Ares Capital Management Discusses Q4 2011 Results - Earnings Call Transcript

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 |  About: Ares Capital (ARCC)
by: SA Transcripts

Ares Capital (NASDAQ:ARCC)

Q4 2011 Earnings Call

February 28, 2012 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

Arren Cyganovich - Evercore Partners Inc., Research Division

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

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

Joel Houck - Wells Fargo Securities, LLC, Research Division

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

Fla Lewis - Weybosset Research & Management LLC

Operator

Good morning. Welcome to the Ares Capital Corporation's Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded on Tuesday, February 28, 2012.

Comments made during the course of this conference call and webcast and the accompanying documents contain forward-looking statements and are subject to risks and uncertainties. Many of these forward-looking statements can be identified by the use of 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, 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 Q4 Earnings 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.

Michael J. Arougheti

Thank you, operator, and good morning to everybody and thanks for joining us today. This morning, we issued our fourth quarter earnings press release and posted a supplemental earnings presentation on our website that highlight certain financial data. We'll refer to this presentation later in our call.

We're pleased to report record fourth quarter core earnings per share of $0.48. For the full year, our 2011 core earnings per share increased 9.1% from 2010 to $1.56. This compares to dividends paid in 2011 of $1.41 per share, representing the strong dividend coverage from core earnings. We also earned $1.56 in 2011 GAAP earnings per share, and our net asset value increased from 2010 by approximately 3% to $15.34 per share.

We also earned meaningfully more taxable income than we distributed again in 2011. As you may recall, we carried over approximately $64 million or $0.32 per share from 2010 for distribution in 2011. Subject to finalization of our 2011 tax returns, we currently estimate that our undistributed taxable income carried over from 2011 into 2012 is approximately $170 million or $0.77 per share. Therefore, in light of among other factors, our 2011 core earnings performance, our view on our core earnings power going forward and the estimated size of our excess undistributed taxable income carry forward, we have elected to increase our quarterly per share dividend from $0.36 to $0.37. Penni Roll, our CFO, will provide more detail on our results a little bit later in the call.

Now I'd briefly like to highlight recent changes in the market environment. At the time of our last call in early November, markets were reflecting significant uncertainty, driven primarily by euro sovereign debt and global economic growth concerns. On that call, we also highlighted that despite the volatility, the market environment might present us with attractive investment opportunities. Specifically, the ability to provide full balance sheet solutions for larger, high-quality middle-market borrowers, as many large investment banks were unwilling to take underwriting and distribution risk. As we'll discuss later in the call, we took advantage of these opportunities by making approximately $853 million in gross commitments at an attractive weighted average yield on debt and income producing securities of approximately 12.5%.

Since that time, investor sentiment and market tone have steadily improved and capital markets volatility has eased, primarily due to encouraging economic trends and more aggressive policy actions in the Eurozone. In the latter part of the fourth quarter, we saw slower fund outflows in the loan market and actually very strong fund inflows into the high-yield market. These trends helped drive a rebound in activity, higher asset prices and tighter spreads.

As we've stated in the past, our core market, the middle market for leverage loans, is less volatile, and there is often a time lag or disconnect between broad leverage loan market trends and changes in our market. As an example, according to Thomson Reuters, all-in pricing on middle-market senior secured loans in the primary market ended the quarter relatively unchanged from prior quarter levels.

Since the end of the fourth quarter, market liquidity and investor risk appetite have increased further, causing middle-market loan spreads to tighten. That said, we are seeing comparable middle-market spreads at roughly 150 basis points wide of broadly syndicated loans and with significantly better structural protections.

While we've seen pricing tighten, the current environment has presented opportunities for us to raise capital efficiently. Since year end, we accessed 3 different capital market channels to raise nearly $600 million in new capital, including approximately $252 million of new common equity and $344 million of attractively priced long-duration debt capital. Our new debt capital included a $200 million, 8-year secured revolving funding facility from Sumitomo Mitsui, attractively priced at LIBOR plus 2 1/8% with no LIBOR floor and approximately $144 million in 10-year 7% unsecured notes.

In addition to this new debt capital, we also extended by 1 year the reinvestment period and maturity date of our revolving funding facility with Wells Fargo, as well as reduced the stated interest rate on that facility by 25 basis points to LIBOR plus 2.5% with no LIBOR floor. Pro forma for this first quarter capital raising activity, our available debt capacity would have increased approximately $1 billion at year end, positioning us well to execute on our backlog, pipeline and future investment opportunities as they arise.

Given the speed with which news and capital flow these days, market windows can open and shut very quickly. We constantly evaluate the quality of these windows both as an investor and issuer of capital. We leverage Ares' broad market view to inform not only our investment decisions and portfolio composition, but also our capital raising strategy. In markets like these, it is important as ever that we utilize all of our competitive advantages to drive asset selectivity, namely our broad and direct origination capabilities, significant scale, flexible capital offering and synergies derived from the broader Ares platform. And now, more than ever, it is critical to remain highly disciplined on the underwriting and investment side. To that end, we continue to focus primarily on senior secured loan opportunities where we can leverage the knowledge of the entire Ares platform and where we can serve as the lead investor or agent in the transaction.

As we've talked about before, this lead status allows us to perform more direct intensive upfront due diligence, structure the terms of the investment and assume a more active role in the credit post-closing. And ultimately, we believe that this approach leads to lower defaults and higher recoveries on defaulted loans and positions us for incremental opportunities for well-performing companies.

I'd now like to turn the call over to Penni for more detailed comments on our fourth quarter and fiscal year '11 financial results. Penni?

Penni F. Roll

Thanks, Mike. For those viewing the earnings presentation posted on our website, please turn to Slide 3, which highlights our financial and portfolio performance information. As Mike mentioned, our basic and diluted core earnings were $0.48 per share for the fourth quarter of 2011, a $0.05 per share increase over core EPS of $0.43 per share for the third quarter and $0.06 per share higher than the same quarter a year ago. The $0.05 per share increase in our fourth quarter earnings per share over the third quarter was primarily driven by the net growth in our earning assets, increases in our weighted average investment spread and higher structuring fee income.

On that latter point, our structuring fees as a percent of our gross commitments increased compared to the third quarter, partially due to the increase in co-investments through the SSLP, where we earn a greater percentage of structuring fee income on such co-investments. As we have stated in the past, our structuring fees vary from quarter-to-quarter based upon investment activity levels and mix. For the year, we reported core earnings per share of $1.56 in 2011 compared to $1.43 in 2010, excluding $0.02 and $0.11 per share, respectively, in professional fees and other costs related to the Allied Acquisition.

During the fourth quarter, we made gross commitments totaling $853 million as compared to gross commitments of approximately $1.4 billion during the third quarter. As we exited commitments of approximately $688 million in the fourth quarter, which included the termination of an unfunded commitment of $100 million, resulting in net commitments of $165 million. Net fundings actually increased quarter-to-quarter from approximately $207 million in the third quarter to about $297 million in the fourth quarter. Accordingly, our total investments at fair value increased from $4.8 billion at September 30, 2011, to $5.1 billion at December 31.

For the full year, we made gross commitments of $3.7 billion, with net commitments of $1.1 billion. On a funded basis, we had gross fundings of $3.2 billion and net fundings of $0.8 billion, which drove an 18% increase in our total investment portfolio during 2011. The level of exits and repayments in 2011 was driven by continued proactive rotation of the Allied portfolio, a highly liquid market during the first quarter of 2011, and our more focused syndication strategy during the second half of the year.

Our net investment income during the fourth quarter decreased to $0.45 per share compared to $0.48 per share in the third quarter, an increase compared to $0.32 per share in the fourth quarter of 2010. GAAP net income for the fourth quarter was $0.58 per share, an increase compared to $0.20 per share for the third quarter, but a decrease compared to $0.79 per share for the fourth quarter of 2010. For the full year, we reported 2011 GAAP net income per share of $1.56 compared to $3.91 in 2010. Our 2010 GAAP net income per share included the gain on the Allied Acquisition of $1.10 per share and a significant rebound in investment values as compared to 2009.

Our net investment income and GAAP net income per share for the fourth quarter of 2011 were reduced by an increase in the GAAP accrual for capital gain incentive fees of $0.02 per share. For the full year, our capital gain incentive fee accruals totaled $0.16 per share in 2011 compared to $0.09 in 2010. These amounts directly reduce our net investment income and GAAP net income per share, but are excluded from our core earnings per share.

As a reminder, the cumulative GAAP accrual for the capital gains incentive fee represents the amount that would be payable if we liquidated our entire portfolio at its most recent fair value. This does not represent amounts currently payable to our investment advisor under our investment advisory and management agreement. No amounts are currently due under the agreement regardless of the amounts we accrued, as only realized gains and realized and unrealized losses and not unrealized gains are counted towards the capital gains portion of the incentive fee. As of the end of the fourth quarter, the cumulative deficit of realized gains compared to unrealized and realized losses was approximately $63 million.

Net realized and unrealized gains for the fourth quarter were $0.13 per share compared to a net realized and unrealized loss of $0.28 per share in the third quarter and net realized and unrealized gains of $0.47 per share for the fourth quarter a year ago. For the full year, net realized and unrealized gains were $0.18 per share and included $0.38 per share in net realized gains, partially offset by $0.20 per share in net unrealized losses, which included the reversal of net unrealized appreciation of $0.10 per share on the net realized gains. For the full year 2010, net realized and unrealized gains were $1.59 per share and included $0.28 per share in net realized gains and $1.31 per share in net unrealized gains, which included the reversal of net unrealized appreciation of $0.09 per share on the net realized gains.

At December 31, 2011, our total assets were $5.4 billion and our total stockholders' equity was $3.1 billion, representing an NAV per share of $15.34. During 2011, our investment portfolio grew to approximately $5.1 billion at fair value and included 141 portfolio companies at year end. The majority of our portfolio companies continue to be in senior secured debt. And at quarter end, our portfolio at fair value was approximately 52% in senior secured debt investments and 21% in the subordinated certificates of the Senior Secured Loan Program, the proceeds of which were applied to co-investments with GE to fund first lien senior secured loans.

Now let me highlight 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 at amortized cost increased from 11.9% to 12.1% quarter-over-quarter, reflecting primarily higher yields on new investments funded during the fourth quarter, as well as lower yields on investments exited. Our weighted average stated interest rate on our debt capital decreased slightly from approximately 5% to 4.8% 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 stated interest on debt capital, our weighted average investment spread increased from 6.9% to 7.3% quarter-over-quarter.

The weighted average stated interest rate on our debt at December 31 reflects a slightly higher weighting toward unsecured fixed rate debt, which carried a higher stated interest rate compared to our floating rate debt. The asset and liability interest rate sensitivity included in our 10-K as of the end of the fourth quarter demonstrates how our net income could potentially benefit from increases in interest rates.

We continue to seek to diversify our funding sources through a combination of lower-cost floating rate secured financing and higher-cost fixed rate unsecured debt with medium to long durations. We believe this allows us to maximize diversification, flexibility and duration at a reasonable cost. As Mike stated earlier, our new 8-year $200 million revolving funding facility carries a spread of 2 1/8% over LIBOR with no floor. We matched this facility with new 10-year unsecured notes with a fixed rate of 7%. Therefore, the 2 new debt facilities combined, assuming the Sumitomo facility was fully funded, have a blended interest rate of approximately 4.5%.

Now turning to Slide 6. You will find our fixed and floating rate assets and our nonaccrual statistics. Overall, our floating rate debt assets on a combined portfolio basis at fair value increased from 64.6% in the third quarter to 67.5%. And our fixed rate debt assets declined from 21.2% to 19.8% over the same period, reflecting our continued emphasis on investing in senior floating rate assets, many of which have LIBOR floors. At the end of the fourth quarter, 64% of our floating rate assets have LIBOR floors and 31% of the floating rate investments were in the subordinated certificates of the SSLP. All of the underlying senior secured loans made through the SSLP at December 31, 2011, carried LIBOR floors.

As to credit quality, we believe our portfolio is stable and remained healthy during the fourth quarter. Core ARCC portfolio non-accruals as a percentage of the combined portfolio were relatively unchanged from 1.4% and 0.4% at cost and fair value, respectively, at the end of the third quarter as compared to 1.5% and 0.3%, respectively, at the end of the fourth quarter. We experienced one new nonaccrual investment offset by the exit of another nonaccrual investment within our Core ARCC Portfolio. The legacy Allied portfolio's non-accruals as a percentage of the combined portfolio decreased from 2.6% of cost and 1.2% at fair value to 1.8% of cost and 0.6% at fair value. During the fourth quarter, we incurred no new nonaccrual investments, and we exited 3 nonaccrual investments within the legacy Allied portfolio. Therefore, the combined portfolios' total non-accruals declined quarter-over-quarter from 4% at cost and 1.6% at fair value to 3.3% at cost and 0.9% at fair value at year end. In the aggregate, we reduced our non-accruing investments in both percentage terms and a number of companies.

Now let's turn to Slide 11 for a discussion of our debt capital. As of December 31, we had approximately $2.6 billion in committed debt facilities and approximately $2.2 billion in aggregate principal amount of indebtedness outstanding. The weighted average maturity of our outstanding indebtedness was 9.3 years, with a weighted average stated interest rate of about 4.8%. In total, we had approximately $405 million in available debt capacity subject to borrowing base and leverage restrictions plus $109 million in unrestricted cash available. At December 31, our debt to equity ratio was 0.66x, and our debt to equity ratio net of available cash was 0.62x.

Since year end, we increased our revolving funding capacity by $200 million following the closing of the SMBC facility, and extended the reinvestment period and maturity date and reduced the interest rate on the Wells revolving funding facility. We also issued approximately $144 million in fixed rate notes and raised approximately $252 million in net proceeds from a common equity issuance. We used the net proceeds of the fixed rate notes issuance and the equity issuance to repay outstanding borrowings under our revolving credit facilities.

Pro forma for these activities, using our December 31 balance sheet, we would have had available debt capacity of approximately $1 billion at December 31, a weighted average maturity on our indebtedness of approximately 11 years and a debt to equity ratio of 0.53x.

Our first quarter dividend of $0.37 per share will be payable on March 30 to stockholders of record on March 15. Since our IPO in October of 2004, we have paid or declared cumulative dividends per share of $11.23, including our first quarter 2012 declared dividend. For more details on our financial results, I refer you to our Form 10-K that was filed with the SEC this morning.

And now I will turn the call back over to Mike.

Michael J. Arougheti

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

If everybody could turn to Slide 14. You'll see that in the fourth quarter, we made 18 commitments totaling approximately $853 million. Five to new portfolio companies, one to an existing portfolio company and 12 additional companies made through the Senior Secured Loan Program, which included 5 to existing companies and 7 to new companies.

Our fourth quarter investment activity reflected our strategy to leverage our larger scale and structuring capabilities, to make attractive investment in larger, high quality borrowers during volatile market environments. For example, we led a $340 million senior secured facility for a leading discount grocery operator on the West Coast, utilizing our syndication capabilities to reduce our commitment amount to approximately $107 million at quarter end. Interestingly, this company was an existing investment in a fund managed by our portfolio company, Ivy Hill Asset Management, and our sourcing and confirmation of this transaction is a perfect example of the strategic benefits that Ivy Hill Asset Management brings to ARCC. We also led a $240 million senior secured facility to finance the acquisition of a former portfolio company of ours that is a leader in the student travel and supplemental education sector. Here too, we syndicated $75 million of our exposure, resulting in a final investment of $165 million.

On Slide 16, you'll see an update on our progress with the legacy Allied portfolio from April 1, 2010, the date on which we acquired Allied, through the end of the fourth quarter of 2011. On a fair value basis, the size of the total legacy Allied portfolio stood at $781 million at the end of the fourth quarter or approximately 15% of our total investments at fair value, down from $1.8 billion or approximately 45% of total investments on April 1, 2010, acquisition date.

The reconciliation at the bottom of the slide highlights that we have actually received over $1.3 billion in cash from exit to repayments of investments in the legacy Allied portfolio, including net realized gains of about $122 million and net unrealized depreciation of about $49 million for a total net realized and unrealized gains of approximately $73 million. As a reminder, this total net realized and unrealized gains through the fourth quarter don't reflect the roughly $130 million noncash purchase accounting gain that we recorded on the acquired portfolio, reflecting the difference between the fair value of the investments at the time we acquired them and the purchase price we paid.

You can also see that we have made progress by significantly reducing both the nonaccrual investments and the equity securities by 91% and 44%, respectively, at fair value since April 1, 2010. Our initiatives have substantially reduced lower-yielding investments and increased the yield on the remaining portfolio. We've reduced the equity investments primarily through the sale of several controlled portfolio companies. And we remain focused on reducing the lower yielding, nonyielding assets acquired as part of the Allied Acquisition. And we will continue to review strategic alternatives for the remaining equity investments.

Now turning to Slide 17. On a combined basis, the underlying portfolio company weighted average last dollar leverage remained steady at 4.3x quarter-over-quarter. Our overall weighted average interest coverage improved slightly from 2.5x to 2.6x. At the end of the fourth quarter, the underlying borrowers within the Senior Secured Loan Program had similar metrics, with a weighted average total net leverage multiple of 4.5x and weighted average total interest coverage ratio of 3x.

On Slide 18, you can see that we generally invested in larger companies with nearly $54 million in weighted average EBITDA during the fourth quarter. The overall weighted average EBITDA of the companies in our combined portfolio increased from $41 million to approximately $45 million. And at the end of the year, weighted average EBITDA for borrowers within the SSLP was approximately $45 million.

Skipping to Slide 20, you'll see that the portfolio remains well diversified by issuer. While our largest investment at quarter end continued to be in the Senior Secured Loan Program, which was approximately 21% of the portfolio at fair value, the program is supported by investments in 32 separate borrowers. The program continued to have no nonaccrual investments as of December 31. The largest single borrower in the program represented about 6% of the total aggregate principal amount of loans outstanding under the program and approximately 4% of the program's available capital of $7.7 billion. Excluding SSLP, our remaining largest 14 investments totaled approximately 33% at the end of the fourth quarter.

Please turn to Slide 23 for a summary of the grades for the core ARCC and legacy Allied portfolios. On a combined basis, the portfolio experienced 7 ratings upgrades and 4 ratings downgrades during the fourth quarter. In the aggregate, as of December 31, the weighted average grade of the entire portfolio remains stable compared to the third quarter with a 3 rating.

Our historical focus on lending to market-leading, growing and high-margin companies in defensively positioned industries continues to bear fruit. Despite the slow growth economy, our combined portfolio company weighted average revenue and EBITDA growth remains strong at approximately 9% and 14%, respectively, on a comparable basis for the year-to-date period in 2011 versus the same period in 2010. These growth rates are comparable to the 10% and 12% growth rates that we reported on our last call for our underlying portfolio company revenues and EBITDA.

On Slides 25 and 26, you'll find our recent investment activity since January 1, 2012, and our current backlog and pipeline. As of February 24, we had made additional new commitments of approximately $190 million, of which $146 million were funded since December 31. Of these new commitments, 85% were in first lien senior secured debt and 15% were investments in subordinated certificates of the SSLP. The proceeds of which were used to fund co-investments with GE and senior secured floating rate loans. The weighted average yield of debt and income-producing securities funded during the period at amortized cost was 10.3%. We may seek to syndicate a portion of these commitments to third parties although there can be no assurance that we will do so.

Also from January 1 to February 24, we exited $226 million of investment commitments, of which 97% were in first lien senior debt and 3% were in equity and other securities. The weighted average yield of debt and income-producing securities exited or repaid at amortized cost of 7.6% was substantially lower than our new investment commitments. And on these exits, we recognized $7 million in net realized losses in total.

As shown on Slide 26, as of February 24, 2012, our total investment backlog and pipeline stood at $280 million and $700 million, respectively. While the size of our pipeline in particular has increased since our last call, the recent market trends I outlined earlier could impact our ultimate execution. And as always, we can't assure you that we'll make any of these investments or that we will syndicate a portion of any of these investments that we do make.

So now I'd like to conclude with a few thoughts on our fourth quarter and full year accomplishments as well as our outlook as we progress further into 2012. In 2011, we recorded our strongest year of core earnings since our IPO in 2004. We also reported another year of positive net realized gains, making 2011 our sixth year to do so out of the last 7 years. In addition, since our IPO in October of 2004, our cumulative realized gains in our investments have exceeded our cumulative realized losses on investments through the end of '11 by roughly $147 million. We believe that our investment track record illustrates the benefits we received from the depth of our origination, underwriting and portfolio management infrastructure, and the market insight and resources that we draw upon across the Ares platform.

We believe that our balance sheet is extremely well positioned, as we spent most of the last year extending debt maturities primarily by accessing attractively priced, fixed rate unsecured capital. And as I mentioned earlier, we now have significant available debt capacity to make new investments.

We expanded our investment portfolio, primarily with additional senior debt, while reducing our equity exposure. And we improved our overall credit quality by reducing nonaccrual investments. And despite the sluggish economy, we believe that the quality of our investment portfolio is reflected by the solid growth in revenue and EBITDA of our portfolio of companies. Although we remain focused on reducing the remaining low or nonyielding assets acquired in the Allied Acquisition, we believe that the significant majority of our stated rotation strategy has been completed. And while the financial benefits from the Allied Acquisition can be clearly seen in our results, we believe that it's also provided significant strategic benefits in the form of increased scale and a strengthened competitive position.

As for the market environment, in 2012 and beyond, we continue to believe that a compelling long-term opportunity remains for nonbank capital providers. On the supply side, we expect capital to be constrained by increased bank regulations and stricter capital requirements, a weakened competitive environment as nonbanks struggle to obtain sufficient and cost-effective capital, and the expiration of reinvestment periods among outstanding CLO vehicles.

The significant amount of uninvested private equity capital seeking transaction financing, as well as the need to refinance the still significant amount of maturing debt for leveraged issuers is expected to drive ongoing demand. And as these trends play out, we see attractive risk-adjusted lending opportunities arising in many sectors of the middle market that are no longer effectively served by regional banks and other traditional providers. To capitalize on these opportunities, we continue to review the addition of other investment professionals with unique industry and product expertise. As an example, we added a team of experienced professionals during 2011 to target investments in the power generation and energy space. And we continue to review the addition of other specialists in niche asset classes within private debt.

As for the immediate outlook, we are entering into a tighter pricing environment as improved investor confidence, low interest rates and central bank policy decisions drive liquidity, similar to what we experienced during the first quarter of 2011. Accordingly, we plan to continue to leverage what we believe are our competitive advantages to invest only in the highest quality companies available to us, and to remain selective and disciplined with our investment capital. As we all know, the market environment can change rapidly as our capital markets are increasingly sensitive to global events. And we therefore plan to remain patient and vigilant as we wait for opportunistic market windows to open.

Operator, we'd now like to open the line for Q&A, please.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from John Hecht at JMP Securities.

John Hecht - JMP Securities LLC, Research Division

First, just trying to kind of characterize Mike's opinion on the market. Now you mentioned a lot about the overhang of booked -- the private equity capital that has yet to be deployed, the winding down in the CLO markets. You've also referred to the tightening environment over the past couple months and the flows of high yield. If things were to stabilize right here, how would you characterize 2012 versus 2011, both in terms of spreads and supply of opportunity?

Michael J. Arougheti

I'd characterize it as stable and attractive. What we're trying to convey, and we had a very similar dialogue on our first quarter conference call last year is, you have to think about our business in terms of long-term trends driving the investment opportunity, and then short-term trends that are being driven by what we refer to as kind of the rapid flow of news and capital. One of the things that we think we have that others don't is a very broad global view as to how funds are flowing, where investors are putting their money looking for risk-adjusted return. And having that insight allows us to be very prudent raisers of capital, but also know when good times to be in the market are. What you'll notice over the course of any given year, 2011 being the perfect example, is we'll be in and out of the market raising capital and investing capital. We're rarely completely out of the market, but you'll see us change the asset classes that we're targeting, sometimes the nature of the borrowers that we're targeting and also just the zeal with which we're in the market investing. So when I look at where we are now, we're not overly concerned. We're still seeing, as demonstrated by our backlog and pipeline, a number of very attractive investment opportunities. We still see a very favorable capital raising backdrop, which will drive growth and hopefully, net interest margin expansion for the company. But when you see this type of rapid spread tightening and this amount of liquidity pouring into the liquid capital markets, you have to take pause. And again, 2011 is the perfect example where our comments were almost verbatim, the same. And by the time we got to May of 2011, the market environment changed pretty dramatically and positioned us to have an incredible opportunity in Q3 and Q4. So I think if it stays where it is, we'll continue to be cautious and prudent. We're finding plenty of things to do, but probably not going to be as aggressive as we otherwise could be.

John Hecht - JMP Securities LLC, Research Division

Okay, great. Second question is, can you characterize the backlog and pipeline, the terms, the type of loan and the industries? Is there any meaningful shift there?

Michael J. Arougheti

There is no meaningful shift. When you look at the composition of the backlog and pipeline, it looks a lot like our historical investment backlogs and pipeline and the existing portfolio, both in terms of the industries that we're going after as well as the risk-adjusted return profile.

Operator

Next question comes from Arren Cyganovich at Evercore.

Arren Cyganovich - Evercore Partners Inc., Research Division

The credit quality in the portfolio improved somewhat this quarter. Can you talk a little bit about, looks like there was one new nonaccrual and then the 4 that came off. Were the 4 that came off sold? Or were they restructured? How did those go through?

Michael J. Arougheti

Yes. The one new investment is a company called Pillar Processing, which is a mortgage foreclosure processing company. There were both industry and company-specific issues that had caused us to need to restructure and try to move on from that investment. And that had about $19 million at cost. The name that came off was an investment in the company called Direct Buy, which we sold in the quarter. And then we also had an investment in a company called HB&G, which is probably one of our oldest portfolio investments that we eventually sold as well.

Arren Cyganovich - Evercore Partners Inc., Research Division

Okay. And also, maybe you could talk a little bit about the amount of refi activity versus M&A that's in the pipeline, and how that's kind of shaping up for your upcoming quarters?

Michael J. Arougheti

Yes, it's a good mix. If you go back to some of the comments that we had in terms of the fourth quarter activity, you'll see a healthy blend of existing portfolio companies that are either executing on refinancings or M&A deals, and then what we would call new issue M&A trends. When I look at our stated backlog and pipeline of close to $1 billion, it's a very similar mix of new issue and existing portfolio company deals. There are very few opportunistic refinancings in the backlog and pipeline. I think we've talked about this on past calls as well. Unlike in the liquid markets where when you see an oversupply of capital and an undersupply of new issue, there's a lot of opportunistic refinancing. You see some of that in the middle market, but again, it's much slower to react. So a lot of the activity that we're seeing within the existing portfolio is actually change of control M&A, sponsor to sponsor, which speaks a little bit to the trend of the demand driver from unutilized private equity capital.

Arren Cyganovich - Evercore Partners Inc., Research Division

Okay, and then one last quick one. The dividend income has been elevated the last 2 quarters. Would you characterize that as a normal recurring dividend from the portfolio? Or would you characterize some of that as nonrecurring?

Penni F. Roll

This is Penni. There are -- there is one significant preferred instrument that came into the portfolio 2 quarters ago, for about $130 million that is coming through as dividend income. So you should characterize that as more recurring. And then there's just other dividend income that may not be as consistently recurring in that bucket as well.

Operator

Our next question comes from John Stilmar at SunTrust.

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

Just real quickly, and I know this might be a little bit of a technical question. But as I think about the originations and the mix of them between core Ares originations and those through the Senior Secured Loan Program, I'm wondering how we should be thinking about the ratio of those 2. And what's forming in my opinion is the basket ratio. And you guys have been very conservative in your accounting with regards to that basket ratio. I'm wondering if we should kind of be thinking about that as a guidepost for kind of like a 3:1, if you will, kind of core Ares originations relative to the Senior Secured Loan Program as we look out in 2012.

Michael J. Arougheti

Yes, I would just -- maybe it's semantics, I wouldn't refer to it as a guidepost so much as I'd refer to as a governor. And for those who don't know what John's talking about, if you look at our disclosures in our 10-K, we've adopted a conservative position by treating our subordinate certificates as a non-qualifying asset. So long as we continue with that position, which we frankly disagree with, there would be a natural governor on how big the program could grow as a percentage of our total assets. But hopefully, what is not lost on people, when you look at the new originations last quarter and you look at the backlog and pipeline, there's no perfect mix. But we continue to originate a significant amount of on-balance sheet, senior secured unitranche and mezzanine investments that support the growth of the non-qualifying asset basket. So it's something that we're obviously focused on, John, but I think the good news is given the breadth of the platform, it's proved to be very manageable.

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

I'm sure it is, but should we think about it as kind of like 3:1, 4:1 and or kind of just maybe a relative ratio as you kind of look forward. Or is that – I was just trying to put too much level of precision to the business?

Michael J. Arougheti

Yes, I think -- again, to put a guard rail around it, I think given the -- if we continue to treat it as a non-qualifying asset, just given some of the other investments that we have, seeing the program kind of cap out between 20% to 25% of our assets is probably likely.

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

Okay, great. And then in terms of -- you talked -- the themes have remained consistent now for several quarters about the long-term trends and short-term trends and the opportunities of Ares to capitalize on both. I guess my question is, from where you've sat over the past 3 to 4 quarters, what's been the biggest surprise for you? I mean, it seems like this market, both on a tactical basis and the eventual trends, especially the comments coming out of JPMorgan today, only reiterate these themes. So as I sit here and hearing some of these themes be reiterated, what's been the area that's been the biggest surprise for you over the past 3 or so quarters?

Michael J. Arougheti

I don't think that there's been anything that "surprised us." I would just simply say, I think we find it remarkable, how short institutional memories can sometimes be in the capital markets. And also find it remarkable frankly how quickly the markets react to small pieces of good news and bad news and the volatility that, that obviously creates. So part of what we're spending all of our time thinking about is sifting through the noise to identify the long-term trend, and that's not always easy. And it's not always perfect, but that's kind of how we have to go about managing the business, both in terms of the assets and the liabilities. So nothing has surprised us per se, and I think that we've been well prepared to access market windows both as an investor and a capital raiser when they open. But it is quite remarkable how quickly things can change and how surprised frankly other people are when they move that quickly.

Operator

The next question comes from Greg Mason at Stifel, Nicholas.

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

Could you talk a little bit about the SSLP compared to your current -- your on-balance sheet portfolio? As you said, 4.5x leverage through your current portfolio as well as the Senior Secured Loan Program, yet the coupons you get on your on-balance sheet investments are 12.5% versus, call it, 16% plus for the Senior Secured Loan Program. It's kind of been our perception that the markets, the interest rates kind of tell you the perceived credit risk with those investments. So can you discuss your thoughts on the credit risk of your investments in the SSLP versus your on-balance sheet portfolio?

Michael J. Arougheti

Sure. I think as you highlighted they're extremely similar. The issuer size is in the mid-$40 million range. The weighted average leverage is in the 4.3x to 4.5x range. The interest coverage is in the 2.5x to 3x range. So there's a surprising amount of consistency between the type of borrower that is accessing the Senior Secured Loan Program versus accessing the balance sheet. I think as people have understood from past calls, effectively, the Senior Secured Loan Program was a vehicle designed for GE and Ares to invest in unitranches in a way that we had historically co-invested in the market, investing alongside each other, either as partners on senior debt and unitranches or as partners in traditional senior secured and mezzanine investments. And so while we obviously look at the program as a separate program, it really shouldn't be thought of differently. We're having a different strategy, but for the fact that it's investing in unitranches alongside GE versus unitranches on balance sheet. So when you look at the 12.5%, that's a combination of the ROEs that we're generating on the sub certificates out of SSLP. And it's a combination of all of the balance sheet assets that we've accumulated. That's a combination of first lien, second lien and mezzanine debt. The other thing I would add, and I think that it speaks a little bit to our competitive positioning, I continue to believe that we're getting premium pricing on SSLP transactions because of the certainty of close that, that product can provide an issuer, and that leads to some of the slightly higher returns on the sub certs relative to what you may be comping to a traditional market deal. When you look at market environments like Q3 and Q4, where investment banks are not taking meaningful balance sheet risk, the ability for the Senior Secured Loan Program, either a loan or in concert with the balance sheet to come in and provide a $300 million or $400 million buy and hold command a pretty significant premium both in terms of upfront fee and spread. And obviously, that excess premium inures to the benefit of our sub cert investment.

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

Okay, great. And then one question on the dividend. Obviously, with $0.77 of spillover, you have pretty dramatic leeway with what you can do with the dividend. So what are your thoughts in terms of long-term dividend level expectations relative to core EPS. Just what's your philosophy on the dividend going forward?

Michael J. Arougheti

Sure. We've been asked the question before and the answer is always the same, which is, we think it is imperative that we can pay our dividend out of core earnings per share. And when you look at our history, back to the IPO, you'll notice that, that is actually what we've done. When you look at the amount of core earnings capacity within the business, given the structure of our balance sheet, and you look at our competitive positioning, we continue to believe that there's a catalyst for further earnings growth. In terms of the dividend, obviously, once we feel that we're achieving a new level of sustainable core earnings, that's when we start to have conversations about dividend increases. You'll notice obviously in this quarter, the increase of the dividend from $0.36 to $0.37 came with a meaningful increase in core earnings. And so we're constantly looking forward at what we think the sustainable earnings level for the business is, measured against the risk of increasing the dividend, if you will, from a liquidity standpoint, and just making extra sure that we're covered. And I think that's been our consistent philosophy since the day that we went public, and we continue to think of the world that way. In terms of the spillover, we're obviously thrilled that we're spilling over $0.70 into 2012, which is more than 2 quarters of our current dividend. We view that as obviously cushion for the business, but that is just one thing that factors into our decision to raise or not raise the dividend. But we're at just a onetime spillover, and we didn't feel that there was a sustainable level of earnings to support the dividend level. We would not look at that spillover as supporting a dividend increase in and of itself.

Operator

The next question comes from Joel Houck at Wells Fargo.

Joel Houck - Wells Fargo Securities, LLC, Research Division

I guess maybe sticking with the theme on SSLP. If you kind of look at the environment. I don't know if you could characterize it as more normal this year, but to the extent that it gets more competitive, what's your current outlook on structuring fees, particularly as it relates to SSLP and its approaching kind of investment capacity?

Michael J. Arougheti

It's interesting, in the fourth quarter, we actually saw structuring fees in pockets of the market going up in response to spread tightening. And when you look at the history of the company, as well as the history of the middle market, there's been a fairly consistent fee level between 2% and 3%. When the market dislocated, we've actually seen the ability to generate incremental fee income in the 4% to 4%-plus range. And in things like a grocery outlet, which we've discussed earlier in the call, where we're providing meaningful underwriting and distribution solutions to people, we get paid incremental fees over and above what a traditional market participant would be. So anytime you see a huge amount of liquidity coming into the market, you should expect a little bit of pressure on upfront fees. But there's always been kind of a natural floor on fees in the 2% range. And when you look at it quarter-over-quarter, there's been a surprising consistency kind of in that 2.5% to 3% range. So I don't expect a lot of tightening in fees. I do expect at the upper end of our market, if the liquid bank loan market and the high-yield market continue to exhibit the kind of froth that they're exhibiting now that, that would translate into tighter spreads. And then the question for us is whether or not we want to participate in that market environment because we think it's sustaining or we feel that there's a little bit of a bubble, and we'll wait it out like we did in the first quarter of last year.

Joel Houck - Wells Fargo Securities, LLC, Research Division

Okay, good. And then maybe to follow along that theme. So to the extent we've got an environment, and you've decided, well, it wasn't -- you were going to participate at a lower pace given longer-term economic returns. That could potentially induce some volatility with the fees. How do you look at that with respect to, I think this ties into Greg's question about setting the dividend. And if you got into a 6-month period where things were tighter on the fee side, would you then consider using the spillover as opposed to maybe adjusting it during a more...

Michael J. Arougheti

I'd encourage all of you to take a look at our core earnings per share, excluding structuring fees, and I'd also encourage people to look at structuring fee and other fee income on an average basis across the history of the company. And again, what's amazing about this business model is that while you'll see increased fees in response to increased market activity, there's always a baseline of activity. One of the things that hopefully isn't lost on people, when you look at the amount of activity that's resident in the existing portfolio, we're investing in good, high free cash flow companies that are growing. They naturally de-lever and then either transact or re-lever. And then you look at the amount of deal flow that just comes out of the existing portfolio, it's averaged between 20% and 30% of our flow. And so there's a recurring natural baseline of business that occurs across the cycle. One metric that I -- why I encourage you guys to look at it, is that we are very focused on is, what's our core earnings per share just from the spread book excluding restructuring fees. And quarter-over-quarter, that number continues to grow. And ultimately, you want that number to grow and support dividend growth as well. One of the reasons why the dividend is set at the level it is against much higher core earnings per share is to your point, Joel, prudence against the potential for market volatility. But at the level that we currently set it against what we think that benefits our existing portfolio and competitive position are we don't view that level as either unsustainable or in jeopardy.

Operator

The next question comes from Rick Shane at JPMorgan.

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

Just a couple quick questions. One is, and I apologize, I screwed up my notes here. The $100 million of unfunded investment commitments that were exited, was that in the fourth quarter or was that in the up to February 24 period?

Michael J. Arougheti

That was in the fourth quarter.

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

Okay, great. Looking at the $226 million of investment commitments you've exited post quarter, the yield on an amortized cost basis is relatively low, it's about 7.6%. Is that a function of there were stuff in that cohort that was non-accruing? Or is there something there just in terms of vintage, why it's much lower yielding versus the rest of the portfolio?

Penni F. Roll

Yes, Rick, it's Penni. It's just really the nature of the assets. They were more senior assets in nature, thus the lower yield relative to the higher yield of the new loans going on the books at 10%.

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

Got it. And is there anything we should -- that we can conclude in terms of vintage? Because obviously now the more senior stuff you're getting better than a 7.6% yield. So is this just sort of pre-'08 vintage paper?

Michael J. Arougheti

No, I wouldn't read into that. Again, one of -- sometimes we're investing in lower yielding senior and syndicating into the market. Sometimes we're investing in a unitranche and creating a first out or a super senior piece. So it's more that it's just traditional first lien, very high up the balance sheet versus old vintage.

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

Got it. And I want to make sure I understand the last part of that comment fully. Does that mean that there could have been parts of this that you retained a residual piece that is higher yielding then?

Michael J. Arougheti

In theory, yes, although I actually don't have the listing of the exits in front of me to confirm if that happened this quarter, but we can follow up with you offline if you'd like. Also so people know, we're coming up at noon, so I think we have time for one more question and then we apologize to the extent that people have further questions, we are happy to address them after the call.

Operator

Our last question is from Fla Lewis at Weybosset Research.

Fla Lewis - Weybosset Research & Management LLC

I believe I heard you say you were interested in making loans in the energy sector, just like to know a little bit more about that. What kind of loan -- what are you seeing there that is of interest?

Michael J. Arougheti

Sure. So we hired a team of investment professionals a little under a year ago. We have 5 people on that investment team now. Their core focus is on power generating assets, both in traditional power generation and in renewable energy. So these are not E&P loans and oil and gas loans. This tends to be coal and gas-fired turbines, solar, et cetera. What we're seeing there, which is what we're seeing in all sorts of other corners of the middle market economy is that again, based on changing risk appetites at banks or changing regulatory capital requirements, assets that used to be attractive or generating attractive ROEs for banks are no longer areas of focus. Power gen and infrastructure, being one of them, and people know or don't on the call, European banks were historically some of the largest funders of capital, predominantly senior capital into those asset classes. Now obviously, given everything that's going on in the European bank landscape, there's been a pretty significant exit out of that asset class. And while we're not moving into fill exactly where they were playing, it's obviously created a widening of spreads, a dearth of capital and therefore, for the right investments, a pretty attractive risk-adjusted return opportunity for us.

Well look, we appreciate everybody's time today. As always, we're grateful for your support and loyalty, and we look forward to talking to you all next quarter.

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 approximately 1 hour after the end of this call through March 12, 2012, to domestic callers by dialing 1 (877) 344-7529 and to international callers by dialing +1 (412) 317-0088. For all replays, please reference account number 10008893. An archived replay will also be available on a webcast link located on the homepage of the Investor Resources section of our website. Thank you. You may now disconnect.

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