Ares Capital Management Discusses Q4 2012 Results - Earnings Call Transcript

Feb.27.13 | About: Ares Capital (ARCC)

Ares Capital (NASDAQ:ARCC)

Q4 2012 Earnings Call

February 27, 2013 11:00 am ET

Executives

Michael J. Arougheti - President and Director

Penni F. Roll - Chief Financial Officer and Principal Accounting Officer

Analysts

Vernon C. Plack - BB&T Capital Markets, Research Division

Arren Cyganovich - Evercore Partners Inc., Research Division

Kyle M. Joseph - Stephens Inc., Research Division

Kannan Venkateshwar - Barclays Capital, Research Division

Jonathan Bock - Wells Fargo Securities, LLC, Research Division

Robert Ladyman

Douglas Mewhirter - SunTrust Robinson Humphrey, Inc., Research Division

Kenneth Bruce - BofA Merrill Lynch, Research Division

Gilles Marchand - Aladdin Capital Management LLC

Operator

Good morning. Welcome to Ares Capital Corporation's Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded on Wednesday, February 27, 2013.

Comments made during the course of this conference call and webcast and the accompanying documents contain forward-looking statements and are subject to risks and uncertainties. Many of these forward-looking statements can be identified by the use of the words such as anticipates, believes, expects, intends, will, should, may and similar expressions. The company's actual results could differ materially from those expressed in the forward-looking statements for any reason, including those listed in its SEC filings. Ares Capital Corporation assumes no obligation to update any such forward-looking statements. Please also note that past performance or market information is not a guarantee of future results.

During this conference call, the company may discuss core earnings per share or core EPS, which is a non-GAAP financial measure as defined by SEC Regulation G. Core EPS is the net share per increase or decrease in stockholders' equity resulting from operations less realized and unrealized gains and losses, any incentive management fees attributable to such realized and unrealized gains and losses and any income taxes related to such realized gains. A reconciliation of core EPS to the net per share increase or decrease in stockholders' equity resulting from operations to the most directly comparable GAAP financial measure can be found on the company's website at www.arescapitalcorp.com. The company believes that core EPS provides useful information to investors regarding financial performance because it is one method the company uses to measure its financial condition and results of operations.

Certain information discussed in this presentation, including information relating to portfolio companies was derived from third-party sources and has not been independently verified. And accordingly, the company makes no representation or warranty in respect of this information.

At this time, I would like to invite participants to access the accompanying slide presentation by going to the company's website at www.arescapitalcorp.com and clicking on the Q4-12 Earnings Presentation link on the homepage of the investor relations section of the website. The company will refer to this presentation later in the call. Ares Capital Corporation's earnings release and Form 10-K are also available in the company's website.

I will now turn the call over to Mr. Michael Arougheti, Ares Capital Corporation's President.

Michael J. Arougheti

Great. Thank you, operator, and good morning to everyone, and thanks for joining us. This morning, we reported strong earnings for the fourth quarter of 2012, capping off a great year for Ares Capital.

Fourth quarter basic and diluted core earnings per share were $0.45, a level which fully covered our $0.38 per share regular quarterly dividend. Fourth quarter earnings were driven primarily by strong interest in fee income and positive credit and investment performance across our portfolio. Our fourth quarter GAAP earnings of $0.71 per share included $0.27 per share in net realized gains, which were driven in large part by the opportunistic exit, at favorable prices, of 2 of the remaining control equity positions from the legacy Allied portfolio; and $0.06 per share of net unrealized gains.

For the full year, we reported our highest ever core earnings per share of $1.65 and strong GAAP earnings per share of $2.21. Our net asset value per share as of the end of the fourth quarter of $16.04 represented increases of 1.9% and 4.6% from our third quarter 2012 and 2011 year-end net asset values per share, respectively.

We reported net realized gains of $0.19 per share for 2012, marking 8 out of the last 9 fiscal years since our IPO in October of 2004 in which we have reported realized gains in excess of realized losses. Specifically, on a cumulative basis, our realized gains have exceeded our realized losses by $194 million since our IPO, excluding the $196 million realized gain that we recognized from the Allied acquisition.

We believe our investment portfolio performed extremely well in 2012. First, our year-end non-accruing investments as a percentage of the portfolio were just 2.3% at cost and 0.6% at fair value, a post-Allied acquisition low as we exited a few non-accruing investments and added no new nonaccruals during the fourth quarter.

Secondly, our weighted average portfolio grade improved from 3 at the end of the third quarter to a 3.1 at the end of the fourth quarter. And finally, the weighted average EBITDA of our corporate portfolio companies increased in the aggregate by approximately 10% on a comparable basis for the fiscal year-to-date reported periods in 2012 versus the same periods in 2011.

We were very active from an investment standpoint during the fourth quarter, investing nearly $1.1 billion. We continued to focus on backing the capital needs of our existing portfolio companies and selectively making new investments in defensively positioned companies. While the fourth quarter investment activity was elevated, in part due to increased liquidity and activity spurred by anticipated changes in tax regulations, the size of our investment portfolio remained roughly flat compared to the prior quarter as repayments and exits offset this investment activity. So as of yearend, we had a sizable amount of available debt capacity totaling approximately $1.6 billion, subject to borrowing base and leverage restrictions, and our leverage ratio of 0.55x, or 0.49x net of available cash, was below our target range of 0.65x to 0.75x.

Based upon our strong 2012 performance and the $1.60 per share in dividends that we distributed during the year, we currently estimate that we will carry forward excess taxable income of approximately $239 million or $0.96 per share into 2013 compared to the $0.79 per share that we carried forward into 2012.

Now let me turn to the current market environment and how we believe it's impacting our business. In general, aggressive central bank policies and a global thirst for yield from investors have created abundant liquidity and incrementally riskier behavior across the credit markets. While this liquid market environment is attractive for raising new capital and supportive of credit performance and asset values, this is obviously less desirable for originating new investments with attractive risk-adjusted returns. And although the middle market continues to offer superior relative value compared to the broadly syndicated loan market, in our view, the middle market has not been immune to current market trends. Middle-market pricing has tightened and leverage has drifted higher.

Thus far in 2013, M&A loan volumes has been relatively low, which in turn has exacerbated the supply-and-demand dynamic in the market. And while we believe that there are several fundamental factors that could drive M&A volume higher, we're not convinced at this point that a rebound in M&A loan volumes could fully satisfy the current demand for credit given trends in liquidity and investor behavior. Of course, an external shock could reduce liquidity and dampen risk mentality quickly. So therefore, in the current environment, we'll continue to focus on using our competitive advantages in direct origination to remain highly selective on new investments, and we'll leverage our incumbent status to defend our best portfolio companies. Expect us to be very patient and to seek to take advantage of any volatility if and when it arrives. There are significant macroeconomics, sovereign and geopolitical risk, that still remain and make the market and economic environment volatile, and we believe that our excess capital position supports our ability to be opportunistic.

This liquid environment does present some interesting opportunities to improve our portfolio and our cost of capital. It's conducive for exiting non-core or sub-optimal investments at attractive prices, as we demonstrated last quarter; and on the liability side, it presents opportunities to improve our cost of capital, and we'll continue to lock in attractively priced longer-duration liabilities. As you know, as a management team, we've successfully navigated through environments like this before, and based upon those experiences, we believe it's critical to employ thoughtful and prudent strategies when managing both sides of our balance sheet.

And now Penni, if you'd walk us through additional detail on our fourth quarter and full year financial results.

Penni F. Roll

Sure. Thanks, Mike.

For those of who you in the earnings presentation posted on our website, please turn to Slide 3, which highlights our financial and portfolio performance information. As Mike stated, our basic and diluted core earnings were $0.45 per share for the fourth quarter of 2012, a $0.03 per share increase over core EPS of $0.42 per share for the third quarter and a $0.02 per share decline from our record core EPS in the fourth quarter of 2011. The $0.03 per share increase in the fourth quarter core earnings per share over the third quarter was primarily driven by higher structuring and amendment fees and some nonrecurring dividend income.

For the last several years, our fourth quarter structuring fees have been elevated due to our participation in increased year-end investment activity. For the year, we reported core earnings per share of $1.65 in 2012 compared to $1.54 per share in 2011, representing a growth rate in core EPS of over 7%. Our net investment income per share for the fourth quarter decreased slightly to $0.38 per share compared to $0.39 per share in the third quarter and was also lower as compared to $0.45 per share in the fourth quarter of 2011.

The lower fourth quarter 2012 net investment income per share was primarily due to the higher capital gain incentive fees attributed to net realized and unrealized gains that we accrued of $0.07 per share, as compared to $0.03 and $0.02 per share in the third quarter of 2012 and the fourth quarter of 2011, respectively. By comparison, net realized and unrealized gains for the fourth quarter were $0.33 per share compared to $0.20 per share in the third quarter of 2012 and $0.13 per share for the fourth quarter of 2011.

GAAP net income for the fourth quarter was $0.71 per share, an increase compared to $0.59 per share for the third quarter and $0.58 per share for the fourth quarter of 2011. For the year, we reported 2012 GAAP net income per share of $2.21 compared to $1.56 per share in 2011.

At December 31, 2012, our total assets were $6.4 billion and our total stockholders' equity was $4 billion, resulting in an NAV per share of $16.04, up 1.9% from $15.74 at the end of the third quarter of 2012 and 4.6% higher than the $15.34 we reported a year ago.

Now I will turn to our investment activity. As Mike highlighted, we had a very active fourth quarter where we made gross investment commitments totaling approximately $1.1 billion, as compared to gross investment commitments of approximately $1 billion during the third quarter. We exited commitments of approximately $1.2 billion in the fourth quarter, resulting in net excess of commitments of $94 million. When excluding unfunded commitments, the net exits for funded amounts were only $35 million for the fourth quarter.

For the full year, we made gross commitments of $3.2 billion, with net commitments of $583 million. On a funded basis, we had gross fundings of $3.2 billion and net fundings of $679 million, which drove a 13% increase in the size of our total investment portfolio during 2012. The relatively high level of exits and repayments in 2012 was primarily driven by the elevated amount of liquidity in the markets, resulting in higher levels of refinancing, repayment and sale activity especially during the fourth quarter of 2012, also continued proactive rotation of the remaining Allied portfolio and continued execution of our syndication strategies throughout the year.

Our portfolio at December 31 consisted of 152 portfolio companies and was approximately 60% in senior secured debt investments; 21% in the subordinated certificates of the Senior Secured Loan Program, the proceeds of which were applied to co-investments with GE to fund first lien senior secured loans; 5% in senior subordinated debt; 4% in preferred equity; and 10% in other equity and other securities.

The portfolio remains significantly weighted towards floating rate loans with LIBOR floors. Floating rate assets were 75.3% of our total portfolio at fair value at the end of the fourth quarter of 2012 compared to 73.8% at the end of the third quarter. Of these floating rate assets, excluding the Senior Secured Loan Program, approximately 97% featured LIBOR floors. Further, all of the first lien senior secured loans to the underlying borrowers in the Senior Secured Loan Program had LIBOR floors.

From a yield standpoint, the weighted average yield on our debt and other income-producing securities and amortized costs declined 20 basis points quarter-over-quarter and 70 basis points year-over-year to 11.4%. This decline reflects moderately lower yields on new investments and the exit or repayment of some higher-yielding investments. The weighted average yield on our total portfolio at amortized cost also declined 20 basis points quarter-over-quarter but only 30 basis points year-over-year to 10.1% as we reduced our holdings in non-yielding equity positions.

The weighted average stated interest rate on our debt at yearend increased 30 basis points quarter-over-quarter and 70 basis points year-over-year to 5.5%. However, it is important to note that the weighted average stated interest rate on our debt is calculated based upon our actual borrowings at period end when amounts outstanding under our lower-cost secured revolving debt facilities are generally less than the outstanding amount of our higher-cost fixed rate term debt. Stated differently, this metric does not reflect the weighted average stated interest rate on our fully drawn total debt capital.

To put this into context: If we had fully drawn our revolving credit facilities as of the end of the third and fourth quarters, the weighted average stated interest rate on our debt would have been 4.2% or about 40 basis points lower than the 4.6% fully drawn stated rate as of the end of the year 2011. Of course, these weighted average yields on our total portfolio and weighted average stated interest rate on our debt are all calculated at a point in time and are thus not necessarily indicative of our net interest margin. Interestingly, although our portfolio yield declined, our full year net interest margin, which we look at as net interest and dividend income over our average total portfolio at amortized cost, was actually up modestly from 2011 to 2012.

Now let's turn to Slide 8, and I will highlight the components of our net realized and unrealized gains for the fourth quarter, which totaled $80.7 million or $0.33 per share. While we incurred fairly modest net unrealized appreciation of $15 million or $0.06 per share for the fourth quarter, our net realized gains of $65.6 million or $0.27 per share were very strong, driven primarily by the exit of 2 former Allied-controlled portfolio companies, Reed Group and Stag-Parkway, which together resulted in realized gains totaling $71 million.

For the full year, 2012 net realized and unrealized gains were $0.69 per share, consisting of $0.19 per share in net realized gains and $0.50 per share in net unrealized gains. For 2011, net realized and unrealized gains were $0.18 per share, consisting of $0.38 per share in net unrealized gains offset by $0.20 per share in net unrealized losses.

On the topic of investment gains, I would like to note one additional item regarding the capital gain incentive fees. As I discussed earlier, we continue to make GAAP accruals for capital gain incentive fees, but until the fourth quarter, we had not had any payment obligations under our investment advisory and management agreement since 2006. Due to our strong net realized gains and the improvement in our portfolio values during 2012, $11.5 million or approximately $0.05 per share of the capital gains incentive fee became due and payable under the agreement as of December 31, 2012. As a reminder, under our investment advisory and management agreement, a capital gains incentive fee is only payable if cumulative realized gains exceed cumulative realized and unrealized losses at yearend.

Now let's turn to Slide 10 for a discussion of our debt capital. As of December 31, we had approximately $3.9 billion in committed debt facilities and approximately $2.3 billion of aggregate principal amount of indebtedness outstanding. As you can see, just over 50% of our total committed debt capital and 87% of our outstanding debt at quarter end was in fixed rate term debt, with intermediate to longer-term maturities. In our view, the long weighted average maturity of our debt of nearly 10 years provides us with significant stability and contributes to the overall strength of our balance sheet. In addition, we enjoy operating flexibility by not having any debt maturities until 2016.

In total, we had approximately $1.6 billion in available debt capacity, subject to borrowing base and leverage restrictions, plus $256 million in available cash at yearend. At December 31st, our debt-to-equity ratio was 0.55x and our debt-to-equity ratio, net of available cash, was 0.49x.

Since December 31, 2012, we also completed an amendment to our revolving funding facility with Wells Fargo whereby we reduced the spread on the facility from 250 basis points to a spread ranging between 225 and 250 basis points over LIBOR. As of the date of the amendment, the interest rate charge on the facility was LIBOR plus 225 basis points.

This morning, we also announced that we declared our first quarter dividend of $0.38 per share which will be payable on March 29 to stockholders of record on March 15th.

For more details on our financial results, I refer you to our Form 10-K that was filed with the SEC this morning.

Now I will turn the call back over to Mike.

Michael J. Arougheti

Great. Thanks, Penni.

I'd like to discuss our recent investment activity and portfolio performance in more detail and then provide an update on our post-quarter-end investments, backlog and pipeline before concluding. Please turn to Slide 13.

You'll see, in the fourth quarter, we made 28 commitments for a combined total of just under $1.1 billion, with 10 to both new and existing portfolio companies; and 8 through the Senior Secured Loan Program, 6 of which were existing portfolio companies in the program. Therefore, 57% of commitments were to existing portfolio companies.

In market environments like the current one, we're focused on using our incumbent relationships to continue to back our best portfolio companies. There are clear benefits to this strategy. First, we know these borrowers extremely well and are therefore comfortable investing additional capital in them. Second, since there are switching costs that our existing portfolio companies would incur if they change lenders, we often can negotiate a win-win for both Ares Capital and these portfolio companies when it comes to any changes in pricing or other terms. And finally, we often strengthen an important sponsor or company relationship, which has long-term competitive benefits.

On Slide 14, we summarized our fourth quarter investment activity by asset class. You'll see we invested 84% in first and second lien senior debt, 9% in subordinated certificates of the Senior Secured Loan Program and 7% in equity and other. Our exits and repayments were more diverse, with 72% of these consisting of exits and repayments from first and second lien senior debt; 17% from sub debt; 5% from equity and other; and 4% from the subordinated certificates and SSLP, with 2% from CLO securities.

Now turning to Slide 15. The chart reflects a slight uptick in our portfolio company credit statistics for the fourth quarter, reflecting the market environment that I described earlier. After holding relatively steady for the past year, weighted average total net leverage for the companies in our portfolio increased from 4.4x at the end of the third quarter to 4.6x at the end of the fourth quarter. The increase reflects the higher leverage levels on current market transactions.

For example, the average total debt-to-EBITDA ratio for middle-market LBO transactions for the fourth quarter was 5.3x, per Thomson Reuters data. The modest net leverage increase also reflects the repayment of loans by certain lower-leveraged portfolio companies. Similarly, weighted average interest coverage for these companies declined from 2.6x to 2.4x quarter-over-quarter but remained well over 2x. At the end of the fourth quarter, the underlying borrowers within the Senior Secured Loan Program had similar weighted average total net leverage of 4.5x but a higher weighted average total interest coverage ratio of 3x.

On Slide 16, you can see that we made investments in corporate portfolio companies during the fourth quarter, with a weighted average EBITDA of approximately $37 million during the last 12-month period. Using the most recently available data provided by these companies, the weighted average EBITDA of our corporate portfolio companies for the fourth quarter of 2012 was about $47 million. For the same period, weighted average EBITDA for SSLP's underlying borrowers was similar at approximately $44 million.

On Slide 17, you'll see that the portfolio continues to be well diversified. Our largest investment at quarter end continue to be in the Senior Secured Loan Program, representing approximately 21% of the portfolio at fair value. The program was comprised of investments in 36 separate borrowers as of December 31, 2012.

As of the same date, none of the underlying borrowers in the program were on nonaccrual and the largest single underlying borrower in the program represented about 5.5% of the total aggregate principal amount of loans extended to borrowers under the program. Excluding the Senior Secured Loan Program, our remaining largest 14 investments totaled approximately 33% of the portfolio at fair value at the end of Q4.

Now skipping to Slides 21 and 22 for an update on our recent investment activity since yearend and our current backlog and pipeline. From January 1 through February 22, 2013, we'd made new commitments for approximately $165 million of which $162 million were funded. Weighted average yield of debt and other income-producing securities funded during this period at amortized cost was 9.5%. As always, we may seek to syndicate a portion of these commitments, although there could be no assurance that we'll be able to do so.

Also from January 1 through February 22, 2013, we exited or received repayments on $208 million of investment commitments. The weighted average yield of debt and other income-producing securities exited or repaid was 9.8%. On these exits, we recognized approximately $10 million in total net realized gains.

As shown on Slide 22, as of February 22, our total investment backlog and pipeline stood at approximately $290 million and $155 million, respectively, or about $445 million in total. Of course, we can't assure you that we'll consummate any of these transactions. And if we do consummate any of these transactions, we may syndicate portions of them, resulting in smaller final hold sizes.

So in closing, our strong fourth quarter concluded a great 2012 for us. For the year, we increased our core earnings per share, our net asset value per share and our total dividend per share. Our corporate portfolio companies continue to experience solid growth, and our nonaccrual ratios have further improved. As I stated before, we believe that the balance sheet is well positioned, with relatively low leverage, long lives and primarily fixed rate debt maturities on outstanding debt and significant available debt capacity. Furthermore, we ended the year with an estimated spillover of approximately $0.96 per share in undistributed taxable income.

From a business standpoint, we believe that our advantages in scale, capital markets access, product breadth and market coverage continue to grow and become more meaningful. This, in turn, permits us to gain a broad view of market conditions and available investment opportunities and to be highly selective in choosing investment opportunities offering the most attractive risk-adjusted returns.

So with that said, we believe it is time to be patient, thoughtful and highly selective given the current market conditions. While we're hopeful that market conditions may improve incrementally as M&A volume builds, the potential for additional spread tightening remains. Our plan is to remain focused up the balance sheet on senior debt investments and defensively positioned companies, monetize non-core assets where possible and leverage our structuring expertise to optimize risk-adjusted returns and generate fee income. We continue to believe that the long-term outlook is bright for scaled, non-bank capital providers like us that can provide flexible capital both with larger commitment and hold amounts to support the growing needs of the middle market.

And I'd like to conclude, finally, by thanking the entire Ares team for an incredible job in 2012 and, you, our investors, for your continued support and confidence in us.

And operator, we would now like to open up the line for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Vernon Plack of BB&T Capital Markets.

Vernon C. Plack - BB&T Capital Markets, Research Division

Mike, could you tell me, or Penni, the impact that prepayment fees or fees on exits had on interest in dividend income?

Penni F. Roll

Actually, the prepayment fees that we get are included in our net realized gains and are not included in interest in dividends. So they're below net investment income.

Vernon C. Plack - BB&T Capital Markets, Research Division

Okay. So was -- the increase in interest and dividend income, was that driven by on -- originations?

Penni F. Roll

By just overall for the year and just the growing portfolio and the increases there. We also had a couple loans or -- that came off of nonaccrual status that had some impacts of helping the Q4 interest income. But overall, it's just continued production of interest income off of the existing portfolio.

Vernon C. Plack - BB&T Capital Markets, Research Division

Yes, I'm just trying to get a sense because that number changed meaningfully versus the third quarter and the portfolio essentially stays the same. So...

Penni F. Roll

Right. Part of that too, Vernon, will be impacted by timing of new investments and repayments as well, so it's hard to see when you look at points in time, at 9/30 versus 12/31.

Vernon C. Plack - BB&T Capital Markets, Research Division

Okay, okay. One other question, as it relates to dividend policy, maybe if you could add a little bit of color there just in terms of -- your carryover actually went up this year. You had a very good fourth quarter. What are you thinking in the terms of maybe evaluating where the dividend is versus your earnings? It seems to me like, perhaps this year, even if the portfolio stays flat, that we'd probably see a dividend increase?

Michael J. Arougheti

Yes, I think we've been consistent in our answer to that question. Given where we are as a company, we are much more focused on dividend stability than we are on dividend growth. I think the good news is that the performance of the company continues to drive earnings growth. And given the realized gains performance that we've had, particularly last year, as you noted, we continue to have really attractive spillover. As we did for the last 2 quarters, we showed a willingness to distribute some of those gains to our shareholders in the form of special dividends, as we highlighted last quarter. I think that's something that we would continue to evaluate as the year goes on. We are very focused on making sure that -- when we look forward on our core earnings per share, that there is complete dividend coverage from the core EPS. And as we've said before, if we do see a new level of core EPS emerge that would substantiate a dividend increase, that's when we would start thinking about it.

Operator

Your next question comes from Arren Cyganovich of Evercore.

Arren Cyganovich - Evercore Partners Inc., Research Division

Mike, last quarter, you talked a little bit about part of the market where you saw leverage rising and structures loosening a little bit but the spreads were kind of bottoming out. Can you talk a little bit about the spreads in the fourth quarter and into the first quarter? Have they also deteriorated a little bit? And maybe just your thoughts on competition there.

Michael J. Arougheti

Yes, they have deteriorated modestly. As we mentioned in the prepared remarks, there's an extraordinary amount of liquidity in the credit markets. And while the middle market is much less efficient than the liquid credit markets, you have that much liquidity in the market and you have debt policy driving continued liquidity and risk-taking. You're obviously going to see that manifest itself in lower spreads and higher risk. It is trying to find a bottom. It's down maybe 25 to 50 basis points over the last 2 quarters. So we're not seeing precipitous drops, but clearly there's continued downward pressure on spreads.

Arren Cyganovich - Evercore Partners Inc., Research Division

That's helpful. And in terms of your average portfolio leverage, I guess you're sure did go up a little bit for the first time in a while, to 4.6%, and in your interest coverage a little bit less. Where -- how comfortable -- I guess, what level of leverage would you let the portfolio go to? And do you have any kind of targets, parameters around this?

Michael J. Arougheti

Yes, it's interesting. When you look at the historical levels, you'll see that there's been a fair amount of consistency in the levels from peak to trough in the cycle between 3.5x and 4.5x. Obviously, when you get into a market like the one we're in now, you'll see them creep higher and then there's a natural deleveraging through underlying EBITDA growth of the portfolio companies and then an evolution of the cycle. We are very focused, as we have been historically, on our position in the capital structure. I think it's as important to look at where our first dollar of leverage is as much as it is to look at our last dollar. And as I think people know, we've talked about it in the past, given the high percentage of first lien in senior secured assets in the portfolio, our first dollar of exposure has tended to be somewhere between 1x and 1.5x. So our view is, when you are well within the enterprise value of a good, high free cash flow company, when you are first lien with covenants and you control that tranche lending to 4.5x or even 5x EBITDA, for that matter, it continues to be a very solid risk-adjusted return. One of the interesting things about the market environment is, along with the leverage increases, you obviously enterprise -- see enterprise value multiples increasing as well. We've always been focused on underwriting the portfolio to what we think are cycle-adjusted enterprise values. So even at a 4.6x debt-to-EBITDA ratio in the portfolio, you could still suffer meaningful performance degradation in the underlying company and still be well within the enterprise value of that company even at the cycle trough. That's kind of how we think about the attachment point.

Operator

Your next question comes from Kyle Joseph of Stephens.

Kyle M. Joseph - Stephens Inc., Research Division

Penni, you mentioned some non-recurring dividend income in the quarter. Can you quantify that?

Penni F. Roll

Yes, hold on, I can pull that information up. I'm not sure I have it for the quarter as much as I have it for the full year. So do you want to jump onto your next question and I can come back...

Kyle M. Joseph - Stephens Inc., Research Division

Yes, yes. It looks like, in the fourth quarter and first quarter investment activity thus far, you guys have shifted a little bit to second lien over first lien. Is that a trend? Or is that just a small sample size?

Michael J. Arougheti

Yes, I think that's just a small sample size.

Kyle M. Joseph - Stephens Inc., Research Division

Okay. And then can you give us an idea of what the different new origination yields would be between a first lien and a second lien and also the leverage differences there?

Michael J. Arougheti

Yes. Again, it depends on the size of the company. It depends on the nature of the industry. But generally speaking, traditional first lien senior secured debt is somewhere in the 3.5x to 4.25x range and yields for those assets are somewhere in the 5.25% to 7% range. As my prior comment, that's a little bit higher leverage and maybe slightly lower yield than the prior quarter. In terms of junior debt, whether you're talking about mezzanine and/or second lien, you're probably in the 5x to 6.25x leverage range. And our view is, depending on whether or not you're second lien floating rate or mezz, you're talking about yields in the 10.5% to 12.5% range. And again, the driver of that is really going to be company size and industry- and company-specific characteristics around cash flow and business model stability.

Kyle M. Joseph - Stephens Inc., Research Division

Okay. And it looks like the weighted average EBITDA on companies you invested in, in the fourth quarter went down. Is that because larger companies are able to finance in the public markets or syndicated loan markets? Or...

Michael J. Arougheti

Yes.

Penni F. Roll

Back to the dividend income. This is outlined on Page 67 of our 10-K, so you can get more details there, but we had about $39.7 million of dividend income for the full year 2012 of which only $2.2 million was nonrecurring in nature from just dividends that are declared. Otherwise, about $20 million of that came from dividends from IHAM, a portfolio company. And then we have another preferred stock that I think we've mentioned several times. It's a larger preferred position that has a recurring coupon on it that we include as dividend income as well.

Operator

Next question comes from Kannan Venkateshwar at Barclays.

Kannan Venkateshwar - Barclays Capital, Research Division

Firstly, on the balance sheet side. I want to just check. I mean, now you have almost 90% of your debt in the form of unsecured long-term debt converts and bonds. While there's obviously is an advantage in securing longer-term financing, is there some kind of a mix that you would want given that you're essentially using long-term debt to fund a short-term book? And the cost of funding, obviously, will benefit as you move more towards the revolver. So to that extent, how do you see that mix evolving?

Michael J. Arougheti

Yes, it's -- there's no specific answer to that simply because it's a function of where the portfolio composition is at a point in time. And prospectively, it's going to be a function of what the debt markets are offering us in terms of yield and duration. I just look at our current balance sheet and say that we're very happy with the mix. I think we've been able to lock-in very attractive rates of return with no covenants and long duration, frankly without having to pay for them "on a swap-adjusted basis" relative to where we can borrow in the senior secured market. If you look at our balance sheet today, were we to be fully funded under our revolvers which, as Penni pointed out, is our lowest cost of capital and has a pretty meaningful positive impact on an interest margin, we'd be roughly 50-50. And so I think, in that 50% to 75% range, which is where we continue to hover, is a good range to think about. Obviously, you want to strike a balance, in terms of your cost of capital, your duration and your covenants.

Kannan Venkateshwar - Barclays Capital, Research Division

Okay. And secondly, the -- on the exits, on a normalized basis, and you look at it as a proportion of your book, obviously that was -- I think this was the highest that we've seen historically since your IPO. So could you give us some context around the exits in terms of, what do you expect going forward? It looks like, in the first quarter also, the exits are pretty meaningful. So is it mainly exits, or is it also driven by repayments?

Michael J. Arougheti

There's always a natural amortization in the portfolio. And as we've talked about that year-to-year, that tends to run in the 5% to 10% range. Obviously, one of the advantages of having cash flow loans is that they do amortize. You contractually end through excess cash flow. The rest of the repayments tend to be a function of refinancings and recapitalizations or regular-way exits in the portfolio. Historically, we've communicated, our experience has been roughly 25% to 30% velocity in the portfolio for middle-market credit. You may see that be elevated in periods like Q4 where there's a lot of liquidity in the market or there are tax drivers that are incurring incremental activity. But on a normalized basis, we've tended to see roughly 25% to 30% velocity in the book.

Operator

Our next question comes from Jonathan Bock, Wells Fargo Securities.

Jonathan Bock - Wells Fargo Securities, LLC, Research Division

Mike, you mentioned the value of defending incumbent credits. And we certainly see merit to that. Of course, we also remember, in 2011, the first quarter, the value of defending incumbent positions had its benefits, but on the fee line, it had its costs. And so could you perhaps walk us through some of the fee impacts of defending incumbent positions in light of the fact that your portfolio of companies might perhaps be less apt to pay significant upfront fees for a refi or a repricing?

Michael J. Arougheti

Yes, clearly there's going to be a difference between new money commitments and amended terms or pricing on existing money commitments. Generally speaking, new money commitment fees in the market now are between 2% and 3%. And a straight redo of an existing transaction is tending to come with somewhere between 25 basis points to 100 basis points a fee. Now obviously, there's a lot less organizational effort that goes into a deal with an existing borrower. So from a capacity standpoint, those are easy fees to book and easy transactions to execute, but it's -- it could be as low as 25 basis points up to a point.

Jonathan Bock - Wells Fargo Securities, LLC, Research Division

And then on the SSLP, could you give us a sense of the amount or by a, perhaps, number or overall loan balance amount of the loans that repriced in the SSLP this quarter?

Michael J. Arougheti

Yes. So maybe 15% of the portfolio has repriced. And one of the things, Jonathan, I'll mention which is part of the defending of the existing portfolio of companies both within SSLP and on balance sheet is, a lot of times, what you're trying to do is it's a releveraging, and you saw that happening a little bit within the leverage statistics, but it's not a full reprice. What you're trying to do is reprice, extend more credit and extend duration and call protection. And given these significant upfront fees that you tend to get and the call protection that you'll also have, it puts you in a position to continue to maintain "off-market" risk return even if a borrower is using the competitive dynamic in the market to try to renegotiate price in terms of view.

Jonathan Bock - Wells Fargo Securities, LLC, Research Division

Okay, okay. And then turning to the SSLP again, the value. Or could you expound perhaps on the value proposition of the unitranche solution at a point when senior and junior secured loans spreads have just tightened significantly? Is there a value prop today in light of the liquid credit markets? And maybe contrast that to the value prop that unitranche solution offers at a point where the markets are a bit less liquid?.

Michael J. Arougheti

I think there's 2 answers to that. The value proposition on the unitranche is consistent to the borrower, i.e., deal with one party, have no friction between creditors through inter-credit negotiations pre closing and during the life of a loan; better IRRs because you can amortize your blended cost of capital rather than your highest cost of capital; speed of execution; and certainty insofar as you don't need to go through a drawn-out ratings and syndication process. So the value proposition of the unitranche is very much intact. I think, to your specific question, though, the ability to extract premium pricing for that value proposition is obviously a lot more difficult in an environment like the one we're in now than it is when either the loan market or the high-yield and mezz market is disjointed.

Jonathan Bock - Wells Fargo Securities, LLC, Research Division

Okay. And then last question. As it goes to the buildout of the liability side of the balance sheet, look at it very favorably as well. Yet we also see one long-term, perhaps lower-priced, solution in the form of on-balance sheet securitizations. I know that you're no strangers to this market, so can you perhaps talk about the use of such a financing tool and whether or not that would make sense in light where CLO spreads are today?

Michael J. Arougheti

Sure. And I think we've talked about this in prior quarters. And just as a refresher: Ivy Hill Asset Management is probably the largest manager of middle-market CLOs. And in fact, I think we issued the first middle-market CLO that had a reinvestment period close to dislocation in November of '11. And we had issued another CLO through Ivy Hill in December of 2012. So we're in that market and have a very good sense for where the cost of capital is. We are seeing the cost of funds on the AAA side come down to the point where it's starting to get interesting. Understand, though, that when you borrow through a true CLO structure on a balance sheet securitization, it comes with significant inflexibility in terms of your ability to manage the portfolio, whereas we stated before, you have to be able to see a significant cost benefit in terms of the cost of capital relative to where we can borrow senior secured in order to accept that lack of flexibility. AAA spreads right now for middle market are in about 150- to 175-basis-point range against our ability to borrow with significant flexibility at LIBOR 2.125. So it's now through where we can borrow, which is a nice trend, but I think we'd like to see it tighten a little bit more before we would seriously consider executing on a non-balance-sheet securitization.

Operator

Next question comes from Bo Ladyman, Raymond James.

Robert Ladyman

A question on the SSLP as well. In Q4, your purchases in the SSLP were $91 million. From what you disclosed earlier, total commitments by you and GE were $1.3 billion. That equates to about 7% "net purchase to commitment" ratio. If we look back to 2010 and '11, that ratio was 15%. Any color on why that's been declining?

Michael J. Arougheti

Yes, that -- it's misleading insofar as the way that the joint venture works is, as we get repayments, we reinvest. So the 7% number seems artificially low because it's not accounting for the recycling of capital in the program. There's actually been no meaningful change in the relative contributions to the joint venture between us and GE.

Operator

Our next question comes from Doug Mewhirter at SunTrust Robinson Humphrey.

Douglas Mewhirter - SunTrust Robinson Humphrey, Inc., Research Division

Most of my questions have been answered. I've just 2: 1 general and 1 more specific question. First, yes, it's obvious that the spreads have come in a bit -- although not to as great as extent as the more liquid markets. Is there any particular area where the market has been more dislocated in the middle market side in terms of spreads or in terms of conditions, whether it be higher on the credit, the senior secured? Or is it maybe getting a little wobbly more on the subordinated side? Or is it more across-the-board?

Michael J. Arougheti

I think, generally speaking, it's across-the-board. When you start to see the leverage levels increase to where they are for certain transactions now, why you have seen similar spread tightening, I'd say the risk that is being put on junior securities today is probably offering weaker risk-adjusted return than the senior market, which is why you continue to see us focus on the senior secured side of things both through SSLP and otherwise. So I think, when you're talking just about spreads, it's pretty much across-the-board. But obviously, a lot of the increase in risk is coming on the backs of the junior securities, which is why we've been deemphasizing them as of late.

Douglas Mewhirter - SunTrust Robinson Humphrey, Inc., Research Division

My second question, more of a numbers question. You have pretty moderate leverage on your own balance sheet right now at maybe, what, it's about debt-to-equity of about 0.5, 0.48, 0.5. Do you have any kind of area which we're -- which you're targeting or any kind of upper bound? I mean, I know you have regulatory limits, but is there an area where you're kind of in that sweet spot? Do you want it to go a little more higher, a little lower?

Michael J. Arougheti

Yes, it's interesting. We've historically laid out a range of 0.65x to 0.75x and we've been running consistently below that. So I would be more than comfortable running the balance sheet within that range. And the ability to get into that range and stay there is really just a function of the markets both on the asset and the liability side. So clearly, we're comfortable running the business at higher leverage. We've always laid out a 0.65x to 0.75x target range. It's just so happens, given what's going on in the markets and the portfolio, we're just running a little less leverage right now.

Operator

Our next question comes from Karls Von Veterheim [ph], private investor.

Unknown Shareholder

You've answered the question to some extent, but let me just ask it plainly. With the riskier behavior by investments, and it's becoming harder to source, as you point out, to -- at what point or to what extent might that really threaten the basic business model of the company and the dividend, et cetera?

Michael J. Arougheti

Yes, again, I -- for those who have been following the company since we went public, being in these market environments is not anything new to us. And ironically, this trend of dramatic liquidity increases amidst the backdrop of low transaction volumes in the first quarter -- or first half in the year, followed by a significant uptick in transaction volumes and risk-adjusted return in the back half of the year, has been playing out now for the last 3 years. I don't believe that that's 100% coincidence. I think it has a lot to do with the way capitals was getting allocated into the capital markets and the way that business are executing on their financial and strategic plans. So if you look, over the last couple of years, this is not new to us. So I think, in these markets that we talk about, you have to be disciplined on deployment, which is why you're not seeing meaningful loan book growth in Q4. And if you look at the backlog and pipeline numbers that we talked about in the prepared remarks, you're also not seeing meaningful loan book growth in Q1. In terms of that compromising the underlying business model, that's not really something that we're that concerned about. The demand for credit is significant. Deal flow continues to be attractive. Our balance sheet is well positioned to continue to generate a very healthy margin and growth even in a very liquid environment. And back to the earlier conversation around dividends, one of the reasons why we like to carry the amount of spillover we're having is to make sure that the market understands the stability of the dividend through volatile markets. But I think we are a very long way away from feeling that the core business model is in any way compromised given what's going on in the market.

Operator

Our next question comes from Kenneth Bruce of Bank of America Merrill Lynch.

Kenneth Bruce - BofA Merrill Lynch, Research Division

My question really comes right out of maybe the end of that earlier answer. And I guess it's not having been around these markets for some time, having seen how the business evolves. It -- your earlier comments about risk discipline and pricing discipline, obviously being compromised at the fringe. Notwithstanding the comment you just made, that maybe we're a long way off from the basic business model being threatened, are you thinking that maybe you at some point need to take more conviction in those thoughts and begin to actually scale down the portfolio or begin to take a much more defensive kind of approach to managing the portfolio?

Michael J. Arougheti

I don't think we're there. But as you saw the way we behaved in 2006 and 2007, that's not something that we're averse to doing. I think we're having 2 separate conversations. One is credit risk and one is relative value and risk-adjusted return. And I think it's important that people interpret our comments appropriately. When you look at the underlying performance of the portfolio and you look at the credit risk that we're taking, we are absolutely comfortable with the credit risk that we're taking. We're backing high-margin, growing companies. We're structuring securities where we have meaningful covenant protection and control and influence. So we're not feeling that there is a deterioration in credit or irrational credit behavior, but at the end of the day, you can't fight the Fed. And what we're really saying is, relative value is intact. When you look at what we're able to generate in our securities relative to other credit product, both in the high-grade, high-yield market and the liquid loan space, et cetera, there's a very, very compelling value proposition. But we would be foolish to suggest that -- with spreads coming down globally across-the-board, that our asset class is immune from it -- I mean, to it. So when we're talking about conservatism now, we're really not talking about credit. We're just talking about making sure that we're getting paid appropriately for the risk that we're taking. But the value prop, on a relative value basis, is very much intact. I mean, in fact, when you look at where BDC dividend yields are now relative to comparable yield product, there's still a significant premium to be had within the BDC sector, which we think is a direct reflection of the premium to be had in the underlying collateral. So anyway, long-winded answer, but I think it's a little bit different than conversations we've had in the prior cycles where there's a belief that credit is being compromised. I think what we're seeing is, just given what's going on with base rates and fiscal policy, you're seeing spread tightening and relative value come in.

Kenneth Bruce - BofA Merrill Lynch, Research Division

Okay, but maybe just reflecting back to the prepared remarks where you said that leverage levels are creeping higher, I assume that -- just taken in the context of that prior comment, that they're not at a point where you think that there's underlying concern from how you either underwrite new credits or where -- how you think about your portfolio companies?

Michael J. Arougheti

Correct.

Operator

Our last question comes from Gilles Marchand at Knights of Columbus.

Gilles Marchand - Aladdin Capital Management LLC

I was wondering if you could just talk about why M&A activity is so low when there's so much liquidity out there and the sponsors have a lot of money.

Michael J. Arougheti

So it's a good question and a little bit of an enigma. We've obviously started to see M&A increase in the larger equity markets. We mentioned in our prepared remarks, we believe that the catalysts are in place for M&A volumes to tick up. We have liquid credit markets. We have a lot of dry powder in the private equity market. We have stable underlying financial performance at companies, et cetera, et cetera. And you have significant cash on the balance sheets of corporate acquirers to transact. I would chalk it up to the sell-in community, meaning that I'm not sure, that those that have companies for sale, given where they are in their own strategic evolution, whether or not they're motivated sellers. And that can be a combination of, for the more optimistic people of you, that the value that they can get 6 months to 12 months from now is going to be higher than they can get now; and for some of the more pessimistic, a -- of you, that they have come through the crisis unscathed, they've changed the businesses, they're now very liquid and feel that they have business stability and are just going to go it alone for a while. So when I look at all of the variables that you would expect to be driving increased M&A volume, the one that you can't really predict is just seller behavior. Again, the technicals that should support M&A are very, very robust right now, so we're hopeful that, as the year progresses, we'll continue to see that volume pick up.

Gilles Marchand - Aladdin Capital Management LLC

And Mike, can you expand on the activity in Q1? Your average yield was 9.5, which seems a bit low compared to your current second lien coupons.

Michael J. Arougheti

Yes, again, a lot of that is mixed, right? So if you look at the composition of that activity, it continues to be skewed higher up the balance sheet. As we've done in past markets like this, we tend to focus as much on the risk side as we do on the return side, and that's really a reflection of pushing up the balance sheet.

Gilles Marchand - Aladdin Capital Management LLC

Okay. And then lastly, on Page 2, on the bottom of the page of your press release, it says you've invested in a keg management company. I presume that's "key" and not "keg?"

Michael J. Arougheti

No, it's actually keg. It's an interesting question and really a good, maybe, way to end the call, just to remind everybody what the core business is. But that's a company that we have been financing now for a number of years called MicroStar Logistics. And they are the largest fleet manager of kegs to the beverage industry. So if you're not in bev but you're a smaller beverage company, you don't actually own your own kegs. You're probably in a rental pool and you're probably with this company. Again, it's a really good example of the type of leading -- industry-leading niche businesses that you invest in, in middle-market credit that oftentimes people don't even know exists, but it's a really, really interesting business and one that's been growing quite nicely for us over the years.

Operator

This concludes the question-and-answer session. I would like to turn the conference back over to Mr. Michael Arougheti for closing remarks.

Michael J. Arougheti

Yes, if we have nothing further, I want to reiterate how grateful we are for your time and support. And we look forward to talking to everybody next quarter. Thank you.

Operator

Ladies and gentlemen, this concludes our conference call for today. If you missed any part of today's call, an archived replay of this conference call will be available approximately 1 hour after the end of this call through March 12, 2013, to domestic callers by dialing (877) 344-7529 and to international callers by dialing 1 (412) 317-0088. For all replays, please reference conference number 10023413. An archived replay will also be available on the webcast link located on the homepage of our Investor Resources section of our website. Thank you. You may now disconnect.

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