In todays headlines I posted a few hours ago there were earnings that are important to at least some of us.
Eagle Point Income Company (EIC) posted earnings today–and generally they were quite satisfactory. For the collateralized loan obligation (CLO) company I watch a few key items which give me a good hint as to how the company is performing. I watch the net asset value (NAV) from quarter to quarter–in this case the NAV per share grew by 9 cents quarter over quarter which is excellent–large changes down in NAV indicates they are paying too high of dividends. The 2nd item I watch for is can the company raise cash–sell equity? Eagle Point Income has no problem selling equity–selling common shares at prices over net asset value. Additionally they have ‘at the money’ offerings on some preferred shares.
Recall that Eagle Point Income (EIC) is the CLO owner that holds mainly CLO debt tranches–considered safer than equity tranches.
EIC’s press release is here
Why is CLO debt safer than CLO equity? if a company goes belly up then isn’t the debt worthless? Does the equity include tangible assets like real estate?
This comes from AI but it’s a pretty good summary:
A Collateralized Loan Obligation (CLO) is structured as a series of “tranches” of debt, with each tranche representing a different level of credit risk, where the most senior tranche has the highest credit quality and receives payments first, followed by progressively more junior tranches, with the remaining residual cash flow going to an equity tranche which absorbs the first losses; essentially, the structure functions like a waterfall where higher-rated tranches are paid first, with lower-rated tranches only receiving payments if there are sufficient funds remaining after servicing the senior tranches. [1, 2, 3, 4, 5]
Key aspects of a CLO structure: [1, 2, 4]
• Tranches: A CLO issues multiple tranches of debt, ranging from senior (highest credit quality, lowest risk) to junior (lower credit quality, higher risk). [1, 2, 4]
• Credit Enhancement: Due to the nature of the underlying leveraged loans, CLOs often utilize credit enhancements to improve the credit rating of senior tranches. [2, 4, 6]
• Equity Tranche: A small portion of the CLO is structured as an equity tranche, which receives the remaining cash flow after all debt tranches are serviced, but also bears the first losses. [1, 2, 4]
• Active Management: CLOs are actively managed by a portfolio manager who can buy and sell loans within the underlying portfolio to optimize returns and manage risk. [1, 2, 7]
Life Cycle of a CLO: [7, 8]
• Warehouse Period: The manager initially purchases loans to build the collateral pool. [7, 8]
• Ramp-Up Period: The manager completes the portfolio by adding more loans to reach the target size. [7, 8, 9]
• Reinvestment Period: During this period, the manager can reinvest proceeds from maturing loans to maintain the portfolio. [2, 7, 8]
• Amortization Period: As underlying loans are repaid, the CLO tranches are paid down in order of seniority. [2, 8, 10]
Saying about the same thing 2whiteroses did, but in my own words:
Both the “debt” and the “equity” are backed by the exact same pool of low quality loans. The difference is that the “debt” gets paid a guaranteed floating rate first, while the “equity” gets paid whatever is left over after all the debt obligations are satisfied.
So when times are good, the equity pays very well, but this can go to zero very quickly if loans stop being repaid. The debt holders will always be paid in full before the equity holders get anything. The equity is usually only a thin ~10% layer, so is very risky if things turn south. The equity holders (the CEF, not you) do have voting rights that can balance things a bit.
There are different “tranches” of debt, and they all get paid in order. The majority is rated AAA and at the top. It’s probably almost as safe as its name implies. The lower tranches of debt are safer than equivalently rated bonds in good times, but more brittle in bad times. They will experience no losses in normal situations, but could be wiped out completely in a bad recession.
The only tangible assets involved are those backing the individual loans. If a loan fails to be paid, the CLO will try to reclaim the borrowers assets. The high rated debt holders get first crack at those assets. This means that unlike a pool of low rated bonds which will usually recover something, the lowest tranches of debt could conceivably have zero recovery.
ECC holds mostly CLO equity.
EIC holds mostly low grade CLO debt and a little equity.
EII (not publicly traded but issues preferred) is about half and half.
ohhhhhh, thanks Nathan, thanks 2wr, now i get it.
Thanks for the update…I own EIC and EICC
Tim, I made a comment on the earning reports you posted. It was about the sister company ECC ( disclosure, I own none of the ECC preferred) The report for EIC looks better compared to ECC.
I guess you can say 2024 wasn’t as good a year as 2023, my how time goes by when you’re having flies.
I wish they would use some of the earnings to produce end of year financial reports in a timely manner. They are the only laggards for me as of today.