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Ares Capital (NASDAQ:ARCC)

Q3 2010 Earnings Call

November 04, 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

Jasper Burch - Macquarie Research

Faye Elliott - BofA Merrill Lynch

Vernon Plack - BB&T Capital Markets

Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc.

Troy Ward - Stifel, Nicolaus & Co., Inc.

Jason Arnold - RBC Capital Markets Corporation

John Stilmar - SunTrust Robinson Humphrey Capital Markets

Arren Cyganovich - Ladenburg Thalmann & Co. Inc.

Donald Fandetti - Citigroup Inc

David Chiaverini - BMO Capital Markets U.S.

Christopher Harris - Wells Fargo Securities, LLC

James Ballan - Lazard Capital Markets LLC

John Hecht - JMP Securities 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 in 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, excluding professional fees and other costs related to Ares Capital Corporation's acquisition of Allied Capital Corporation, is the net per share increase or decrease in stockholders' equity resulting from operations less professional fees and other costs related to the Allied acquisition, realized and unrealized gains and losses, any incentive management fees attributable to such realized gains and losses and the income taxes related to such realized gains and other adjustments as noted.

A reconciliation of Core EPS, excluding professional fees and other costs related to the Allied acquisition, to the net per share increase/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.

Certain information discussed in this presentation, including information relating to portfolio of 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, 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 Q3-10 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 will now turn the conference over to Mr. Michael Arougheti, Ares Capital Corporation's President.

Michael Arougheti

Great. Thank you, operator, and good morning to everybody, and thanks for joining us. I hope you've had a chance to review our third quarter earnings press release including our fourth quarter dividend announcement this morning, as well as our third quarter investor presentation posted on our website. We'll refer to this presentation a little bit later in the conference call.

I'd like to start off by discussing current market and economic conditions, and then update you on some recent events at ARCC, including our strong third quarter results, before I turn the call over to Rick Davis. Once Rick takes you through the detail behind our third quarter results, I'll cover our recent investment activity, discuss our portfolio in greater detail and provide an update on our backlog and pipeline before closing and taking questions.

Following the volatility experienced during the second quarter, caused in part by sovereign debt concerns and mixed economic data, the broader leveraged finance markets bounced back during the third quarter with strong volumes, moderately tighter pricing and slightly higher asset prices. While overall leveraged loan market volumes were modestly below second quarter levels, specifically LBO and M&A-driven volume increased during the third quarter. Increased LBO activity is being driven by, among other things, improved earnings, uncertainty regarding tax rates and a significant overhang of uninvested private equity capital. Spreads in the more liquid, broadly syndicated leveraged loan market started higher on average at the beginning of the quarter, but narrowed toward the end of the quarter as fund flows increased and investor confidence improved.

From the high-yield bonds side, record third quarter new issue volume of $76 billion was driven by strong inflows, as investors chased yield in the sector. High-yield spreads tightened as volatility declined and the default rate outlook improved. Unlike the leveraged loan market where activity has been focused on M&A financing, high-yield issuance continued to be dominated by refi activity. Within the less liquid middle market where we operate, activity has also been very healthy.

Overall third quarter close volumes were slightly down from second quarter levels, but we too saw a meaningful increase in sponsor-driven activity. Middle market transactions in progress and under review increased, particularly post-Labor Day, and this is reflected in our Q3 investment pace and strong current backlog and pipeline levels. Unlike the spread tightening experienced in the broader syndicated and high-yield markets, third quarter middle market pricing was relatively stable on average compared to the second quarter.

That said, leverage levels did increase slightly during the third quarter. However, compared to the historical averages over the past decade, current market leverage levels are reasonable, while current market spreads and fees remain well above historical average levels.

Despite the strong level of refinancing activity in the leveraged loan and high-yield markets year-to-date, the medium-term opportunity in our asset classes remains strong. Fitch Ratings estimates that over $1 trillion of loans and bonds will mature by 2015 with a potential supply-demand gap of between $375 billion and $425 billion. Similarly, we've seen reports from Thomson Reuters estimating approximately $480 billion in middle market maturities between now and 2015.

Clearly, there's some overlap in this data. But it should give you an idea of the magnitude of the potential future capital opportunities and the importance of being in a strong position to capitalize on these opportunities in the future.

In terms of the macroeconomic environment and its impact on ARCC, the underlying companies on our portfolio continue to generate comparable weighted average revenue and EBITDA growth in the single- and double-digits, respectively, versus the prior year. We continue to believe that we are likely in a prolonged period of slow economic growth, and in our view, a slow growth environment can favor credit over equity, particularly if such slow growth is sufficient to allow companies to deleverage their balance sheets and maintain default rates at relatively benign levels.

Although Rick will go into our third quarter financial results in detail, I'd like to highlight a couple of key takeaways. First, from an earnings standpoint, we increased our core earnings per share sequentially by $0.06 from $0.32 for the second quarter to $0.38 for the third quarter, excluding $0.06 and $0.01 per share, respectively, in fees and other costs associated with the Allied acquisition. The increase was driven in part by strong investment activity. Our $0.67 in quarterly GAAP earnings per share also reflects our solid net portfolio appreciation during the quarter in both our core ARCC portfolio and the legacy Allied portfolio. As a result, our third quarter net asset value increased for the fourth consecutive quarter.

We continue to make progress on the rotation and repositioning of the legacy Allied portfolio. Of the $231 million of investments exited during the third quarter, $99 million were legacy Allied portfolio investments, including $24 million that were on non-accrual. Such legacy Allied investments were exited at a realized gain of approximately $1 million.

Our overall credit performance continues to be solid in our view, as evidenced by the fact that we reduced our overall non-accrual ratio by 1.9% of the combined portfolio, and our weighted average portfolio rating remains stable.

I'll provide more detail on our cumulative progress to date with our legacy Allied portfolio later in the call, but we're obviously pleased with what we've accomplished thus far. We believe a significant opportunity remains to improve the expected risk-adjusted return on the remaining low- or non-yielding assets in the legacy Allied portfolio.

And lastly, as you may have seen from our press release this morning, we declared our fourth quarter dividend of $0.35 per share payable on December 31 to shareholders of record on December 15. And following payment of this dividend, we will have paid a dividend of at least $0.35 per share for five straight years dating back to the first quarter of 2006.

And with that, I'd like to turn it over to Rick Davis, our CFO, for a more detailed comment on our third quarter financial results. Rick?

Richard Davis

Thanks, Mike. As you'll see, we've continued to report a number of the core ARCC portfolio statistics separately from the legacy Allied portfolio stats, so that you can continue to track the performance of both.

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 $0.38 per share for the third quarter, excluding $0.01 per share professional fees and other costs related to the Allied acquisition, a $0.06 per share improvement over core EPS of $0.32 per share for the second quarter, excluding $0.06 per share of acquisition-related professional fees and other costs incurred in Q2. The quarterly increase in core earnings per share was driven largely by higher structuring fees and interest and dividend income, which offset a slight decrease in our weighted average investment spread.

Structuring fee income can fluctuate from quarter-to-quarter depending on the mix and level of new investments generated. In addition, we had net investment gains for the third quarter of $0.30 per share, substantially all of which were unrealized. The growth in our core earnings and net investment appreciation for the quarter contributed to our GAAP earnings of $0.67 per share. After paying our $0.35 third quarter dividend, our net asset value was $14.43 per share, a 2.3% increase from last quarter.

Consistent with the higher market levels of transaction activity, we made significant new commitments of over $510 million during the third quarter. In addition, we experienced significantly lower exits and repayments during the third quarter relative to the unusually high levels we experienced in the second quarter. After $231 million of exits, our net new commitments in the quarter were approximately $281 million. Our new debt investments made during the quarter yielded approximately 13% on a weighted average basis, compared to our debt investments exited or repaid, which had a weighted average yield of approximately 13.2%.

Turning to the legacy Allied portfolio, we incurred exits and repayments of approximately $99 million at a $1 million net gain during the third quarter. These exits were included in the $231 million in total exited commitments. We reduced the non-accruing investments acquired in the Allied acquisition through both exits and repayments and successful restructuring transactions, resulting in new accruing loans. We continue to be focused on divestitures of non-core assets and the restructuring and repositioning of selected assets. We will seek to reinvest the proceeds of these and future exits in the core assets with a higher blended yield, so there can be no assurance that we will be successful with this strategy.

We ended the quarter with an investment portfolio of approximately $4.1 billion at fair value, including 184 portfolio companies. Our quarter-end portfolio was comprised of approximately 37% of senior secured debt securities, with 31% in first lien and 6% in second lien debt investments; 29% in senior subordinated debt; 6% in CLO investments, some of which are managed by our portfolio company, Ivy Hill Asset Management; 17% in equity and other securities; 10% in the Senior Secured Loan Program; and 1% in commercial real estate.

Now, I'll walk you through changes in our yield and investment spread for the quarter. Our overall weighted average investment spread at September 30 was 8.5%, a decrease of about 19 basis points compared to last quarter. From a yield standpoint, our weighted average yield on debt and income-producing securities at amortized cost for ARCC's core portfolio declined from 12.79% to 12.4% quarter-over-quarter. Our overall combined portfolio weighted average yield decreased from 13.4% at amortized costs last quarter to 13.1% this quarter. This decline in weighted average yield at amortized cost primarily relates to the exits and repayments for the third quarter having a slightly higher yield than the new investments funded.

Due to increased borrowings on our revolving credit facilities, our weighted average cost of debt decreased from 4.74% last quarter to 4.63% in the aggregate this quarter. However, our funding costs may increase modestly due to our recent unsecured notes issuance, which I'll discuss a little later.

On Slides 4 and 5, we provide additional quarterly detail. But I'd like to turn to Slide 6 to highlight our fixed and floating rate assets and our non-accrual statistics by portfolio.

On a combined basis at fair value, our percentage of fixed rate debt assets increased slightly from 51.9% at the end of the second quarter to 53.2% at the end of the third quarter. Over the same period, our floating rate debt asset also increased slightly, from 23.7% to 25.6%.

With respect to our floating rate assets, keep in mind that approximately 69% of those floating rate assets carry a LIBOR floor that is significantly higher than current short-term LIBOR rates. Given the fact that we are benefiting from these LIBOR floors, we are slightly more sensitive to a sharp rise in interest rates going forward. We continue to monitor interest rates in the yield curve, with the continued goal of being as match-funded as practicable.

Staying on Slide 6, I'd like to highlight our third quarter strong credit performance for both portfolios. As shown on the slide, non-accruing investments, as a percent of the total combined portfolio, declined from 9.4% at cost and 7.6% at fair value at the end of the second quarter to 7.5% at cost and 5.2% at fair value, respectively, at the end of the third quarter. With respect to the core ARCC portfolio, non-accruing investments, as a percent of the combined portfolio, were relatively unchanged at 2.2% at cost and 0.2% at fair value at the end of third quarter versus 2.3% and 0.2%, respectively, at the end of the second quarter.

Excluding the legacy Allied portfolio from the denominator, core ARCC portfolio's non-accruing investments were 3.6% at cost and 0.3% at fair value at the end of the third quarter, down from 4% and 0.4% at cost and fair value respectively at the end of the second quarter. Since the closing of the Allied acquisition through the end of the third quarter, the legacy Allied portfolio has incurred no new non-accruals, and non-accruing investments has been reduced to 5.3% at cost and 5% at fair value as a percent of the combined portfolio, down from 7.1% at cost and 7.4% at fair value at the end of the second quarter.

Now let's skip over to Slide 9 for a discussion of portfolio gains and losses during the third quarter. On this slide, you'll see that we reported net realized and unrealized gains in total of approximately $57 million or $0.30 per share. Approximately 2/3 of the net unrealized gains were from the core ARCC portfolio, with about 1/3 from the legacy Allied portfolio. The net unrealized gains primarily reflected the improvement in investment performance of specific investments and, to a lesser extent, higher market values.

From a longer-term standpoint, I'd like to point out that since our inception in 2004 through September 30 of 2010, excluding the gain recognized in connection with the Allied acquisition, we've generated realized gains that have exceeded our realized losses.

Slide 10 shows a summary of our debt facilities at quarter-end. As of September 30, we had approximately $2.1 billion in committed debt facilities with a weighted average maturity of 7.7 years and a weighted average cost of 4.63%. We had approximately $1.6 billion in aggregate principal amount of debt outstanding, of which $714 million was outstanding under our two revolving lines of credit that have total capacity of approximately $1.2 billion, leaving just under $500 million available. Adding in availability from unrestricted cash on hand of approximately $100 million, we have roughly $590 million of debt capacity and cash, subject to leverage and borrowing base restrictions.

During the third quarter, we continued to exercise the accordion feature under our revolving credit facility, securing an additional $60 million, to bring total commitments to $810 million. Since the beginning of 2010, we've increased our revolving credit facility by $285 million in new commitments from the $525 million in commitments we had at the beginning of 2010. As a reminder, subject to obtaining additional commitments, the accordion feature of our revolving credit facility allows us to increase the total facility size to just over $1 billion, although we cannot assure you that we will be able to obtain additional commitments.

On Slide 11 is our balance sheet. Our debt-to-equity ratio at quarter-end was 0.55x based on the carrying amount of our debt, which, when reduced by available cash and cash equivalents, declines to an even more conservative 0.51x. This net debt-to-equity ratio is still lower than our targeted leverage of approximately 0.65x to 0.75x. Given the potential investment opportunities that we see in the middle market, we anticipate that we may continue to seek to raise debt or equity capital opportunistically in the most efficient manner possible.

Figures on this slide do not reflect our recently closed $200 million retail unsecured notes issuance. Since the net proceeds from the offering reduced our revolving credit facility borrowings, our leverage ratios would have not changed materially on a pro forma basis using our September 30 balance sheet. We're extremely pleased to have issued these 30-year, unsecured fixed-rate 7 3/4% notes of what we believe was an attractive credit spread inside of 4% of our 30-year treasuries.

Although it modestly increased our overall funding costs, this transaction extended our debt maturity profile, further diversified our funding sources and significantly increased our unsecured debt profile. Approximately 44% of the principal amount of our indebtedness outstanding was unsecured at the end of the third quarter, and pro forma for the notes offering, our unsecured indebtedness would've increased to approximately 56%. We also place great value on the callability of these notes at par after the fifth year.

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

Michael Arougheti

Great, thanks, Rick. I'll say a few words about our recent investment activity, review performance stats for the core ARCC portfolio and the legacy Allied portfolio, discuss our portfolio rotation initiatives and highlight our backlog and pipeline before concluding.

If people could turn to Slide 13. In the third quarter, we booked 19 new transactions, with an average commitment size of about $27 million. Our average commitment size declined slightly due to the relatively smaller dollars invested per name in the senior secured loan fund during the third quarter.

Turning to Slide 14. You'll find more detail behind the specific asset classes of the new investments and exits. The table on the left illustrates that we were particularly active with first lien debt investments either on our balance sheet, representing 45% of investment activity, or within the senior secured loan fund, representing about 41% of this quarter's investment activity. This reflects our current portfolio strategy to move incrementally up the balance sheet into higher attachment points, given our view that, that's where the best risk-adjusted return is in the current market. In total, our third quarter new commitments in debt and income-producing investments had an aggregate yield of 13%.

Slide 14 also highlights that our exits have also been predominantly in the first lien debt category, representing 66% of the total, and to a lesser extent, subordinated debt, representing 27% of the total. The higher level of exits of first lien debt was in large part driven by our portfolio rotation and repositioning strategy of lower-yielding assets for the legacy Allied portfolio.

Now let's start turn to Slide 15, and we'll focus on our cumulative progress with respect to the rotation and repositioning of a portion of the legacy Allied portfolio during the third quarter. As shown on Slide 15, the total legacy Allied portfolio at fair value has declined $153.5 million, from $1.83 billion at the time of acquisition on April 1, to $1.68 billion at the end of the third quarter. During this six-month period, we have generated $261 million in cash from the legacy Allied portfolio, with net realized gains of about $1.5 million. The redeployment of these cash proceeds from investments averaging lower yields into investments averaging higher yield should drive growth in our interest income going forward.

We've also reduced non-accruing investments from $335.6 million at fair value since April 1 to $208 million at fair value at the end of the third quarter. This $127.6 million reduction in non-accruals represented about 38% of the beginning balance. We've accomplished this reduction primarily through exits or repayments of $76.1 million and restructurings of investments with a fair value of $42.2 million.

Through exits and repayment and, to a lesser extent, balance sheet restructurings of lower- or non-yielding securities, we've also increased the yield on the remaining portfolio by approximately 80 basis points at fair value as of the end of the third quarter.

In addition to the $261 million in exits and repayments from the legacy Allied portfolio during this period, the portfolio has experienced $67 million in net unrealized appreciation, and we funded certain revolving and other commitments in this portfolio. As you can see, the legacy Allied portfolio continues to provide further rotation and repositioning opportunities. And as of the end of the quarter, over $600 million in such low- or non-yielding securities at fair value remain, with an aggregate yield of 1.6%.

Now turning to Slide 16 for a review of the leverage and interest coverage statistics for the core ARCC portfolio and the legacy Allied portfolio. In the core ARCC portfolio, the underlying portfolio company weighted average last dollar net leverage, and weighted average interest coverage both remain little changed compared to the second quarter, at 3.8x and 3.2x respectively. For the combined portfolio, our weighted average total net leverage and interest coverage ratios were stable at 4.1x and 2.8x, respectively, at the underlying weighted average net leverage was slightly reduced to 4.4x, and interest coverage slightly increased to 2.4x in the legacy Allied portfolio.

Note that the portfolio statistics for the senior secured loan fund are not included in the ARCC averages. We co-manage this program with GE Capital and seek to manage and make senior secured unitranche loans to middle market companies. The Senior Secured Loan Program had 17 underlying borrowers, with a weighted average total net leverage and interest coverage of 3.9x and 3x respectively as of the end of third quarter. The program had no non-accruing investments as of September 30.

The program investment companies that are similar industries to the company in which we invest, and the largest single issuer in the program's portfolio at September 30 represented 12.9% of its total investments as of the end of the quarter. Of course, as the program invests further, portfolio diversification should increase.

On Slide 17, we break down weighted average EBITDA for the core ARCC and legacy Allied portfolios. Overall, weighted average EBITDA for the core ARCC portfolio remain relatively steady at approximately $45 million. As you can see, new portfolio companies funded during the third quarter generally averaged a little over $30 million in annual EBITDA. And on a combined basis, our total weighted average portfolio company EBITDA was approximately $36 million at the end of the third quarter. Given competition from the high-yield market at the upper end of our market opportunity, we expect our focus to remain on companies in these size ranges in the near term.

Skipping to Slide 19, you can see that the portfolio remains well diversified by issuer. Our largest investment is in the Senior Secured Loan Program, which increased from 5% of our portfolio to approximately 10% at the end of the third quarter at fair value. We are pleased with the risk-adjusted returns from this fund to date, although such returns will likely vary from quarter-to-quarter, and there is no assurance it will be able to maintain these historical returns. Beyond the Senior Secured Loan Program, you can see the next largest investment is 3.1% of the portfolio at fair value, and the top 15 represent just over 39% of the portfolio at fair value.

Slides 20 through 22 provide a snapshot of the portfolios by asset class, industry and geography. The portfolio remains balanced and diversified by asset class, with not a lot of changes during the quarter. Given the growth in our investments in the Senior Secured Loan Program, our investment fund's categories are largest at 18% followed by business services, healthcare services, consumer products and restaurants and food services. Our investment funds category includes investments in senior loan funds that are managed or co-managed by us or our wholly-owned portfolio company, Ivy Hill Asset Management, and other various fund investments managed by third parties.

On Slide 23 is a summary of the grades by category for the two portfolios. Specifically, the portfolio is graded on a scale of one through four, with an investment grade of one defined as the lowest grade, generally indicating that the risk to our ability to recoup the cost of such investment has substantially increased since origination or acquisition. And an investment grade of four is defined as the highest grade, with the least amount of risk to our initial cost basis. As a reminder, all newly acquired or originated investments in new portfolio companies are initially assessed a grade of three.

Within the core ARCC portfolio, we experienced four rating upgrades and two rating downgrades during the quarter. However, both downgrades were from grade four to grade three, and one of the downgrades reflected a partial exit.

Turning to the legacy Allied portfolio, we experienced two rating upgrades, from grade three to grade four, and two rating downgrades from grade three to grade two. As of September 30, the weighted average grade of the core ARCC portfolio was three, and the weighted average grade of the entire combined portfolio was also a three.

As I mentioned in my opening remarks, the underlying portfolio companies continued to experience solid comparable revenue and cash flow growth on a year-to-date basis. Weighted average revenues in EBITDA for the core ARCC portfolio of companies increased approximately 7% and 15%, respectively, on a comparable basis for the year-to-date period versus the same period last year. We're seeing little signs of slowing growth, and in fact, revenue growth trends are very similar to the levels we saw in the second quarter. The remaining legacy Allied portfolio companies also experienced improved comparable weighted average revenue and EBITDA growth of approximately 4% and 12% respectively for the year-to-date period versus a year ago.

The overall combined portfolio companies' weighted average revenues and EBITDA increased year-to-date by about 6% and 14%, respectively, versus the same period last year.

On Slides 25 and 26, you'll find our recent investment activity since quarter-end, and our backlog and pipeline. As of November 3, we had made additional new commitments of approximately $128 million since September 30, including 61% of these investments in the Senior Secured Loan Program, to fund unitranche and senior loans and 29% in first lien senior debt. As of this date, we had also exited the $146 million of commitment, of which $80 million came from the core ARCC portfolio and $66 million came from the legacy Allied portfolio, including another $4 million that were on non-accrual. We've also realized net gains of approximately $19 million from the sale of legacy Allied investments since quarter-end.

Turning to Slide 26. As of November 3, our total investment backlog and pipeline stood at $180 million and $310 million, respectively. Of course, we can't assure you that we'll make any of these investments, and we may syndicate a portion of these new investments. Our pipeline does not include the more than 75 transactions that were in process of being reviewed at various earlier stages by our investment teams.

Now let me conclude by reiterating some key takeaways on the quarter. We had an active quarter from an investment standpoint, which allowed us to increase our investment portfolio and drive higher core earnings per share to $0.38, excluding nonrecurring costs associated with the Allied acquisition versus our declared $0.35 quarterly dividend. As I outlined, our overall credit and investment performance remains strong, as evidenced by the decline in our non-accrual ratios, increase in underlying portfolio EBITDA growth and the net portfolio appreciation we experienced during the third quarter. We've also continued to make progress with the legacy Allied portfolio by reducing non-accruing investments, rotating $260 million in cash received into higher-yielding investments and improving the yield and credit profile on the remaining portfolio. We believe that attractive portfolio rotation and repositioning opportunities remain, with respect to the legacy Allied portfolio, with approximately $600 million in low- or non-yielding securities, with an aggregate yield of 1.6% still in that portfolio.

And although there can be no assurance that we'll be successful with these efforts, we will continue to actively pursue them with the intention of increasing interest income and improving expected risk-adjusted returns.

We believe that our backlog and pipeline, as well as the other transactions that we're currently reviewing, reflect both the attractive current market opportunities available to us, as well as our enhanced competitive position in the marketplace as a result of the Allied acquisition.

And finally, we continue to be successful in securing additional debt capital on favorable terms. We added another $60 million in commitments to our primary revolving credit facility during the quarter, and subsequent to quarter-end, access to new funding channel for an additional $200 million. We believe these transactions highlight our continued access to debt capital and have provided us with additional balance sheet flexibility and investment capacity.

We hope that you continue to share our enthusiasm for our company. And thank you for your time and support today, and always. And with that, operator, we can now open up the line to questions.

Question-and-Answer Session

Operator

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

Vernon Plack - BB&T Capital Markets

Mike, my question has to do with portfolio rotation, something that you all have been talking about here for the last several quarters. And I know the equity/other component of the portfolio at fair value stood at 17%. And I'm curious in terms of where would you like to see that number and -- where will that go? Are you happy at 17%, or could we see that number actually going to the low teens? Or what's a good number, you think, for the portfolio?

Michael Arougheti

Sure. Obviously, the 17% is reflective of the assets that we acquired in the Allied acquisition. If you look at the core ARCC portfolios over time leading up to the acquisition, that number was much closer to 10%. And as people know, that 10% was largely co-investment equity alongside debt investments, as opposed to control buyout equity. As we've stated numerous times, on a go-forward basis, we do not view ARCC as a buyout fund, and we will not be, for the most part, buying companies at ARCC. So our hope is that we can take that 17% and move it down over time to be more in line with our historical portfolio composition.

Vernon Plack - BB&T Capital Markets

Regarding Allied, I know that there was just a minimal amount of costs associated with the acquisition. Are there any additional or lingering fees or expenses that we can expect related to Allied?

Michael Arougheti

They've come down significantly, quarter-over-quarter. In this quarter, they were about $0.01 a share. We'll still have some runoff of those expenses through the end of the year and into early 2011. But you should expect them to be in the similar range of $0.01 or less per share.

Operator

.

Our next question comes from John Hecht from JMP Securities.

John Hecht - JMP Securities LLC

First one, just related to modeling. You had elevated capital structuring fees this quarter, and I know those are somewhat tied to origination activity. Is there any other activity we should tie that to, at this point? Or should we really just tie that to where we think the pipeline's going to come in the next couple of quarters?

Michael Arougheti

Yes, there's really no change in how that flows through our income statement. I would highlight two things, though. Number one, generally speaking, fee levels in the market are higher today than they have been in prior periods. As spreads have come in broadly across the market, lenders such as ourselves are actually getting incremental income through fees. And we've seen, in most instances, increases in fees of about 100 basis points versus what we were getting historically. That's driving some of that number too. As I think most people know, we do have a very efficient fee arrangement in the Senior Secured Loan Program. And so, to the extent that we're making investment disproportionately into that vehicle versus on the balance sheet, you should tend to see it at a higher fee line. Historically, if you look at the company, our average investment income, coming from capital and structuring fees, is about $0.06 a share versus $0.11 a share this quarter, just given the heightened level of activity.

John Hecht - JMP Securities LLC

I guess an indirect follow-up to that, by all measures, that Senior Secured Loan Fund has been somewhat of a success. Can you highlight, if you haven't done so, the remaining capacity? And are there any discussions to maybe form a new one?

Michael Arougheti

The program, as currently laid out, is a $3.6 billion program, of which our commitment is about $525 million. Obviously, given the amount of activity and the success that we've had in the market ramping, I do think that we'd like to increase the size of that program over time. And it's something that we'll continue to discuss with our partner, GE. And, obviously, keeping an eye on our own balance sheet capacity is something that we need to factor in as well. But I would say that the program has been very successful from an economic standpoint for our company, but also from a competitive positioning standpoint. I think it's really been well-received in the market, and our partnership with GE has been absolutely wonderful.

John Hecht - JMP Securities LLC

And final question. You edged up your composition of fixed-rate assets or investments. I know you pushed out the duration of your portfolio. Is this part of maybe a longer-term strategy or intermediate-term strategy to start positioning the portfolio for a rising rate environment, and kind of capture the right part of the yield curve along the way?

Michael Arougheti

It is, although you can never get it perfectly. But that is absolutely what we're focused on. Obviously, as we've talked about liability management, other things other than duration come into play. But we have been very focused on getting fixed rate and getting longer-dated maturities. And as you see in the recent activity with the retail deal, we're also very focused on increasing the percentage of unsecured debt on the balance sheet, which is going to be an ongoing initiative for us.

Operator

.

Our next question comes from Don Fandetti from Citigroup.

Donald Fandetti - Citigroup Inc

Mike, in terms of the companies you're investing in, I was curious what you're hearing from management teams in terms of their confidence, the tone and also hiring?

Michael Arougheti

I think the tone is actually quite positive. Obviously, it's all relative. I think everybody is aware of the economic backdrop and some of the challenges that we face in the economy. But I think generally speaking, the tone is positive. I think one of the reasons that the tone is positive is because most of the companies, where they could, cut costs in expectation of a different economic reality. They reposition their operating expenses. They maybe revisited manufacturing processes, plant capacity, supply chain dynamics. And I think most of the companies that weathered the storm are operating much more efficiently, with a lot more operating leverage than they have in the past. And therefore, very moderate increases in revenue as we see in our own portfolio, as well as across the broader market are still resulting in pretty significant increases in profitability. That said, I don't believe that, that increase in operating leverage and efficiency necessarily is going to manifest itself in a rapid increase in hiring and job creation. I think that most of the companies that we're invested in, and this is across the platform, are obviously happy where they are, running the businesses efficiently, and are able to continue to generate profits without adding bodies.

Donald Fandetti - Citigroup Inc

And then the other question. I know that you've sort of highlighted your relative balance sheet capacity scale as an advantage in the marketplace, and also in your Senior Secured Loan Fund. Is that still the case today? And is that increasing or decreasing in relevance?

Michael Arougheti

I think it's absolutely the case today, and I'm not sure that it can increase more in relevance. If you think about the market that we're in, and as we highlighted, we have moved down a little bit, just given some of the levels of activity that we're seeing in the high-yield market. But for a $40 million EBITDA company in today's environment that wants to borrow $200 million through a combination of senior debt, mezzanine debt or in a unitranche structure, there are very few capital providers that have the scale to provide a single solution at $200 million, or the flexibility to meet whatever the desired needs of the borrower are. So we're finding, in our target size range, that the scale and the flexibly are absolutely competitive advantages, and we don't expect that to change.

Operator

.

Our next question comes from Jim Ballan from Lazard Capital Markets.

James Ballan - Lazard Capital Markets LLC

Mike, you talked about a large portion of the investments that you made in the quarter coming in senior debt. Can you talk a little bit about the structure, whether it's a first lien, second lien, unitranche? And also, just the returns you're getting on senior debt. Meaning, the returns you're getting on debt that you're putting into the BDC? And then also, what you're getting in the unitranche fund outside the senior...

Michael Arougheti

The bulk of the senior investments are coming in as either first lien senior debt or first lien stretched senior debt, which we all affectionately refer to as the unitranche. Giving you a general sense of where we see the market today, the first lien bank loan asset class is 3x to 3.5x leveraged, with total rates of return through a combination of spreads and fees somewhere in the 7% range. The mezzanine market is leveraging upwards of 5x today, as we mentioned in our prepared remarks, while spreads have remained consistent. We have seen a little bit of a creep up in leverage, as people are willing to take on a little bit more risk. And the rates of return there, on a total return basis, are in the 15% to 18% range, with spreads hovering around 12% to 14%. And when you take that balance, and you look at what a unitranche price is at today, most unitranches at the asset level are getting funded somewhere between 8% and 10% first lien. When you look at what we're generating in the Senior Secured Loan Fund, and this is in the Q, and again, there's going to be some variability in the returns coming off of that fund, depending on how much leverage we're using at the fund level and what the underlying asset composition is. But generally speaking, that fund is kicking up 16% to 17% cash-on-cash returns right now.

James Ballan - Lazard Capital Markets LLC

One other thing. Again, there was a good amount of investments that were made into the existing portfolio of companies. Can you talk about how much of that is supporting expansion of the businesses versus supporting credits that are underperforming that need the incremental capital?

Michael Arougheti

Most of the activity is, as we said, is coming from new change of control buyout activity and/or add-on acquisition activity, as opposed to growth capital or restructuring or refinancing.

James Ballan - Lazard Capital Markets LLC

The $200 million, the new debt that you issued. The $30 million in the overallotment, is that not going to happen? Or are we still waiting to find out?

Michael Arougheti

That is not going to happen.

James Ballan - Lazard Capital Markets LLC

So the $200 million is the number we should model, going forward?

Michael Arougheti

Yes.

Operator

.

Our next question comes from Chris Harris from Wells Fargo Securities.

Christopher Harris - Wells Fargo Securities, LLC

Nice appreciation again in your portfolio this quarter. I'm wondering how much of that appreciation is coming from the Allied assets versus legacy Ares?

Michael Arougheti

Sure. And this is in the slide, you'll see on Page 9, to give you a little bit of a breakdown. Now let's just call it out for you. Yes. So, $57 million in the quarter of the net appreciation was from the Allied portfolio.

Richard Davis

I think that's the gross number for the quarter. And it's roughly $18 million of...

Michael Arougheti

Net. So about 2/3 core, 1/3 Allied.

Christopher Harris - Wells Fargo Securities, LLC

I know you guys are definitely getting a lot of benefit, having a large portfolio from an origination perspective. But I'm just curious if you feel like, as you get larger, you might lose some flexibility, and how might that impact your ability to generate alpha returns through kind of an asset rotation strategy that you guys have been able to execute in the past?

Michael Arougheti

When you say losing flexibility, just to clarify, in what sense?

Christopher Harris - Wells Fargo Securities, LLC

Well, in other words, if you're feeling that things were getting toppier, the market was getting frothy, I would presume it would be a lot harder to rotate a $5 billion portfolio than it would be to rotate a $1 billion portfolio.

Michael Arougheti

I would actually focus on number of portfolio companies more than actually size of portfolio. Because again, when you're managing a $5 billion portfolio or a $10 billion portfolio, you have to manage your portfolio composition on a relative basis than a percentage basis. I think you've highlighted a good point which is, post-Allied, we have 184 portfolio of companies relative to what was roughly 90 to 100 for both companies, pre-acquisition. And as we've talked about in prior quarters, one of our stated goals, and we're working towards it, is to reduce the number of portfolio companies and get it back to a level of diversification more consistent with what our historical composition was. Now, that obviously takes time. And the 184 number is somewhat misleading, because when you actually look at the average position size for a number of those names, there are some very small stub companies that don't take up a lot of management time and attention, et cetera, et cetera. But I do think you should expect that the number of portfolio companies in the book will continue to shrink over time, as we try to mark it back down to what our historical levels were. In terms of the ability to move the portfolio, again, it's a function of the number of portfolio companies, where we are in the balance sheet. We always have believed, and I think we've proved it through the downturn, that the higher up the balance sheet you are, the more liquidity you have in the portfolio. Initiative is like growing our Ivy Hill Asset Management subsidiary and some of our other third-party managed account business provides other relationships for us to start to look for liquidity. So it's something you're always thinking about. But size, in and of itself, in our opinion, doesn't necessarily constrain the liquidity nor the ability to move the portfolio.

Operator

Our next question comes from John Stilmar from SunTrust.

John Stilmar - SunTrust Robinson Humphrey Capital Markets

Just to dovetail back on the Senior Secured Loan Fund. Can you go through the amount of available capacity that remains? I think your disclosure in the Q said it was $95 million. But it seems like you've done some incremental investing. And dovetailing with that, but also to follow up on some of the previous points, maybe it's not a Senior Loan Fund or expanding it, but what is your level of confidence of creating sort of alternative funds to achieve somewhat similar results? It may not be specifically Senior Secured Loan Funds, but something along that line, given you have a long track record of creating vehicles like Ivy Hill and Senior Secured Loan Fund and purchases out of Allied? Can you walk me through your level of confidence of creating structural advantages like you have in the past?

Michael Arougheti

Sure. As i mentioned, the total program size is $3.6 billion, and we were roughly $2 billion invested as of the end of the third quarter. When you look at the leverage profile in that fund, our unfunded commitment in the fund is about $98 million as of the end of the third quarter. As I mentioned earlier in the Q&A, I think our hope and goal is to continue to grow that program alongside GE. And that's something that we're both working on as we speak. That said, we're not looking for alternatives to the program, again, given the strength of the partnership and the success of the fund. But I think given the scope of our operations and the success that we've had in the structured products market and in the debt capital markets, both here and in Ares Management, to the extent that we're looking to continue to extend that type of operation, I have every confidence that we'll be able to do it.

John Stilmar - SunTrust Robinson Humphrey Capital Markets

Given the return prospects that you outlined previously with first lien and mezzanine and unitranche, as I look at the investments where 2/3, I think, were fixed rate at a total yield of 15%, and about 1/3 had a weighted average spread, implying that they are floating at 6.2%. If I look at Senior Secured Loan Fund, which is traditionally, I believe, a floating rate piece of debt, can you -- and then if I look at the senior pieces, which I wouldn't think are fixed, the yields versus what the investments are seem to be a little counterintuitive. Can you help reconcile fixed versus floating of structure versus the yields that you're referencing here?

Michael Arougheti

Sure. Just to clarify, for the purpose of the numbers that you just quoted, the Senior Secured Loan Fund is deemed to be a fixed-rate investment. So that's probably skewing it a little bit. The other thing I'd highlight too, is that as you know, we're getting LIBOR floors on the bulk of the floating rate investment that we're making. And that's if that 60% of our floating rate assets actually have LIBOR floors meaningfully in excess to the current LIBOR environment. And so fixed versus floating is obviously relevant, but you'd need to see a significant spike in interest rates in order for the floating rate nature of those assets to actually come into play. And if I understand your question correctly, I think you feel that the stated interest spreads are higher or lower than what I put in terms of the market? Help me understand what you're...

John Stilmar - SunTrust Robinson Humphrey Capital Markets

No, actually, you answered it perfectly with the Senior Secured Loan Fund answer. And then the final question has to do with expense leverage. As you certainly talked about managing the portfolio size, how should we be thinking about, not in the coming quarter or two quarters, but four to five quarters, or even longer out, the degree of expense leverage that might be in the platform, as we start unfurling sort of the Ares to after Allied becomes fully rotated, and you start redeploying your capital?

Michael Arougheti

Again, there's probably not a lot of expense leverage in the business, given that we're externally managed. As we've talked about around the acquisition, there's clearly economic benefit as we get through the integration in the non-management fee and non-incentive fee expenses such as D&O insurance and the like. But the scope of those expense interviews, if you will, pale in comparison to all of the other operating and income benefits that we've been talking about from the Allied acquisition. But obviously, as an externally managed structure, there's not a huge amount of expense leverage that's running through, given the acquisition. As you would expect us to have done, we've meaningfully increased the number of people and the amount of infrastructure, post-acquisition, in order to support the growth and continue management of the business. But obviously, that's helping soon by the management incentive fee coming off of the vehicle.

Operator

Our next question comes from Troy Ward from Stifel Nicolaus.

Troy Ward - Stifel, Nicolaus & Co., Inc.

Mike, subsequent to the end of the quarter, you've announced originations and prepayments that obviously show a flattish, if not slightly declining, net portfolio growth. Can you just comment on what you see in the pipeline towards the end of the quarter, and whether or not you think that can get through a positive portfolio growth for Q4?

Michael Arougheti

Yes. We mentioned, in terms of the backlog and the pipeline, the backlog and pipeline remain pretty healthy, combined in excess of $400 million. As we sit here today, obviously, fourth quarter tends to be very, very active but also very back-end-weighted, just as people try to get deals closed before year-end. As you'll see on Page 26, the backlog stood at $180 million. And again, that's deals that are committed and in process. The pipeline stood at $310 million. And as we said, there's an excess of 75 transactions actively being reviewed and worked on behind what we consider to be the actionable pipeline. So our expectation, as we sit here today, is that we will see another quarter of net portfolio growth in Q4.

Troy Ward - Stifel, Nicolaus & Co., Inc.

And then as we think about moving into 2011, obviously there's been a lot of talk about volumes in Q4 for different reasons, whether it be tax or otherwise. Obviously, but look at your pipeline today, it's not going to completely shut off, because many of those deals won't close by the end of the year. But how do you see originations in the first quarter? Do you think there'll be a slight lull heading into 2011?

Michael Arougheti

Just based on the frenetic pace post-Labor Day, I think you have to expect a lull. And if you look at just the historical seasonality in the business, you tend to see elevated levels in Q4, people fleeing down the pipeline. It'll leach a little bit into January and February, and then ramps meaningfully through Memorial Day. So if it just followed the historical pattern, I think you would see slightly less activity levels in Q1, and then it would continue to ramp. That said, the phone is still ringing off the hook, and people are very busy, and the activity levels are holding. So while a lot of this is clearly tax-driven and, technically, driven by the market, another big driver that I think people need to recognize is the TTM [trailing twelve months] performance of a lot of these companies is very strong. And for the first time in a very long time, companies that were either looking to sell, or companies that were looking to acquire have very good visibility into positive performance trends, which is somewhat new over the last couple of quarters. And I think that fact, in and of itself, is going to sustain some pretty healthy volumes into Q1 as well.

Troy Ward - Stifel, Nicolaus & Co., Inc.

Finally, how we should be viewing potential equity issuance? Looking at your balance sheet, you're not overly levered. But just all the different things that go into that, how should we look at equity issuance versus debt in the near term?

Michael Arougheti

We never really talked about visibility on capital raising. I will say, one of the things that we're very pleased with is, number one, over the last two quarters, we have been able to show either earnings growth without growing our investment portfolio, or meaningful earnings growth in excess of our dividend while growing the investment portfolio. And in both scenarios, we've been running at leverage levels below our target leverage level. So as far as positioning of the balance sheet and the earnings power of the business, we feel very, very good about it. Equity raises, obviously, have to be done with an eye on what our backlog and pipeline are. But they also have to be done with an eye on opportunistically positioning the balance sheet, not just for the short term but over the medium term and the long term, and doing what's in the long-term interest of the shareholders. And in an environment like the one where we're in now, where we're laser-focused on taking advantage of the debt capital markets to reposition the liabilities side of our balance sheet, equity raises have to come into the conversation, as we're thinking about resetting our debt capital structure. So as Rick mentioned in his comments, I think we will be opportunistic in looking at both the equity and debt capital markets, given the health of those markets. But we'll do it prudently and obviously, always with an eye towards making sure that we're trying to maximize shareholder value.

Operator

.

Our next question comes from Sanjay Sakhrani from KBW.

Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc.

In terms of debt availability going forward from a funding perspective, I thought it was interesting that you guys, as well as your peers, kind of accessed the secured/non-secured market this time around. Do you think this is kind of a trend that we're going to see on a go-forward basis? And I guess the second question is as far as your dividend policy is concerned, I was wondering if you could just help conceptualize how you're thinking about it on a go-forward basis?

Michael Arougheti

Well, number one, I think there's a big difference between accessing secured debt markets versus accessing unsecured debt markets. And I think the answer is somewhat different, whether you're talking about secured debt or unsecured debt. Our goal, as I stated earlier, is to diversify our funding sources, push back duration, get an appropriate waterfall of maturities and do it all while having an efficient cost of capital. Obviously, the more unsecured debt we have on our capital structure, I think the more upward pressure there is to our credit worthiness and our ratings profile, which is one of the reasons why we're focused on it. I think one of the challenges for finance companies in general, not just BDC, is obviously going to be the ability to access the debt capital market. One of the reasons why we pursued the Allied acquisition when we did was to increase our scale and increase our relevance in the market, so that we could continue to diversify our funding sources. So I think the answer is going to be different depending on the company. I think some companies like ourselves and others will continue to access new channels and get deeper into the existing channels. And I think others are going to be very challenged getting efficient access to debt capital. And while we don't wish bad for anybody, I think that will continue to show separation and differentiation. What we are recognizing is it is somewhat binary. I think certain companies are going to able to access senior secured and unsecured debt, and others are going to have a challenge in both markets. And I apologize, the second question was just around our dividend policy?

Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc.

Yes, how you're thinking about it on a go-forward basis.

Michael Arougheti

We've been pretty clear that we think that our business works best and our structure works best when you're running a diversified book of debt investments, and that you're covering your dividends from core earnings per share. I think this quarter, we stepped towards that goal, with $0.38 of core against the $0.35 dividend. We talked about it last quarter, that even though we were underleveraged and shrunk the book, the earnings capacity in the business and the trajectory were positive towards that goal. So as we think about dividend, obviously, we're looking forward as to what we think the potential earnings power of the business can be, given what we're seeing the market and what we are seeing in our own capital raising, and setting the dividend accordingly. But we've been very clear that we think that, as a company and as a sector, we all need to work towards recovering the dividend through operating income. And I think that we've done that while running with fairly low leverage.

Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc.

Back to that first question's answer. I was just wondering, is there a reluctance by banks to want to provide revolvers on a go-forward basis, given all the accounting changes, et cetera?

Michael Arougheti

I think that the capacity in the bank loan market is limited. Now, when I look at what's going on in the landscape, one of the reasons why our business exists, to begin with, is because it's inefficient for large financial institutions and banks to actually access this market directly. It's much more efficient for them to lend investment-grade credit to get better capital treatment and ultimately better ROEs. So while I believe that the capacity is limited today, looking forward, I actually think that it's a fairly high probability that as they continue to look to grow their loan books, which everybody has stated they'd like to, that lending senior secured to investment-grade borrowers like us to, number one, get access to the asset class. But number two, generating attractive ROEs is something that will get more attention. And so as you saw this quarter, we added a number of borrowers to our revolver as we did last quarter. So we're seeing continued interest. But as we sit here today, the market is still fairly limited.

Operator

.

Our next question comes from Faye Elliott from Bank of America Merrill Lynch.

Faye Elliott - BofA Merrill Lynch

Of the investments made in the quarter, how many where in Allied legacy companies versus Ares companies?

Michael Arougheti

I won't pull the exact number of takes [ph] (1:12:12) for you. But just qualitatively, very few were investments into the existing Allied portfolio.

Richard Davis

Yes, Faye, I don't think we had any in existing [indiscernible]

Michael Arougheti

I know one that was $3 million. And there was some revolver activity within the portfolio, but it was a de minimis number.

Faye Elliott - BofA Merrill Lynch

And then what were the nature of the investments in the Ares legacy portfolio?

Michael Arougheti

In terms of asset mix or in terms of the nature of the companies?

Faye Elliott - BofA Merrill Lynch

Nature of the companies. The investment purpose, I guess, or the purpose of that?

Michael Arougheti

The bulk of them, as I mentioned previously, were change of controls, financings or add-on acquisition financing as opposed to refi, restructure or growth capital. So the bulk were to finance change of control buyouts and acquisition activity. And in terms of the nature of the companies, if you look in our press release on Form 8-K, you'll see a description of what the largest investments we made were in the quarter.

Operator

.

Our next question comes from Jasper Burch from Macquarie.

Jasper Burch - Macquarie Research

Just wondering if we could go a little deeper into sort of -- and if you look at the notes that you issued, 3 3/4% [sic] [7 3/4%], I mean that seems really commendable. But then comparing that to your equity cost of capital, I know you're yielding 8% right now, and there's an explication period for your dividend to go up. So how are you approaching your cost of capital, and in terms of optimizing sort of the mix, and how you trade that off compared to any other metrics, like stacking into the maturities, et cetera?

Michael Arougheti

A couple of general comments, and then we can -- if we need to drill down a bit more. But number one, I think the ability for us to access 30-year notes that are callable after five years with the structure that we got is frankly extraordinary. And we're thrilled that we're able to do it, and I think it obviously is a pretty big differentiator. I'm not sure that people fully appreciate the value in the call option there, or just the value for us to be able to match-fund our assets and our liabilities with that kind of duration profile. I hope people do appreciate that. And so when you're looking at the headline rate of 7 3/4%, you can't look at it in any near-term quarterly trade, you have to think about it in terms of long-term value creation. And we think that, that was an extraordinary value creation opportunity for the company. When you look at where it would swap to on a floating-rate basis, if you shorten the duration, while it's a little bit more expensive near-term than our current revolvers, it's not wildly more expensive, given the amount of flexibility, long-term, that we generated. You bring up an interesting point in terms of the cost of equity versus the cost of debt, and it's our job to position the balance sheet for long-term value creation and to make sure that we're in available markets and accessing efficiencies or, better said, inefficiencies where we see them. And one of the interesting things about the capital market now, and this is whether you're talking about an investment grade, corporate or financial borrower or corporate issuer, the markets are not necessarily trading in tandem. And there is a little bit of a dislocation between the equity markets, the unsecured institutional market, the unsecured institutional private market versus the public market, the bank loan revolver market. So I think our job is to have relationships in those markets and be able to issue where we see inefficiency, number one. But we have to do that prudently, because obviously, we're trying to set the balance sheet for long-term value creation and income optimization. So for us, again, we want to be diverse in our funding sources, even if it means it's a little bit more expensive or a little bit less expensive. We want to make sure that we're pushing on our durations. We want to make sure that we're match-funded in terms of our interest rate exposure. So all of that is going into all of our capital-raising decision. But clearly, what we're trying to do is find inefficiencies in various capital markets that meet our needs and go after them.

Jasper Burch - Macquarie Research

Just moving on, also in terms of rotating your portfolio and also looking at the equity interest in getting the Allied portfolio, I'm just wondering if you guys can give a little bit of color on sort of -- obviously, the equity's going to be written up. And what sort of ROEs do you expect on the current equity portfolio, and how you weigh those versus current income and current yielding assets.

Michael Arougheti

We put a very high premium on current yield versus capital gains and equity appreciation. One of the nice things about the Allied acquisition is we got to buy the assets at fair value, and the fair value of those assets as of April one. So we feel good about where we bought these assets. And as we mentioned, up until the end of the third quarter, we exited a number of assets at a net gain position of $1.5 million. And since quarter-end, we've exited additional investments that realized gains of $19 million. So where we are able to, we're exiting our equity positions at gain. Clearly, we have to look at the capital gains opportunity against the ability to redeploy into current yield. But obviously, the volatility of the return profile in equity is much different than the current return profile and total return profile of debt securities. And I'd say, all else being equal, our strong desire is to reduce our exposure to the equity asset class in favor of the debt asset class, and particularly current pay debt.

Richard Davis

So for the most part, we'll continue to see equity sales until you get down to that sort of 10% level and rotation into higher-yielding assets?

Michael Arougheti

Yes, I think that's right. And again, I think our goal over time is to reduce our exposure to control equity in favor of non-control equity that we're investing alongside debt investments as a way to enhance yield without meaningfully changing the risk profile. So even if we get down to 10%, I think the composition of that 10% will be different. The other thing I'll highlight is when you look at Slide 15 in the investor presentation, you see a little bit less success, or rapid success, reducing the equity bucket. Two things, obviously, given the volatility of that asset class and given the capital markets backdrop, there's been some write-ups in those securities as well. So we've actually made more progress and, as probably indicated here, just by looking at the 270 versus the 250. But I think as people probably know, these are private companies that have to go through a process in order to get sold as well. So they are probably the slowest in terms of our ability and disposition, because we obviously need to go in, formulate a strategic view on the company, evaluate a sell decision versus a reinvest or a hold decision. And to the extent that we decide that we are going to sell, we then have to engage advisors and run a process. So those are the longest duration exits for us. But obviously, now that we're six months post-acquisition, our hope would be that we can accelerate our exits in that category.

Operator

.

Our next question comes from Arren Cyganovich from Evercore.

Arren Cyganovich - Ladenburg Thalmann & Co. Inc.

The Senior Secured Loan Program seems to be getting a little bit larger. I just want to understand it a little better. The yield on these notes you have, LIBOR plus 8% means that you're getting a cash yield of 16%. Can you just explain to me what that leverage is going into if we get to 16%? And is restructuring fees that you have included in that?

Michael Arougheti

The restructuring fees are not included in that. The way the fund works, without going into too much detail, because obviously, a confidential product with us and GE, is the contractual rate of our subordinated position in that fund is LIBOR 800. But as the subordinated tranche in the fund, we are privy to all of the excess cash flow in the fund. And so, similar to a moderately levered structured product, to the extent there's excess cash flow, it inures to the benefit of the equity. So that's how you get the difference between the LIBOR 800 and the 17%.

Arren Cyganovich - Ladenburg Thalmann & Co. Inc.

And then the floating-rate securities that you had that's listed in as 26% of the portfolio. Then you said 60% had floors. So is the 26% actually floating now? Or is it more like 40% of that is actually floating right now?

Michael Arougheti

I just want to make sure I understand the question. We're not changing the characterization of a floating rate asset to a fixed-rate asset if it has a floor. So those numbers are actually the floating rate assets. But of those floating rate assets, you could think of the portion with floors as fixed-rate, given where some of those floors are set

Operator

.

Our next question comes from David Chiaverini from BMO Capital Markets.

David Chiaverini - BMO Capital Markets U.S.

My question is on your new investments. It looks like 10 of 19, or a little more than half, were on the non-sponsored side, which seems a little higher than what you normally do. Could you talk about the relative attractiveness of non-sponsored versus sponsored deals in this environment?

Michael Arougheti

Yes, I think as people know, our platform, from an origination and execution standpoint, is broad enough that we're not reliant just on the sponsor channel, but we're actively out originating product direct to companies, and to non-sponsored entities. Obviously they're harder to originate, just because there's less efficiency going through intermediaries in directed companies versus going through sponsors who are serial users of capital. Number two, it's always been our view that where we are coming into a non-sponsored situation as effectively the largest institutional capital provider, that, that obviously comes with a different sets of risks. And therefore, we expect to get paid more in a situation where there is not institutional capital below us, and where we're effectively serving as the sponsor. Those opportunities have been some of the best performers in our portfolio, both on the realized side and what's currently in the portfolio. But again they're hard to find, probably more resource-intensive on an ongoing basis and more risky, and we expect to get paid more. In terms of the activity this quarter though, a lot of the investments into non-sponsored transactions were into existing portfolio companies that were not sponsored. One of the nice attributes of the non-sponsored situation is because you're effectively the institutional capital partner for that company, to the extent that company is growing and has capital needs, you tend to get an opportunity to continue to grow with that company without a competitive process. Whereas even with your best sponsor relationships, they may test your structures or test your pricing. So there's a much stickier relationships, in my opinion, when you finance a non-sponsored company and your relationship with the entrepreneurial owner or the management community is there. But most of what we did this quarter was into existing names like OTG and ABB. So not a lot of new non-sponsored activity in the quarter.

David Chiaverini - BMO Capital Markets U.S.

Do you have a rough estimate of what percent of the debt portfolio is made up of non-sponsored versus sponsored?

Michael Arougheti

Well, it's hard now, post-Allied, because it's skewed it. So I'll just give you a general range. If you look historically at ARCC's business, 65% to 75% of our business has been sponsored versus non-sponsored, and that fluctuates quarter-to-quarter. Now with Allied, where we have a number of investments where we're effectively the sponsor, it kind of skews that number, and it's not necessarily comparable. But generally speaking, given the size of the market opportunity and our position in it, it tends to be in that 65% to 75% range.

David Chiaverini - BMO Capital Markets U.S.

And is your pipeline made up of a similar split?

Michael Arougheti

Yes. Again, it varies from quarter to quarter. But I think on a go-forward basis, that tends to be what you usually expect to see from us.

Operator

.

We have time for one more question. Our final question comes from Jason Arnold from RBC Capital Markets.

Jason Arnold - RBC Capital Markets Corporation

As you mentioned, you witnessed some great gains post-quarter and on your Allied investments. So I'm just wondering if you can offer some additional color here. I guess, particularly, were you more optimistic that these investments were going to give you gains, I guess, relative to others in the portfolio? Just a little bit color there would be great.

Michael Arougheti

On the Allied names in particular, or just generally across the portfolio?

Jason Arnold - RBC Capital Markets Corporation

Allied names in particular, please.

Michael Arougheti

Again, we've talked about the -- this quarter, we've given some more numbers behind the investment fees and in the progress we're making to date on the portfolio. But at a very high level, as we talked about on prior quarters, our view was Allied came with strategic value and economic value. And the strategic value was the ability to grow our balance sheet at a time when we felt that we could have increased competitive relevance and access to the capital markets, and to increase our asset management capabilities with similar benefits. On the economic side, given that we're able to purchase the assets at the price we did, we always felt that we were well-positioned to generate gains, both through sales with gains and rotation of portfolio. I don't think it's lost on anybody, ourselves included, that sometimes it's better to be lucky than good. And our timing was extraordinary, having announced a deal in October and closed it in April. And since both of those dates, directionally, both the economy and the credit markets have been significantly improved. And so we went in, as you would imagine, having unwritten that portfolio and that acquisition with a whole host of potential outcomes. It was always our expectation that even in the worst case, it was going to be an extraordinary value creation opportunity for the company. But given what happened in the broader market, I think we're pleasantly surprised at both the liquidity that we're finding in the portfolio, but as well as the valuation. And that's underpinned, when you look at the economic performance of the portfolio, with both revenue and EBITDA gains in the two quarters since we acquired the portfolio, we're obviously very pleased.

Operator

.

This concludes our question-and-answer session. I would now like to turn the floor back over to our hosts for any closing remarks.

Michael Arougheti

We have no closing remarks other than to thank everybody for spending so much time with us today and in continuing to support us. And we look forward to speaking to everybody next quarter with hopefully more to report. Have a great day.

Operator

.

Ladies and gentlemen, that does conclude our conference call for today. If you missed any part of today's call, an archived replay of this conference call will be available one hour after the end of this call through November 19, 2010 to domestic callers by dialing toll-free (877) 344-7529, and to international callers by dialing +1 (412) 317-0088. For all replays, please reference conference passcode 445047. An archived replay will also be available on a webcast link located on the homepage of the Investor Resources section of our website. You may now disconnect.

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