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Edited Transcript of ARCC earnings conference call or presentation 30-Apr-19 4:00pm GMT

Q1 2019 Ares Capital Corp Earnings Call

NEW YORK Jun 1, 2019 (Thomson StreetEvents) -- Edited Transcript of Ares Capital Corp earnings conference call or presentation Tuesday, April 30, 2019 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* John W. Stilmar

Ares Capital Corporation - MD of IR

* Michael Lewis Smith

Ares Capital Corporation - Co-President

* Penelope F. Roll

Ares Capital Corporation - CFO

* Robert Kipp DeVeer

Ares Capital Corporation - CEO & Director

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Conference Call Participants

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* Arren Saul Cyganovich

Citigroup Inc, Research Division - VP & Senior Analyst

* Casey Jay Alexander

Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst

* Finian Patrick O'Shea

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* John Hecht

Jefferies LLC, Research Division - Equity Analyst

* Krishna Gadamsetty

BMO Capital Markets Equity Research - Senior Business Consultant

* Michael John Ramirez

SunTrust Robinson Humphrey, Inc., Research Division - Associate

* Richard Barry Shane

JP Morgan Chase & Co, Research Division - Senior Equity Analyst

* Robert James Dodd

Raymond James & Associates, Inc., Research Division - Research Analyst

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Presentation

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Operator [1]

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Good morning. Welcome to Ares Capital Corporation's First Quarter Ended March 31, 2019, Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded on Tuesday, April 30, 2019.

I will now turn the conference over to Mr. John Stilmar of Investor Relations.

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John W. Stilmar, Ares Capital Corporation - MD of IR [2]

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Great. Thank you, Jake, and good afternoon, everybody. Let me start with some important reminders. Comments made during the course of this conference call and webcast and the accompanying documents contain forward-looking statements and are subject to risks and uncertainties. Many of these forward-looking statements can be identified by the use of words such as anticipates, believes, expects, intends, will, should, may and similar such expressions. The company's actual results could differ materially from those expressed in such 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 certain non-GAAP measures as defined by the SEC Regulation G such as core earnings per share or core EPS. 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 operation. A reconciliation of core EPS to net per share increase or decrease in stockholders' equity resulting from operations, the most directly comparable GAAP financial measure, can be found in the accompanying slide presentation for this call.

In addition, reconciliation of these measures may also be found in our earnings release filed this morning with the SEC on Form 8-K. 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 warranties in respect to this information. The company's first quarter ended March 31, 2019, earnings presentation can be found on the company's website at www.arescapitalcorp.com by clicking on the Q1 '19 earnings presentation link on the homepage of the Investor Resources section of the website. Ares Capital Corporation's earnings release and 10-Q are also available on the company's website.

I will now turn the call over to Kipp DeVeer, Ares Capital Corporation's Chief Executive Officer.

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [3]

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Thanks, John. Hello to everyone and thanks for joining us. I'm here with several members of the management team, including our Co-President, Michael Smith; our Chief Financial Officer, Penni Roll and other folks in the finance, investment and investor relations teams. Penni and Michael will walk through our first quarter financial results, our investment activity and our portfolio statistics in detail later in the call.

Let me start by discussing our first quarter results, and I can put them in context with recent market conditions. I will also briefly update you on our recent balance sheet initiatives before turning the call over to Penni and Michael.

This morning, we reported very strong financial results for the first quarter. Core earnings were $0.48 per share, which is an increase of 26% over the first quarter of last year. With our ACAS-related rotation largely complete, our core earnings benefited from increased interest income driven by net portfolio growth and increased portfolio yields as well as a higher level of fee income. We also generated higher quarterly GAAP earnings of $0.50 per share. Our core and GAAP earnings were both well in excess of our recently increased quarterly dividend of $0.40 per share, and we had another quarter of rising net asset value with growth to $17.21 per share.

Let me transition to some thoughts on the rebound in the leveraged finance market. Following tremendous market volatility at the end of 2018 in the broadly syndicated market, things have rebounded quickly but this volatility did leave some aftereffects. The most significant reason for the rebound is that transaction volume continues to be lower across the board, and the existing demand for assets has outstripped the supply of deal flow. Several large signature transactions have cleared, and the tone around new deals has improved. However, the fourth quarter volatility has slowed M&A activity.

Secondary prices for traded loans have rebounded, spreads have started to tighten and new deal activity is finally building. And while this has had some impact on our company, Ares Capital has been able to continue to prosper and actively invest in what we believe are select franchise businesses. This is largely due to our broad market coverage, our large portfolio of existing companies to work with and our size and scale. We're still seeing interesting origination opportunities, however, we need to be highly selective and remain engaged as a lead on new deals to influence terms and economics.

During the first quarter, we made $2 billion of new commitments with 45% of those commitments to incumbent borrowers. We continue to believe that we're late in the credit cycle, and we see some evidence of moderating economic growth. With this, we continue to see better risk/reward for investment opportunities in the middle market, as we evaluate relative value across the entire alternative investment landscape. The lower middle market remains quite crowded in our opinion with competitors that lack differentiation and a real ability to compete. Our successful investment approach has remained consistent for 15 years, and we see no reason to make any adjustments today. We simply utilize our long-standing relationships and our direct origination focus to review a very broad opportunity set, provide flexible solutions to companies, support our successful incumbent borrowers and proactively manage our investments post closing. The approach is cycle-tested, and in fact, our strong credit outperformance during the last downturn created substantial opportunities for us to consolidate market share from weaker players. We do look forward to some more volatility one of these days. It is likely to reemerge, and it creates a great market for investing.

Similar to the conservative and proactive approach to finding new deals, we continue to expand our sources of financing and to extend the maturities of our liabilities. This enhances the stability of our balance sheet and it provides us with additional dry powder. As Penni will discuss in more detail, so far this year, we've closed over $1.7 billion of incremental debt financing commitments and renewed another $2.1 billion of financing commitments across a diverse set of lending institutions. These efforts position the capital base to support new investing and to take advantage of the regulatory relief provided by the SBCAA. As a reminder, ARCC can exceed the 1:1 leverage ratio on June 21, 2019.

I'd like to turn the call over now to Penni for a more detailed financial review.

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Penelope F. Roll, Ares Capital Corporation - CFO [4]

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Thanks, Kipp. Our core earnings per share were $0.48 for the first quarter of 2019, up compared to $0.45 for the fourth quarter of 2018 and $0.38 for the first quarter of 2018. Our GAAP earnings per share for the first quarter of 2019 were $0.50, including $0.03 per share from net gains on the portfolio and other transactions. This compares to GAAP net income of $0.36 per share for the fourth quarter of 2018.

In total, we reported net realized and unrealized gains on investments and other transactions for the first quarter of 2019 of $13 million. The net gains were primarily a result of a $46 million net realized gain from the receipt of a litigation judgment payment related to a former American Capital portfolio company, offset by $39 million of net unrealized depreciation on our portfolio. We also recognized $7 million of net realized gains on our investment transactions during the quarter.

Shifting to the balance sheet. As of March 31, our investment portfolio totaled $13.1 billion at fair value, an increase of 7% from a year ago. The yields on our portfolio at the end of Q1 increased slightly from Q4, as we benefited from exiting some lower yielding investments and originating new investments that had modestly higher yields during the quarter. At March 31, 2019, the weighted average yield on our debt and other income-producing securities at amortized cost was 10.4%, and the weighted average yield on total investments at amortized cost was 9.3% as compared to 10.2% and 9%, respectively at December 31, 2018.

Moving to the right-hand side of the balance sheet. Our stockholders' equity at March 31 was $7.3 billion, resulting in a net asset value per share of $17.21 versus $17.12 a quarter ago, or a 0.5% increase. Compared to a year ago, our NAV per share increased over 2%.

As of March 31, our debt-to-equity ratio was 0.86x, and our debt-to-equity ratio net of available cash of $530 million was 0.79x compared to 0.73x and 0.69x, respectively at December 31, 2018. As Kipp mentioned, the Small Business Credit Availability Act becomes effective for us in June, and we expect to prudently begin making progress toward our long-term goal of operating with a moderately higher net debt-to-equity ratio. Our target range after June will be 0.9 to 1.25x. Consistent with the multiyear plan we laid out last year, we anticipate that it will take 12 to 36 months post June to reach these targeted leverage levels. The speed at which we reach this long-term range will depend on the quality of the investment environment and the opportunities we have to source attractive new investments.

So far, in 2019, we have made significant progress to position our balance sheet for future growth. During the first quarter, we repaid $300 million of 4 3/8 convertible unsecured notes at their maturity in January. And then in March, we issued $403 million of 4 5/8 5-year convertible unsecured notes, effectively replacing the notes that were repaid and extending maturity.

Post quarter end, we also closed on an extension and significant upsize to our revolving credit facility. The total facilities size increase from $2.1 billion to $3.4 billion, adding 9 new lenders to the bank group and bringing the total number of banks in this facility to 34. We believe that the upsize not only shows confidence in the credit quality of the company but also reflects the ability for Ares Capital to benefit from the broader Ares platform with access to capital that few other BDCs can match. To date, we have closed or renewed over $3.8 billion of financing commitments across bank and capital markets transactions that not only added to our dry powder but further extended the committed term of our debt capital.

Pro forma for the facility upsize on April 1, our available and undrawn liquidity at March 31, 2019, was close to $2.8 billion, which is sufficient capacity to allow us to move into our new target leverage range. As such, we believe we are well positioned to take advantage of future investing opportunities, particularly as we can operate with greater leverage flexibility.

Shifting to our dividends payable. We announced this morning that we declared a regular second quarter dividend of $0.40 per share. Also during the second quarter, we will pay the previously declared additional dividend of $0.02 per share. This is the second of our 4 previously declared additional quarterly dividends of $0.02 per share to be paid in 2019. The second quarter regular dividend as well as the $0.02 per share additional dividend are both payable on June 28, 2019, to stockholders of record on June 14, 2019. We currently estimate that our undistributed taxable income from 2018 is approximately $323 million or $0.76 per share. The spillover income determination will not be complete until we file our final tax return later this year. And as such, these amounts remain subject to change.

I will now turn the call over to Michael to walk through our investment activities for the quarter.

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Michael Lewis Smith, Ares Capital Corporation - Co-President [5]

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Thanks, Penni. As Mitch Goldstein and I do each quarter, I would like to spend a few minutes providing more detail on our first quarter investment activity and portfolio performance. I will then provide a quick update on post quarter end activity and our backlog and pipeline.

During the quarter, as Kipp mentioned, our team originated $2 billion of new commitments across 37 transactions with a focus on defensively positioned high quality companies. Our large origination team and scaled balance sheet coupled with our flexible capital enables us to provide financing solutions to a wide array of borrowers. In particular, this quarter's activity reflects our efforts to continue to finance high quality middle-market companies and to opportunistically invest in larger, upper middle-market companies at this stage in the cycle. I will further touch on this in a moment.

First, let me highlight 2 recent transactions to give some context and how we are using our sourcing and scale advantages in this market. In the quarter, Ares provided a $1.1 billion commitment as part of a $4.9 billion senior secured credit facility to support Veritas Capital and Evergreen Coast Capital's public to private acquisition of athenahealth. Athenahealth provides electronic health records and revenue cycle management services to the ambulatory health care market in the United States. Using our ability to provide a scaled commitment across the capital structure that provided the buyers with certainty of execution, we were awarded the mandate to lead the second lien financing of the transaction and were named joint book runner on the senior secured tranches of the deal. This was particularly important in this take private transaction.

Additionally, during the quarter, ARCC led a $273 million senior secured credit facility for IntraPac International to support the recapitalization of the business and provide capital for a strategic acquisition by the company. IntraPac is a leading designer and manufacturer of a diversified set of specialty rigid packaging solutions. As part of this transaction the sponsor, ONCAP, with whom we have done a number of transactions, sought to replace the existing bank group with a capital solution and strategic partner better equipped to scale with the business. The depth of our relationship with the sponsor, along with our ability to provide certainty of execution and additional capital as the business grows, were all important factors in us winning the transaction.

Shifting to ARCC's balance sheet. As Penni mentioned, at quarter end, the total portfolio was $13.1 billion, consisting of 345 individual borrowers. The portfolio remains highly diversified with an average hold position at fair value of only 0.3% of the portfolio. Our portfolio weighted average EBITDA increased to $122 million, reflecting, as I mentioned earlier, our ability to provide compelling capital solutions to an increased number of borrowers, including larger companies, which has driven the weighted average EBITDA up over the past few quarters.

We have discussed our interest at this stage in the cycle in making investments in larger companies. However, it is worth making one clarification so that investors are clear that we are still very much a lender to middle-market companies with quality documentation and covenant packages.

To this end, we wanted to point out some nuances behind the $122 million of weighted average EBITDA for our portfolio. As you may have noticed in our earning presentation, we have added additional disclosure that provides our average borrower EBITDA in addition to the weighted average, which for the quarter ended March 31, 2019, was $66 million. These 2 metrics illustrate that we continue to squarely focus on the core middle market but have opportunistically invested in strong upper middle-market companies that have much higher EBITDA and required -- require larger dollar commitments.

The increased focus on opportunities in large companies has been supported by structural changes to the liquid credit markets, particularly in the high yield market that have left a void at the upper end of the middle market. As an example, in 2004, about 40% of the high-yield market had issuance sizes of less than $300 million. Today, that segment of the high yield market represents only 5% of the high yield market. Given the nature of our capital base, we have been positioned very well to go direct on many of these companies, as sponsors look for private capital solutions in this market. We feel we can get attractive terms and strong lender protections in these transactions due to our unique positioning.

Shifting to the portfolio. Credit quality remains stable. Our portfolio companies continued to generate solid growth with weighted average EBITDA up 5% over the past 12 months. In the first quarter, the company had no new nonaccruals. Nonaccruals decreased in the quarter to 2.3 as a percentage of total portfolio amortized cost, down from 2.5% last quarter and from 2.7% during the first quarter of 2018. Nonaccruals at fair value also decreased to 0.4% in the first quarter, down from 0.6% last quarter and from 1% during the first quarter of 2018.

Before I turn the call back over to Kipp, let me provide a brief update on our post quarter end investment activity. From April 1 to April 24, we made new investment commitments totaling $183 million and exited or were repaid on $747 million of investment commitments, generating approximately $14 million of net realized gains. As of April 24, our backlog and pipeline stood at roughly $1.1 billion and $195 million, respectively.

As always, these investments are subject to approval and documentation, and we may sell a portion of these investments post closing. Please note that there is no certainty that these transactions will close.

I'll now turn it back to Kipp for some closing remarks.

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [6]

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Thanks, Michael. In closing, we're pleased with our first quarter results. We believe the company is very well positioned moving forward. We're navigating the shifting market conditions well, and we will seek to benefit from the enhanced flexibility provided in the Small Business Credit Availability Act. With our long-tenured team, our national footprint and a healthy $13 billion balance sheet, we're one of the largest providers of direct capital to the expanding middle-market segment and continues to enables us to finance strong middle-market companies and deliver what we believe are attractive all-in returns for our shareholders.

That concludes our prepared remarks today. We'd be happy to open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The investor relations team will be available to address any further questions at the conclusion of today's call.

The first question comes from Arren Cyganovich from Citi.

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Arren Saul Cyganovich, Citigroup Inc, Research Division - VP & Senior Analyst [2]

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Kipp, you had mentioned that M&A activity slowed a bit, yet you still had a very strong investment activity in the first quarter, and your backlog also continues to look strong. What are you seeing from -- or where are you generating that -- those investments if the M&A activity is -- and the market in general has kind of slowed?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [3]

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Yes, I mean I think it's ticked back up a little bit. But the comment definitely sticks. I mean, the good news, remember, Arren, something we like to point out is the benefit that we have of continuing to finance a lot of our existing portfolio companies, so about half of our new investment activity is just driven from the portfolio, remains a huge advantage. And look, I mean, also we've got 100 people out looking for new investments, so $2 billion divided by 2 is $1 billion of backing the existing portfolio companies. When you're doing some larger transactions like in athenahealth and other things like that, it's not all that hard to find enough deal flow to drive an additional $1 billion of kind of new deal volume. So it's really the size and scale advantages as well as playing off the existing portfolio.

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Arren Saul Cyganovich, Citigroup Inc, Research Division - VP & Senior Analyst [4]

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Okay. And then I was wondering if you could give an update on your working with the SEC to get some relief from the AFFE rule. Is there any update from that process?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [5]

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It's something that continues to be real effort on our behalf. Obviously, we responded to some comments that we received from the SEC early this year on the application for relief that was filed in September of last year. So it's just back-and-forth clarification points. We obviously are going to provide a formal response to the SEC and are working with other BDCs in trying to be coordinated, but that's about it for now. The good news I think is the dialogue is -- an open and vibrant dialogue, whereas a year or 2 ago, it probably wasn't. So I think we see an improvement and are optimistic there that we can move that forward.

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Operator [6]

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The next question comes from Finian O'Shea with Wells Fargo.

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Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [7]

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I'll start one with Mitch. To your comments on the core versus larger company would be liquid, maybe opportunistic type plays and forgive me, I -- my phone dropped during this, but can you talk about how you feel in terms of this being a sustainable part of your book, in terms of a going-forward strategy, core middle market versus large opportunistic? And do you feel that this -- these kinds of deals would move off with faster turnover if the markets come back?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [8]

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Sure. Fin, this is Kipp, and I'll start with the response, but Michael can happily jump in too. I mean I think we tried to, in the prepared remarks, indicate that we think that there's been a secular shift in the market that is not cyclical and not sort of a point-in-time opportunity, where particularly in the sponsored market, we're seeing a lack of interest in pursuing sort of the subscale high yield deal. A lot of these deals are getting done privately, as Michael mentioned. And I don't think we have an expectation that, that's going to reverse anytime soon. So part of scaling the capital base has been playing into that market opportunity that's continued to emerge over the last 10 years. To your point about getting refinanced more quickly, maybe. The good news around a lot of these larger cap junior pieces is they've got pretty hefty call protection on them. So if that's the case, we're going to see an acceleration of pretty high returning investments and presumably be able to redeploy.

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Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [9]

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That's very helpful. And then just as a follow-on. For the deals where you kind of take the first and second split, we've seen more of these in recent quarters especially. But can you talk about the allocation mechanics that you -- that would lead to your more so second lien overweights? Does it -- do these tend to be deals where you kind of lead the second lien and speak for some of the first? Or is it that the BDC doesn't choose to take allocation of the first more so?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [10]

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So it's sort of a difficult question to answer because there's not a single answer to how we approach each first and second lien deal. And we've got an allocation policy here like many other investment firms that dictate if it fits the mandate, obviously, each fund for which the mandate is a fit gets the opportunity to see that. I don't want to -- I don't know how to answer it, Fin. I'm sorry to be difficult, but there's just not a simple answer to that question and all of our transactions are a little bit different.

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Operator [11]

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The next question comes from Rick Shane with JPMorgan.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [12]

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Kipp, you said something interesting. And I think about it in the context of you sitting in portfolio review, looking at all these companies, you talked about some sign of a global slow -- or not a global slowdown. You've talked of some signs of a slowdown. I'm curious when you delve into that, what factors companies are citing? Is it material inflation? Wage inflation? Interest rates? Is there something globally that's going on? What do you attribute it to? And are you seeing it in any particular sectors?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [13]

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Yes. I mean, I think it's moderating growth, which again, for a business that's predominantly a lender doesn't give us concern. But I mean, you're definitely seeing a little bit of a slowdown. I would, to your point, categorize it more as sort of cost side inflation generally. Some wage inflation, you hear about things like a labor shortage of folks available to drive trucks, for instance, in one of our portfolio companies. In other places, it's some food cost inflation or some material inflation. It's a little bit of everything with the lack of real volume growth on the top line. So we're seeing just a moderating kind of margin contribution growth. Again, I think more of an issue for owners of companies at this point than for lenders to those companies. So we're still pretty positive on where we sit, but we're definitely seeing a modest slowdown.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [14]

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Got it. And as a follow-up to that, with that in mind, is there anything that, as a management team, you've communicated to your originators of places that you might want to raise the bar in terms of what you're willing to lend on at this point?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [15]

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Yes. I mean, the bar is pretty high today. I mean we do still think that we're late in the cycle. We've got to be extremely cautious. This is a time, and it has been a time for the last little while where people can make mistakes. We think some of the competition in deals that we've walked away from probably made some mistakes, so the bar is pretty high. And I would just say the easiest way, and we emphasize this in investor meetings, certainly ones that we've been in with you, Rick, we don't have to invest to the benchmarks. So for us, the key is to stay out of industries that tend to produce the most defaults. That's historically been things like retail and media and other places where spend is much more discretionary and can go away much more quickly. And we're underexposed, if you go through our industry breakdowns, to most of the industries that tend to create the most defaults. So first things first, really orient the investing to defensive industries and then of course try to pick the best companies and lay in place the best structures and the best documents that we can, all the while understanding that we're a participant in the market and need to compete for deals too.

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Operator [16]

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The next question comes from Doug Hecht (sic) [John Hecht] with Jefferies.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [17]

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First question, just you guys have had a very good trajectory of yields as the rate cycle has played out. I think now we're looking at kind of a flat curve. Maybe, I guess, the first question would be what should we expect to your margins and your yields as the course of this year progresses given that the benchmark background?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [18]

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Yes, I don't know. I appreciate the question. I'm obviously not an interest rate strategist. But I'm surprised about this kind of 70% outlook for a rate cut this year. I've said to others I just don't -- I don't see it. I think we do expect kind of a moderate, i.e., probably no increases would be my guess to you, just sort of a maintenance of where LIBOR is today. So a flat curve for us is actually kind of a Goldilocks environment because we're lending on the asset side for the most part, LIBOR plus as you know, and we have a mix of financing costs, both fixed and floating. So if we can keep issuing in the unsecured markets or in the convert markets off a lower 5-year or even 7-year benchmark, that's great for us. So I think if the yield curve stays sort of as is, we would see a steady state net interest margin at the company, and that's kind of our expectation.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [19]

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Okay. And then the second question, just looking at some of the disclosure, it looks like the term -- the new loan term has gone out. Is that just -- the weighted average commitment term in months, is that just a function of being involved with some larger deals, or how should we think about that?

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Penelope F. Roll, Ares Capital Corporation - CFO [20]

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It's really just a matter of how we're rolling our maturities forward. So if you look at the liability side, we just paid off 5 year debt in the converts and issued a new 5-year debt instrument, which extended the maturity. In addition to that, on April 1, we extended the maturity of our large revolving line of credit by a year. So that would also extend out the maturity as well. So...

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [21]

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You there?

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Penelope F. Roll, Ares Capital Corporation - CFO [22]

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Oh, yes.

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [23]

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Yes, sorry, we were just inquiring here on something, John, trying to make sure we've got a full answer for you.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [24]

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Yes. I was actually looking at the commitment terms more than anything.

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [25]

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You're saying on the asset side, John?

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [26]

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Yes, on the asset side. It looked like the average term went to 90 months.

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [27]

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To be honest, I didn't really notice. I mean, none of the standard terms of our investing have changed, so it's got to just be a mix thing, but...

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Penelope F. Roll, Ares Capital Corporation - CFO [28]

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It's also a weighted average. So sometimes, it will skew a little bit depending on the size of the deal that we're holding for certain durations.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [29]

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I think that's right, it explains it. All right, guys.

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [30]

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I'll take a look. We'll take a look at it, John. We can come back to you offline and just see if there's an answer that's actually material. But I don't think it is.

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Operator [31]

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The next question comes from Casey Alexander with Compass Point.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [32]

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Given the amount of repayments in your subsequent activity that have already taken place and looking at the robust originations the last couple of quarters, would it be reasonable to expect somewhat more modest portfolio growth, at least in the second quarter, as you're looking at it right now?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [33]

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I think Michael laid out, we've got a pretty significant backlog. But when you add up the backlog and pipeline, it would suggest that we're sort of below where we were for Q1.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [34]

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Okay. Great. Secondly, I noticed on the balance sheet, the inclusion of an operating lease asset and liability. And there -- could you explain what that is? They're not matched off dollar for dollar. Was there a corresponding cash transaction that makes up for the difference? I'm just kind of wondering because I'd never seen it before.

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Penelope F. Roll, Ares Capital Corporation - CFO [35]

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Casey, it's Penni. This is purely an accounting thing. There was a new GAAP pronouncement that we had to adopt related to any liabilities that we have in connection with leases that Ares Capital Corp is in. While we sublease most of what ARCC actually owns, we still have to have this disclosure that gives this gross-up in the balance sheet that basically does a net present value of future payments on the leases and gives you an operating right-of-use asset with a corresponding liability. The reason there is a difference between the two, normally, those would be the same, but because of purchase accounting for Ares -- or sorry, for American Capital a couple of years ago, we assumed some leases from ACAS that we already had a liability on our books for, and that's why the liability is greater than the assets.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [36]

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So the transaction that took place in this quarter, Penni, was it actually -- did it knock $0.07 a share off of NAV? That's what I calculate the difference as.

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Penelope F. Roll, Ares Capital Corporation - CFO [37]

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No. Because that -- if you look at the balance sheet, the operating lease asset is $105 million and the lease liability is $137 million. The difference between $137 million and $105 million was already in the balance sheet from the ACAS purchase accounting ages ago. So the entry we booked, if you want to get into nerdy accounting, is we booked an asset for $105 million and a liability for $105 million when we adopted this new pronouncement. So there was no P&L impact, it's just a balance sheet gross-up.

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Operator [38]

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The next question comes from Robert Dodd with Raymond James.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [39]

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Just going back to kind of like recent trends. I mean obviously, funded yields in the quarter, advertised cost, tends to be -- it was 9 last quarter, so up 130 basis points on just the funded, not the average portfolio, weighted average or average. Obviously, SDLP was -- grew a bit this quarter, LIBOR was up a tiny bit. But it still seems to indicate that maybe deployed yields were up 70, 80 basis points sequentially in a quarter where -- on a weighted average basis, in a quarter where your weighted average EBITDA went up pretty well. So can you give us anymore -- if I were to grossly simplify it, and you can correct me, if I've got rising yield on rising EBITDA from the borrower, it would tend to imply more risk as a simplistic view. So can you walk -- talk us through that a little bit about how that yield popped up so much while the average borrower is rising and you're maintaining a late credit cycle view?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [40]

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Sure. Thanks for the question. I don't think that's the case. I mean if we're looking just sequentially from Q4 '18 to Q1, obviously, we're up on our income-producing securities, i.e., the stuff that backs out equity from 10.2% to 10.4%. So not a whole lot going on there from my perspective. I do think that there was a modest widening in spreads at the end of the fourth quarter that probably carried over a little bit into particularly early Q1 investing. I don't think that's changed much. But we're definitely not trying to increase yields and put more risk into the underwriting process at this point, we're actually doing the opposite. So my guess is it's just a little bit of math flowing through to the quarter.

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Operator [41]

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(Operator Instructions) The next question comes from Mark Hughes with SunTrust.

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Michael John Ramirez, SunTrust Robinson Humphrey, Inc., Research Division - Associate [42]

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This is Michael Ramirez in for Mark. So while the leveraged finance market has rebounded as per your comments, we're seeing industry leverage loan volumes are down significantly year-over-year, but you consistently have managed to fund new originations at a greater pace than last year. So I guess, our question is to accomplish this the -- are you guys closing on a higher rate of deals seen? Or does your size and scale still afford you to look at a majority of the deals in the marketplace to remain selective? And I guess, just as a quick follow-up, additionally, has covenants changed for these new investments?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [43]

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Sure. Thanks for your question. Look, I'll just revert back to one of the comments that I made earlier, which is it was a pretty significant origination quarter even in a slower market. About half of what we did, $1 billion-or-so of investments were made through existing portfolio companies. So that's something that regardless of market activity, allows us to stay busy and obviously allows us to continue to back what we think are the really high quality companies that are looking for more capital in the portfolio. The other $1 billion-or-so of new dealers, I mean, just to say, it's not that hard for us to get $1 billion to work even in a slow market and particularly when we participate in something like an athenahealth, which is a very large deal, a very large investment for us, driving the other $1 billion of originations is not that difficult with the size of the team that we have out in the field. Look, we're fighting the good fight along with everybody else on the documentation and covenants front. We think that our ability to lead deals and be there at the front, negotiating agreements that we believe make sense for the long haul is a real advantage as we think about risk management going forward. Certainly, there's a material change in docs or in covenants from last quarter. But I think like you'd hear from many others in our markets, it's deteriorated a bit over the last couple of years, and we think our position allows us to get to a point that makes sense for us when taking on new assets.

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Operator [44]

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We have time for one more question, so Lana Chan with BMO Capital Markets.

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Krishna Gadamsetty, BMO Capital Markets Equity Research - Senior Business Consultant [45]

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Krishna Kanth on behalf of Lana Chan. I just had one question on the credit environment, so in addition to the slowing economic growth, are you seeing any cracks at all out there regarding credit?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [46]

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I think that if you look at the metrics that would get you there, the answer is no. I mean, we're kind of -- if you look at the broadly syndicated markets and the default rate in the market, it's at a, I think, 5-year low, and in terms of the index, clear channel is about to roll out of the index, and it will be at a more than 5-year low. So the broadly syndicated markets would be telling you that there is very little to no stress in the credit markets. And I think the way that we try to communicate it to folks is where do our nonaccruals sit. Companies that aren't performing our nonaccruals were around 2.5% of cost, and things that have been on nonaccrual for a while have generally gotten marked down, and we haven't seen any negative migration this quarter, i.e., we have no new nonaccruals. So I think we're later in the cycle. I think we're keeping probably a longer watchlist than we might just to be vigilant about risk management. But we don't see an increase in defaults in the portfolio, obviously, as we've laid out the stats for you all.

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Operator [47]

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This concludes our question-and-answer session. I'd like to turn the conference back over to Mr. Kipp DeVeer for any closing remarks.

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [48]

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No, I think we're all set. Appreciate all the questions. And hope you have a great day. We'll sign off.

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Operator [49]

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Ladies and gentlemen, this concludes our conference for today. If you missed any part of today's call, an archived replay of this conference will be available approximately 1 hour after the end of the call through May 14, 2019, at 5:00 p.m. Eastern Time 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 10129711. An archived replay will also be available on our webcast link located on the homepage of the Investor Resources section of Ares Capital website. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.