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Ares Capital (NASDAQ:ARCC)

Q3 2011 Earnings Call

November 08, 2011 11:00 am ET

Executives

Michael J. Arougheti - President and Director

Penni F. Roll - Chief Financial Officer

Analysts

John Hecht - JMP Securities LLC, Research Division

Jasper Burch - Macquarie Research

Richard B. Shane - JP Morgan Chase & Co, Research Division

Joel Houck - Wells Fargo Securities, LLC, Research Division

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

Dean Choksi - UBS Investment Bank, Research Division

John Stilmar - SunTrust Robinson Humphrey, Inc., Research Division

John T. G. Rogers - Janney Montgomery Scott LLC, Research Division

Operator

Good morning. Welcome to Ares Capital Corporation's Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded on Tuesday, November 8, 2011.

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

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

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

At this time, 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 '11 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 call over to Mr. Michael Arougheti, Ares Capital Corporation's President. Mr. Arougheti, the floor is yours, sir.

Michael J. Arougheti

Great. Thank you. Good morning, everyone, and thanks for joining us. I'm joined today by the Senior Partners of Ares Management's Private Debt Group, Eric Beckman, Kipp deVeer, Mitch Goldstein and Michael Smith; our Chief Financial Officer, Penni Roll; and Carl Drake and Scott Lem, who Head our Investor Relations and Accounting teams, respectively.

This morning, we issued our third quarter earnings press release and posted an investor presentation on our website that highlights certain financial data. We'll refer to this information presentation later in our call.

I'd also like to first start with a discussion of recent market trends and how they continue to influence our business and strategy. I'll then highlight key elements of our third quarter performance before turning the call over to Penni, who will take you through our quarterly results in greater detail. Finally, I'll cover our recent investment activity, the state of our current portfolio and update you on our backlog and pipeline before taking questions.

Throughout this year, liquidity in the debt capital markets has ebbed and flowed, often influenced by macroeconomic and political events. Rapidly changing fund flows have influenced loan volume, repayments, pricing and ultimately, the risk-adjusted return opportunity for capital providers. Following slowing inflows into bank loan and high-yield bond funds during the second quarter, the market experienced a sharp reversal during the third quarter, as investors reacted toward increased European sovereign debt issued, the fallout from the U.S. Treasury debt downgrade and signs of slowing economic trends.

The ensuing volatility generally lead to reduced loan and high-yield bond volume, increased credit spreads and more conservative capital structures. For example, according to S&P, third quarter broadly syndicated new issue leverage loan volume declined 57%, and high-yield new issue volume dropped by 70% compared to second quarter levels. Also, during the third quarter, average credit spreads widened by approximately 200 basis points in the broadly syndicated leverage loan market and leverage multiples began to hedge slightly lower. In addition, the S&P/LSTA Leveraged Loan Index declined about 5%, and the Merrill Lynch High Yield Master II Index declined more than 8% during the third quarter.

Our core market, the middle market for leveraged loans, was less volatile during the third quarter, as most investors in our market are buy-and-hold in nature and are less likely to quickly exit investments in reaction to global capital markets events. For example, according to Thomson Reuters' middle market loan index, bid prices declined only 2.2% during the third quarter.

That said, similar to the liquid credit markets, the overall middle market did experience softer loan volumes, wider credit spreads and modestly improved capital structures creating, in our opinion, an improved climate for making new investments. Thomson Reuters also reported that middle market loan volume declined 23% quarter-over-quarter, but remained up 18% versus the same quarter a year ago and sharply higher for the year-to-date period compared to 2010.

So despite softer market volumes, we utilized our scale and flexibility to make attractive debt investments in a number of high-quality companies.

Generally speaking, credit spreads among primary new issues in the middle market increased approximately 100 to 150 basis points in the third quarter. However, in certain situations, lower-rated, higher leveraged credits flexed to levels above that range during syndication processes. Although LBO purchase multiples didn't change materially, total leverage multiples began to decline modestly toward the end of the third quarter, creating improved loan-to-value on new investments.

Interestingly, we saw better relative value at the upper end of the middle market than in the lower end, as a result of volatility in the high yield and broadly syndicated markets and a reduced appetite for syndication risk from investment banks. Accordingly, we found several attractive investment opportunities in larger companies during the third quarter.

To give you a sense of current middle market terms, all-in returns for regular rate senior secured loans are in the high-single digits. Unit tranche loans have climbed into the low-double digits, and second lien returns emerged in the low-teens. Given the supply/demand dynamics in the mezzanine markets specifically, mezzanine returns haven't materially changed from the low- to mid-teens level.

The market is meaningfully differentiating high-quality companies from lower quality ones as evidenced by recent loan syndication activity and the relative performance of loans by rating. In the current environment, we continue to focus on higher yielding, senior unitranche investments given the greater principle protection from the first lien senior secured nature of these loans.

At this point in the fourth quarter, the flows out of loan in high yield funds have either abated or reversed once again based on encouraging U.S. macroeconomic trends and some signs of progress in the eurozone. This has led to a partial recovery in the indices that track secondary bid pricing. The tone in the market remains cautious, but recent events seem to have improved investor confidence. From our standpoint, we continue to review a similar quantity of transactions, and the investment opportunities we are now seeing are more attractive compared to 6 months ago. Our backlog and pipeline remained at healthy levels, as we continue to have strong market visibility in this slower but still active market.

You may have seen that GE and ARCC recently announced an increase in the amount of capital that we have made available through the Senior Secured Loan Program, our joint venture, through which we've been co-investing in unitranche loans. The program has been a success for both firms. And consequently, we jointly agreed to increase the amount of the available capital in the program from $5.1 billion to $7.7 billion.

Our portion of the capital that we have agreed to make available through the program was increased from approximately $1 billion to $1.5 billion. This increase in the program size should further enhance our visibility on transaction flow in the market and improve portfolio diversity.

Now let's turn briefly to our quarterly performance. We're pleased to report an improvement in our third quarter core earnings per share, which increased from $0.34 in the second quarter to $0.43 in the third quarter excluding a $0.01 of Allied acquisition-related fees and expenses in both quarters. Our core earnings were driven primarily by strong investment activity with approximately $1.4 billion in new commitments and $1.1 billion in new fundings. The increase in our commitments primarily reflects a jump in our average commitment size and the opportunity to commit greater dollars in new transactions.

We saw the continued benefit of incumbency this quarter, with over 70% of new investment commitments going to existing portfolio companies. Despite the decline in market activity, we were able to exit nearly $1 billion of investments, either through repayments, loan syndications, refinancings or sales during the third quarter, and these exits included $105 million from the legacy Allied portfolio.

Reflecting the continuing strong performance of certain portfolio investments, we recorded net realized gains of approximately $49 million or $0.24 per share in the aggregate on all exits. These gains bring our total cumulative net realized gains to over $150 million since our IPO in 2004.

The overall quality and performance of our investment portfolio also helped reduce the impact of yield-based valuation adjustments as of September 30. As of the end of the third quarter, we had a debt-to-equity ratio of 0.58x and approximately $684 million of debt capacity subject to borrowing base and leverage restrictions and cash available to us to make new investments. As we'll discuss later in the call, we've been actively making new investments, and we've increased our portfolio further since quarter end.

And finally, reflecting the continued strength in our franchise and core earnings, we declared an increase in our quarterly dividend from $0.35 for the third quarter to $0.36 per share for the fourth quarter.

And now I'd like to turn the call over to Penni Roll, our CFO, for more detailed comments on our financial results. Penni?

Penni F. Roll

Thanks, Mike. For more details on our financial results, I will refer you to our Form 10-Q that was filed this morning with the SEC. To begin, please turn to Slide 3 of the investor presentation posted on our website, which highlights financial and portfolio performance for the quarter.

As Mike mentioned, our basic and diluted core earnings were $0.43 per share for the third quarter of 2011, a $0.09 per share increase over core EPS of $0.34 per share for the second quarter and a $0.05 per share increase over the same quarter a year ago.

Our Q3 '11, Q2 '11 and Q3 '10 core earnings all excluded $0.01 per share of professional fees and other costs related to the Allied acquisition. The increase in our third quarter core earnings per share of $0.09 per share, as compared to the second quarter, was primarily due to an increase in our interest and dividend income and structuring fee income, which was driven by our growth in investment assets and increased origination.

As Mike mentioned, during the third quarter, we made significant commitments totaling approximately $1.4 billion, as compared to gross commitments of approximately $890 million in the second quarter.

We have also exited commitments of approximately $972 million in the third quarter, resulting in net commitments of $458.1 million. Net fundings for the third quarter were $207.1 million. Our total investments at fair value increased from $4.6 billion at June 30, 2011 to $4.8 billion at September 30, 2011.

Our net investment income per share for the third quarter increased to $0.48 per share compared to $0.21 per share in the second quarter and $0.37 per share in the third quarter of 2010. GAAP net income for the third quarter was $0.20 per share compared to $0.18 per share for the second quarter and $0.67 per share for the third quarter of 2010.

Our net investment income and GAAP earnings per share for the third quarter of 2011 were positively impacted by a reduction in the GAAP accrual for capital gain incentive fees of $0.06 per share. This reduction primarily resulted from the third quarter's net unrealized depreciation, which decreased our cumulative net realized and unrealized capital gain position under GAAP. Comparatively, in the second quarter of 2011, the GAAP accrual related to capital gains incentive fees was $0.12 per share, which reduced net investment income and GAAP earnings per share. As of September 30, 2011, there continues to be no capital gain incentive fee payable to our investment advisor under the advisory and management agreement.

Net realized and unrealized losses for the third quarter were $0.28 per share compared to $0.03 per share in the second quarter. Net losses for the third quarter of 2011 included $0.24 per share of net realized gains, offset by $0.52 per share in net unrealized losses. Net unrealized losses included net unrealized depreciation of $0.33 per share and the reversal of net unrealized appreciation related to net realized gains of $0.19 per share.

At September 30, 2011, our total assets were $5 billion, and our total stockholders equity was $3.1 billion, representing an NAV per share of $15.13. Our investment portfolio was approximately $4.8 billion at fair value and included 141 portfolio companies, which represented a net reduction of 7 portfolio companies since June 30. Our portfolio continues to reflect the higher percentage of senior secured debt, and as of quarter end, our portfolio at fair value was comprised of approximately 54% of senior secured debt securities, up from 49% at the end of the second quarter, with 38% in the first lien and 16% in second lien debt investments. Also, we had 17% in the subordinated certificates of the Senior Secured Loan Program, the proceeds of which were applied to co-investments with GE to fund first lien senior secured loans, 11% in senior subordinated debt, 5% in preferred securities, 11% in other equity securities and 2% in CLO investments.

Now I would like to walk you through the changes in our yields and investment spread for the quarter. From a yield standpoint, our weighted average yield on debt and income-producing securities and amortized costs decreased from 12.5% to 11.9% quarter-over-quarter, primarily reflecting slightly lower yields on new investments funded compared to investments exited during the third quarter. However, based upon our new investments funded relative to the investments exited since September 30 and through November 4, the yield on new debt and income-producing investments was higher than the yield on similar investments exited or repaid, as Mike will address later.

Our weighted average stated cost of debt capital decreased slightly from approximately 5.1% to just under 5% quarter-over-quarter, as we financed our net investment growth with our lower cost revolving credit facilities. As a result of these changes in yield and cost of debt capital, our weighted average investment spread declined from 7.4% to 6.9% quarter-over-quarter.

Of course, the spread will vary from period to period depending on the level of assets spreads available for new investments and the amount borrowed under our lower cost revolving credit facilities. I would also like to point out that the yield on our debt and income-producing securities and therefore, our weighted average investment spread does not take into account the higher level of fees we've been able to generate in the current market nor the potential benefit of higher interest rates that was embedded in our asset and liability position as of the end of the third quarter.

On Slide 6, we have set forth our fixed and floating rate assets and our non-accrual statistics. Overall, our floating rate debt assets on a combined portfolio basis at fair value increased from 57.5% in the second quarter to 64.6% in the third quarter, and our fixed rate debt assets declined from 24.8% to 21.2% over the same period, reflecting our continued emphasis on investing in senior floating rate assets. Overall, we believe our portfolio credit quality was stable and remained healthy.

The core ARCC Portfolio non-accruals as a percentage of the combined portfolio decreased from 1.9% and 0.6% at cost and fair value, respectively, at the end of the second quarter to 1.4% and 0.4%, respectively, at the end of the third quarter. The legacy Allied portfolio's non-accruals increased as a percentage of the combined portfolio from 1.6% at cost and 1% at fair value to 2.6% and 1.2%, respectively.

The combined portfolio's total non-accruals on a cost basis modestly increased quarter-over-quarter from 3.5% to 4%. They remained unchanged on a fair value basis at 1.6% for both the second and third quarters. The legacy Allied portfolio experienced 2 portfolio companies placed on non-accruals, offset by the exit of 2 core ARCC non-accruals. Therefore, on a net basis, there was no change in the number of investments on non-accruals.

Now I turn to Slide 9 for more detail behind the net gains and losses for the quarter. As Mike stated, we had a successful quarter of positive realizations on our prior investments. Net realized gains totaled $48.8 million, as we exited several successful core ARCC equity co-investments namely, DSI Renal, Industrial Container Services and Reflexite. We reversed unrealized appreciation of $39.3 million when these net gains were realized.

On an unrealized basis, we recognized $67.2 million of net unrealized depreciation. The net unrealized depreciation resulted from a combination of debt yield valuation adjustments and some performance-related write-downs net of performance-related write-offs. In total, our net unrealized and unrealized losses for the third quarter totaled $57.7 million.

Now turning to Slide 10. As of September 30, we had approximately $2.5 billion in committed debt facilities and approximately $1.9 billion in aggregate principal amount of indebtedness outstanding. The weighted average maturity of our outstanding indebtedness was 10.6 years with a weighted average stated interest rate of just under 5%. On this date, we had $383 million outstanding under our $400 million revolving funding facility and $189.8 million drawn under our $810 million revolving credit facility.

We also had available unrestricted cash on hand of approximately $91 million at the end of the quarter. In total, we had approximately $684 million in available debt capacity subject to borrowing base and leverage restrictions and cash available to make new investments. In addition, after quarter end, we increased the capacity under our $400 million revolving funding facility by $100 million to $500 million. We continue to explore various options to further increase our committed debt capacity although there can be no assurance that we will be successful.

At September 30, 2011, our debt-to-equity ratio was 0.58x, and net debt to equity ratio net of available cash and cash equivalents was 0.55x. This compares to a net debt to equity ratio of 0.49x at the end of the second quarter.

Now I will turn the call back over to Mike.

Michael J. Arougheti

Great. Thanks, Penni. I'd like to start off by discussing our recent investment activity, update you on our portfolio and highlight our post quarter-end investments and backlog and pipeline before concluding.

If folks could turn to Slide 14, you'll see in the third quarter, we invested approximately $1.1 billion, with over 70% of our funded investments made to existing portfolio companies either through a change of control, an add-on acquisition or refinancing or recapitalization. We've often talked about our strategy of leveraging our incumbent lead investor positions to drive additional deal flow, and I believe this quarter's investment activity illustrates the effectiveness of this strategy.

It's often preferable to underwrite an existing portfolio company, given our experience with a particular borrower. And in doing so, we believe we can enhance credit performance given the deeper knowledge we have obtained of the company's market position, operations, historical performance and franchise value. We made 20 commitments this quarter, 11 to existing portfolio companies, 5 to new portfolio companies and 4 to companies through the Senior Secured Loan Program. We also leveraged our scale and took advantage of the opportunity in the upper middle market to increase our average new commitments to over $70 million in the third quarter compared to just under $50 million for the second quarter.

Turning to Slide 15. You can see that 65% of our investment commitments during the third quarter were in senior secured debt and another 4% were to the Senior Secured Loan Program, through which we co-invested with GE in senior secured floating rate debt. The balance of our investments were in second lien investments and a junior capital investment structured as a cash pay preferred equity investment. On the right side of the slide, you'll see that our exited investments by asset category were similar to our new investments, 63% in senior secured debt, 12% in second lien and 9% in equity and other securities.

Of the $972 million in commitment exits and repayments during the third quarter, we control the exit either through a loan syndication or an ARCC-lead refinancing on over 70% of that total. Hopefully, this illustrates our capability to generate significant liquidity by leveraging our lead investor and incumbent positions. And also, as we discussed last quarter, our ability to underwrite and distribute in certain situations can lead to higher fee income, improved returns and enhanced portfolio optimization.

On Slide 16, you'll see an update on our progress repositioning the legacy Allied portfolio from April 1, 2010 through the end of the third quarter, a 1.5 year since we closed the acquisition.

On a fair value basis, the size of the total legacy Allied portfolio stood at $859 million at the end of the third quarter or approximately 18% of total investments, down from $1.83 billion or approximately 45% of total investments on the April 1, 2010 acquisition date. The reconciliation at the bottom of the slide shows that we have received over $1.2 billion in cash from exits or repayments of investments in the legacy Allied portfolio, including net realized gains of approximately $124 million and net unrealized appreciation of about $42 million for a total net realized and unrealized gains of approximately $82 million since the Allied acquisition. Keep in mind, these total net gains to date do not take into account the roughly $130 million purchase accounting gain we previously recorded on these investment assets to reflect our purchase of the Allied assets below fair value.

Also shown on the slide, we've made progress by significantly reducing non-accruing investments by over 80%, substantially reducing lower yielding investments and increasing the yield on the remaining portfolio. We continue to focus on exiting the $183 million in legacy Allied equity investments, which yield about 0.4%, and we're currently exploring strategic options to exit a number of the remaining legacy Allied equity investments. Of course, there can be no assurance that we'll be able to exit these investments.

Now turning to Slide 17. On a combined basis, the underlying portfolio company weighted average last dollar net leverage decreased moderately from 4.4x as of the second quarter to 4.3x as of the third quarter, reflecting our emphasis on investing in senior secured debt. Our overall weighted average interest coverage declined slightly, but remains at a healthy 2.5x. At the end of the third quarter, the underlying borrowers within the Senior Secured Loan Program had a similar weighted average total net leverage multiple of 4.4x, but a more conservative weighted average total interest coverage ratio of 3.1x.

On Slide 18, you can see that we generally invested in larger companies, with just over $44 million in weighted average EBITDA during the third quarter. The overall weighted average EBITDA of the companies in our combined portfolio increased from just under $38 million to over $41 million.

Now skipping over Slide 19 to Slide 20. You'll see there that the portfolio remains well diversified by issuer. Our largest investment at quarter end continue to be in the Senior Secured Loan Program, which was approximately 17% of the portfolio at fair value at the end of the third quarter.

Within the program, there were 25 separate borrowers, and the program continued to have no non-accruing investments as of September 30. The largest single issuer in the program represented about 8% in aggregate principal amount of total investments.

Please turn to Slide 23 for a summary of the grades for the core ARCC and legacy Allied portfolios. As a reminder, each portfolio is graded on a scale of 1 through 4, with an investment grade of 1 defined as having the greatest risk to our initial cost basis and a grade of 4 having the least amount of risk to our initial cost basis.

Each investment is initially graded a 3 at the time of investment or acquisition. On a combined basis, the portfolio experienced 2 ratings upgrades and 7 ratings downgrades. However, 6 of these 7 downgrades reflected a change from a 4 to a 3 rating, and 5 of those were triggered by a realization on an underlying portfolio company investment. Only one downgrade was to a rating falling below a 3. In the aggregate, as of September 30, the weighted average grade of the entire portfolio decreased from 3.1 at the end of the second quarter to 3, primarily the result of our exiting a number of 4-rated credits.

Now to give you a little information on how the companies in our combined portfolio are performing in this slow growth economy. Weighted average revenue and EBITDA growth remain strong at approximately 10% and 12%, respectively, on a comparable basis for the year-to-date period versus the same period last year. These growth rates are relatively unchanged compared to the numbers we shared with you last quarter.

On Slides 25 and 26, you'll find our recent investment activity since quarter end and our current backlog and pipeline. As of November 4, we had made additional new commitments of approximately $537 million, of which $532 million were funded since September 30. Of these new commitments, 57% were in first lien senior secured debt, 29% were investments in the subordinated certificates of the SSLP, 12% were in second lien senior secured debt and 2% were in equity securities. The overall weighted average yield of debt and income-producing securities funded during the period at amortized cost was 12%. We may seek to syndicate a portion of these commitments to third parties, although there can be no assurance that we will do so.

As of the same date, since September 30, we had also exited $183 million of investment commitments, of which $56 million were from the legacy Allied portfolio. Of these investments, 80% were first lien senior debt, 17% were in second lien senior debt and 3% were in senior subordinated debt. Of this amount, 17% were on nonaccrual status.

Since the weighted average yield on debt and income-producing equities exited or repaid was 9.4%, we picked up about 260 basis points of incremental yield on the new investments compared to the investments repaid or exited since September 30. And on these exits, we recognized $21 million in net realized losses in total, substantially all of which were associated with non-accruing investments from the legacy Allied portfolio.

As shown on Slide 26, as of November 4, our total investment backlog and pipeline stood at $140 million and $340 million, respectively. As you know, we can assure you that we will make any of these investments, and we may syndicate a portion of these investments as well.

So I'd like to conclude with a few thoughts on our third quarter and our outlook. In our view, our performance for the third quarter illustrates the core earnings capability of our business, particularly when our new investment activity is robust, as it was this past quarter. We're pleased that we're able to provide shareholders with an increased the dividend, reflecting the strength in our core earnings and investment performance.

As you may recall, we carried over $64 million or approximately $0.32 per share of undistributed taxable spillover income from 2010 for distribution in 2011, which provides further support for the dividend. We believe our portfolio remains in solid condition, demonstrated by the revenue and EBITDA performance, the comfortable leverage in interest-covered statistics, the relatively low and stable trends in non-accruals and our continuing progress with respect to the legacy Allied portfolio.

We further believe that our balance sheet is in solid shape, as our weighted average debt maturities are over 10 years, and 65% of our debt consist of fixed rate, unsecured funding against predominantly floating rate assets. Also, we continue to obtain additional debt capital commitments, as evidenced by our recent revolving funding facility upsize.

As for the market environment, we believe that risk adjusted returns have improved considerably since the beginning of the year. For example, expected returns on new senior unitranche debt investments are now generally higher by 200 basis points compared to 6 to 9 months ago. We continue to benefit from our strong market position, origination and scale and our incumbency across over 500 portfolio companies, including those managed by our wholly-owned portfolio company, Ivy Hill Asset Management.

That said, given macroeconomic uncertainty and recent global capital markets volatility, we'll continue to remain defensively positioned, with investments in high-quality, franchise businesses. And on a longer-term basis, we continue to believe that there remains a significant opportunity in our core market for non-bank capital providers with scale. There are a number of long-term factors that we expect will drive the need for additional capital in the middle market.

The requirement for new capital created by maturing debt, uninvested private equity dollars requiring debt financing, declining funds available for reinvestment in the CLO system and increasing bank regulation under Basel III and Dodd-Frank, just to name a few. We believe that with our scale, flexibility and origination in portfolio management infrastructure, we are uniquely positioned to take advantage of these opportunities as they develop.

We thank you for your time and support today, as always. And with that, operator, we'd like to open up the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question we have comes from Rick Shane of JPMorgan.

Richard B. Shane - JP Morgan Chase & Co, Research Division

When we look at our model, I think the one area of variance that we don't necessarily know how to model going forward was the increase in dividend income that went through the P&L this quarter. When I look at it, it looks like control affiliate dividend income, which I assume is SSLP, was pretty flat, and it looks like the increase was in non-control, non-affiliate dividend income. Am I right in concluding SSLP was flat on a sequential basis? And can you help us characterize the dividend that you -- the increase in dividend that you received non-control, non-affiliate this quarter? Is it recurring? And also, is it a semiannual dividend? So as we look at it going forward, we make sure we model it correctly.

Penni F. Roll

Yes, Rick. It's Penni. We had a new investment come into the portfolio this quarter that was partly structured as a preferred security, that has a coupon on it. So that increase in dividend income will be more of recurring, with respect to that investment. You'll see that going up going forward. Otherwise, we continue to have the other dividend, so we have primarily the dividend that comes from Ivy Hill Asset Management running through there. So given the structure of that, that is a preferred security. We did put that recurring income through the dividend line instead of the interest line.

Richard B. Shane - JP Morgan Chase & Co, Research Division

Got it. And Penni, just a quick follow-up. There weren't any structuring fees that ran through that, so it's good run rate that we're looking at? And just want to confirm, it's a quarterly dividend, not a semiannual?

Penni F. Roll

Yes. It is a coupon that accrues very similar to a debt security, but it just happens to be on a preferred security.

Operator

And the next question we have comes from Dean Choksi of UBS.

Dean Choksi - UBS Investment Bank, Research Division

Mike, I believe you mentioned that you effected 70% of exits in the quarter. Can you just provide a little more color on what you can do as the senior loan holder and kind of how you think about those rights going forward?

Michael J. Arougheti

I'm sorry, Dean. Just to clarify, the exits in the third quarter or the exits since the end of the third quarter?

Dean Choksi - UBS Investment Bank, Research Division

Whichever you referred to at the 70%.

Michael J. Arougheti

Sure. Got it. We spent some time on last quarter's call just discussing a strategy of underwriting and syndication. And as I mentioned in our prepared remarks, you get a couple of benefits when you get to scale and you develop distribution capabilities. Number one is I think you see more of the market. Number two, in periods of volatility when the investment banks retrench and really aren't active underwriting and syndicating, we can come in and benefit by providing some very attractive capital to larger companies that may otherwise have gone for a distributed product. When you control that underwriting and that distribution, you obviously have much more influence and control over the structuring and pricing of that security. You have the ability to participate much more fully in the underwriting and due diligence. And as we talked about, it gives you the ability to create liquidity with certain flexibility by either syndicating that the security itself or as we walked through on last quarter's call, the ability to sell in certain cases a first-out security to enhance the yield on your final hold and really optimize the portfolio from a risk-adjusted return standpoint. So what we saw in the third quarter in particular was this retrenchment on the part of some of the larger underwriters. We used our scale to take advantage of it by providing loans to companies that we felt were of an extraordinarily high quality. And given our scale, we were able to effectively take down the entire capital structure of those companies and then through the quarter, distribute that risk into the market either within that security or by creating new securities to benefit the portfolio. That's always been a part of our strategy, as we talked about. But it gets amplified when we're in periods of extraordinary volatility like we were in the third quarter.

Operator

The next question we have comes from John Stilmar of SunTrust.

John Stilmar - SunTrust Robinson Humphrey, Inc., Research Division

I guess touching on that same point of syndication. It seems like last quarter, we were talking specifically about the investment of Anthony Inc, and I think it was like $245 million. I was wondering, if it's not too sensitive, if you could walk us through the story of that investment over the quarter and how it relates to -- it seems that you're paining [ph]. And if you can't go into that specific investment, maybe talk about your opportunities with the investment, some of the larger investments that you made that might look like that this quarter, and whether you're thinking about syndicating almost all of it or whether you're thinking about restructuring as a last out and what are some of the other criteria that might go into making that decision under today's environment.

Michael J. Arougheti

Sure. We can't speak specifically about any loan. So again, I'll reiterate. If you think about syndication just for syndication's sake, we do benefit by increasing our fee income. But in and of itself, that doesn't drive the value proposition. Again, the value proposition is in accessing the investment opportunity, controlling the structuring of that investment opportunity, and then having the flexibility either within the quarter or over time to manage the liquidity on balance sheet by distributing risk. I think one of the unique things that we offer as a platform is the origination capability. And even in a slow quarter, at least relative to the second quarter, we were able to demonstrate through the origination infrastructure and the incumbency that we can continue to originate very attractive loan securities. And so, that liquidity is available to us because we are seeing loans and able to invest in companies that other people aren't able to access. And so, there's really no single answer or single strategy, John. It's a function of looking at the quality of the underlying borrower, the yield we're getting on that bar relative to the risk that we're taking, and then evaluating the liquidity needs on the balance sheet on an ongoing basis. So when we're syndicating, you'll see us to syndicating to SSLP from time to time. You'll see us selling to Ivy Hill from time to time. You'll see us selling to third-party market participants and that may happen, again, prior to us closing or it could happen 6 or 12 months after as we to continue to refine the portfolio. So I wish there was a simple answer, but there's really not.

John Stilmar - SunTrust Robinson Humphrey, Inc., Research Division

That's a perfect clarity. And then my second question has to do with capital. And it seems like in the public markets, we can see either BDC IPOs or secondary offerings for raising capital. How is the middle market in terms of capital raising from something we may not see but you might have a vantage point in, in terms of sourcing, private sources of capital that might come into the market? And has that changed some of the dynamics in how you're investing today?

Michael J. Arougheti

Sure. I think one of the long-term CC's around this sector and this asset class has always been a difficulty in capital formation, both in the private market and the public market, and that has not changed. So while we are seeing an increase in global investor demand for credit, and in many cases, private credit because, as I mentioned, you're accessing collateral that you can't otherwise find. I think the challenges of capital raising are as real as ever. I think that those challenges benefit scale platforms like Ares, because the reality is as a private investor looking to access this asset class, I think has looked at the experience of the sector and looked at the experience of the collateral, and figured out that origination breadth and access to high-quality investments, deep portfolio management infrastructure, distribution capabilities, all of those lead to outperformance. And so, where we're seeing capital formation in the private market, it's behind larger incumbents, but we're not seeing a real willingness on the part of the private markets or frankly, the public markets as you know, to support new entrants without meaningful track record and meaningful scale.

Operator

The next question we have comes from Joel Houck of Wells Fargo.

Joel Houck - Wells Fargo Securities, LLC, Research Division

I'm wondering if you may be able to disclose the coupon fees and IRRs for the capital you put out in the third quarter by senior unitranche and sub debt?

Michael J. Arougheti

We cannot, but I can tell you generally, as we talked about in my remarks, Joel, when you look at what we've put out since the end of the quarter, the weighted average yield was 12% across the $500-plus million that was put out between September 30 and November 4, and that excludes fees. And as we've talked about, fee income is higher in this current market environment than it has been in quite some time. We continue to see market dislocation offer us investment opportunities, as we mentioned on the prepared remarks, that are at least 150 to 200 basis points wider than where they were 6 months ago. And despite some stabilization here, week to week, we don't expect to have to give any of that back. So as a general comment, my expectation is that the backlog and pipeline, once funded, will evidence a spread that is in excess of what we've done quarter to date and also our current weighted average spread.

Joel Houck - Wells Fargo Securities, LLC, Research Division

Okay, that's helpful. And then another question on the -- how should we think about or how do you guys think about how much cash or capacity you need to kind of reserve for your unfunded commitments of $537 million as of November 4? Obviously, you have many issues to syndicate some of that, not all of it will close. But how do you think about how much capacity you have to save for that?

Michael J. Arougheti

Yes, it's something that we, as you would imagine, look at daily. And when we look at the unfunded, it's a combination of traditional revolving credit facilities, with borrowers that we have a significant amount of experience with, in terms of their drawing needs and the cycles of their own business month to month. A large portion of it is delayed draw or acquisition pipelines, with a specified use of proceeds where we have pretty good visibility into the utilization of those lines on a go-forward basis. And as you know, we've talked about this in prior quarters, a portion of it as well is net of unfunded commitments where we have discretion over whether or not those lines get utilized. So I can't give you a specific number, but we're looking at it all the time. Some of that makes its way through the backlog and pipeline on a quarter-to-quarter basis when we're quoting numbers in the backlog and pipeline, often times, it will include drawings under some of those facilities, just based on an acquisition or a meaningful capital expenditure within the portfolio. But it is something that we have to factor in when we're talking about liquidity. That's one of the reasons that we do run at the leverage levels that we run just to make sure that we have adequate cushion on the balance sheet to continue to meet those obligations.

Joel Houck - Wells Fargo Securities, LLC, Research Division

Okay, and then last question. In your 10-Q, I think you guys -- there's a new disclosure with respect to Safe Harbor. With respect to an eligible portfolio company, you guys are now calculating senior loan funds [ph] if it's a non-qualifying asset, based on, I guess, the concept release [ph] of the SEC. But what is -- if you had specific comments of the SEC, what's the risk that they would force you to consolidate the senior loan fund on balance sheet? And the reason I ask that is all of the other BDCs have basically been restricted from off balance sheet leverage. So there is something unique with Ares, whether it's an understanding with the SEC or is there something unique with the specific program with the GE unitranche fund?

Michael J. Arougheti

Sure. I can't comment specifically on other people's conversations with the SEC or our own. What I can tell you, number one is that the disclosure is not new to this quarter, Joel. The disclosure started, I believe, last quarter or if not, 2 quarters ago. We disagree with the SEC's position with regard to eligibility. But again, an abundance of caution, we're managing our 30% basket as though the SEC were right, and that is an ongoing dialogue. And as I think many people know there was a request for comment on this and other related issues that is in process. And I think after that process is completed, there will be hopefully more clarity one way or the other. And without getting into details, we don't believe and we've never had anybody tell us that the Senior Secured Loan Program is leverage. It's a joint venture between ourselves and GE with all sorts of strategic benefits and administrative benefits, both for us and for GE. So again, I can't comment as to how our experience managing this program now over 2.5 years, with multiple registration statements and financial statements, impacts other peoples strategic decisions or what structures they're looking at. But obviously, we continue to believe that the structure is appropriate, and we have not consolidated nor do we have anybody at the SEC or the accounting profession tell us that it should be.

Operator

The next question we have comes from Greg Mason of Stifel, Nicolaus.

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

Mike, on Slide 5 of your presentation, we've seen the average yield on your debt investments and costs go from upper 13% as of last year to now down to 11.9% as you focus more on senior secured assets. What's your expectation for the overall portfolio yield going forward? How much more kind of compression do you think there's going to be in that line?

Michael J. Arougheti

It's always a function of the risk you're taking. So if you look at Slide 5, I think you also have to look at it in conjunction with the slide that shows our weighted average leverage and coverage statistics. And we've been able in what was a frothy environment to maintain credit quality. In a very low interest rate environment, we've been able to effectively maintain yield. And the total return proposition, as I mentioned earlier, shows up in other ways like OID and fee income, et cetera, et cetera. So I think spread is obviously very important, and you have to stay focused on the net interest margin, but there are other components of the total return that hopefully is not lost on people. As I talked about a couple of minutes ago, when we look at the current market environment and the types of yields that we're generating, particularly against the fact that those investments are getting funded with our lower cost revolving credit facilities. All else being equal, our expectation is that we shouldn't see more compression and that, in fact, that should reverse itself.

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

And then to follow up on that comment on using the credit facilities. I think you've outlined in the past that you want to utilize the credit facilities as more of a short-term financing until you build up a large amount of those, and then convert those into a longer term debt funding source. Is that still the idea with those credit facilities? And if so, what's the outlook for different debt opportunities for you in the CLO market or other long-term debt?

Michael J. Arougheti

Yes, the markets are constantly moving. I think we have a demonstrated track record of accessing market windows when they're open and when they're open at attractive pricing and structure. And so that should not change. Interestingly, as we saw post quarter end, we were able to upsize our revolver, and that's a market that we're seeing increasingly open to us, whereas given some of the issues facing the banking community, that market was probably less open to us 6 or 9 months ago. And so you have to be constantly in those markets dialoguing with investments and market participants to figure out where the most efficient capital is. As a long-term strategy, you're right. Our preference is to continue to push out duration on our liabilities to the extent that we can and to the extent that we can do it cost effectively. And that's always just a function of what's available in the market and obviously, looking at the structure of the asset side of our balance sheet as well. So without going through each market specifically, I believe that all of the markets that we could borrow in are open to us today at a price, and for us really, the challenge and the task is to make sure that if we are looking at the debt capital markets that we're going to the right market at the right time with the right asset mix to, again, maintain the net interest margin.

Operator

The next question we have comes from Jasper Burch of Macquarie.

Jasper Burch - Macquarie Research

You just mentioned how leverage is at least somewhat contingent on the asset side of your balance sheet. Looking at leverage is 0.55x quarter end. Pro forma of the investments post quarter end, it's probably closer to 0.66 which is kind of in that c-spot range that you cited in the past of 0.65x to 0.75x. I was wondering if you could give us a little more color on to your appetite for leverage, how comfortable you are bringing up leverage considering as you're moving into more senior secured loans -- senior secured securities, sorry, also, how you're weighing leverage against your equity cost of capital and growing the balance, in growing the portfolio.

Michael J. Arougheti

Sure. So with regard to leverage, I think we talked about this last quarter as well. Our appetite or willingness to leverage the assets that we have on the balance sheet is significantly in excess of the regulatory restriction. And as we've talked about, we're, not for that, we would be comfortable running at higher leverage. So the 0.65x to 0.75x range that we continue to talk about has everything to do with prudent balance sheet management and managing regulatory risk, as opposed to a view on the quality or the risk of the underlying assets. So that said, particularly when you're in volatile markets, you're going to see us running less levered or trying to run less levered than more levered in order to manage that risk. With regard to equity and debt, you bring up a good point. Again, building off of Greg's question, when we're looking at the capital markets, the question is, can we invest dollars accretively against new capital raises either equity or debt? And I think what we do well is we have good visibility into all of the markets available to us, equity or debt, public or private, and we're constantly looking at where the most efficient place to raise capital is, if the capital is needed to continue to grow the balance sheet and grow the core earnings of the business. So again, I can't give you a simple answer that says, we'd always rather raise debt than equity, it's all about relative cost and relative benefit at any point in time. What you do see, particularly in volatile markets, is inefficiencies pop up where one market in particular, just given us supply/demand imbalance, is mispriced. And it's our responsibility to identify where that inefficiency is and make sure that, that's the market that we access. I think, for example, we did that well with our convertible issuances earlier in the year.

Jasper Burch - Macquarie Research

Okay. that's helpful. And then, on a different topic, looking at your core earnings, after backing out the incentive fee reversal and sort of what we consider above run rate structuring fees. It's still looking like your core earnings is at least a couple cents above the $0.36 dividend. I was wondering if you could give us a little more color on your or the board's thinking on what run rate earnings might be, and what sort of the outlook is on growing the dividend towards that?

Michael J. Arougheti

Sure. I think at a high level, your calculation is right. And as we've talked about time and time again, I think it's important to put dividend stability and dividend predictability above dividend growth. And when we look at the issues that I think plagued our sector historically, it was irresponsible dividend policy. And so, as a management company and a board, we're very focused on making sure that where there are dividend increases that they're measured, and that they do come from a place of predictability and stability. But what we've been communicating really since the Allied acquisition is that both through the rotation of that portfolio and the re-leveraging of the balance sheet that there was a meaningful opportunity to grow core earnings. And as we've begun to talk about through this year given some of the balance sheet initiatives that we accomplished at the end of the last year and earlier this year, going into a market dislocation, we continue to believe that there's growth opportunity within the business. So again, our policy and strategy has always been, I think, one of conservatism and making sure that the dividend is well covered from core earnings. I think we are in the position now, as I mentioned in the prepared remarks, given the spillover income from last and into this year, we have further comfort and further confidence from which to have raised the dividend this quarter, and we'll see how things develop.

Operator

The next question we have comes from John Hecht of JMP Securities.

John Hecht - JMP Securities LLC, Research Division

Mike, you talked about that during the third quarter, large banks exited the high yield markets. I guess they were concerned about syndication risk. We've seen a little bit of recovery in the markets since the end of the quarter. Are big banks willing to take on syndication risks? And I guess at the high-level what I'm asking is you're talking about 200 basis points widening since the quarter. Is that sticky? Or is there upside to that? Or is that going to ebb and flow based on the large bank behavior?

Michael J. Arougheti

I think it's going to ebb and flow based on large bank behavior and fund flows into bank loan funds and high yield funds. I think the markets have stabilized over the last couple of weeks, but I would not say that they have healed necessarily. Banks are still effectively out of the market. And where there is a willingness to underwrite and distribute it tends to come with significant flex. I think the one difference now is I think people have a much better view as to where assets will clear than they did 6 weeks ago. But the risk appetite hasn't necessarily changed, because I think despite some stability here in the last 10 days, I really don't think that the level of confidence is back on the part of the banks to meaningfully take balance sheet risk. So you'll see -- through the end of the year, I think you'll see some pockets of willingness to take risk on balance sheet. But as a general rule, I wouldn't expect much a lot of it. And where they do, I'd expect to see meaningful flex and wide spreads.

John T. G. Rogers - Janney Montgomery Scott LLC, Research Division

Okay. And then of your exits, it sounded like 70% were syndications and sales. Does that mean of the excess of 30% is just sort of a core repayment level that we should think about? Or what's your expectations for just typical repayment trends at this point?

Michael J. Arougheti

Yes. I don't know what the number is including this quarter, but my recollection is our historical natural repayment rate was roughly 30% to 32%. So seeing a 30% annually -- so seeing a 30% number x active syndications is probably a good sense. Our historical experience has been depending on the M&A environment and the capital markets environment, somewhere between a 3- to 4-year average life on our collateral. So 25% to 30%.

Operator

It appears that we have no further questions at this time. We'll go ahead and conclude our question-and-answer session. I would now like to turn the conference back over to Mr. Arougheti for any closing remarks. Please go ahead, sir.

Michael J. Arougheti

Nothing other than to again thank everybody for spending the time with us this morning and for their continued support. We appreciate the dialogue, and we look forward to talking to everybody next quarter.

Operator

And we thank you for your time, sir, and also to the rest of the management. And 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 approximately 1 hour after the end of this call through November 23, 2011, to domestic callers by dialing (877)344-7529 and to international callers by dialing area code (412)317-0088. For all replays, please reference account number 10004438.

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