to a loan loss reserve. What's happening is we model, and all the assumptions are in there. But basically, once the CLO has ramped up about 2% defaults per year, we're not seeing that. The default rate remains well below the long-term average. So it might catch up with us, maybe we'll have a spike, and we'll -- those defaults will catch up. But right now, what we're seeing is many CLOs are performing better than our credit assumptions in our expectation, we're not anticipating a default spike. So what we're using is these -- are these recurring cash flows, which is – which, touchwood, continue quite robustly.

So the recurring cash flow does not include your sort of anticipated loan loss, although your experience has been that you don't usually achieve that as much of a loan loss as you might kind of mentally or financially reserve for it. And I guess, the fact that you -- and loan loss anticipation a reserve that you would create, that's not part of your -- that's not a taxable loss until you actually have the experienced the loss. So you're required to pay out a certain portion of your pretax income, obviously. So I guess, that gets complicated, trying to reserve for a loss that you're not allowed to include in your tax.

Exactly. So GAAP, we have to use the effective yield method, which includes a reserve for losses. Maybe there's been a year, where there's been exactly an average number of losses. But in my experience, it's usually above or below the average. I mean, over time, you get to the average. And what you've seen is that translates -- so that's -- the GAAP is basically an accrual model. Tax is a realized model. So I mean, there's been years, where the vast majority of our distribution has been treated as a return of capital for tax because CLOs, even if it's -- if you bought a loan at par, you sold it at [ 90 ], you bought another loan at [ 88 ], you get to take the $0.10 loss on the first one and you don't have to pick up the gain on the next one until you sell it. So there's been years, where we've had very low taxable income. And then there's been years, where we've had these -- the next year invariably when all those [ 88 ] loans pay off at par, which stays in the system because it doesn't get paid out to us because it's in the principal account, we've had situations, where we've had -- and we talked about with the prior question, needs to pay big specials. So the crux of the matter is GAAP is accrual, tax is as incurred.

So can work both for you and against you. It's complicated. Appreciate your explanation.

Cash in the bank is the simple part. That's the -- yes, we can debate all the [indiscernible] of it. Money in the bank is the easiest part to analyze in our opinion. So thank you.

Thank you. There are no further questions at this time. I'd like to hand the floor back over to Thomas Majewski for closing comments.

Great. Thank you very much, everyone, for your time and attention today. We appreciate all the questions. Ken and I will be around later today to the extent people have follow-up questions. And we also invite you to join the Eagle Point Income Company Call, which will be held today at 11:30 a.m. Thank you very much.

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