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Executives

Mike Arougheti – President

Penni Roll – CFO

Analysts

Troy Ward – Stifel, Nicolaus

Richard Shane – JPMorgan

Jasper Burch – Macquarie

Arren Cyganovich – Evercore

John Hecht – Stephens

Jonathan Bock – Wells Fargo

Jason Freuchtel – SunTrust

Vernon Plack – BB&T Capital Markets

Ares Capital Corporation (ARCC) Q2 2012 Earnings Call August 7, 2012 11:00 AM ET

Operator

Good morning and welcome to Ares Capital Corporation’s Earnings Conference Call. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded on Tuesday, August 7, 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 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 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/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 Q2 2012 Earnings Presentation link on the homepage of the Investor Relations section of the website. The company will refer to this presentation later in the call. Ares Capital Corporation’s earnings release and Form 10-Q are also available on the company’s website.

I will now turn the conference over to Mr. Michael Arougheti, Ares Capital Corporation’s President.

Mike Arougheti

Great. Thank you, operator. Good morning to everyone and thanks for joining us today. This morning we reported strong second quarter results, which were highlighted by growth in our core earnings per share, solid net investment growth and continued strong credit performance.

Over the past year, our core earnings per share have benefited from meaningfully higher recurring net interest income, primarily reflecting a higher level of yielding debt securities in our portfolio and slightly lower funding costs. Second quarter core earnings per share were $0.40, a 21% increase compared to the same period a year ago and 5% increase compared to the first quarter. In addition, our second quarter core earnings per share were $0.03 per share higher than our second quarter dividend of $0.37 a share.

In light of this performance, we’re pleased to announce that we declared $0.01 per share increase in our quarterly dividend, from $0.37 per share to $0.38 per share, and it continues to be our goal to distribute a consistent quarterly dividend covered by core earnings.

Today we also announced this $0.05 per share additional dividend. You may recall that we carried over approximately $160 million or $0.72 per share of undistributed taxable earnings into 2012. This additional dividend reflects our current view that a portion of this excess can now be distributed to shareholders while still providing future support and stability to our regular dividend.

We may consider paying another additional dividend after evaluating a number of factors, including our liquidity position, general market conditions, portfolio performance, our core earnings and the level of our undistributed taxable earnings relative to our current level. With this framework in mind, although there can be no assurances, we may be in a position to declare another additional dividend as early as next quarter.

Let me now provide a little more color on our second quarter results and try to put them into context with current market conditions before turning the call over to Penni Roll, our CFO, for further details on the quarter. We had a productive second quarter with $728 million in new investment commitments, the majority of which were issued to existing portfolio companies that we view as being among our strongest credits. In total, we funded $704 million of investments on a gross basis and $248 million on a net basis.

Although second quarter gross originations were materially higher compared to our first quarter levels, they were slower than our gross originations for the same period a year ago, mirroring the slowdown in the overall middle market during this period. Our investment portfolio also continued to perform well. We had no new non-accrual investments this quarter and our non-accrual ratio declined. Our weighted average portfolio grade was stable at 3.0 and the performance of the underlying portfolio companies continues to be strong.

Finally, as we discussed in our last call in May, we further strengthened our balance sheet during the second quarter. We expanded the capacity and extended the maturities on two revolving facilities and also reduced the stated interest rate on one of our facilities. As result of these actions and our net investment activity, we ended the second quarter with approximately $884 million in available debt capacity, subject to borrowing base and leverage limitations, and we have no debt maturities until 2016.

Turning to the credit markets. Volatility continues to be the overarching theme. Market conditions have been somewhat choppy due to sluggish and uncertain economic growth and frequent investor concerns over developments in the Eurozone and, to lesser extent, China. In terms of market pricing, investor uncertainty drove senior loan spreads higher toward the end of the second quarter and pricing appears to have leveled, if not moderately tightened, since the end of the quarter.

In general, pricing and terms remain reasonably attractive, particularly when measured against the benign credit and very low interest rate environment. And although leverage multiples have crept higher over the past six months, risk-adjusted returns are attractive at this point in the cycle and in this rate environment. That said, given the increased volatility and potential macroeconomic risks, we stayed defensive in our investment activities, with a preference toward senior loans in franchise businesses.

As we have in the past with both our capital deployment and liability management, we’ll remain opportunistic so that we can take advantage of opportunities presented by volatility in either direction. Our strategy continues to be to leverage our strong origination platform and significant scale to uncover the most complete opportunity set while remaining extremely selective and disciplined.

Penni, would you now walk us through additional detail on our second quarter’s financial results?

Penni Roll

Sure. Thanks, Mike. For those viewing the earning’s presentation posted on our website, please turn to Slide 3, which summarizes our financial and portfolio performance information. As Mike stated, our basic and diluted core earnings were $0.40 per share for the second quarter of 2012, a $0.02 per share increase over our core earnings of $0.38 per share for the first quarter of 2012 and a $0.07 per share increase from the same quarter a year ago.

Our net investment income for the second quarter was $0.40 per share compared to $0.36 per share in the first quarter of 2012 and $0.21 per share in the second quarter of 2011. Net realized and unrealized gains for the second quarter were $0.01 per share compared to $0.13 per share in the first quarter of 2012, and a net loss of $0.03 per share in the second quarter of 2011.

Our GAAP net income for the second quarter was $0.41 per share, compared to $0.49 per share for the first quarter and $0.18 per share for the second quarter of 2011. As of June 30, 2012, our total assets were $5.8 billion and our total stockholders’ equity was $3.4 billion, resulting in an NAV per share of $15.51, up slightly from $15.47 at the end of first quarter, and improved from $15.28 a year ago.

Now I will turn to our investment activity. As Mike highlighted, we made gross commitments of $728 million in the second quarter 2012, compared to $384 million and $890 million during the first quarter of 2012 and the second quarter of 2011, respectively. We exited commitments of $473 million in the second quarter, compared to $331 million and $376 million during the first quarter of 2012 and the second quarter of 2011 respectively, which resulted in net commitments of $254 million in the second quarter, compared to net commitments of $53 million in the first quarter of 2012 and $514 million during the second quarter of 2011.

Primarily as a result of new investment activity, our investment portfolio grew to $5.5 billion at fair value at quarter end and now consists of 144 portfolio companies. Our portfolio mix shifted further toward senior debt, with approximately 57% in senior secured debt investments, 20% 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, 8% in senior subordinated debt, 5% in preferred equity and 10% in other equity and other securities.

From a yield standpoint, our weighted average yield on debt and other income-producing securities at amortized cost, declined from 12.2% to 11.7% quarter-over-quarter, primarily reflecting a higher level of lower-yielding and generally more conservative senior debt in the portfolio.

The weighted average stated interest rate on our debt capital declined modestly from approximately 5.1% to 5% quarter-over-quarter. This 5% stated rate reflects our actual quarter end borrowings on our debt facilities, which were weighted roughly two-thirds toward longer-term, fixed rate unsecured notes, which naturally carry a higher stated rate, compared to about one-third and floating rate revolving secured facilities, which carry a lower stated rate.

If these revolving facilities were fully drawn, our weighted average stated interest rate on our debt would be about 4.3%. Our weighted average investment spread decreased sequentially from 7.1% to a still strong 6.7%.

While we have experienced a decline in the yield on debt and income-producing securities over the past year, our debt – our total portfolio yield remained steady at 10.4%, compared to the second quarter of 2011, reflecting our rotation out of the legacy Allied portfolios initial higher weighting of non-yielding debt and equity securities into a greater percentage of income-producing debt securities.

Now please turn to Slide 5. Our portfolio remains significantly weighted toward floating rate loans with LIBOR floors. Floating rate assets were 71.6% at the end of the second quarter, compared to 67.7% at the end of the first quarter at fair value. Of the floating rate assets, approximately 68% featured LIBOR floors and another 29% were in the Senior Secured Loan Program, where all of the underlying loans have LIBOR floors. You can also see the results of our continued portfolio rotation as we reduced our equity and other non-interest earning assets to 11.1% of the portfolio at the end of the second quarter, compared to 13.2% at the end of the first quarter, and to 17.7% at the end of the second quarter of 2011 at fair value.

On Slide 6, you can see the growth in our investment income compared to our expenses, as we reported $87.9 million in net investment income in the second quarter of 2012, compared to $77 million in the first quarter, and $43.8 million in the second quarter of 2011.

Net investment income was reduced in these periods by $0.6 million, $5.7 million and $24.6 million, respectively, for capital gain incentive fees accrued but not paid. Excluding the impact of these accrued capital gain incentive fees, you can see that our second quarter net investment income increased 7%, compared to the first quarter, and 29% compared to the second quarter of 2011.

Turning to Slide 7, you can see that one of the primary drivers of this improvement is the growth in our net interest income. Our second quarter net interest income of $103 million increased 2.9%, compared to our first quarter, and 24.5% from the second quarter of 2011.

Now let’s turn to Slide 10 for a discussion of our debt capital. As of June 30, we had $3.2 billion in committed debt capital and $2.3 billion, an aggregate principal amount of debt outstanding, with a weighted average stated interest rate of 5%. We believe that the long weighted average maturity and diversified sources of our debt provide strength and stability to our balance sheet.

As of June 30 2012, the weighted average maturity of our outstanding debt was nearly 10 years and we have no debt maturities until 2016, which improves operating flexibility. The primary changes in our debt capacity during the second quarter were the $90 million increase in our revolving credit facility to $900 million, the $80 million increase in our revolving funding facility to $580 million and a $60 million decrease from the repayment in full of the remaining notes issued as a part of our 2006 debt securitization.

Since the end of the second quarter, one additional lender has committed $40 million to our revolving funding facility, bringing the total committed capacity of that facility to $620 million. As of the end of the second quarter, we had approximately $884 million in available undrawn debt capacity, subject to borrowing base and leverage restrictions. At June 30, our debt-to-equity ratio was 0.64 times and our debt-to-equity ratio, net of available cash, was 0.61 times.

As Mike stated, we declared two dividends this morning: a $0.38 per share third quarter dividend; and a $0.05 per share additional dividend, both of which will be paid on September 28 to shareholders of record on September 14.

Now Mike, I’ll turn the call back over to you.

Mike Arougheti

Great. Thanks, Penni. Now I’d like to discuss our recent investment activity and portfolio performance in more detail, and then I’ll provide an update on our post quarter-end investments, and backlog, and pipeline before concluding.

Folks, can turn to Slide 13. You’ll see in the second quarter, we made 20 commitments totaling $728 million, five to new portfolio companies, 12 to existing portfolio companies and commitments to three companies made through the Senior Secured Loan Program, which included two existing companies and one new company.

As I mentioned, our second quarter investment activity included commitments to a number of existing portfolio companies that have had strong performance. While this resulted in slightly lower fee income, these transactions highlight the benefits of incumbency and our continued strategy backing the capital needs of our best borrowers.

On Slide 14, we summarize our second quarter investment activity by asset class. You’ll see we invested 93% in first and second lien senior debt, 5% in senior subordinated debt and 2% in subordinated certificates of the SSLP. The proceeds from exits were fairly diverse with 49% in first and second lien senior debt, plus another 4% in the Senior Secured Loan Program, with the remaining 47% in junior capital, including 19% in various equity and other categories.

Turning to Slide 15. Primarily reflecting higher recent market leverage levels, the underlying portfolio company weighted average total net leverage increased slightly from 4.3 times at the end of the first quarter to 4.4 times as of the second quarter. However, our underlying portfolio weighted average interest coverage improved slightly from 2.5 times to 2.6 times, quarter-over-quarter.

At the end of the second quarter, the underlying borrowers within the Senior Secured Loan Program had similar metrics, with weighted average total net leverage of 4.5 times and a weighted average total interest coverage ratio of 3.1 times.

On Slide 16, you can see that we made investments in larger middle market companies, averaging $63 million in weighted average EBITDA during the second quarter, which was a fairly sizeable jump from $28 million in the first quarter. This increase reflects the fact that we reinvested in several of our larger portfolio companies, which also explains the slight uptick in overall portfolio leverage, as larger companies typically command modestly higher leverage.

The overall weighted average EBITDA of the companies in our portfolio increased to approximately $48 million and during the second quarter the weighted average EBITDA for borrowers within the SSLP was approximately $45 million.

On Slide 17, you’ll see that the portfolio continues to be well diversified. While our largest investment at quarter-end continued to be in the Senior Secured Loan Program, at approximately 20% of the portfolio at fair value, the Program was comprised of investments in 34 separate borrowers.

As of June 30th, none of the underlying borrowers in the Program were on non-accrual, and the largest single underlying borrower in the Program represented about 5.6% of the total aggregate principal amount of loans extended to borrowers under the program. Excluding the Program, our remaining largest 14 investments totaled approximately 31.6% of the portfolio at fair value, as of the end of the second quarter.

Despite the slowing growth rate of our economy, our underlying portfolio companies continued to experience nice growth. Weighted average revenue and EBITDA growth of these companies was approximately 12% and 9%, 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 12% and 13% growth rates that we reported on our last call.

Now turning to Slide 20. As I stated earlier, during the second quarter, we had no new non-accruals. On an amortized cost basis, portfolio non-accruals as a percentage of the portfolio declined from 3.6% at the end of the first quarter to 2.3% at the end of the second quarter. On a fair value basis, these same percentages improved as well, with just 0.7% on non-accrual at the end of the second quarter, compared to 1% and 1.6% at the end of the first quarter of 2012 and the second quarter of 2011, respectively.

On Slides 21 and 22, you’ll find our recent investment activity since June 30 and our current backlog and pipeline. From July 1 through August 3, we had made new commitments of approximately $299 million, of which $281 million were funded. Of these new commitments, 70% were in first lien senior secured debt, 17% were in subordinated certificates of the SSLP, 10% were in second lien senior secured debt, and 3% were in other equity securities. Of the $299 million in commitments, 97% were floating rate and 3% were non-interest bearing.

The weighted average yield of debt and other income-producing securities funded during the period at amortized cost was 10.4%. We may seek to syndicate a portion of these commitments to third parties, although there can be no assurance that we’ll do so. And as we’ve discussed on prior calls, post syndication, we generally expect to see an increase in the weighted average yield on new investments.

Also from July 1 through August 3, we exited at $144 million of investment commitments, of which 58% were in first lien senior debt, 39% were senior subordinated debt, and 3% were in other equity securities. Of the $144 million of exited commitments, 56% were floating rate, 39% were fixed rate, 3% were non-interest bearing, and 2% were investments on non-accrual.

The weighted average yield of debt and other income-producing securities exited or repaid at amortized cost was 11.5%. In addition, net realized gains on these exits totaled approximately $23 million.

As shown on Slide 22, as of August 3, our total investment backlog and pipeline stood at approximately $430 million and $570 million, respectively, or about $1 billion in total. So, as always, we can’t assure you that we’ll consummate any of these transactions.

So in closing, we believe that we’ve had a very solid second quarter and a positive first half 2012. Our core earnings have been strong, primarily reflecting a higher amount of yielding debt securities from our portfolio rotation, away from non-yielding securities and, to a lesser extent, lower funding costs.

Our credit quality continues to be strong and we believe that our balance sheet provides significant flexibility and allows us to be opportunistic in volatile markets. From a market standpoint, we believe that we continue to benefit from a favorable competitive position in the middle market, given our large scale and ability to provide flexible capital solutions.

Further, as we’ve discussed on prior calls, we have added two experienced teams in Project Finance and Venture Finance and we’ll continue to look for ways to make additional enhancements to our platform.

In our view, there’s a very bright outlook for non-bank capital providers to small and medium-size businesses, like Ares Capital, particularly as CLO reinvestment periods expire over the next two years and more stringent bank regulations, such as Dodd Frank and Basel III, are implemented.

And lastly, as a result of our performance and our level of undistributed taxable earnings, we’re very happy to be in a position to, not only increase our quarterly dividend, but to also declare an additional dividend for the third quarter.

And that concludes my prepared remarks. So, as always, we thank you for your time and support. And we’d now like to open up the line for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Troy Ward, Stifel, Nicolaus. Please go ahead.

Troy Ward – Stifel, Nicolaus

Great and good morning, guys. Just a couple of quick things, Mike, you talked about the different environments that are out there. One of the things that we’d like some color on is the syndication environment. What level of activity do you anticipate in the syndication market as you guys use it to offload certain larger pieces? And has that changed at all? Or do you still find that a very attractive way to boost yields when you take down the senior debt?

Mike Arougheti

No, nothing’s really changed. As we’ve talked about in and of itself the spread income or the fee income that we generate through syndication is attractive, but it’s really not the core reason why we do it. As you highlight, having the ability to distribute into the market allows us to be much more thoughtful about how we want to structure our portfolio. So to the extent that we can use our large balance sheet and flexibility to take down large senior secured positions, we can then use our distribution and syndication capability to structure first-outs or last-outs or distribute some of that risk.

So, for us, the syndication and distribution is as much about risk management and portfolio management as it is about driving fee income. That said, I think as you know one of the benefits of being a self-originator is to access assets that other people can’t, and so when we are syndicating we are typically skimming fees, the order of magnitude of 200 basis points to 300 basis points to the market.

So, I think you’ll see it continuing quarter-over-quarter. It is a little bit lumpy as to how much quarterly activity there will be, but it is a core part of our business.

Troy Ward – Stifel, Nicolaus

But there’s still a good number of syndication partners that want product that you have to offer.

Mike Arougheti

Absolutely.

Troy Ward – Stifel, Nicolaus

Okay. And then on the debt side as you build out your liability structure, I know you said you added another $40 million to the revolver. Can you just speak to the environment, from a liabilities perspective, as you think about growing your balance sheet? And what – how do you anticipate you grow your balance sheet, kind of ratio between revolver and fixed?

Mike Arougheti

Sure. Then we’ll start off at a high level and then we can drill down into specific credit markets. As we’ve talked about before, in terms of a liability management, we want to make sure that we’re focused on diversifying our funding sources, getting the right mix of fixed and floating rate, pushing out maturities to the extent that we can on a cost-effective basis, and, where possible, reducing the amount of covenants and security that we have to give up to provide maximum operating flexibility.

The interesting thing on the credit markets is that they’re not – they don’t always work together in tandem and we have seen an opportunity to exploit inefficiencies or opportunities in one market versus the other.

So, if you go market-by-market, all of the markets are available to us, the retail notes markets, which we’ve accessed multiple times, continues to be open and amenable at very attractive rates. The bank market, in terms of secured revolvers, as demonstrated by our Q2 activities in addition to the $40 million that we recently brought in post quarter-end, continues to improve.

As a side note, we continue to discuss the market opportunity that is developing for us as result of Basel III and a de-emphasis of the low investment grade lending on the part of a lot of banks.

Interestingly, we’re actually seeing that work in our favor as the borrowers’ banks are still looking to access middle market and they’re finding it more efficient, we believe, to access it through outsource partners or aggregators, such as ourselves. So we are seeing a renewed interest in the bank market to lend to the balance sheet.

The convert market continues to be open to us and is a market that we have tapped in the past and the institutional, both private and public notes market, is open on a secured basis, also at attractive rates.

So again, as we manage the liabilities you’re going to see us tapping each of those markets periodically, as we try to strike that balance between cost of capital and balance sheet flexibility.

Troy Ward – Stifel, Nicolaus

Okay. Great. And then just one last comment kind of tying into liability side, on the regulatory front there’s been quite a bit of news in the past six to nine months, in particular House Bill 5929, can you provide any color on that? And how you guys potentially view that – I don’t know – likelihood going forward?

Mike Arougheti

Sure. Well, we can’t comment on the likelihood and I think as everybody knows there’s a long way to go from a bill getting introduced in the House to becoming law. But what I can say is that the bill is getting a significant amount of bipartisan support in the House, and we’re hopeful that it will continue to work its way through the legislative process.

From my perspective, I just think-that this would be most importantly a big boon for middle market America and for small business in this country. And it would also be a pretty big benefit for the BDC sector as really one of the last bastions of capital available to small business in this country.

What’s interesting about it, I think a lot of people are focused on the increase in leverage and viewing it as a way to enhance returns or taking the other side and maybe introducing more risk. The way that we really look at it is it now provides the ability to enter new markets that historically, just based on lower yield and a lower risk profile, may not have been a good fit for the BDC structure. And I think that’s going to be a big driving force behind, hopefully, the legislation getting passed.

Troy Ward – Stifel, Nicolaus

Right. Great color. Thanks, guys.

Operator

The next question is from Rick Shane, JPMorgan. Please go ahead.

Richard Shane – JPMorgan

Thanks, guys, for taking my question; it really sort of falls on what Troy was asking. Ordinarily, it’s pretty clear sort of what you guys think about the market in terms of some of the commentary you provide and also how your balance sheet’s positioned. And if you think back to, for example, last year at this time you had an extraordinary amount of capacity at this point to deploy capital.

When we look at the world today it’s unclear to me whether or not I think you guys are going to be growing. You see the greater opportunity in the short-term on the left-side or the right-side of your balance sheet. Mike, when you’re thinking about this and when you’re thinking three months down the road, what’s going to be your focus over the next quarter? Are you going to enhance the liability structure? Are you going to grow the assets? Or is it going to be sort of balanced because that’s where we are in the market?

Mike Arougheti

Again, you never know. As we’ve talked about, volatility continues to be the only thing that is constant in this market right now. I think we have done a very good job, given the breadth of our platform and our global view and understanding how capital is flowing and how those capital flows are impacting the asset side, as well as the liability side. Given where the capital markets are now, I would expect that we’ll take advantage on both sides.

As I mentioned earlier, the liabilities markets are wide open to us at very attractive rates, and I think we’ll continue to rebalance and extend our balance sheet. And on the asset side, things are changing week-to-week and month-to-month, but generally speaking, as I mentioned, the risk-adjusted returns that we’re able to generate today are very attractive, particularly in light of where we are in the credit cycle and the interest rate environment.

To put that in perspective Q2 2011, the tenure was at 3.2% and our yield on debt securities was 12.5% at 4.4 times. Today, the tenure’s at 1.4%. We’ve given back a little bit on yields, 50 basis points. And we’ve maintained a leveraged profile in the interest coverage. So the risk-adjusted return in this interest rate environment is as good as we’ve seen it.

Richard Shane – JPMorgan

Got it. And, again, as primary market buyers, how long do you think it takes for dislocations in the market to actually – how long do they have to persist? And how long does it take for them to show up, in terms of pricing on when you’re putting things on the balance sheet?

Mike Arougheti

It actually happens pretty quickly. The nice thing about the breadth of platform in the self-originated business that we have is you’re consistently building backlog in the pipeline, and then to the extent that there are meaningful moves in leverage and pricing, you’re recalibrating the backlog and pipeline. So you do have the ability over the three to six-month period from when you first start working on a transaction to when you ultimately close it, to reflect changes in the market. It’s one of the benefits of being in the market consistently.

Where we have seen the biggest opportunity from the volatility and the fourth quarter – and end of the third quarter last year is a perfect example – is when there’s enough uncertainty and volatility that the banks exit the market and show an unwillingness to take balance sheet risk, that’s when we can come in with our scale, both on balance sheet and for the Senior Secured Loan Program to really disintermediate the distributed solution.

And so, where you’re going to see it move quickly is at the upper-end of the size range for borrowers that otherwise would go to the liquid markets, but are going to choose to borrow from us, just given the lack of certainty of execution that the markets could provide.

Richard Shane – JPMorgan

Great. Thank you.

Mike Arougheti

Thanks.

Operator

The next question is from Jasper Burch, Macquarie. Please go ahead.

Jasper Burch – Macquarie

Hi, good morning, gentlemen. I guess just backing up a second, really looking at the bigger picture at Ares, I mean, you guys did a great job this quarter growing your core income. But if you look at it going forward, I mean, you’re going to start hitting, in the absence of regulatory changes, some leverage constraints. I mean, it looks like you’re starting to hit at least the sort of near-term ceiling in terms of yields on the new investments and yields on the portfolio.

So I was just wondering, how are you going to continue to juice the model and continue to access growth? Is it through, I mean, structural leverage? Is it through the piece of your portfolio that you’re syndicating, possibly due to securitizations? I mean, where is the added growth coming from?

Mike Arougheti

When you say growth, you mean growth in earnings or growth in asset...

Jasper Burch – Macquarie

Growth in earnings.

Mike Arougheti

We’ve said this before but I’ll say it again loud and clear so everybody hears it. We as credit asset managers never focus on growth in assets or growth in earnings in and of themselves. I think that if you start managing a business like ours with growth as an objective, you start to make bad credit decisions and it shows up in your performance.

That said, I continue to believe that we have a lot of levers to pull to drive growth, both in terms of how we manage the liability side of our balance sheet and how we ramp the asset side. What’s interesting to me, and I just rattled off some statistics about the interest rate environment, I continue to be a little bit baffled, frankly, by the market’s desire to see earnings growth in excess of a 10% cash-on-cash yield, given the risk profile in our portfolio.

So I would say growth will come through continued rotation in the portfolio, continued use of leverage and rebalancing of leverage. But at the end of the day, the fact that we’re delivering a consistent and stable 10% yield to our shareholders, with very little balance sheet risk, in an interest environment like the one we’re in and will continue to be in, I actually think that questions around growth should really be secondary.

Jasper Burch – Macquarie

Okay. I mean, that’s fair. I mean, looking at the dividend and the yield that you’re returning in cash to shareholders, I mean, considering your commentary that you’re considering another special dividend in the third quarter, and the earnings at least look stable and might continue to grow on or above the dividend, why pay the special dividend rather than, I mean, continue to increase that regular quarterly dividend?

Mike Arougheti

Sure, hopefully, we can do both. To put the additional dividend in context, we entered 2012 with about $160 million or $0.72 a share in spillover income. We just are now finalizing our 2011 tax return and we firmed up that number. When you look at what drove that spillover, it was the combination of the gains from the Allied acquisition as well as a lot of positive performance in the core ARCC equity portfolio, coupled with the fact that we’ve been out-earning our dividends in core earnings.

So, at some point, we think it’s appropriate to start to share that value creation, and that spillover, and those gains with the shareholders. Our view is, though, we’d rather pay it out over time, make sure that we’re rewarding people for long-term and patient shareholding. But also making sure, given all of the volatility that we just got finished discussing that when we’re paying it out we’re evaluating things like our portfolio performance, our core earnings per share, our liquidity position, market conditions, et cetera, et cetera.

So when we think about the regular dividend in the context of the additional, one way to look at is, is if you look at our core EPS today, this quarter it was $0.40. And we had about $0.08 per share coming from structuring fees. So if you look at it a different way, that’s $0.32 a share is coming from core earnings per share, just off the spread income being generated by the portfolio, which is roughly $0.06 less than our $0.38 declared dividend.

So at $0.72 per share, we have three years of dividend support, with no growth to your prior question, and very little new investment activity. We think that’s an incredibly compelling position to be in.

That said, we continue to perform very well. We’re out-earning our dividend. We continue to generate gains and so we feel that we can pay the additional dividends, without number one, jeopardizing the level of the regular dividend; and number two, without jeopardizing the number of spillover income.

Jasper Burch – Macquarie

Okay. That’s helpful. And then I guess just one last question, I had to hop off the call a little bit earlier, so I’m sorry if you already covered this. But looking at the portfolio composition, I mean, it seems pretty clear that you’re going – that you’re increasingly moving the portfolio into floating rate assets. Does that have to do with matching – putting on matching liabilities on this side? Or is that a view on where risk is and that you’re getting long interest rates with the expectation that at some point down the road they’re going to go up?

Mike Arougheti

Well, we know they can’t go down.

Jasper Burch – Macquarie

Yeah.

Mike Arougheti

So we’ve talked about this before. We started repositioning the balance sheet to benefit from rising interest rates 18 months to 24 months ago and then the Fed declared that rates would be low for longer and they continued to push that date out. What’s interesting about the way that we’ve constructed the balance sheet and you can see this on our Q on page 85 is we’ve set it up just based on the way that the floors are constructed, and the way the assets and the liabilities are matched, to effectively benefit in any directional rate environment.

So, yes, it is by design we are seeing better risk-adjusted return up the balance sheet and those securities tend to be floating rate. We do believe the interest rates will go up at some point and we will benefit when they do. But at the end of the day, it’s frankly a very easy decision to make because we know that interest rates aren’t going down. And the way the markets are pricing in the flatness of the curve, we’re able to create that optionality on rates going up without really having to pay for it.

Jasper Burch – Macquarie

Excellent. Thank you, guys, for the color and the nice job in the quarter.

Mike Arougheti

Thank you.

Operator

The next question is from Arren Cyganovich, Evercore. Please go ahead.

Arren Cyganovich – Evercore

Thanks. The EBITDA growth that you’ve mentioned, the 12% and 9%, I forget which time period those were referencing. But the very, very strong underlying portfolio growth relative to where the U.S. economic activity is, should we be concerned about that slowing down? And – or should this be almost a precursor that economic activity may be a little bit better than it seems at face value?

Mike Arougheti

Yeah, I don’t think you should be concerned that we’ll be going down. Just to clarify, it’s for the year-to-date period 2012 versus the year-to-date period 2011. We’ve been seeing that kind of growth rate both on the top line and the EBITDA line now really through the entirety of the credit dislocation. While we have a large portfolio and we are seeing this type of outperformance across many of our non-ARCC portfolios, I think it’s really more a function of our credit selection and the types of industries that we invest in rather than a real indicator as to the health of the U.S. economy.

Because, remember, when you look at the types of industries that we’re investing in, they tend to be very high free cash flow, not economically sensitive industries, like healthcare services, waste management, business services, value-added distribution. And so the portfolio construction by design should not be showing as much economic sensitivity as the broader market. And so our hope is just based on that and what we’re seeing out of the portfolio that this type of performance will continue.

Arren Cyganovich – Evercore

Is that what’s been driving – the underlying EBITDA trends that we’re seeing, is that what’s been driving the relatively healthy origination market for you? And I guess and sponsors feeling comfortable enough to put money to work, or are sponsors just still kind of in that phase of we raised money a few years ago and we need to put it to work?

Mike Arougheti

No, again, it’s putting aside the macroeconomic environment and all of the uncertainty and volatility that creates, which people should be focused on and concerned about, the U.S. economy is okay. We’re treading water from a growth perspective, but it is okay. Most of the companies that we deal with have put together a number of sequential quarters, if not years, of positive performance.

They probably rightsized their balance sheets, they probably streamlined their manufacturing and distribution processes, they probably re-jiggered their supply chains to bring out maximum efficiency. And so, I think companies right now are leaner and better run than they were going into the dislocation and, for the most part, are reaping the benefits of that.

The sponsors do have a lot of capital that they are looking to put to work. They do have a little bit of a clock ticking behind that capital and that is spurring a lot of activity. We’re seeing a fair amount of activity in the non-sponsored world as well.

Arren Cyganovich – Evercore

Okay, that’s helpful. And then, lastly, on the Senior Secured Loan Program that the investment activity was a little bit lighter this quarter. Was that intentional or was that just the timing of opportunities?

Mike Arougheti

Yeah, I wouldn’t read anything into that. It’s really the timing of the opportunities. But one thing I will say and I referenced it a little bit earlier, that product, particularly in the size that we offer it through the Senior Secured Loan Program, is most impactful and most attractive in markets like the ones that we saw at the end of last year where the syndicated loan market and the high-yield market are not functioning as efficiently or effectively as they could and we can come in with meaningful size and disintermediate that market. So you’re going to see the deployment in that program ebb and flow, largely in relation to what’s going on in the syndicated loan market and the high-yield market.

Arren Cyganovich – Evercore

Great, thanks a lot.

Operator

The next question is from John Hecht, Stephens. Please go ahead.

John Hecht – Stephens

Good morning, guys. Thanks for taking my questions, most of them have been asked. But, one, I wonder if, Mike, could you characterize – you mentioned that a large portion of the commitments was for your current large portfolio companies. Can you characterize the reasons they’re raising capital? Is this expansion areas? Is this related to consolidation? Or is there any theme that you’re seeing?

Mike Arougheti

Yeah, there’s no theme. It’s a combination of just a natural de-leveraging and re-leveraging. One of the reasons we like amortizing first-lien debt is our portfolio companies, as they continue to grow EBITDA, de-leverage and we get an opportunity to re-leverage them in the ordinary course.

Two, being that they’re all performing well, they have a number of strategic initiatives that they’re exploring, whether it’s facility expansion or small acquisitions, and there’s been a number of tuck-in acquisitions that we’ve been funding. There is a fair amount of consolidation going on and we’re benefiting from the M&A activity within that portfolio. And then, lastly, there’s a fair amount of sales where we’re backing a new financial buyer to come in in a secondary or tertiary buy-out. But it’s really a balance of all of those things, there’s not one trend that’s emerged.

John Hecht – Stephens

Okay, great. And final question is you did mention that the larger commercial banks seem to be interested in indirectly accessing this market by providing you some debt capital. Is there any commentary or changes you’re seeing in the competitive front, either from the banking system or from other participants in the middle markets, or is it fairly stable?

Mike Arougheti

It’s very stable. We’re not seeing any meaningful new entrants, we’re not seeing any meaningful change in behavior on the part of the banks. So very consistent and very stable from our standpoint.

John Hecht – Stephens

Okay. Thanks very much.

Mike Arougheti

Thank you.

Operator

The next question is from Jonathan Bock, Wells Fargo. Please go ahead.

Jonathan Bock – Wells Fargo

Yes, thanks for taking my questions. Mike, in the Q, I think I saw unfunded commitments of roughly $426 million, which is about 50% or so of the availability that you have on your credit line. Maybe speak to how you balance the use of that facility for new investment funding and keeping any portion of that dry to make investments if your capital is called?

Mike Arougheti

Sure, I think we’ve talked about this in past quarters and I know that it was something that we spent a lot of time discussing through the downturn. When you look at the unfunded commitments, you have to think about – and for people’s benefit this is on Page 56 and 57 of the Q – think about what they are and how the borrowers utilize them.

They’re a combination of ordinary course working capital facilities and, in some instances, CapEx facilities or acquisition facilities for some more active middle market borrowers. It’s broadly distributed across a number of issuers. And I think people understand and appreciate where we are extending revolvers and lines to borrowers, we tend to be the agent and have very close proximity to their cash management and the utilization of those lines.

We have an ongoing process here, for what it’s worth, where we’re sitting down as a management team weekly and examining that number relative to our new investment activity and our current capacity. The reality is when you look at the utilization on those facilities even through the downturn, it has been very low.

So in an environment where people are generating cash flow and naturally de-leveraging, we’re just not seeing a lot of utilization there. So it’s something we – to your point, you have to balance, you have to watch it. But our experience now over 8.5 years as a public company is that they tend not to be heavily utilized, even though the downturn.

Jonathan Bock – Wells Fargo

Okay, great. Thanks. And you also mentioned on previous calls that there’s a natural velocity in both the portfolio as well as the SSLP, and that leads to somewhat consistent fee income. Is the current loan environment pushing the portfolio velocity higher or lower? And maybe look at that in the context of senior secured assets.

Mike Arougheti

It’s interesting, if you look at the broadly syndicated market and the high-yield market, the majority of activity has been opportunistic, i.e., not new M&A and new transaction-oriented, so it’s been mostly refinancings on an opportunistic basis and amend and extend transactions. Those trends are not really pushing their way into the middle market.

I think we’ve talked about in past quarters, the traditional middle market borrower, sponsored or corporate, really is not as opportunistic in accessing the capital markets or changing the way they’re financing their business in the same way the large market borrowers are. So, yeah, not a lot really to talk about there.

Jonathan Bock – Wells Fargo

Okay, great. And then just one last item. I saw that you did your first venture loan here very recently. And maybe could you speak to the opportunities that you’re seeing within that business segment, particularly from a competitive viewpoint?

Mike Arougheti

Yeah, it’s a really interesting business. I think for those on the call are aware there are two BDCs that are focused exclusively on the venture space. Our view has always been that it’s a very attractive asset class but not the most scalable asset class. So we actually think it is well served existing as part of a much larger portfolio than financed on a stand-alone basis.

The team that we hired has been in the venture lending business for well over 20 years. We have about 10 people based in Chicago and on the West Coast that are doing the business in the origination of lending for us. The amount of flow that we’re seeing has been a pleasant surprise. The market is very active, the pipeline is very large and the competitive environment seems to be what we expected it would be. There are a handful of public and private lenders in that space that are active. That said, given the ( inaudible) (50:44) tenure in the market as well as all the things that we bring to bear from a platform and balance sheet standpoint, I think we’re going to get our fair share.

Jonathan Bock – Wells Fargo

Okay, thank you.

Operator

The next question is from Jason Freuchtel, SunTrust. Please go ahead.

Jason Freuchtel – SunTrust

Hey, good morning. Most of my questions have been asked and answered. However, on the heels of the last question, are you seeing other niche lending teams in the market that you could bring on to the Ares platform as well?

Mike Arougheti

Yes.

Jason Freuchtel – SunTrust

Could you describe those or give a little color?

Mike Arougheti

Yeah, again, I think one of the thing that has us so exited here is when you look at what’s going on in the banking space and how difficult it is for capital to form both in the private and public markets behind specialty lending and specialty finance companies, we think there’s a huge opportunity to continue to consolidate some of these niche opportunities, power gen and venture were two that we’re already executing on.

Other things that we find interesting are healthcare lending, healthcare receivables finance. We think there’s an opportunity in energy lending, which is a really interesting part of the market that is underserved. Infrastructure in certain circumstances is something that can be very interesting.

So, as banks are dealing with the implementation of Dodd-Frank and dealing with Basel III, they’re ceding a lot of the middle market to folks such as ourselves. But these are not businesses to fund on a stand-alone basis and so there are lot of very talented teams that either come with a portfolio or without that we think that we can add to the platform.

What’s important, though, is when you look at the size of these asset opportunities, they tend to be $250 million to $1 billion dollar type total portfolio opportunities. So they’re going to exist within the existing portfolio as yield enhancement and diversification, but we don’t expect that any one of these new strategies will overtake the core business.

Jason Freuchtel – SunTrust

Okay, great. Thank you.

Operator

Your next question is from Vernon Plack, BB&T Capital Markets. Please go ahead.

Vernon Plack – BB&T Capital Markets

Thanks. Mike, I noticed in the backlog and pipeline not much difference from what you reported three months ago. Seems that many of the BDCs that we’ve talked to after coming off very strong second quarters have essentially talked down new business, at least for the third quarter. But that does not appear to be the case here.

Mike Arougheti

No. Again, we have a very consistent and steady level of activity. We’ll see it spike up or down in response to the overall market environment, but one of the nice things about the depth of the platform is I think we’re seeing the entirety of the market opportunity. And we can drive the conversion percentage or the close percentage based on our views of what’s going on out there.

Vernon Plack – BB&T Capital Markets

Okay.

Mike Arougheti

So, it’s been fairly consistent. One of the things that we’re happy about, too, is when you look at the post-quarter activity, you’ll see we’ve been able to exit some further equity and sub-debt positions, we’ve been able to generate incremental gains of about $23 million and we’ve been able to do that without really sacrificing a lot of yield.

And so, back to the earlier question about earnings growth and the risk-adjusted return opportunity, the portfolio rotations opportunity, given the level of originations here is still very much a focus and still – we’re still benefiting from it.

Vernon Plack – BB&T Capital Markets

Okay. And the gain that you talked about, will that have any impact to NAV? Or will that be offset with a reversal?

Penni Roll

Well, there will be some reversals against those gains.

Vernon Plack – BB&T Capital Markets

Right. Okay. And speaking of Page 85 as it relates to interest rate risk, can you explain to me why if rates go up 100 basis points, interest income comes down a little bit?

Mike Arougheti

Yeah. A lot of that just has to do with the amount of LIBOR floors in the portfolio, so there’s a little bit of...

Vernon Plack – BB&T Capital Markets

Right.

Mike Arougheti

A “speed bump” that you have to get over before you get the full benefit.

Vernon Plack – BB&T Capital Markets

All right. Okay. Thanks.

Operator

Having no further questions, this concludes our question-and-answer session. I would like to turn the call back over to management for any closing remarks.

Mike Arougheti

Great. Well, we have nothing further, again, thanks, everybody, for your time and attention. And thanks to all of our shareholders for all of their loyal support and we look forward to speaking again next quarter. Thanks.

Operator

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 one hour after the end of this call through August 22, 2012, to domestic callers by dialing 877-344-7529 and to international callers by dialing +1-412-317-0088.

For all replays, please reference conference number 10015145. 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.

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