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Ares Capital (NASDAQ:ARCC)

Q1 2010 Earnings Call

May 10, 2010 11:00 am ET

Executives

Richard Davis - Chief Financial Officer

Michael Arougheti - Principal Executive Officer, President, Portfolio Manager, Director, Member of Investment Committee and Member of Underwriting Committee

Analysts

Jason Arnold - RBC Capital Markets Corporation

Greg Mason - Stifel, Nicolaus & Co., Inc.

John Stilmar - SunTrust Robinson Humphrey Capital Markets

Donald Fandetti - Citigroup Inc

Jasper Birch - Fox-Pitt, Kelton

Christopher Harris - Wells Fargo Securities, LLC

Steven Kwok - KBW

James Ballan - Lazard Capital Markets LLC

Operator

Good morning. Welcome to Ares Capital Corporation's Earnings Conference Call. [Operator Instructions] 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 the SEC Regulation G. Core EPS is the net per share increase or decrease in stockholders' equity resulting from operations, less realized and unrealized gains and losses, any incentive management fees attributable to such realized 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 in the company's earnings press release. 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. At this time, we 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 Q1-10 Investor Presentation link on the homepage of the Investor Resources section of the website. Ares Capital Corporation's earnings release and quarterly report are also available on the company's website. I would now turn the call over to Mr. Michael Arougheti, Ares Capital Corporation's President.

Michael Arougheti

Great. Thank you, operator, and good morning, everyone, and thanks for joining us. I hope you had the chance to review our earnings press release this morning and our investor presentation posted on our website.

Before I open with comments on the market, highlight our first quarter's results and discuss our dividend, I'd like to update everyone on our recent acquisition of Allied Capital, which closed on April 1. Since the transaction closed during our second quarter, we will not be discussing any results from the former Allied portfolio until our second quarter's earnings conference call. However, I would like to review our strategic rationale and investment thesis for the transaction and then provide an update on our current strategy and progress to date with respect to the former Allied portfolio.

With the Allied transaction, Ares Capital now manages approximately $12 billion in committed capital. This increased scale brings many benefits including greater market coverage, the ability to support larger underwriting commitments and hold positions, more efficient access to capital, increased portfolio diversification and enhanced competitive relevance.

The former Allied Capital Asset Management funds and entities have also meaningfully increased the scale of Ares Capital's and Ivy Hill Asset Management initiatives, which bring significant access to deal flow, research and yet another potential source of capital for our borrowers. We now have enhanced capabilities that we can offer to our middle-market clients, and they are already making a difference in an increasingly competitive market environment.

As a reminder, our investment thesis for acquiring Allied Capital was based in part upon the following strategy: one, we wanted to opportunistically purchase a stressed portfolio at an attractive price and potentially benefit from an economic recovery; two, to rotate and reposition a portion of this legacy portfolio into higher yielding assets; three, to leverage the greater scale, market coverage and capital base of the combined company to solidify and improve our position in the marketplace; and four, to leverage Ares Capital's existing infrastructure and reduce duplicative cost.

While we are confident that we will execute well upon this strategy, it may take the better part of 2010 and into next year to fully implement our plan and realize all of the benefits of the acquisition. We believe we got the price and timing right, as it is clear that we are now in a stronger market environment for asset dispositions. This stronger market should help us realize improved values upon exiting certain non-strategic assets.

Throughout 2010, you can expect to see us monetizing certain assets and rotating selected other assets into higher yielding securities with a goal of driving earnings and recapturing a portion of the value in the former Allied portfolio. We believe we are making significant progress in this area but keep in mind that as we continue to sell assets, the size of our investment portfolio and our core earnings may be impacted in the short term until we reinvest sale proceeds.

Therefore, given this strategy, it'll be important to track both core and GAAP earnings per share since unrealized and realized gains or losses and prepayments fees are reflected only in our GAAP earnings. Net realized gains and prepayments fees would also be income available for potential dividends.

Finally, it is important to note that there will be some non-recurring acquisition-related costs that will be expensed throughout the balance of 2010 with some tail-end cost that may continue until later periods. Some of these costs are obvious like professional and advisory fees paid in the second quarter, but others may be more subtle like transition employee costs and overlapping leases.

Now let me turn to the leveraged finance markets. As expected, the broad leveraged finance markets continue to recover during the first quarter but candidly, the pace and degree of such recovery has been much faster than we anticipated just a few months ago. As a result of significantly improved liquidity, loan repayments have accelerated as a strong high-yield market and some new, but primarily existing institutional investors, reinvest capital into a shrinking loan supply. Transaction activity has picked up, velocity has increased and not surprisingly, new issue pricing has tightened and leverages expanded in the broadly syndicated loan market.

Although the middle market has lagged the broader market, we are experiencing similar directional trends. Middle-market activity has clearly picked up again in the second quarter as evidenced by the significant growth in our backlog and pipeline since the date of our fourth quarter's earnings release in February. This market backdrop is a double-edged sword for us.

On the positive side, our existing investment portfolio benefits from greater liquidity and higher asset values. Our access to the debt and equity markets has improve. We can also benefit from the greater overall transaction activity through fee income and longer term asset growth as we work through our portfolio rotation initiatives.

The downside is that new issue spreads have tightened, and leverage multiples on new transactions have continued to creep higher. This makes our competitive advantages in scale, product breadth and market coverage more critical than ever.

Similar to the broadly syndicated market, middle market spreads tightened 50 to 75 basis points during the quarter, but remained attractive and are still in excess of 200 basis points higher than historical average levels. Middle-market straight senior leverage multiples were approximately 3x EBITDA, with total leverage multiples increasing to approximately 4.5 and in some cases, 5x. We are seeing further modest pressure on spreads and leverage multiples into the second quarter.

On a positive side note, loan-to-value ratios continue to be attractive by historical standards as private equity sponsors have responded by paying higher purchase multiples and often contributing 40% or more of equity in such transactions. In this environment, we are once again using our structuring capabilities to move incrementally up the balance sheet into higher first dollar leverage attachment points.

Given the high level of market activity and the availability of attractive assets for sale, we had $304.7 million in gross fundings during the fourth quarter of 2010, down only slightly from our record investment activity in the fourth quarter of 2009, but well above our quarterly average for the past two years. However, during the quarter, we also experienced an equivalent amount of exits and repayments in our portfolio, and we expect repayment velocity to remain elevated in the near future.

Of course, these repayments may benefit us with realized gains, embedded call protection and/or repayments at par on marked down assets. In addition, during this period, we were able to reinvest our capital in debt yields in excess of the yields on debt investments that were repaid during the year. Our new debt investments made during the quarter yielded approximately 13.6% on a weighted average basis, compared to our debt investments exited, which had a yield of approximately 12.1%.

Although we are encouraged by the greater level of market activity, the events of last week are a good reminder that volatility in the capital markets will persist throughout this recovery. Market windows are opening and closing more quickly, and there is a fair amount of concern in the market between sovereign debt contagion, rising interest rates and others that could impact new issue pricing. Expect us to remain highly selective and disciplined until we get greater visibility on how market conditions will play out.

We want to be opportunistic and flexible with our capital so that we can act accordingly as market conditions dictate, and we're leveraging our large-scale, middle-market origination and asset management platform to ensure that we see the vast majority of the deals in our market and that we choose the most attractive to invest in.

We are also continuing to pursue our strategy of providing one-stop financing to meet client needs, exploit capital structure inefficiencies and realize the highest risk-adjusted returns in our portfolio. Importantly, we believe that the favorable supply-demand imbalance in our market for private debt could exist for years to come and therefore, we are in no rush.

Now let me highlight our first quarter results. Overall, we believe our credit quality and investment performance remain very strong. As a reminder, our investment adviser employs an investment rating system with grades one through four, with one being the lowest grade for investments that are not anticipated to be repaid in full and with four being the highest grade for investments that involve the least amount of risk in the portfolio.

For the first quarter, we experienced 3x as many performance-related rating upgrades as downgrades, and our weighted average investment rating improved from a 3 to a 3.1. Our underlying portfolio performance from a revenue and cash flow standpoint continued to improve from already strong levels. We reported another quarter of increasing net asset value per share, primarily reflecting improved values for our assets.

While one issuer was removed from non-accrual status during the quarter, we placed three issuers on non-accrual status during the quarter. However, one of these issuers subsequently repaid its entire loan amount near par after quarter end, resulting in a greater than 10% rate of return on net investment. The other two issuers remained current on interest payments, but we chose to apply the interest to principal and place both on non-accrual. These two loans were not new credit situations but rather reflect continued underperformance in already lower-rated credits.

Our quarter-end non-accruing loans, representing 4.2% of our portfolio at cost and 1% at fair value, remains very favorable when compared against our peers, particularly when measuring non-accruals in conjunction with net realized losses over the past 12 months. If you back out the loan that was repaid after quarter end, we would've had six issuers on non-accrual status, totaling 3.7% of our portfolio at cost and only 0.5% at fair value using the portfolio fair values at cost and costs as of March 31. Although industry default rates have fallen sharply since we saw the double-digit levels at year end, S&P's Leveraged Loan Index default rate was at 5.8% measured by principal amount, and at 7.6% measured by the number of loans in default as of March 31.

Turning now to our earnings. We reported another quarter of strong GAAP earnings of $0.61 per share driven in part by higher asset fair values and overall improved portfolio performance. Our net asset value increased to $11.78 per share, an increase of about 3% compared to the end of 2009. However, our first quarter core earnings per share of $0.28, excluding $0.03 in professional fees associated with the Allied Capital acquisition, were partially impacted by a number of financing-related costs and other items.

In the process of strengthening our balance sheet during the first quarter of 2010, we incurred certain non-recurring costs, investment-related costs and temporary delusion. With respect to our primary credit facility, we increased commitments by $90 million and extended out the maturity to January of 2013.

As part of this new facility, we incurred a 200 basis point increase in our borrowing spread, higher financing fees to be amortized and a one-time write-off of the previously unamortized facility fees associated with the old facility that was retired. The higher borrowing cost resulted in a reduction to core earnings per share of approximately $0.02, and these costs will continue to impact our core earnings per share going forward. However, the non-recurring write-off of old unamortized fees, which resulted in the reduction of our core earnings per share this quarter of about $0.01, will not impact our core earnings per share going forward.

At March 31, our blended cost of debt stood at 2.3% with a weighted average maturity of over five years. In this environment, we believe the trade-off of increase debt capacity at this cost and longer-term maturities is well worth the increased interest expense and fees.

Secondly, we raised approximately $277 million in net proceeds from an equity offering of approximately 23 million shares in early February. This add-on offering was priced at a 1.1x premium to our then NAV and was our 11th equity capital raise as a public company. The temporary earnings dilution we incurred by raising this capital, coupled with the lack of growth this quarter in our investment portfolio, lowered our quarterly core earnings per share by about $0.03. However, we do expect this capital raise to be long-term accretive to our core earnings per share as we use the proceeds to help grow our portfolio over time.

There were three other items of note in the quarter. We earned slightly lower structuring fees in the first quarter relative to the fourth quarter's level. This accounted for a sequential quarter-to-quarter reduction in our core earnings per share of about $0.01. There were fewer primary market transactions, which typically carry higher fees, closed during the first quarter compared to the fourth quarter. And as in the past, structuring fees will continue to be variable depending upon new origination activity.

Secondly, the additional loans placed on non-accrual, and for which we are applying cash payments to principal, impacted our quarterly core earnings per share by about $0.01. And finally, we received $2.2 million in prepayment fees during the first quarter, which accounted for between $0.01 and $0.02 of earnings per share. However, consistent with our past practice, we do not recognize prepayment fee income in our core earnings per share but rather within realized gains in our GAAP earnings.

So to summarize, our $0.28 in core earnings per share, excluding the professional fees associated with the Allied transaction, would've been $0.32 per share after adding back $0.03 of dilution from the equity offering and $0.01 from the non-recurring write-off of unamortized financing fees. Since we are in the fortunate position to have approximately $500 million of debt capacity at quarter end, pro forma for the Allied Capital acquisition and financing commitments received after quarter end, we will seek to increase our core earnings per share by making accretive investments with this available capital over the coming quarters.

As you may have seen from our press release this morning, we declared our second quarter dividend of $0.35 per share payable on June 30 to shareholders of record. Many of you know that we do not provide dividend guidance, but we recognize the importance of dividends to our shareholders, and we're proud of our consistent dividend track record having now declared or paid at least $0.35 per share for the past 18 quarters dating back to the first quarter of 2006. Our goal of providing full dividend coverage from our core earnings per share has not changed, and we believe that embedded earnings potential may exist by using our available debt capacity to make new investments. However, there are no guarantees that we will achieve this goal.

With that, I'd like to turn it over to Rick Davis, our CFO, for more detailed comments in our first quarter financial results. Rick?

Richard Davis

Great. Thanks, Mike. Please turn to the financial and portfolio highlights slide in our presentation, which is Slide 3. As Mike mentioned, our basic and diluted Core EPS were $0.28 per share for the first quarter excluding $0.03 of professional fees related to the acquisition of Allied Capital, a $0.09 per share decrease over core earnings per share last quarter and $0.03 lower versus a year ago. As Mike discussed, this quarterly decrease primarily resulted from the impact from the increase in our shares outstanding, the non-recurring write-off of unamortized financing fees, higher borrowing costs, modestly lower structuring fees and a modest increase in non-accruals.

Net investment gains were $0.36 per share comprised of higher net unrealized depreciation of $0.40 per share, partially offset by net realized losses of $0.04 per share. The net result was GAAP earnings per share of $0.61 compared to $0.64 last quarter and $0.36 for the first quarter of 2009. After paying our $0.35 first quarter dividend, our net asset value was $11.78 per share, an increase of 3% from last quarter.

Consistent with the rebounding market and higher levels of transaction activity, we experienced both higher levels of new investments and prepayments during the first quarter. Gross fundings of $304.7 million were actually offset by higher exits and repayments of $313 million, resulting in a net reduction of $8.4 million. The exits and repayments included $94.5 million of loans sold to funds managed by Ivy Hill Asset Management. The remainder of the exits and repayments were comprised of prepayments, selected portfolio sales, portfolio amortization and net paydowns on revolving lines.

We ended the quarter with 94 portfolio companies valued at approximately $2.2 billion. Our quarter-end portfolio was comprised of approximately 45% in senior secured debt securities with 32% in first lien and 13% in second lien assets, 26% in senior subordinated debt securities, 21% in equity and other securities and approximately 8% in the Senior Secured Loan Fund that we co-manage with GE Capital, which currently holds a diversified pool of 12 loans.

Our weighted average investment spread at March 31 was 9.92%, which represented an 11 basis point decrease during the quarter and a 71 basis point increase year-over-year. Our overall yield on debt and income-producing securities at amortized cost increased to 12.2%, compared to 12.1% last quarter and 11.2% a year ago. Up to this point, we've been able to increase our portfolio yield at a higher yield on new investments and loan repricings. As previously discussed, our weighted average funding cost increased somewhat to about 2.3% for the quarter versus 2.1% last quarter and 2% a year ago. The weighted average funding cost does not include unamortized facility costs or unused fees.

On Slide 4, we've provided detail regarding our fixed and floating rate portfolio assets at fair value. Our fixed-rate assets accounted for 51.5% of our portfolio with 32.5% of our assets at floating rates. We now have LIBOR floors on 21% of our total investments at fair value and 64% of our floating rate portfolio. Our portfolio remains well matched from an interest rate standpoint.

During the first quarter, third-party independent valuation providers reviewed a little over 50% of the portfolio based on fair value. Over the last two quarters, third-party independent reviews had been conducted on approximately $2.1 billion of our portfolio at fair value, with 95% of the portfolio at fair value either reviewed or new to the portfolio over this period.

As shown on Slide 6, we incurred net realized losses of $5 million and net unrealized investment gains of $49.7 million, for a total net appreciation of $44.7 million in the first quarter. On a positive note, our realized losses on investments were approximately $3.5 million less than our previously recognized net depreciation for these assets.

This is illustrated by the reversal of prior-period net unrealized depreciation of $8.5 million on investments for which we recognized $5 million in net realized losses. As Mike mentioned, our net unrealized gains were broad based, and reflect both improved asset values including tighter spreads on primary market loans and debt comparables and overall stronger credit and investment performance.

Slide 7 shows the summary of our debt facilities at quarter end before the Allied Capital acquisition. As discussed last quarter, we extend the maturities on our two primary credit facilities and increased the capacity on our revolving credit facility. As of March 31, we had approximately $771 million in total debt outstanding, cash on hand of approximately $84 million and approximately $509 million of debt capacity available for additional borrowing subject to leverage and borrowing base restrictions.

Since quarter end, we further increased the size of their revolving credit facility by an additional $100 million, and we expect to receive an additional commitment of $25 million, bringing the total to $740 million of capacity, an increase of $75 million. With contention upon the closing of our Allied Capital acquisition, an additional $25 million increase in commitments was completed by adding one new lender through our accordion feature on our revolving credit facility. And as I mentioned, we expect to receive the additional $25 million commitment from another lender shortly. These actions highlight our continued access to the debt capital market.

On April 1, we drew on our revolving credit facility and retire in full Allied Capital's $250 million senior secured term loan, which had approximately $138 million outstanding at the closing of our acquisition. In addition, we assumed approximately $745 million in Allied Capital's unsecured bonds maturing in 2011, 2012 and 2047.

Even after retiring the Allied term debt, our available debt capacity was relatively unchanged. Although we increased our borrowings on our revolving credit facility by the $138 million to repay Allied Capital's outstandings on its senior secured term loan, we nearly offset this amount with the increase in our revolving credit facility capacity by $125 million since the end of the first quarter assuming the receipt of the additional $25 million commitment.

On April 1, the closing date for the Allied transaction, we had increased our available debt capacity by $100 million at that point, bringing total availability subject to borrowing base and leverage restrictions to approximately $472 million at closing. The total available debt capacity amount will step up to approximately $500 million after we secure the additional $25 million commitment to our revolving credit facility.

On Slide 8 is our balance sheet. Our debt-to-equity ratio at quarter end was 0.49x and including cash and cash equivalents, our net debt-to-equity ratio was an even more conservative 0.44x. This net debt-to-equity ratio is substantially lower than our targeted leverage of 0.65 to 0.75x. Therefore, as Mike discussed, we plan to invest a portion of our available debt capacity in accordance with our investment objective to bring our leverage more in line with our target range and increase core earnings.

Turning to Slide 9. We paid our first quarter dividend of $0.35 per share on March 31 and are pleased to announce the declaration of our second quarter dividend of $0.35 per share this morning. This dividend is payable on June 30 to stockholders of record as of June 15.

As Mike mentioned earlier, we will be incurring certain non-recurring costs related to our acquisition of Allied Capital. In particular, these costs pertain to an acquisition advisory fee incurred upon closing, additional professional fees, compensation expenses for transitional former Allied employees, runoff insurance costs, dual-lease expense and other miscellaneous costs that we will break out in future reporting. We will provide an update on these non-recurring costs when we report our second quarter earnings, but we wanted to let investors know that there will be some lingering acquisition-related transition costs throughout 2010 with a possibility of smaller cost incurred in 2011.

With that, I'll turn the call back over to Mike.

Michael Arougheti

Great. Thanks, Rick. Now a few words about our recent investment activity, our portfolio performance and then our pipeline and backlog before concluding and going to Q&A. If you would turn to Slide 10.

In the first quarter, we closed an approximately $300 million in new commitments across five new and 10 existing portfolio companies. Of the new investments made, 5% were in first lien debt, 57% in senior subordinated debt, 34% in equity and other securities and 4% were in subordinated notes in the Senior Secured Loan Fund. Our significant new commitments included a $54 million senior subordinated debt investment in a health plan management provider, $48.5 million in senior subordinated debt and equity of a diversified consumer products manufacturer and $41.5 million in senior subordinated debt of an aftermarket automotive services provider.

In addition, as part of our purchase of Allied Capital's CLO [collateralized loan obligation] investments in the Knightsbridge funds, which closed at the end of March, we invested $51.9 million in certain CLO debt securities and made an incremental investment of $48.3 million into Ivy Hill Asset Management to facilitate its purchase of management contracts and certain equity securities in the Knightsbridge CLO vehicles. As I mentioned in my earlier comments, debt and income-producing securities purchased during the first quarter of 2010 had an aggregate yield of 13.6% on fair value versus the 12.1% yield on assets repaid.

Now turn to Slide 11 for a current review of our portfolio's aggregate credit statistics. This historical data hopefully illustrates the success of the strategy that we pursued throughout the cycle. We increased portfolio investment spread while reducing portfolio risk throughout the credit dislocation of the past few years.

The left chart shows that our weighted average investment spread increased over the past year, but declined slightly this past quarter due to the aforementioned increase in our borrowing costs. The line graphs on the left demonstrate that our underlying portfolio's last dollar net leverage multiple has declined once again to 3.7x this past quarter. And although not shown, it is equally important to understand that our portfolio's first dollar net leverage was at approximately 1.6x at quarter end. Our portfolios interest coverage statistics have also improved, with our weighted average interest coverage moving from 2.7x to 2.9x.

Given that overall market leverage and interest rates are increasing, it maybe difficult to hold these portfolio metrics or improve them going forward. As you can see on the right chart, the average EBITDA for our portfolio company declined slightly from the previous quarter to approximately $44 million, reflecting our recent investments in companies with EBITDA of approximately $30 million. We are finding better relative value in companies of this size in the current market environment particularly given the recent strength in the high-yield market.

Consistent with our past practice, I'd like to provide an update on our portfolio companies revenue and EBITDA performance in the aggregate. As I mentioned earlier, our comparable portfolio companies weighted average revenues and EBITDA continued to increase versus the same period a year ago. For the first quarter, our comparable portfolio companies weighted average revenues increased approximately 7%, and their comparable weighted average EBITDA increased approximately 21% versus the prior period a year ago.

This increase is after our portfolio companies, in the aggregate, experienced 4% weighted average revenue growth and 25% weighted average EBITDA growth from 2008 to 2009. One notable change is that we are seeing solid aggregate weighted average revenue growth in our portfolio, which when combined with expense reductions and productivity improvements, has driven EBITDA margin expansion in the underlying portfolio.

Slide 12 shows additional detail on the diversification of our portfolio by issuer concentration, asset class and geography. We continue to be overweighted in defensive industries such as healthcare, service industries, education and food services, but you will see that our recent CLO securities purchases and our investment in Ivy Hill, which includes investments and asset managers and various senior loan funds, resulted in our financial category increasing again from 16% to 21%.

The increase this quarter is due to our purchase of certain CLO securities and two Knightsbridge funds formerly managed by Allied Capital. The Knightsbridge funds are comprised of two senior loan funds with over 175 issuers and committed capital of $800 million. Other than our investment in the Senior Secured Loan Fund, which in turn has investment in 12 different underlying borrowers, we believe that our portfolio remains highly diversified with no single investment representing more than 4.6% of the portfolio at fair value.

Slide 13 provides another view of our attractive portfolio quality. At the end of the first quarter, the weighted average grade of our portfolio investments increased from 3 to 3.1 this quarter reflecting the overall improvement in our portfolio. We experienced six performance-related upgrades and only two performance-related downgrades. We also experienced two downgrades from our highest rating of four, which indicates an exit is likely to our average rating of three, which means that underlying company performances is as expected, once it became clear that an eminent exit of these investments was less likely. Therefore, the net rating changes were positive, and we believe are not a reflection of the positive credit performance in our underlying portfolio.

Overall, we have just 0.9% of our portfolio at fair value in our lowest rated category of one, where we do not expect a full recovery, and 8.5% at fair value in our highest rated category of four. As I mentioned earlier, after backing up the loan on non-accrual that we exited after quarter end at a profit and positive IRR, the 0.5% of our portfolio at fair value and 3.7% at cost was on non-accrual as of March 31. Other than these portfolio company on non-accrual, we have no other companies delinquent in payment, and two of our issuers on non-accrual were actually current in payment at quarter end. However, we elected to apply their interest payments to principal.

Turning to Slide 14, you'll see our recent investment activity since quarter end and our backlog and pipeline. As of May 6, we have made additional investments of $95 million since March 31. All of these new investments were floating rate, with a weighted average spread at amortized cost of 14%. Approximately 75% of these investments were in second lien secured debt, with 25% in first lien secured debt.

As of this date, we had also exited $143 million of investments, of which 67% were in first and second lien secured debt, 28% were in senior subordinated debt and 5% was in the Senior Secured Loan Fund. Of $143 million on investments repaid, 57% were in fixed-rate investments with a weighted average yield at amortized cost of 13%, and 32% were in floating rate assets with a weighted average spread at amortized cost of 13%.

On this date, our total investment backlog and pipeline stood at $72 million and $980 million, respectively. Of course, we can't assure you that we will make any of these investments, and we may syndicate a portion of these investments. Also, as a reminder, we define our backlog as committed transactions that are under a letter of intent.

Our pipeline is the finest transactions with no formal commitment but where significant due diligence has been performed, and there is a good probability of us consummating the transaction. Unlike some of our peers, our pipeline does not include more than 50 transactions that are currently being reviewed at various stages by our investment teams.

In light of our portfolio rotation strategy following the Allied acquisition, we thought it would also be important to update investors on potential portfolio exits over the coming quarters. As of May 7, 2010, we had identified between $300 million and $600 million of potential exit opportunities for the second quarter of 2010, which is higher than our normal level of exits. Approximately $400 million of these exits are portfolio investments acquired in connection with the Allied acquisition.

Some of these exits are voluntary, where we are taking advantage of current market conditions to harvest and rotate the portfolio. Of course, other exits are involuntary, where we are getting refinanced by more aggressive market participants. However, we cannot assure you that any of these exits will be made.

Now let me conclude by summarizing some key points on the first quarter. Our portfolio quality and investment performance remain strong. You can see this in the number of upgrades compared to the number of downgrades. Our higher asset values are improved overall portfolio performance statistics and our low level of non-accruing loans. We made great progress to continue to strengthen Ares Capital's balance sheet going into the closing of the Allied transaction. We expanded and extended the maturities on our credit facilities at a modest incremental cost and further strengthened our balance sheet and capital base with February's equity raise of $277 million.

Subsequent to quarter end, we have increased our revolving credit capacity by an additional $100 million, and we expect to add an additional $25 million through the commitment of another lender in the near future. Although the increased capital that we secured have a short-term economic cost risk this quarter, we expect that we will able to deploy this capital in an accretive manner.

Of course, just after quarter end, we completed the strategic acquisition of Allied Capital, making us a leading player in our industry with significant capital and scale in the middle market. We remain very excited about this purchase and all of the benefits that we expected to bring to ARCC. We believe that our timing has worked quite well given the improved economic environment and the strong markets for leveraged assets. And we are confident in our ability to monetize as well as to rotate and reposition certain assets in the former Allied portfolio into higher-yielding assets.

And lastly, I would like to welcome our new shareholders that came to us from Allied Capital, and we'd like to thank both our new and existing shareholders for their strong support throughout the Allied Capital acquisition process. We believe the acquisition will be rewarding to all of our shareholders, and we're confident that our company is well poised for success in today's market. We hope that you share our enthusiasm for what we believe is a unique competitive position and enhanced capabilities that leave us well positioned to pursue the market opportunities in front of us.

And with that, operator, I think now we'll open up the line for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Greg Mason of Stifel, Nicolaus.

Greg Mason - Stifel, Nicolaus & Co., Inc.

Mike, can you talk about the $400 million that you highlighted on potential exits from the Allied portfolio? As we look at reinvesting that capital, what generally are the types of returns on those investments looking at recycling into higher yielding investments?

Michael Arougheti

Yes, I can't go into specifics now. But obviously, as we laid out our strategy on Allied, if you recall from our prior call, we had about six buckets that we would put Allied's portfolio assets into: Performing debt, non-performing debt, performing equity, non-performing equity, CLO and structured product and real estate. And each of those asset categories has a different strategy for us to try to drive value. Some may require just an outright sale and monetization. Some will require a reinvestment of capital and a repositioning within the portfolio. I'd say, generally speaking, the good news is that the $400 million that we're targeting, it's really a broad swap across each of those asset categories. And while I can't go into the details of the spread pickup, clearly, the yield on the securities that we'll be selling is meaningfully lower than the returns that we're able to generate on new investments in today's markets.

Greg Mason - Stifel, Nicolaus & Co., Inc.

And touching on the new investments that you made since March 31, I'm kind of surprised given the increased competitiveness of the environment. You're getting 14% rates of return on these investments. Can you talk about are those unique, or should we be expecting those types of returns even with the competition increasing?

Michael Arougheti

Yes, I think those are frankly unique. If you remember, in our business, typically takes us anywhere from three to nine months to work through an investment process, from our initial introduction to a transaction through the closing. So deals that are closing now were being formed and committed to in the back half of last year, if not the early half of 2010. So recognize, the pricing you're seeing now is not necessarily a reflection of the pricing available in the current market environment. So I would expect that on a go-forward basis, you should see investment spreads continue to come under pressure. I think anybody in this market, if he tells you that they're able to generate these types of returns on a go-forward basis is probably taking undue risk to try to generate those returns. And as a result, similar to what we did in 2006 and 2007, when we're faced with increased competition and a tightening spread environment, we tried to take our scale and our origination cloud and position ourselves for a better risk-adjusted returns. So I'd look at it, if you see our spreads coming in, in future quarters, you should also expect to see a maintenance of that first dollar, last dollar leverage that I described in our prepared remarks.

Operator

The next question comes from Chris Harris at Wells Fargo Securities.

Christopher Harris - Wells Fargo Securities, LLC

On the exits we're just talking about here, the $300 million to $600 million, are those exits you've identified and are expecting to perhaps close in subsequent quarters? Or do you think a large majority of that might close in the second quarter?

Michael Arougheti

I think it's possible, given the strength in the high-yield market, particularly, and the performance in our underlying portfolio. You can see a lot of that happening in Q2.

Christopher Harris - Wells Fargo Securities, LLC

And then on the new investment landscape here, I guess if you add up the investments you've made subsequent to the end of the quarter and your current backlog, I think you're getting about $170 million of potential new investments. And that number seems a little bit low, at least relative to our estimates. Is there something that's really driving that? I mean, I know you guys are really focused on rotating and rebouncing the portfolio, but is there some maybe seasonality impacts related to the lower pace of originations here?

Michael Arougheti

I don't think so. Historically, we've talked about seasonality. And typically Q2 and Q4 are much busier periods for investments, but I don't think that's it. I think it's important for people to really appreciate what's happening in the broader markets. Despite what's happened over the last week, the bank loan capital markets are overheating. The high-yield market is very aggressive right now. And so what you're really seeing is, number one, a lot of increased velocity in our portfolio. And number two, while there's still a pretty meaningful inefficiency in our market, you can see that when you look at the spreads that we're generating relative to the historical spread, as well as the spreads in the current liquid market. That said, there's always some reference to the broader capital markets, where people are looking to finance themselves in our market. One of the things hopefully we have developed over this last cycle is credibility with the investor community and the research community, that we're not the guys who are going to be out there chasing yields. We're not the guys that are going to be out there being aggressive to try to meet the quarter's origination targets. Frankly, with the Allied purchase, having bought it for what we bought it for and when we bought it, we show that we're meaningfully participating in this rally. And as a result, I think we're being a little bit more cautious in how we're deploying capital, given the strength of the capital markets. But it really is amazing. If you look at even what's happened since the end of last week through to today, as we mentioned in our prepared remarks, the windows in the capital markets are opening and closing very quickly. And so while we're watching the rally, we have in no way slowed down our origination efforts, and you see that in our backlog and pipeline numbers. But what we are doing is when that backlog and pipeline find its way to our boardroom, were being a little bit more measured in what we're willing to book and for what rate of returns. So I'm not, today, going to say that this is going to sustain itself throughout 2010. We're still very bullish about our opportunity throughout the course of the rest of the year and beyond. But I think everybody needs to recognize that at least in the broader liquid markets, there's a lot of liquidity that has come in to the market right now, and just given how low interest rates are and how much people are looking for yield.

Christopher Harris - Wells Fargo Securities, LLC

Some of your peers, obviously, have access to SBA [Small Business Administration] leverage. Is that something that you guys would think about looking to add to your, I guess, funding mix?

Michael Arougheti

Absolutely.

Christopher Harris - Wells Fargo Securities, LLC

Any timing on that, perhaps? Have you already submitted an application?

Michael Arougheti

We have not submitted an application. It's something that we're looking at and spending a fair amount of time with -- recognize that the nature of the program requires a pretty significant move downmarket in terms of borrower size and the types of assets you're going after with that leverage. So it's something that we're just spending a lot of time thinking about how we resource and how we would go after it. But obviously, it's very attractive, and we think it could be a nice complement to our platform.

Operator

The next question comes from Jim Ballan at Lazard Capital Markets.

James Ballan - Lazard Capital Markets LLC

Mike, just to make sure, are we going to get any kind of pro forma numbers relative to Allied? Anything on like, kind of a run rate NIR [natural interest rate] number, or how much in asset they sold in the first quarter? Are you planning on doing anything on that before you report second quarter?

Michael Arougheti

Probably not, Jim. We're obviously in the process of pulling all that together, depending on the timing of when all that work is completed. If we feel that it would be helpful to communicate something to the market, we may. But at this point in time, it's not clear if that's something we're going to do.

James Ballan - Lazard Capital Markets LLC

Can you talk a little bit about the unrealized gains in the quarter? Maybe just a little more granularity on how, if it's a nice number there, is there anything you can -- were there a couple of specific investments that did well there? Or is there anything you could talk about that gives little more granularity?

Michael Arougheti

Yes. Well, let's just remind everybody about what our valuation process does when we think about fair valuing our portfolio. For each of our investments, the management team and the deal teams look at a number of inputs. We look at comparable public company multiples. We look at comparable private M&A transaction multiples. We look at high-yield debt comparables to the extent that they exist. We look at relevant bank loan multiples to the extent that they exist. We run discounted cash flow analysis over a range of different model sensitivities for every portfolio company. We look at the general market backdrop against which we're valuing a portfolio. And then we obviously look at the underlying portfolio performance against prior period and budget. And our third-party valuation providers go through a similar process. Given those inputs, you could appreciate the public equity markets were up. And so, on the equity side, we saw healthy increase in multiples. Number two, spread tightened and leverage increased, which had a pretty meaningful impact on our debt securities. I think most importantly, hopefully, it's not lost on people this quarter, the underlying performance of our portfolio continues to be amazing. So we've seen now 20% EBITDA growth throughout the full fiscal 2009. We're seeing continued profit growth of 20%-plus into 2010. So with that EBITDA performance, we're getting a deleveraging, and therefore enhanced value when we apply all of those variables to the portfolio. The nice thing about this quarter is it was very broad-based. The move was roughly split evenly between increases in debt securities and increases in equity securities. And as I mentioned, it was very broad-based, there wasn't one or two names that were driving the bulk of that. It was pretty much across the board.

James Ballan - Lazard Capital Markets LLC

And the professional fees and integration expenses that you're expected to have over the rest of this year and possibly in the next, can you give us an idea maybe just of an aggregate number of how much you think that might be, even roughly?

Michael Arougheti

Yes, we don't want to mislead. But excluding the advisory fees, I'd venture to say it's probably a $10 million number. And obviously, as that materializes, we'll communicate it to the market next quarter as well.

James Ballan - Lazard Capital Markets LLC

And that's probably more in the next couple of quarters than beyond that?

Michael Arougheti

Yes. As Rick mentioned in his remarks, you may see some very modest lingering effect into 2011. But the majority of our transition expenses, in terms of overlapping leases and transitional employee expenses, will be, for the most part of 2010, line item. We do have tail insurance and some other things that go well beyond 2010, but the bulk of it will be for this fiscal year.

Operator

Next question comes from Sanjay Sakhrani at KBW.

Steven Kwok - KBW

This is actually Steven Kwok filling in for Sanjay. I was wondering, just to follow up on Jim's question, if you can help us think about the run rate of investment income post the acquisition of Allied?

Richard Davis

It's a little difficult to nail a run rate down right now, as Mike mentioned, with some issue of the portfolio being rotated. And with the bulk of the valuation work still related to be done on the -- related to the Allied portfolio. I don't know if it would be very helpful to try to give a range because the range would be so broad right now.

Michael Arougheti

I'll highlight a couple of things, though. Remember, around the closing of the acquisition, we stated to the market that it would be an accretive transaction to NAV and accretive to earnings within the first year, and we're still standing by that. And you can already see the NAV [Net Asset Value] numbers coming through in the pro formas that were part of the prospectus that were circulated as part of the acquisition. Number two, this is a bittersweet market for us because you liked being cash-rich in this kind of environment. And getting taken out by an aggressive high-yield market and a rising interest-rate environment is not necessarily a bad thing. But when you're running at 0.4x leverage versus a target of 0.7x to 0.75x, obviously, your stated earnings are going to be lower than your potential earnings. That's not something that concerns us, particularly given all of our competitive advantages. And then, lastly, when you think about the Allied purchase, as I mentioned in my prepared remarks, there will be a balance between core earnings and GAAP earnings that we need to strike and that we all need to focus on and communicate. Because the reality is, in certain situations, you may decide to hold the non-interest bearing security to try to maximize value, and the value of that investment may not materialize in the income statement for a year, or two or three. And there may be another situations, like you're going to see in the second quarter, where we're aggressively taking advantage of the market environment to sell assets, either book gains or book pre-payments fees, or, at worst, reduce our exposure to lower-yielding assets and reinvestments in the market when it develops. So we don't want to be nebulous here, but I think, as Rick pointed out, there's so many variables that play here. The best we can do right now is give you guys a roadmap to the strategy and the disposition of the portfolio. I think you'll see a lot of these things coming into play as the year develops.

Steven Kwok - KBW

I guess, just to follow up on that, how much has Allied portfolio changed post the latest numbers that we have, which was as of December 31, I guess?

Michael Arougheti

In terms of change, in terms of performance? Or change, in terms of size?

Steven Kwok - KBW

In terms of portfolio, like the mix of the portfolio, the yield?

Michael Arougheti

Yes, I don't think we can comment on that today. But again, you should assume that we continue to execute on our strategy. And we'll continue to look at the portfolio to either monetize it or reinvest in it.

Steven Kwok - KBW

On the interest expense in the first quarter, it seemed a little bit high compared to the fourth quarter. I'm just wondering how much of it was related to the $15.6 million that was paid for the restructuring and amendment fees?

Richard Davis

Yes, the amount of the carry in the first quarter was impacted both by write-off of old unamortized fees on our old facility of roughly $0.01. And then, the new amortization during the quarter, I think, probably incrementally was about $1 million to $1.2 million, it's included in that number.

Michael Arougheti

And then plus the modest increase spread.

Richard Davis

For the spread, okay.

Michael Arougheti

So if you take all three of those combined, you're probably somewhere between $0.03 and $0.04.

Steven Kwok - KBW

And then I guess the $1 million to $2 million that we continue going forward...

Michael Arougheti

Yes, the only non-recurring portion of that is the write-off of the unamortized facility fees from the prior revolver.

Operator

The next question comes from Donald Fandetti of Citigroup.

Donald Fandetti - Citigroup Inc

Can you talk a little bit about the newer non-accruals? It sounds like credit's generally holding up relatively low, but could you provide some color?

Michael Arougheti

Sure, as we mentioned in our remarks, I think the good news is, if you could say that's good news when you put something on non-accrual is, the two new loans were put on non-accrual because, I'll exclude the third one, that was a little bit of a unique situation, but we had a pre-rated credit that we were working on a restructuring for. We got blocked as a sub-debt provider and consistent with our policy, which I think may be a little bit more conservative than some of our peers. We've put that loan on non-accrual only to monetize it very shortly after the quarter at a greater than 10% IRR [internal rate of return]. So I'll exclude that one just, talk about the two true new non-accruals. The two companies that we put on non-accrual were Masterplan and Wastequip. They've been lower-rated credits for probably the last two and a half years. We've been aggressively monitoring them and hoping for improved performance. As I mentioned, we're still current on interest there, so we're getting paid interest. It's just that we don't see a catalyst for improved performance in either of those companies. And as a result, we thought it would be appropriate to start applying interest to principal and reducing the principal balance. But interestingly, they're both still current on interest payments and we think that should continue.

Donald Fandetti - Citigroup Inc

And so it seems like there's almost kind of winners and losers coming out of these two. Obviously, as time passes, it's clear that they may not be in a position to recover. I mean, do you expect a couple more of these sort of hiccups each quarter? Or is this -- what's your sort of outlook?

Michael Arougheti

If we're doing our jobs well, you should never be surprised, or we should never be surprised. Obviously, we're heavily involved with these companies. We're very actively dialoguing with management and sponsors. In some cases, we're sitting on the boards, observing the boards. As we've talked about on past calls, I think the good news is, we identified our basket of difficult credits, two or three years ago going into the cycle. And for the most part, that basket has been the same, and we've been working harder to try to shore up or restructure and protect value in the same small handful of national assets two or three years. These two names, you'll see, if you go back and look at the trajectory of NAV, have been problems for us for a long time. So the fact that we put them on non-accrual is not a surprise to us, it's really just a recognition that we don't see an ability, unlike in certain other situations, to really turn this around and see our way to a full recovery. So when you look at our run rate of credits of about 0.9% at fair value, it's not surprising that, that's approximate to the non-accruals. And it just so happened that most of our lower-rated credits have been the same names. So I can't rule out that another one or two names may find their way into a lower-rated category. But for the most part, and this has been true for the last year or two, we haven't seen new problems emerging. It's really just been trying to resolve our existing issues.

Operator

Your next question comes from John Stilmar at SunTrust.

John Stilmar - SunTrust Robinson Humphrey Capital Markets

So the first one is a housekeeping item. Do you have the average portfolio before fair value adjustment? And then the average amount outstanding, at least, on your debt facility for the quarter? And we can come back to a recon [reconciliation] offline if it's not readily available.

Michael Arougheti

We'll look at that. If there's another question, we'll hope that we can be able to get back to you before we hang up.

John Stilmar - SunTrust Robinson Humphrey Capital Markets

And Mike, I guess, it's a couple of questions, it comes back to the thought process of capital raising. I mean, you raised capital earlier in the quarter. You knew investments are almost equal to repayments. And so far, through the second quarter, the portfolio access has been greater than new portfolio investments. And while we certainly understand the discipline, can you help me understand the rationale of raising incremental capital when it seems like, for lack of a better term, you're almost choking on the fact that you've got so much more portfolio exits that you're prudently deploying. But what's the need for incremental capital? Is it that you have to have that cash and capital on hand to write a check six months out for current conversations and that sort of projects?

Michael Arougheti

No, I don't think it that said it all. Number one, I wouldn't say they were choking on it. Quite the opposite, I think that we're thrilled to have it. The reality is, in this market, and I'm sure that you're seeing this in other financial companies as well, there has been a meaningful and drastic improvement in the liquid capital markets since the end of last year. When we raised capital in February, leading up to the Allied transaction, we had a strategic view and continued to have a strategic view. That being overadvertised, if that's where we wound up, is of much greater strategic value than being underadvertised, number one. Number two, the markets are so frothy right now, particularly the high-yield market. We could not have foreseen, as connected as we are to the broader capital markets, we could not have foreseen the number of repayments in the existing portfolio resulting from what's going on in the high-yield market. However, you can't run your business quarter-to-quarter and you can't manage your liquidity quarter-to-quarter. You have to have a view at least to what your secular opportunity is, and what's going to happen over a multi-quarter and multi-year time frame. So as we sit here today, we'd love to be a little bit more, invested and a little bit more leveraged. But we're happy to have the cash, were happy to have the origination infrastructure we have. And you look at the backlog and the pipeline and we're out there actively seeing the market. I think that we're seeing almost every deal that's available. But the reality is, now is not the market environment where I think you're supposed to be aggressive. If we've learned nothing else from the prior cycle, those who moved too quickly into a market shift were those who exited the market shift, grew over those who did not perform well and are experiencing a track record we say that you're supposed to be moving in and out of volatile markets in a little bit more measured way. And then lastly, when you think about where we're levered versus what our target range is, if you think about the size of our balance sheet, the ability for us to now increase our final hold, our available debt capacity of $500 million, frankly, relative to the size investments that we are looking to make and relative to the size of our market position, is not a huge number. So it may feel like a big number today, but that could get eaten up by a handful of transactions. And the last thing you want to do is be in a situation where you see an opportunity in the market, and you can't take advantage of it. So again, I think we got a little bit surprised by the froth in the liquid market, but by no means are we concerned about it. And frankly, given of the volatility we've experienced over the last week here, I think we're actually quite happy to be in cash right now.

Richard Davis

And again, those two numbers that you were looking for, the average cost bases of the portfolio, didn't change a lot at about $2.3 billion. And you can see that parenthetically on the balance sheet for the investments, and average debt outstanding for the quarter was about $815 million.

Operator

The next question comes from Jasper Birch at Macquarie.

Jasper Birch - Fox-Pitt, Kelton

Just to start off, with the $52 million of CLO [collateralized loan obligation] purchases, that was all in Knightsbridge?

Michael Arougheti

Yes.

Jasper Birch - Fox-Pitt, Kelton

And what's your outlook on possibly continuing to purchase CLOs? Are there still more color on that? I mean, what tranches were you buying in dollar pricing? And do you need -- are you looking to only buy notes in places where you could ultimately on management control?

Michael Arougheti

Yes, we have no desire to buy structured product where we don't control the asset. So all of the purchases of the CLO-restructured products from Allied or elsewhere were all in situations where we maintain control. I would highlight though now that we sold the management contracts of Callidus. We actually still hold a fair amount of underlying Callidus securities, both notes and equity. Again, when we talk about getting the timing right on the Allied transaction, similar to what we're seeing in the high-yield market and the leveraged loan market, the structured products market has probably rallied even more. And so the good news is, they were strategic purchases for us to help build Ivy Hill Asset Management up, given all the benefits that we derive from that. But this was all in a market where asset values were only going one way, and that way was up.

Jasper Birch - Fox-Pitt, Kelton

Changing tags here. Could you maybe give us a really good commentary or some commentary on possibly pursuing an SBA license. I was just wondering, can you give us some color on what your long-term view of the capital structure area is going to be? What role an SBA might play to trim that revolver, securitization, et cetera?

Michael Arougheti

Sure, well let's just talk about what is available to us and then we can talk about how we access them. Obviously, the bank loan market is something that we're always in. You could see this quarter that even in addition to the $75 million that was committed going into the Allied transaction, we brought two new lenders into the facility through the accordion, showing that we can continue to access capital in that market. My general sense and this is a long-term view is that market will continue to improve for us. And one of the investment thesis for the BDC [Business Development Company] sector in general, and for us, specifically, is that the larger money center banks and even some of the regional and smaller international banks will not be building direct origination and portfolio management infrastructures to go after the middle-market. That said, with increased liquidity, they are looking to deploy capital into the asset class. So again, if you think about how the markets have improved, a year ago, banks were asking for their money back. And now you're getting reverse inquiry for people looking to put capital to work. And we think that, that's a long-term trend for us. So we'd expect the bank loan market to continue to improve for us and be open to us. I'd also highlight there, though, that I think that scale is very important. You have to be not only investment-grade-rated borrower, I think, to truly officially access that market. But you have to be large enough that you can actually demonstrate the survivability, if you will, that some of the bank risk managers are looking for. That's the bank loan market. Two is the unsecured notes market, either private or public. Again, that market is quite hot as well. Spreads have tightened, although the underlying base rates are obviously widening, so the cost of borrowing in that market, while attractive on a long-term basis, is significantly in excess of our current cost of funds. But it's a market that we continue to look at. And at the appropriate time, we would probably be issuing into that market. Third is the securitization market. We are seeing meaningful signs of life in that market. I'll remind everybody on this call that Ares Management, the parent of the Investor Manager for ARCC, is one the largest managers of bank loans in the world. We have seen a resurgence in appetite for leveraging bank loan assets. And as a result, I think we'll eventually be able to take advantage of strength in that market, both at Ivy Hill and on balance sheet. Fourth is the SBA program. I don't want to belittle the program because it's a wonderful program for our sector. And it's a great thing for the us economy to get capital for small companies. But given the constraints on size, I can't say that it's going to be a meaningful component of our asset liability management. But it will be a nice complement to what we already have. But it's just not a large enough program right now to really move the needle and be a cornerstone of our liability management strategy. And then there are a number of creative things that I think are available at different points of time, whether it's the convert market or the trust market or the retail preferred market. And when the cycle was at a different place, those were available to us. If you look at Allied, for example, and we are inheriting some retail baby bonds with a 2047 maturity and a roughly 6% interest rate. And so there is precedence for those markets to be open to folks like us, and obviously, to the extent that it makes sense to get into those markets, we will. So I think the good news is, with the improvement in the market, we are seeing improved capital access, and we're seeing it at a long-term rape that are attractive. And I think, again, part of the investment thesis for the Allied acquisition is that, when you're going into those markets, particularly the liquid markets, scale is very important to efficiently access those markets. And we think we're in a good position to do it. In terms of secured versus unsecured, fixed versus floating, obviously, we spent a lot of time thinking about that and working on our interest rate strategy and our duration matching. But you should assume that, over time, you're going to see a fairly healthy mix of both senior secured and unsecured debt, as well as fixed and floating, as we work on our portfolio construction.

Jasper Birch - Fox-Pitt, Kelton

And then, Mike, also on the other side, in terms -- you mentioned that you expect favorable supply-and-demand imbalance that could persist for years on a normal bank lending. At the same time, you've seen you move down, marked a little bit in terms of company size that you're investing in. Can you just talk a little bit to the difference, the segmenting and competition across certain company size that you're seeing? And what part of the market you expect to be most attractive going forward?

Michael Arougheti

Yes, absent in flows, so I can't say as we sit here today, one is going to be more attractive for a long period of time versus others. One of the things that I think makes us unique and is a big differentiator given the scale of our platform in the way that we originate our business is, we're participating in the entirety of the middle-market from sponsored finance to non-sponsored finance, from senior debt through the structured equity, from $10 million EBITDA issuers $250 million EBITDA issuers. At different points in the cycle, depending on what's going on in the high-yield market, depending on what's going on with community banks and regional lenders, depending on what's happening in the securitization market, different parts of the market are more or less attractive. So we think our responsibility to our investors is to be in all of those markets, looking for the best relative value in the best risk-adjusted return. As we sit here today, the high-yield market is frothy. And I would actually argue irrational right now. And therefore, has really eaten into the upper and of the middle-market opportunity for private debt. And so as you saw in Q3, Q4 and Q1, you continue to see us pursuing smaller issuers, just because we're not in the business of competing against the high-yield market. There are other mezzanine providers that view that as their core business. But obviously, in an environment like this, where you're competing against the high-yield market, you're sacrificing covenants and meaningfully sacrificing pricing relative to what you can get downmarket, and that's not something we're very focused on doing right now. At the lower end of the market, while liquidity is still constrained, it's actually easy to get a deal done at the lower end of the market because you only need one capital provider to be willing to do something rational or irrational in order to get a transaction done. And so in the smaller company market, while you can still get inefficient pricing, we don't perceive a real liquidity constraint. So today, and this is all obviously subject to change, but today, we think that kind of write-down in the middle of the fairway in middle-market issuer would somewhere between $20 million and $50 million of EBITDA, that's too big to access the local bank market, but too small to really be attractive to the high-yield market or the syndicated loan market, is where at least we're seeing the bulk of the attractive opportunity today. But again, things are changing very quickly out there. If you look at our Q4 originations versus Q1 originations, you'll see we went from being down balance sheet to up balance sheet, where our originations quarter-to-date, as you saw, were predominantly first and second lien loan versus sub debt. So we don't want to put ourselves in a position where we are laying out an asset strategy, only to find that the asset opportunity changes. We're out in the market trying to see every possible deal in the available market. And then once we get them in-house, decide where we can exploit it in efficiency. And again, aside from sort of rambling about it, but aside from what we saw today from the ECB [European Central Bank], as felt going into the weekend, that the high-yield market was going to take a breather and maybe put us in a position to start financing some larger borrowers again. Obviously, things have changed today. It may go back to being an opportunity a week or two from now. So you just have to be in the market, looking at everything and continuing to exploit your competitive advantages to find good opportunity.

Jasper Birch - Fox-Pitt, Kelton

When you put something on cash on accrual and you're taking -- and it's still current, you're taking the interest to pay down principal. I know that you backed that out of core income. Do you also back that out of taxable?

Richard Davis

Yes, it is. It's back out of taxable, too.

Operator

Our next question comes from Jason Arnold at RBC Capital Markets.

Jason Arnold - RBC Capital Markets Corporation

Back to the $400 million in potential exits from Allied, are these coming more from loan repayments that caused meaning those potentially going up at levels higher than the fair value marks?

Michael Arougheti

Well, remember, when we bought the portfolio, we are fair valuing the portfolio as of April 1, and we're resetting basis. So I just want to make sure we're using the same language here. To the extent that we are selling something, the game would be measured against our new fair value as of April 1. And I'd say, generally speaking, given the strength in the markets, we are low to sell assets below fair value; unless of course, they are non-performing and we want to generate cash, or they are so far up the balance sheet and low-yielding that we want to rotate the portfolio. So I think you should assume that there's going to be a fair amount of discipline around where we're willing to sell an asset. And obviously, for the non-debt securities and the equity portfolio, we have to look at the long-term IRR opportunity and cap gains opportunity in that portfolio, versus the ability to take a non-interest-bearing security and turn it into an interest-bearing security. And again, the M&A market is improving, the multiple environment is improving. And so I wish I could say that, that equation is becoming easier for us. In certain instances, it's actually becoming more difficult because there's just a lot more asset liquidity. And I think we have a lot more flexibility to make those types of decisions.

Again, thank you for spending so much time with us this morning. Sorry, it ran so late. We appreciate everybody's support, and we look forward to speaking with you on our next quarter's call and giving everybody a more fulsome update as to what's going on in the market and, more specifically, what's happening within the Allied portfolio. So thanks, again. We'll talk to you soon.

Operator

Ladies and gentlemen, that does conclude our conference call for today. If you missed any part of today's call, a recording of this conference call will be available through May 24, 2010, at 9 a.m. Eastern Time. To access the replay, you can call 1(877)344-7529. To call internationally, you can call 1(412)317-0088. For all replays, the ID number is 439895.

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Source: Ares Capital Q1 2010 Earnings Call Transcript

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