Eagle Point set for CLO buying opportunities at 'best time'
Eagle Point Credit Co. has plans - and the cash - to pounce on CLO investment opportunities in the event of a market downturn.
In its third-quarter earnings call with analysts on Wednesday, CEO Tom Majewski said the closed-end investment management firm will "maintain good visibility on our new investment pipeline for the next few quarters."
"We have a number of accumulation facilities in place, which we expect over the coming months and quarters will be converted into new CLOs," Majewski said. "Yet, there is never a rush to do it. We like to do it when we believe it’s the best time."
To that end, the company has built up its cash reserves to $29.1 million, up from $1.23 million in the second quarter from cash flow, investment asset sales and proceeds from a stock issuance.
Eagle Point (NYSE:ECC) in the third quarter continued its high volume of reset and refinance activity involving six deals that extended the reinvestment period on these well-performing deals up to five additional years. Eagle Point has reset or refinanced more than 50 third-party CLOs it controls through first-loss, ownership equity investments since early 2017.
Majewski explained the plans alongside concerns over recent media coverage of the industry that has focused on weakened investor protections in CLOs and leveraged loans, but lacked key details that might mitigate the elevated risk concerns on deals - such as growing corporate revenue figures and the historical strong performance of CLOs, including during the financial crisis.
“Mass media outlets have taken a keen interest in CLOs,” said Majewski, who described many of the articles as "hyperbole." But “unfortunately," he added, the articles are not “providing a lot of important data to back up their sentiment.”
In recent weeks, concerns have been raised over weakened investor protections on leveraged loans. Critics include influential voices like former Federal Reserve chair Janet Yellen and Oaktree Capital co-chairman Howard Mark, who have cautioned investors to be more aware of risks and for regulators to more closely scrutinize leveraged ratios of non-investment-grade corporate borrowers.
Majewski said during the analyst call that even though “some articles have highlighted concerns related to degradation in lending standards,” none have noted CLOs’ traditionally strong performance during economic downturns – and even calamity.
“For all cash-flow CLOs created between 2002 and 2011, which includes the entire period of the financial crisis, some of you may be aware that 96% of CLOs generated positive returns to the equity class” representing the first-loss position in deals, Majewski said. “CLOs have been tested and withstood one of the worst recessions in nearly 80 years.”
While reports also cite concerns over lower potential CLO recovery rates from higher corporate leverage, Majewski said none have included the fact that these same junk-rated corporates have healthy year-over-year revenue growth in the last two years (12% and 14% in 2017 and 2018, respectively). “Further, those growth rates have been accelerating ... over the past few quarters.”
“We consider it highly unusual for companies with significant revenue and EBITDA growth to be at near-term risk of default,” Majewski said. “It just doesn’t make sense to us.”
Majewski is also not concerned about the near universal rise of cov-lite structures in leveraged loans, nor with CLOs expanding their ceilings on cov-lite exposure and the wider band of low triple-C rated loans into their portfolios. He says that these looser features will actually benefit CLOs. They provide nimble managers more buying opportunities of below-par assets, for which obligors with cov-lite allowances will have a wider berth to “navigate through tough times” without triggering downgrade or maintenance-based defaults that might result in missed payments.
“With so many loans now covenant-lite, we believe that will likely delay the onset of the next default cycle and may lower the cumulative default rate,” Majewski told analysts. “We do agree with the rating agencies that recoveries will likely be lower in the next cycle. However, there is an enormous difference between a credit cycle ... and a credit crisis.”
In particular, CLO equity investments – which currently total $448 million in assets for Eagle Point – have “historically benefited” from loan-price volatility. “The CLOs have the ability to reinvest loan principal and lower price loans at that time,” Majewski said. “That money can come from amortization, recoveries on defaults and relative value trades from selling other loans.”
Majewski said Eagle Point is “well positioned to go on the offense and take advantage of lower loan prices,” after having reset or refinanced more than 50 CLOs through which it holds controlling third-party equity control since 2017.
“This is why we spent so much time on resets and talked about lengthening our weighted average reinvestment period,” Majewski said. “More optionality for the CLO equity.”