Ares Capital Management Discusses Q1 2012 Results - Earnings Call Transcript

May. 8.12 | About: Ares Capital (ARCC)

Ares Capital (NASDAQ:ARCC)

Q1 2012 Earnings Call

May 08, 2012 11:00 am ET


Michael J. Arougheti - President and Director

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


Jasper Burch - Macquarie Research

Joel J. Houck - Wells Fargo Securities, LLC, Research Division

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


Good morning, and welcome to Ares Capital Corporation's Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded on Tuesday, May 8, 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 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 the SEC filings. Ares Capital Corporation assumes no obligation to update any such forward-looking statements. Please also note that past performance or market information is not a guarantee of future results.

During this conference call, the company may discuss core earnings per share or core EPS, which is a non-GAAP financial measure as defined by SEC Regulation G. Core EPS is the net per share increase or decrease in stockholders' equity resulting from operations, less realized and unrealized gains and losses, any incentive management fees attributable to such realized and unrealized gains and losses, and any income taxes related to such realized gains.

A reconciliation of core EPS to the net per share increase or decrease in stockholders' equity resulting from operations to the most directly comparable GAAP financial measure can be found on the company's website at 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 to 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, and clicking on the Q1 '12 Earnings Presentation link on the homepage of the Investor Resources section of the website. Ares Capital Corporation's earnings release and Form 10-Q are also available on the company's website.

This morning, Ares Capital Corporation issued its first quarter earnings press release and posted a supplemental earnings presentation on its website. The company will refer to this presentation later in the call.

I will now turn the conference over to Mr. Michael Arougheti, Ares Capital Corporation's President. Go ahead, please.

Michael J. Arougheti

Great. Thank you, operator. Good morning to everyone, and thanks for joining us. We're pleased to report first quarter core earnings per share of $0.38, a level that is 23% higher than the $0.31 per share that we reported for the same period a year ago. On a net income basis, we reported first quarter GAAP earnings per share of $0.49, which included net realized and unrealized gains of $0.13 per share, driving a modest 1% sequential increase in our NAV to $15.47 per share.

This morning, we also announced that we upsized, lowered the pricing and extended the maturity on our revolving credit facility. Specifically, we increased commitments under this facility from $810 million to $900 million and lowered the spread over LIBOR in the facility by 75 basis points from LIBOR plus 300, to LIBOR plus 225. The amended facility has a 4-year maturity of May 2016, which includes a 3-year revolving period that ends in May 2015. Including this upsize, we now have $1.6 billion in total commitments across our 3 revolving credit facilities at a blended cost of LIBOR plus 2.3%, with no floor, and we have no debt maturities until 2016.

Pro forma for the upsized revolving credit facility, our available undrawn capacity on these lines, is over $1 billion as of the end of the first quarter, subject to borrowing base and leverage restrictions, which we believe positions us well to take advantage of market opportunities as they arise. This availability of lower cost debt capital will enable us to reduce our blended funding costs as we draw on the revolvers to make new investments over time.

As most of you know, we also issued $163 million in 4 7/8% senior unsecured convertible notes in early March. This latest convert carries the same 17.5% conversion premium and 5-year term, but a coupon that is a 100 basis points lower than our first convertible note issuance in January of 2011. These latest capital raises illustrate the fact that we're leveraging our scale and credit quality to reduce our cost of debt capital, while at the same time, increasing funding diversification, duration and flexibility.

Our Chief Financial Officer, Penni Roll, will provide more detail on our results and our financial condition a little bit later in the call.

I'd now like to give you a brief update on the market and investment environment. Many of the trends that we discussed in our last call are continuing. Generally speaking, investor sentiment and market tone remained positive, primarily due to strong corporate earnings and continuing signs of economic recovery in the U.S. as investors overlook potential economic and solvency issues in the Eurozone. During the first quarter, liquidity in the broader credit markets was quite strong, driven largely by record high-yield bond inflows, stable loan fund flows and higher loan repayment activity. Against this demand for loans, the new issue market was seasonally soft, causing the supply of loans to shrink, secondary market loan prices to rise and spreads on new issue loans to decline. This has had a modestly positive impact on portfolio valuation, but made the current investment market marginally less attractive.

The size of our current backlog and pipeline mirrors a near-term pickup in the forward calendar for new loans, which should help absorb some of the market liquidity and incrementally improve pricing and terms on new investments. As always, our strategy is to rely on our strong origination platform and significant scale, while remaining extremely disciplined and patient for improved market opportunities to arise.

Although our core middle market has also experienced softer new issue loan volumes and incrementally tighter pricing, we believe that it remains more attractive than the larger broadly syndicated loan market. Average total leverage levels in the middle market remain about 1x EBITDA lower on leveraged transactions and comparable senior debt pricing remains about 150 basis points higher. And of course, structural protections and loan covenants are more prevalent in our market.

We continue to focus primarily on senior secured loan opportunities, particularly stretch senior or unitranche investments in franchise businesses, where we currently see the best relative value and risk-adjusted returns.

And now Penni, would you like to walk us through additional detail on our first quarter's financial results?

Penni F. Roll

Yes, Mike, thanks. For those viewing the earnings presentation posted on our website, please turn to Slide 3, which summarizes our financial and portfolio performance information. Our basic and diluted core earnings were $0.38 per share for the first quarter of 2012, a $0.09 per share decline over our core EPS of $0.47 per share for the fourth quarter of 2011, but a $0.07 per share increase from the same quarter a year ago. I will provide more detail on our core earnings a little later.

Our net investment income per share for the first quarter decreased to $0.36 per share compared to $0.45 per share in the fourth quarter of 2011, but increased compared to $0.24 per share in the first quarter of 2011. Our GAAP net income for the first quarter was $0.49 per share compared to $0.58 per share for the fourth quarter of 2011, and compared to $0.61 per share for the first quarter of 2011. As we have discussed in the past, our net investment income and GAAP net income per share are reduced by an increase in the GAAP accrual for capital gains incentive fees in any quarter when our portfolio experiences net gains, as long as our cumulative realized and unrealized gains continue to exceed our cumulative realized and unrealized losses.

In the first quarter, both measures were reduced by an increase in this accrual of $0.02 per share, in line with the $0.02 per share in the fourth quarter and $0.07 per share a year ago. No amounts are due under the investment advisory agreement with our investment adviser, since only realized gains and not unrealized gains are measured against both realized and unrealized losses when determining the actual capital gains portion of the incentive fee that is payable.

At March 31, 2012, our total assets were $5.6 billion, and our total shareholders' equity was $3.4 billion, representing an NAV per share of $15.47, up from $15.34 at the end of 2011.

Now I will turn to our investment activity. Given the less attractive and slower market conditions that Mike described, we made gross commitments of $384.3 million in the first quarter of 2012 compared to $852.8 million and $502.3 million during the fourth and first quarters of 2011. We exited commitments of approximately $331.4 million in the first quarter compared to $688.1 million and $567.4 million during the fourth and first quarters of 2011, respectively, which resulted in net commitments of $52.9 million in the first quarter compared to net commitments of $164.7 million in the fourth quarter and net exits of $65.1 million during the first quarter of 2011.

Net fundings of investments also declined to $63.4 million in the first quarter compared to $296.5 million during the fourth quarter and net exits of $92.2 million in the first quarter of 2011.

As a result of new investments and net appreciation in the fair value of our portfolio investments, our investment portfolio grew to approximately $5.2 billion at fair value at quarter end, and included 143 portfolio companies. Our portfolio company mix at fair value was relatively unchanged from the prior quarter, with approximately 52% in senior secured debt investments, 22% 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, stretch senior and unitranche loans. 9% in senior subordinated debt, 5% in preferred equity and 12% in other equity and other securities.

From a yield standpoint, our weighted average yield on debt and other income-producing securities at amortized cost increased from 12.1% to 12.2% quarter-over-quarter, primarily reflecting higher yield on new investments funded during the first quarter compared to investments exited. Our weighted average stated interest rate on our debt capital increased modestly from approximately 4.8% to 5.1% quarter-over-quarter as we repaid a significant amount of lower-cost floating rate revolving debt previously outstanding using our proceeds from our January equity offering and the issuance of our fixed rate unsecured notes and fixed rate unsecured convertible notes during the first quarter. As a result, our weighted average investment spread decreased slightly from 7.3% to 7.1% quarter-over-quarter.

We do expect to reduce our incremental funding cost as we draw on our lower-cost revolving credit facilities from which we can borrow at a spread over LIBOR of between 2 1/8% and 2.5% depending on the facility. Assuming all of our revolving credit facilities were fully drawn as of March 31, 2012, and pro forma for the recent amendments to our revolving credit facility, the weighted average stated interest rate on our total debt capital would have been 4.2%.

On Slide 4, you can see that our net realized and unrealized gains for the first and fourth quarters were each $0.13 per share compared to net realized and unrealized gains of $0.37 per share for the first quarter a year ago. The net appreciation we experienced in the first quarter of 2012 was primarily driven by strong performance of some of our equity positions and some benefit from modest tightening of credit spread.

Now please turn to Slide 5. There was not much change in the floating versus fixed rate asset mix during the quarter, but you can see from our continued focus -- or you can see our continued focus on floating rate assets as such assets have increased to 67.7% at the end of the first quarter 2012 compared to only 50.2% at the end of the first quarter of 2011. At the end of the first quarter and at fair value, approximately 62% of our floating rate assets had LIBOR floors and about 32% 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 March 31, 2012, carried LIBOR floors.

On Slide 6 and 7, you can see the growth in our investment income compared to our expenses as we reported $79.8 million in net investment income before taxes in the first quarter of 2012 compared to $49.9 million in the first quarter of 2011. On Slide 7, the components of investment income are detailed, including the quarterly fluctuations in our structuring fee income. As you can see, our structuring fee income declined from $38.2 million in the fourth quarter of 2011 to $17.7 million in the first quarter of 2012, primarily due to lower gross commitments, which reduced our core earnings, net of related incentive fee expense, by about $0.08 per share. However, despite lower gross commitments, our structuring fee income in the first quarter of 2012 was approximately $7 million higher than the first quarter of 2011, contributing about $0.03 per share more to core earnings compared to the first quarter of 2011.

Therefore, since our core earnings increased by $0.07 per share year-over-year to $0.38 per share, approximately $0.04 per share of the increase is driven from growth in recurring spread income. You can also see that we have incurred quarterly income tax expense of about $0.01 per share in the first quarter of 2012 and the fourth and first quarters of 2011, respectively. This expense was driven by excise tax expense on our estimated excise taxable income that we have carried forward into 2012, as well as our estimate of amounts that we may potentially carry forward into next year.

Now let's turn to Slide 9 -- 10 for a discussion of our debt capital. As of March 31, we had about $3.1 billion in committed debt capital and approximately $2.1 billion in aggregate principal amount of indebtedness outstanding. The weighted average maturity of our outstanding indebtedness was over 10 years, with a weighted average stated interest rate of about 5.1%. The increase in our debt capital during the first quarter reflects the $200 million SMBC funding facility, the new $144 million in senior unsecured notes and the $163 million in convertible notes. At the end of the first quarter, we had approximately $950 million in available undrawn debt capacity subject to borrowing base and leverage restrictions, plus $204 million in unrestricted cash available. At March 31, our debt-to-equity ratio was 0.59x, and our debt-to-equity ratio, net of available cash, was 0.53x.

As Mike mentioned earlier, since quarter end, we upsized our revolving credit facility capacity from $810 million to $900 million, and we were pleased to add 6 new banks to this lender group. This upsize modestly increases our pro forma available undrawn debt capacity at March 31 to over $1 billion and pushes back any debt maturities until 2016.

This morning, we declared a second quarter dividend of $0.37 per share, which will be payable on June 29 to stockholders of record on June 15. Since our IPO of October of 2004, we have paid or declared cumulative dividends per share of $11.60, including our second quarter 2012 dividend. For more details on our financial results, I refer you to our Form 10-Q 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 and backlog and pipeline before concluding and turning over to Q&A. If folks would turn to Slide 13. In the first quarter, we made 12 commitments, totaling approximately $384 million. 6 to new portfolio companies, 1 to an existing portfolio company and commitments to 5 additional companies made through the Senior Secured Loan Program, which included 3 to existing companies and 2 to new companies. Our first quarter investment activity reflected slower market conditions, and our ongoing strategy to remain even more highly selective during tighter and more volatile markets.

On Slide 14, our first quarter investment activity by asset class illustrates that we invested 82% in first lien debt and 17% in the Senior Secured Loan Program, the proceeds of which were applied to co-investments with GE in stretch senior and unitranche loans. From an exit standpoint, about 91% of our exits were also in first lien senior debt, with a small portion of subordinated debt leaving the portfolio.

Now turning to Slide 15. On a combined basis, the underlying portfolio company weighted average total net leverage remained steady at 4.3x quarter-over-quarter. Our overall weighted average interest coverage declined slightly from 2.6x to 2.5x. At the end of the first quarter, the underlying borrowers within the Senior Secured Loan Program had similar metrics, with a weighted average total net leverage multiple of 4.4x and weighted average total interest coverage ratio of 3x.

On Slide 16, you can see that we made investments in companies averaging $28 million in weighted average EBITDA during the first quarter. As we've previously discussed, when the larger liquid capital markets are frothy, we tend to focus on slightly smaller companies where our competitive advantages are stronger and pricing is relatively more attractive. The overall weighted average EBITDA of the companies in our combined portfolio was relatively flat at approximately $45 million. During the first quarter, the weighted average EBITDA for borrowers within the Senior Secured Loan Program was approximately $46 million.

On Slide 17, you'll see that the portfolio remains well diversified by issuer. While our largest investment at quarter end continue to be in the Senior Secured Loan Program, which was approximately 22% of the portfolio at fair value, the program was comprised of investments in 33 separate borrowers. As of March 31, none of the underlying borrowers in the program were on nonaccrual.

The largest single underlying borrower in the program represented about 5.6% of the total aggregate principal amount of loans extended by Ares Capital and GE under the program. Excluding the program, our remaining largest 14 investments totaled approximately 31.3% of the portfolio at fair value at the end of the first quarter.

During the first quarter, our historical focus on lending to high-margin growth companies in defensively positioned industries continued to bear fruit. Despite the slow growth economy, our portfolio of company weighted average revenue and EBITDA growth remained strong at approximately 12% and 13%, respectively on a comparable basis for the year-to-date period in 2012 versus the same period in 2011. These growth rates are similar to the 9% and 14% growth rates that we reported on our last call.

Now please turn to Slide 19 for a summary of the grades in our portfolio. The portfolio rating was unchanged as we experienced 5 rating upgrades and 5 rating downgrades during the first quarter. In the aggregate, as of March 31, the weighted average grade of the portfolio remained stable compared to the fourth quarter with a 3 rating.

And turning to Slide 20, you'll see an update on our nonaccrual statistics. On an amortized cost basis, the portfolio nonaccruals as a percentage of the portfolio were relatively unchanged at 3.6% at the end of the first quarter compared to 3.3% at the end of the fourth quarter and improved from 4.8% at the end of the first quarter a year ago. On a fair value basis, these same percentages were 1%, 0.9% and 2.6%. Overall, we feel very good about the quality of the portfolio and the stable credit environment.

On Slides 21 and 22, you'll find our recent investment activity since March 31, and our current backlog and pipeline. Through May 4, we had made additional new commitments of approximately $340 million, of which $335 million were funded. Of these new commitments, 65% were in first lien senior secured debt, 31% were in second lien debt and 4% were in investments in subordinated certificates of the SSLP. Of the $340 million in commitments, 88% were floating rate, and 12% were fixed rate. The weighted average yield of debt and other income-producing securities funded during the period at amortized cost was 9.3%. 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, since March 31 through May 4, we exited $221 million of investment commitments, of which 41% were in first lien senior debt, 24% were other equity securities, 20% were subordinated debt, 8% were investments in subordinated certificates of SSLP, 6% were second lien senior secured debt and 1% were preferred equity securities. And of the $221 million of exited commitments, 53% were floating rate, 25% were noninterest-bearing and 22% were fixed rate investments. The weighted average yield of debt and other income-producing securities exited or repaid in amortized cost was 13.1%. In addition, net realized gains on these exits totaled approximately $15 million.

As shown on Slide 22, as of May 4, our total investment backlog and pipeline stood at $460 million and $590 million, respectively. While the total backlog and pipeline collectively have increased about $70 million since February 24, our backlog component, which typically carries a higher probability of closing, has increased about $180 million.

I'd like to conclude with a few thoughts regarding the Allied Acquisition and then summarize our first quarter and outlook. Having now past the 2-year anniversary of the Allied Acquisition, we believe that we've accomplished our primary objectives and have delivered significant value to our shareholders. As we've discussed in the past, the acquisition provided us with material strategic benefits in the form of increased scale and a strengthened competitive position. Moreover, the successful rotation of the Allied portfolio has helped us increase our core earnings and our net asset value per share.

From an earnings standpoint, our core earnings per share for the last 4 quarters ending March 31, 2012, have increased approximately 21% compared to our core earnings per share for the 4 quarters prior to the acquisition. We've also increased our regular quarterly dividend to a level that represents a 6% increase compared to the pre-acquisition level.

Given that the remaining Allied assets are now less than 15% of our total portfolio, we are no longer separately showing the legacy Allied portfolio data in our presentations, but we think it's worth recapping what we've accomplished over the last 2 years. On April 1, 2010, we purchased a portfolio with a fair value of approximately $1.8 billion. And over the 2-year period ended March 31, 2012, we've had exits and repayments from the Allied portfolio of approximately $1.4 billion and recognized net realized and unrealized gains in total of $72 million, excluding the approximately $130 million noncash gain that we recognize at closing on the assets acquired.

On a realized basis, we've generated an internal rate of return in excess of 25% on the $1.4 billion of exits through March 31, 2012. And although we have some remaining controlled portfolio investments we plan to exit, we successfully exited a legacy Allied controlled portfolio company last week, generating about $108 million in proceeds from our debt and equity investments in that company, including an approximate $14 million gain from the sale of the equity. Pro forma for this exit, our equity investments from the legacy Allied portfolio would have been reduced from $271 million at April 1, 2010, to approximately $100 million as of March 31, 2012, and we fully expect this number to continue to decline as the year progresses.

Now turning to the first quarter. Again, we're pleased with our strong core earnings per share of $0.38 against our dividend of $0.37 per share, particularly given the relatively light quarter for investment activity. Importantly, we're benefiting from a higher level of recurring spread income, which provides stability in our core earnings even when new investment activity and associated fee income is modest. We have a healthy portfolio of underlying companies, experience solid cash flow growth and the estimated undistributed taxable income spillover from 2011 of approximately $0.72 per share provides visibility and support for future dividends.

Equally as important, we believe that we have a proven investment process with the scale and competitive advantages that enable us to be successful in the current tight market environment, while remaining patient in anticipation of inevitable market volatility and hopefully more attractive investment environment. We have also taken advantage of the more liquid market conditions by issuing new debt capital at favorable interest rates and durations and now have approximately $1 billion of low-cost dry powder for new investments.

We continue to believe that a compelling long-term opportunity is in place for nonbank providers like Ares. On the supply side, capital is likely to be increasingly constrained by additional bank regulations and stricter capital requirements, as well as the capital outflows that should occur as the 2007 and 2008 vintage CLOs move out of their typical 5-year reinvestment periods. In addition, new capital formation in the specialty finance space remains challenging. When you combine these trends with the demand for capital from private equity firms seeking to deploy uninvested capital and the normal course growth capital needs of the middle market, the outlook for attractive investment opportunities appears bright. As these trends play out, we believe that we will see more interesting 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, expect us to continue to seek the addition of investment professionals with unique industry and product expertise.

As an example, last year, we added a team of investment professionals with extensive experience in the power generation sector and last quarter, we added a similarly qualified team in the venture finance sector. We look forward to the addition of new and attractive investments to the portfolio in these sectors and others over time.

And that concludes my prepared remarks. And as always, we thank you for your time and continued support. And operator, we would now like to open the line for Q&A.

Question-and-Answer Session


[Operator Instructions] Our first question is from Jasper Burch of Macquarie.

Jasper Burch - Macquarie Research

Just starting off with, I noticed that your cash balance both this quarter and March 31 last year, has been a little bit high. I was just wondering is that just white noise in terms of the timing of fundings or is there something else going on?

Michael J. Arougheti

White noise, I don't know if I'd characterize it that way, but I think you shouldn't read into that.

Jasper Burch - Macquarie Research

Okay, that's useful. And then looking at the yield on new investments, your 9.3% is a little bit low. Just -- is that what we should sort of expect going forward? And could you speak a little bit to the possibility of sort of adding structural leverage to those and increasing the yield that way?

Michael J. Arougheti

Yes, I think you hit the nail on the head with the second part of your question. As we've seen in past quarters, it's difficult to read into the headline number on new investments because as you know, through the course of the quarter, either through distribution and syndication or structuring, we tend to see that number come up, and I'd expect to see the same in this quarter as well once all is said and done.


Our next question is from Joel Houck of Wells Fargo.

Joel J. Houck - Wells Fargo Securities, LLC, Research Division

I guess, really kind of a big picture question here in regards to what we're seeing in the credit markets, particularly in the middle market, spreads are compressing. I guess they are still more attractive than say the institutional high-yield market. What's your view as the year plays out in terms of originating new credits versus kind of defending your existing portfolio or making existing portfolio investments, presumably you know those credits very well. And to the extent you are deploying capital, which you, obviously, did this quarter, where are you seeing the most kind of attractive types of deals? Obviously, there's senior, but are there certain types of industries or themes that you're gravitating towards?

Michael J. Arougheti

Sure. Let me just address the defending the existing portfolio because as we've said before, one of the benefits of being of our size and breadth is that we have investments, between ARCC and Ivy Hill, in over 500 middle market companies. And as you mentioned, those are companies that we know very well. We've been tracking for a long time. And so the best originations and the most efficient originations, obviously, come from the existing portfolio. Again, when you have EBITDA growth like we've been talking about consistently in the double digits, you also have a natural deleveraging within that portfolio. So while you could think of it as defending the portfolio, I think maintaining and releveraging the portfolio, given its performance, is a great way for us to deploy capital in this environment. And those borrowers just given our incumbency, tend to be much less price sensitive. So that's clearly a theme and as you saw this quarter with the 12 new investments, close to half of them come from the existing portfolio, and I'd expect to see that continue. In terms of how we see the year playing out, we talked about this last call as well. The markets are experiencing significant week-to-week and month-to-month volatility, and I think you have to have a view directionally where you think the market is going over the course of the year and really drive the portfolio composition and the origination to that view. If you look at 2011 as an example, we saw similar inflows into the market in the first quarter and the early parts of the second quarter. We saw spreads similarly tighten to the point where on single B credit, we saw yield to maturity of about 5.5%, 5.6% and by the time we got to October given all of the refocus, I think appropriately, on Europe, we saw that the balloon to 8.8%. So there was roughly a 320 basis point widening of spreads over a 6-month period. When you look at what's going on in the markets today and the renewed focus on issues in Europe, we would expect that the volatility will lead to better investment opportunities for us as the year progresses. And you're already beginning to see us express that view given the size of the backlog and pipeline and the capital that we've already committed quarter-to-date. The other thing that we hope to see, but we have not seen really come through in earnest is we'd like to see an M&A trend emerge given the health of corporate balance sheets, but also some of the potential tax-driven selling that many people are calling for in the back half of the year. And obviously, as the supply of new issue increases, it relieves some of the pressure on spread, and so that's something that we're keeping an eye out for and that we hope to see. In terms of the things that we are focused on, it's more of the same, no new industries or themes have emerged. As you saw, we continue to focus heavily on first lien and unitranche investing, both within the Senior Secured Loan Program and without. And when we look at the spreads that we're able to generate there relative to other asset classes, that continues to be the most compelling.

Joel J. Houck - Wells Fargo Securities, LLC, Research Division

All right. That's excellent color. And one more, if I may, in terms of your kind of current outlook on structuring fees would be helpful. Obviously the SSLP facility has -- there's a capacity issue coming at some point in time. So how should we think about structuring fees in light of that capacity constraint in your future?

Michael J. Arougheti

Yes, well, let's address fees generally and then we can talk about SSLP specifically. So fees are, obviously, lumpy based on investment activities. We talked about in our prepared remarks. I think it's important that as we're growing the portfolio, people understand that the core earnings being generated from recurring spread income is also growing in line with the growth in the portfolio. And I think you asked this question last quarter, Joe, and we talked about it vis-à-vis setting the dividend relative to ordinary course origination activity. So the fees are going to be up and they're going to be down, but if you look at the history of the company over the last 8.5 years, the average level of fees per share has been about $0.05 per share per quarter. And some quarters you'll see it above that. Some quarters like last quarter, you'll see it meaningfully above that. And so when we manage the dividend and we manage the business, we understand that fees are in the ordinary course, part of it. But obviously, the volatility of the fee income is something we factor in when we're setting our dividend. With regard to SSLP, I'm not sure that SSLP is capacity constrained. Number one, similar to the existing portfolio, there's a natural deleveraging within that portfolio that allows us to reinvest capital as it comes back. There's a natural velocity within that portfolio, too, that frees up capacity. And as you've seen over the last 3 years, there's been a consistent growth in the program to meet the market demand. I think we've expanded the size of the program 3 or 4x between the acquisition in the fourth quarter of '09 through to today. And so I'm not quite sure it's capacity constrained, but what you do highlight is true that dollars invested into SSLP carry a marginally higher fee based on the assets booked relative to investments made on balance sheet.

Joel J. Houck - Wells Fargo Securities, LLC, Research Division

Yes, I guess that's where I was going is more, not that it's technically constrained today, as more of kind of your outlook going forward. But the overall commentary on fee income is very helpful.


[Operator Instructions] And our next question is from Greg Mason of Stifel, Nicolaus.

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

Mike, could you comment a little bit on the prepayments that you saw in the second quarter with a 13.1% yield on those debt investments? Were these exits planned from the old Allied portfolio? I know that had high yields, or is this just the repayment activity that just generally occurred?

Michael J. Arougheti

Yes, I would say it's just natural prepayment penalties.

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

Okay. And then can you talk...

Michael J. Arougheti

By the way, just to clarify, too. The 13.1% versus the 9% is post-Q1, not within Q1.

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

Great. And then could you also clarify, is that 13.1% only on the 75% of the debt investments and the 25% nonyielding would lower that number on a weighted average yield for the x?

Michael J. Arougheti

If you actually -- It's a good -- I'm glad you mentioned it. If you actually look at the actual interest income because of the amount of nonyielding in equity securities, it's effectively flat.

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

Okay, great.

Michael J. Arougheti

On a dollar basis.

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

And then could you talk about, with the launching of the new Ares commercial mortgage. Does this take away from your time or senior management's time from Ares, is there any negative ramifications to ARCC?

Michael J. Arougheti

None whatsoever. Just for everybody's benefit, what Greg is referring to is Ares management recently supported the successful IPO of a commercial mortgage REIT called Ares Commercial Real Estate. I'm the Chairman of the Board, which takes up very little of my time. That business is building on some of the themes that I referenced in our prepared remarks just in terms of the opportunity for nonbank lenders to take meaningful market share in a whole host of middle market asset classes, real estate being one of them. I would actually say the opposite. I think that as the platform grows and as we have more capital markets touch points and more investment professionals around the country, trafficking in local markets, I think it's a net benefit to ARCC and to the BDC just based on the information flow and the deal flow that we'd expect to see coming off of that platform.

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

Great. And then one last question. On the venture finance team that you recently hired, how quickly do you think you can ramp that particular team's originations up and how meaningful can that business be to your origination given it's a entirely new sector for you?

Michael J. Arougheti

Sure. So the team that we acquired used to work at a fund called BlueCrest. Some of those -- of you on the phone may be familiar with them because they had filed an N-2 to go public as a BDC. And again, as I mentioned in the prepared remarks, I think it's obvious to many that capital formation in specialty finance is difficult, and if you're fortunate enough to actually get public, growing and scaling a public company successfully is equally as challenging. And so I think the fact that the team came over, and this is a team of about a dozen investment professionals with decades of experience, I think is a testament to the strength of the platform in terms of our ability to support the team and the growth in that business. Given the fact that they were operating up until the point that they joined us and given the depth of experience in relationships that they have, we expect them to ramp pretty quickly. That said, the business itself just based on the size of the investments and the velocity in those investments, our expectation would be that it's probably a $250 million to $500 million portfolio over time. I think they can get there pretty quickly, but these are pretty fast amortizing loans. Beyond $500 million, I don't want to say we won't be able to grow it there, but I think it's tough to sustain that level of fundings for this kind of business.


Showing no further questions, this will conclude the question-and-answer session. I would now like to turn the conference back over to management for any closing remarks.

Michael J. Arougheti

Great. We had nothing further. I'd just like to reiterate our thanks and gratitude for everybody's attention today and continued support, and we look forward to speaking to everybody again next quarter.


Ladies and gentlemen, this concludes our conference call for today. If you missed any part of today's call, an archived replay of this conference call will be available approximately 1 hour after the end of this call through May 21, 2012 to domestic callers by dialing (877) 344-7529 and to international callers by dialing 1 (412) 317-0088. For all replays, please reference account number 10012156. An archived replay will also be available on a webcast link located on the homepage of the Investor Resources section of our website.

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