Eagle Point's CLO equity buying spree accelerates
Eagle Point Credit Co. (NYSE: ECC), a closed-end fund that invests in collateralized loan obligations, is on a buying spree.
In January alone, Eagle Point put $36.6 million to work acquiring the most subordinate securities issued by several CLOs, known as the "equity," the company disclosed in its full-year 2017 earnings release Thursday. This was on top of the $52.6 million it spent adding to its holdings of CLO equity during the fourth quarter of last year.
CLO equity stakes are considered to be risky because they do not receive either interest or principal. Instead, equity holders are entitled to whatever cash flow is available after income from loans in the CLO portfolio are used to pay interest and principal to holders of more senior notes.
Eagle Point and other CLO equity investors have been benefiting from a wave of CLO refinancing and resets, which lower payments to senior and mezzanine noteholders, leaving more left over for the equity.
Eagle Point has been using the cash generated by its own portfolio, along with $38.8 million it raised in an offering of common stock in January, to add to its holdings.
CEO Tom Majewski told analysts in a conference call Thursday that with “solid” cash flows and “attractive” terms on new CLOs and resets, “we feel confident in the current state of our portfolio to continue generating long-term value.”
Eagle Point’s $34 million in cash distribution receipts in the fourth quarter was nearly $10 million above proceeds from the third quarter. But that is already being outpaced with $21 million in the first quarter through Feb. 15, according to the company’s earnings report.
In the fourth quarter the company reset three deals in which it had a controlling interest and participated in a deal call that locked in $1.1 million in capital gains. So far In 2018, it has already reset two more CLOs for which it holds controlling interest, and has “several” reset candidates in mind “for the remainder of the year,” Majewski added.
One deal Majewski mentioned by name: Octagon Investment Partners 26, a $507.7 million March 2016 CLO that has an existing AAA coupon spread in the 160s. “Thankfully that CLO comes off of non-call next quarter,” he said, “and you can be sure it’s on our radar screen of things to do.”
“Reset activity has become an increasing part of our investment process as our portfolio seasons.”
The effective yield on new equity investments the company made in the fourth quarter ranged as high as 22.4%, Majewski said, while the existing portfolio was in the “mid-upper 16s.”
“The biggest reason that’s higher than the yield on the overall portfolio, and not by a trivial amount, is not really [from] additional risks in these new investments,” said Majewski. “These are CLOs that have the lowest cost on the right-side of the balance sheet we’ve ever achieved."
Eagle Point isn't the only CLO investor that has been on a buying spree. Oxford Lane Capital (Nasdaq: OXLC) spent $123.1 million in the fourth quarter to buy positions (including controlling interests) in CLO.
A recent ruling by the federal DC Circuit Court of Appeals could potentially make it easier for investors like Eagle Point and Oxford Lane to source CLO equity. On Feb. 9, a panel of judges said that risk retention rules enacted under Dodd-Frank do not apply to CLO managers that acquire their collateral in the open market, instead of originating the loans themselves. The decision, which could take effect as soon as the second quarter, could result in managers who already hold equity in their deals unloading these stakes.
Majewski downplayed the impact, however. On the conference call, he noted that risk retention rules “had little impact on our ability to subsource majority CLO equity investments.” That's because many CLO managers choose to comply with the rules by holding a portion of each tranche of securities issued in a deal, rather than the equity securities.