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Edited Transcript of ARCC earnings conference call or presentation 30-Oct-19 3:00pm GMT

Q3 2019 Ares Capital Corp Earnings Call

NEW YORK Nov 21, 2019 (Thomson StreetEvents) -- Edited Transcript of Ares Capital Corp earnings conference call or presentation Wednesday, October 30, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Carl G. Drake

Ares Capital Corporation - Partner/Head of Public IR & Communications

* 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

* Christopher John York

JMP Securities LLC, Research Division - MD & Senior Research Analyst

* Finian Patrick O'Shea

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* John Hecht

Jefferies LLC, Research Division - Equity Analyst

* Richard Barry Shane

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

* Robert James Dodd

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

* Ryan Patrick Lynch

Keefe, Bruyette, & Woods, Inc., Research Division - MD

* David Rothchild

- Private Investor

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Presentation

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Operator [1]

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Good morning. Welcome to Ares Capital Corporation's Third Quarter ended September 30, 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded on Wednesday, October 30, 2019.

I will now turn the conference over to Mr. John Stilmar of Investor Relations. Please go ahead, sir.

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

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Thank you, Carl, and good morning, everyone. Welcome to Ares Capital Corporation's Third Quarter ended September 30, 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded on Wednesday, October 30, 2019.

Thank -- let me start with some important reminders. Comments made during the course of this conference call and webcast and accompanying documents contain forward-looking statements and are subject to risks and uncertainties. Many of these forward-looking statements can be identified by the 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 SEC Regulation G, such as core earnings per share or core EPS. The company believes that core EPS provides a useful information for 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 the 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 of companies was derived from third-party sources and has not been independently verified, and accordingly, the company makes no representation or warranties with respect to this information. The company's third quarter ended September 30, 2019, earnings presentation can be found on the company's website at www.arescapitalcorp.com by clicking on the Q3 '19 Earnings Presentation link on the homepage of the Investor Resources section. 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 a lot, John. Hello to everyone, and thanks for joining the call today. I'm here with our Co-Presidents, Michael Smith and Mitch Goldstein; our Chief Financial Officer, Penni Roll, and several other members of the management team.

I'd like to take a few minutes to highlight our third quarter results and to provide some thoughts on the current market conditions. After that, I'll turn the call over to Penni and to Michael, who will cover our detailed financial results and discuss recent investment activity and some summary metrics for the portfolio.

This morning, we reported another strong quarter, with Q3 core earnings of $0.48 per share, well above our regular and additional dividends declared for the quarter. We also continued to experience stable credit performance with no new nonaccruals this quarter. Finally, we believe we're in a strong liquidity position, ending the third quarter with approximately $3 billion of cash and committed debt capital available to us. Overall, we feel very good about our performance and our balance sheet positioning.

In terms of new investment activity, I would describe the market that we operate in as one that remains competitive but investable. Transaction volumes are running below levels from last year and this has increased pressure on some to put capital to work, leading to some aggressive behavior and lower quality underwriting by certain market participants. We believe that we continue to have the many competitive advantages we've developed at ARCC to differentiate us and that our experience in this market will serve us well.

As we look at the market today, we're beginning to see some changes in the broadly syndicated markets that might lead to more broad-based discipline in the middle market. Moderating CLO formation and continued outflows from retail loan funds are 2 factors that have led to a slowdown in activity in the broadly syndicated leveraged loan market.

In addition, there's a widening dispersion of credit performance in the broadly syndicated market that should begin to filter into the middle market. And this has made 2019 a more bifurcated credit pickers market, which we see as a positive for us. Since the middle market's typically influenced by the risk reward dynamics of these larger, broadly syndicated transactions, we remain hopeful that more friendly terms and opportunities are on the way in the middle market. Even with this, we continue to execute on our playbook, focusing on high-quality companies and using our sourcing and competitive advantages to seek the best investments. Our market leadership position with 100-plus investment professionals, a national coverage footprint and long tenure in the market generates opportunities for more than 500 active sponsor relationships as well as with many nonsponsored borrowers.

Additionally, our significant capital base and ability to be a meaningful and stable source of capital positions us uniquely to support our best borrowers. In the third quarter, 47% of our new investment commitments were to existing borrowers, which we continue to view as a differentiated source of deal flow with attractive informational and structural advantages. And when taken together, these sourcing advantages continue to enable us to be highly selective. Our selectivity ratio for new companies this quarter was 4%, in line with our historical average despite the unusually busy quarter of $2.4 billion in new commitments. These sourcing advantages, coupled with our consistent investment approach and our conservative balance sheet construction, has enabled us to deliver strong returns to shareholders through a variety of market conditions. We feel we have a strong plan in place for the current market.

I'd like to turn the call over now to Penni to provide more detail in terms of a financial review.

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

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Thanks, Kipp, and good morning. As Kipp stated, our core earnings per share were $0.48 for the third quarter of 2019 as compared to $0.49 for the second quarter of 2019 and $0.45 for the third quarter of 2018. Core earnings were stable versus Q2 2019 but increased versus Q3 2018 driven by higher interest and dividend income that primarily resulted from a larger portfolio as compared to Q3 of '18.

In addition to our core earnings for the third quarter of 2019, we reported modest net realized and unrealized losses on investments and other transactions totaling $37 million or approximately 0.3% of the average portfolio for the quarter.

Our GAAP earnings per share for the third quarter of 2019 were $0.41 compared to $0.47 for the second quarter of 2019 and $0.49 for the third quarter of 2018. As of September 30, 2019, our investment portfolio was $13.9 billion at fair value, an increase of 24% from a year ago and 7% from the prior quarter. Also at September 30, the weighted average yield on our debt and other income-producing securities at amortized cost declined to 9.8% from 10.4% as of the second quarter, and the weighted average yield on total investments on amortized costs was 8.8% compared to 9.2% at June 30. The yields at September 30 reflect decreases in LIBOR as well as a higher concentration of first-lien senior secured loans as compared to the prior quarter.

Moving to the right-hand side of the balance sheet. Our stockholders' equity at September 30 was $7.4 billion, resulting in a net asset value per share of $17.26, which was basically flat with a quarter ago and up 0.6% from December 31, 2018. As of September 30, 2019, our debt-to-equity ratio, net of available cash, was 0.89x, which increased from our debt-to-equity ratio net of available cash of 0.77x at June 30. We ended the quarter just below the bottom end of our target leverage range of 0.9 to 1.25x.

As Michael will discuss later, Q3 was unusually busy, so we currently don't expect to see similar growth in the fourth quarter. We continue to execute on our strategy of extending and raising additional committed financing to our already diverse capital structure. Taking advantage of favorable market conditions, we reopened our most recent 5-year investment grade unsecured note issuance and raised an additional $250 million on top of the existing $650 million of notes already outstanding.

The additional debt was issued at a premium, resulting in a 3.68% effective yield to maturity as compared to the 4.2% coupon on the original issuance in June 3 -- June 2019. Building on our successes of upsizing and extending our committed bank facilities, in the third quarter, we upsized our existing credit facility with SMBC by an incremental $100 million, bringing the aggregate facility size to $500 million. We also extended the facility's reinvestment period to September 2022.

As of September 30, 2019, our total available liquidity, including $142 million in available cash was approximately $3 billion. With only $600 million of debt maturities between now and the end of 2021, we believe that our balance sheet is in a strong position with significant available capital to invest through a variety of market conditions in the years ahead.

Shifting to our dividends payable. We announced this morning that we declared a regular fourth quarter dividend of $0.40 per share. Also during the fourth quarter, we will pay the previously declared additional dividend of $0.02 per share. This is the last of our 4 previously declared additional quarterly dividends of $0.02 per share to be paid in 2019. The fourth quarter regular dividend will be paid on December 30 to stockholders of record on December 16 and the $0.02 per share additional dividend will be payable on December 27 to stockholders of record on December 16.

Following the filing of our 2018 tax return, we determined that our final taxable income spillover from 2018 going into 2019 was $343 million or $0.80 per share, which provides us with a significant amount of undistributed earnings. Given the amount of spillover coming into 2019, combined with our year-to-date 2019 core earnings in excess of our dividends paid, we believe we will continue to be in a strong, undistributed taxable income position at the end of this year.

Before I turn the call over to Michael, I wanted to remind everyone that the third quarter was the last quarter of our 10-quarter fee waiver that was put into place in conjunction with the American Capital acquisition. As you may recall, our adviser voluntarily waived a total of $100 million of income-based fees over 10 quarters, or $10 million per quarter, in order to aid the company's profitability as we transitioned out of the lower and nonyielding American capital portfolio into higher-yielding Ares directly originated investments.

Since we closed on the acquisition in January of 2017, we have exited almost $2 billion of these investments, realizing a meaningful IRR, generated a higher level of overall core earnings and expanded our quarterly dividend from $0.38 per share to $0.40 per share, while during the same time, increasing ARCC's net asset value over $0.80 per share.

In summary, we believe the fee waiver had the intended impact and the American Capital acquisition has been a success for shareholders, while also positioning the company for future success.

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'd like to spend a few minutes providing more detail on our third quarter investment and portfolio performance. I will then provide a quick update on post-quarter end activity and our backlog and pipeline.

During the third quarter, our team originated $2.4 billion of new commitments across 50 transactions, with 90% of the commitments in leading and controlling first-lien loans. Additionally, nearly 2/3 of these commitments were in various service-related sectors that have performed well for us in past credit cycles. As Kipp mentioned, although broader M&A volume has cooled, companies continue to seek additional capital for growth initiatives and strategic add-on acquisitions. Our significant portfolio and position of incumbency continues to be a meaningful competitive advantage in sourcing new investments in known high quality borrowers. This quarter, 32 of our 50 new commitments came from existing borrowers.

Of note, the EBITDA of the companies we financed in the third quarter range from $12 million to $116 million, with a weighted average EBITDA of $50 million. In comparison, the weighted average EBITDA of borrowers in the portfolio was $137 million, which underscores our ability to be relevant to a wide spectrum of upper middle-market borrowers. We are focused on finding new borrowers that can hopefully be in the portfolio for years to come, while also backing our best borrowers through additional financings.

In the quarter, we continued to broaden and diversify our portfolio, reaching 352 different borrowers with an average hold position at fair value of only 0.3%. Our largest single borrower, excluding our investments in SDLP and Ivy Hill is just 2.6% of the portfolio at fair value, underscoring that no single name has a material impact on the future aggregate performance of our company. We believe our large and diversified portfolio, which is focused on high free cash flow, noncyclical industries, is resilient and positioned to perform well through a wide variety of economic conditions.

As Kipp also mentioned, credit quality continues to be stable. Our portfolio generated weighted average EBITDA growth of 3% over the past 12 months, down slightly from the 4% level in the prior quarter. Our nonaccrual rates at amortized cost of 1.5% and 0.2% at fair value remained very low, and there were no new portfolio companies added to nonaccrual in the quarter.

Before I turn the call back over to Kipp, let me provide a brief update on our post-quarter investment activity. From October 1 to October 24, 2019, we made new investment commitments totaling $360 million and exited or were repaid on $326 million of investment commitments, generating approximately $6 million of net realized gains. As of October 24, our backlog and pipeline stood at roughly $665 million and $265 million, respectively. While these levels are below average, we have seen a recent pickup in our activity and expect the typical year-end push we usually see. Furthermore, should the market experience similar volatilities as we saw in the fourth quarter of last year, we could have a more active quarter than today's backlog and pipeline imply.

Note, our backlog contains investments that are subject to approvals and documentations and may not close or we may sell a portion of these investments post-closing.

With that, I'll 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 had another good quarter of strong profits and stable credit performance. We continue to execute on the same plan that we've had for 15 years, maintaining a defensively positioned portfolio, investing in origination capabilities, to see the broadest amount of deal flow from the best companies, being highly selective in our approach and maintaining a strong and liquid balance sheet. We believe our continued execution against these goals positions our business for success in the future. That concludes our prepared remarks. Carl, can you open the line for questions, please?

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Questions and Answers

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Operator [1]

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Certainly, sir. (Operator Instructions) The first question comes from Rick Shane of JPMorgan.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [2]

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Look, last quarter wash was on nonaccrual, and you guys made a significant additional commitment, I think it was about $107 million, off the top of my head. I'd just like to discuss what you saw last quarter and, sort of, what the developments are for the additional financing.

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

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Yes. So Rick, maybe I'll go back and check some of the facts, but we did do an add-on to wash. It's a long existing portfolio company, it was not on nonaccrual last quarter.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [4]

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Okay. My mistake then. Okay. Can you just talk about that because it is one of the big commitments that you guys made this quarter?

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

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Yes, sure. It's a large leverage buyout that's been in the portfolio for a while. The company literally installs laundry machines in residential apartment buildings where people do their laundry, so it's a pretty stable business. It's a large company. They've continued to make strategic acquisitions. I think that the private equity firm that owns it views it as a consolidation opportunity, so it's one of those good companies that's been in our portfolio now for a while that we continue to keep growing.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [6]

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Got it. Great. And sorry about the confusion on that, I misread the footnote.

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Penelope F. Roll, Ares Capital Corporation - CFO [7]

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Rick, it's Penni. We actually realized after the fact that we had mislabeled that in the 10-Q last quarter, so we've corrected it this quarter. So I'll take that one. You caught me.

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Michael Lewis Smith, Ares Capital Corporation - Co-President [8]

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I was surprised to hear that one. But I guess in those filings, you can't get everything right every quarter so shame on us.

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Penelope F. Roll, Ares Capital Corporation - CFO [9]

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When you have 350 companies we try our best but we had a little hiccup. Our apologies for that.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [10]

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Given what we do for a living, we understand.

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Michael Lewis Smith, Ares Capital Corporation - Co-President [11]

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It's a good company performing well.

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Operator [12]

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The next question comes from Arren Cyganovich of Citi.

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Arren Saul Cyganovich, Citigroup Inc, Research Division - VP & Senior Analyst [13]

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Just kind of touching on your comments around the competitive environment and some actors not doing the best of investing choices. How does this compare, I guess, quarter-to-quarter? Is it worsening? Staying about the same? And how does this compare to some of the more frothy times in the -- over the past decade or so?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [14]

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I don't think there's a huge change quarter-to-quarter. I mean, I think what you're seeing is a widening in loan spreads, a little bit of reticence on the part of loan buyers, in particular, due to higher risk transactions, whether it's single B or CCC deals are as much tougher to get done right now. So I would say that the caution probably in the broadly syndicated markets, whereas you know, Ares is an active player too, just not through the BDC is probably a bit more cautious than we might see from some of the middle-market competition that's probably as a result of folks with a fair amount of dry powder wanting to stay busy. I think one of the things that's nice for us is we've got a very large credit platform here and participate in a lot of markets that others may either not participate in or be more limited in. So that market's informed us to be a little bit careful. I'd say that all the while while having a big quarter, so I'll answer that question too, even though you didn't ask it, Arren, because I'm sure we'll get it.

Just so people remember that the pace of the year has been very funny, and it continues to be a little bit funny today, right? I mean, the first quarter as a result of last year's fourth quarter being so volatile was incredibly slow. And I think we had a reasonably busy, kind of, traditionally busy second quarter. The third quarter was busier than we usually experience because I think a lot of the things that maybe would have gotten done spilled over to the second quarter, and conversely, the second quarter spilled into the third quarter. And as you noticed from Mike's discussion of backlog and pipeline, when we report that number here today as part of our public earnings, it's actually pretty low relative to where we've been historically. That being said, the last couple of weeks have actually been very active.

So it's just a little bit of a weird year in terms of pacing. And we'll see how we finish out the year. We're hopeful that some of the modest dislocations and discipline in the larger markets, as I was trying to get through in some of the prepared remarks, spill over and create a good fourth quarter for us, but we'll see. It's just the end of October here.

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Arren Saul Cyganovich, Citigroup Inc, Research Division - VP & Senior Analyst [15]

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Okay. I appreciate that. On the AFFE rules, is there any movement or update for the industry getting some relief from that?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [16]

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Well, I mean, I think we've continued to tell a pretty positive story about that. We obviously sent as folks are aware an amended application to the SEC on September 3. There's no real update between September 3 and today. I think that it's under advisement. But up until September 3, it's been great. We're being patient, waiting for a response.

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Operator [17]

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The next question comes from Ryan Lynch of KBW.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [18]

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First question is, you guys, this quarter, got into the bottom end of your target leverage range of 0.9x to 1.25x. That's obviously a pretty wide range. So I'm just curious as what factors that you all consider that would cause you to operate at the lower end of that range versus the upper end of the range? And then given those factors, and as we sit here today, do you guys foresee yourself operating more at the lower end or the upper end or in the middle?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [19]

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I mean, I think for now, we made the point that actually, I think based on the busier than we expected quarter, we're a little bit higher than we might have expected here at the end of Q3. I think our inclination for now is to operate at, kind of, the middle or below, being a bit cautious. The upper end of that range can drive more earnings, but the earnings, we think at the company, are quite good. So I think we're balancing, thinking about any potential declines in fair value down the line, preserving enough cushion for that. So I'd say, generally, the middle to below the middle for now. But things change. If the investing environment gets really, really exciting, we might change our view on that.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [20]

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Okay. And then over the last 2 quarters, dividend income, excluding Ivy Hill, has run in, kind of, around the $21 million range versus when you look at 2018 that kind of ran at closer to the $10 million range. I know, Penni, you've mentioned in your prepared remarks that that's just due to the larger portfolio. So is, kind of, the lower $20 million a fair assumption for dividend income going forward excluding Ivy Hill?

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Penelope F. Roll, Ares Capital Corporation - CFO [21]

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Yes. We have a lot of portfolio companies outside of Ivy Hill that pay dividends, but a lot of them don't pay consistently. They'll declare them periodically and pay them. But I think it's still a decent run rate. We do have a few, kind of, preferred stocks that pay a dividend that we approve in as well based on them declaring. So it's probably a good representative level. It will ebb and flow, and if you look at each quarter, you'll see there are timing differences around when those, kind of, not scheduled dividends come in and get paid.

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Operator [22]

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The next question comes from John Hecht of Jefferies.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [23]

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I guess I'd focus a little bit on rates. Penni, you mentioned part of the yield drift this quarter was tied to higher composition of first lien and then some tied to just the effect of LIBOR movements. Can you -- is there any way you can quantify how much was attributed to one versus the other?

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Penelope F. Roll, Ares Capital Corporation - CFO [24]

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Yes. If you look at just overall, I would say roughly 20 bps or so was from LIBOR and about 30 bps was from just portfolio mix, rough split. And that's on the average at the end of the quarter.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [25]

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And then given the rate environment, do you guys -- and I know your revolvers are cheaper funding but there's probably opportunities to fund elsewhere in the market with the lower cost of funding, but how do we think about your ability to optimize cost of funds in this type of rate environment over the next 4 quarters, say?

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Penelope F. Roll, Ares Capital Corporation - CFO [26]

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Yes, I mean, when we look at our balance sheet and how we capitalize it with debt and equity, clearly, we have a little more room to run with higher leverage now under the new leverage construct. But if you look at what we've been focusing on is, we want to continue to be a consistent issuer into the investment grade market, which we've done. We have a large balance sheet that needs a lot of debt capital, so we want to keep the appropriate mix between secured and unsecured. So we have had a strong focus on increasing the capacity on the floating side, which today, is $5 billion committed and only about $2 billion funded. And I think that just gives us flexibility to think about how we fund the balance sheet in the context of rates. Our LIBOR are -- we are -- the LIBOR floaters on the revolving secured facilities have no floor so that's beneficial as well as we use more if -- in a declining rate environment even though right now, I'd say we wouldn't expect the LIBOR to go below the floors in the near-term on the asset side. So -- but it does give us a lot of flexibility on how we manage the balance sheet, gives us some potential benefit from using more floating rate options that we've been very focused on raising in the last 6 months.

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

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I'll just -- I'll add one thing. This is Kipp. I think the question was, right, how do you optimize cost? I would just say, again, and I've -- I say this to a lot of folks, we're not focused solely on optimizing cost, right. One thing that's particular to us is we're a very large company relative to others that finance themselves in the space, and we need to, to Penni's point, have a diversity of financing. But the other thing that we've done that we think is a huge advantage to this company is we've actually bought duration and that's cost something, right? So we actually have a great balance sheet, which positions us with a almost -- I don't know if it's perfect but as close to perfect as we think we can achieve matching of assets and liabilities. And I'd put as much, particularly at this point in the cycle on that as I do optimizing cost as being the first and foremost goal.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [28]

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Makes total sense. And last question. Obviously, credit's trended very well for you guys. I wonder if you could comment on the performance of the companies within the portfolio. And maybe just a brief comment on what industries you might shy away from in the next few quarters, given what you're seeing out there.

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [29]

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Yes. I mean, I think it continues to slow down a little bit. People probably saw the GDP numbers this morning, which looked reasonably good. Our Q3 number in terms of EBITDA growth was 3% versus 4% in Q2 versus 6% a year ago. So we're absolutely with a broad portfolio in a whole host of different industries seeing, I think, the same slowing that others would say they're seeing in other companies and portfolios. When we look at defaults, there have really been a couple of sectors that have driven and led even with lower defaults, the default picture that's been retail, it's been oil and gas and certain aspects of health care. So those are places that we've been a little more cautious, I think particularly retail and oil and gas in the last year or 2. But I don't think that's anything new, right? We haven't really skewed the way that we're investing or chased things in one way or avoided things in another way than we have in the past.

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Operator [30]

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The next question comes from Casey Alexander of Compass Point.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [31]

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I'm sorry if I missed this, but can you go through sort of the broader puts and takes of the realized gains and unrealized -- the realized losses and the unrealized gains in the quarter?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [32]

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The realized -- both of them, Casey, or just the realized?

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [33]

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The -- I mean, the total number is a $37 million loss. I'm just trying to figure out how you got there without going through every name in the portfolio quarter-over-quarter.

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [34]

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I think he's talking about the unrealized.

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

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I think he's saying both.

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [36]

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Well, let me give you the realized because it's in a couple of buckets, and then we can go through the unrealized too, but I'm not sure we have everything here to go name by name. We've got a pretty large portfolio. But the realized loss position was basically writing off an unsuccessful investment that we had in a company called Trident Health Services. That was a roughly $96 million loss so pretty substantial. That was offset by gains in selling an American Capital portfolio that we brought in called Soil Safe, which generated a $13 million gain. So the balance there is a whole host of puts and takes in portfolio companies, a couple here, a couple there.

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

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Yes, and our 10-Q disclosure will list things out more specifically too, just for your reference later.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [38]

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Okay. That's great. All right. I mean, when you discuss the 47% of your new loans were to existing borrowers, it almost feels like when I look at $2.4 billion in new originations and $1.4 billion in repayments, that I should almost be looking at it like $1.3 billion of new originations and $300 million of repayments because that's, sort of, what really happened that wasn't just you taking yourself out and replacing it with another piece of paper.

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [39]

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No, because it's not necessarily -- so there was a question about wash earlier, right? The accounting on wash is add $100 million and whatever it is million, repay $0 because we're just doing an add-on facility.

Right, so if we have an outstanding $200 million loan and we make $100 million add on, we don't account for it as a $200 million repayment and a $300 million origination. We just account for it as a $100 million origination.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [40]

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Okay. Got it. All right. And I guess, lastly, and maybe you don't want to discuss this because it's a portfolio company per se, but we saw another BDC just get waxed today based upon their CLO equity exposure. Can you give us a feel for how that might or might not be impacting Ivy Hill?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [41]

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Yes. So look, we -- I don't think we got waxed. We obviously took modest write-down in Ivy Hill, a $19 million fair -- decrease in fair value. It's really driven by a combination of a couple things, which would be my guess what was happening in whatever other BDC you're referring to, I haven't seen that. But it's a decrease in LIBOR. It's a change in the LIBOR curve. It's a widening in market CLO spreads. And it's also just some particular nuances at Ivy Hill where we happen to be a little bit underinvested in some of our CLOs. So a little bit heavy on cash, which creates lower rates of income that we take in. So I don't have the same concern there because we're running what we think are higher quality, materially lower leveraged vehicles than you'll see in most other maybe BDC portfolios that own a bunch of broadly syndicated CLOs. I think it's pretty different. But look, that market's off. I mean, there's no doubt, the CLO market's off. And a portion of that is what drove some modest declines in our valuation in Ivy Hill.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [42]

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Right. And then lastly, the write-off of Trident, is that what created the decrease in your nonaccrual percentage?

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

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Yes.

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Penelope F. Roll, Ares Capital Corporation - CFO [44]

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On a cost basis, yes.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [45]

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On a cost basis, right. Perfect. Okay.

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Operator [46]

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

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Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [47]

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Just a first question, higher-level. Correct me if I'm wrong, it seems that you shifted a bit toward the more core middle markets with an average EBITDA mentioned of $50 million on, obviously, a great deal of commitments. And this seems to go against what you've been saying, pushing into the larger markets, the softness in those markets, I -- so I would have expected this quarter a good deal of origination but in the larger markets. So any comment on that? And if you've, sort of, changed view on where is the better area to invest.

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

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No, not really. I mean, we've got a pretty broad fairway in terms of what we like to look at. As Mike laid out, I think it was $12 million to $100 million and whatever that number was, $15 million. And Mike can jump in too, I mean my quick thinking around it was more traditional middle market, call it, $50 million of EBITDA unitranche investing this quarter, less of that large-cap, kind of, privately placed second lien, which tends to skew to bigger sizes and larger EBITDAs. And again, it's really hard to -- it's very hard for us to change direction quarter-to-quarter, right? Sort of, deal flow's deal flow and mix tends to dictate itself based on what you find that you like versus what you don't like, so I wouldn't read too much into that, Fin.

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Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [49]

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Okay. And then just a follow-on, on the SDLP scaled down a little bit this quarter. Can you, sort of, remind us of the target area that, that joint venture traffics in? And is that becoming a more difficult origination in front for you?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [50]

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So look, it's one of the products that we offer clients. It's a menu of obviously different -- one of the things that's on the menu of different options that they can pursue. I don't think there's any -- I mean, Smith you can tell me if I'm right, I don't think there's any change in kind of how it's originating, its competitive positioning, et cetera, et cetera. I don't think there is.

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Michael Lewis Smith, Ares Capital Corporation - Co-President [51]

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Yes. We had one big repayment in the quarter. And in general, it's kind of that middle-market unitranche product that goes into that. And so again, to Kipp's point, it really depends quarter-to-quarter, what we're finding and liking and what the borrower's desire is to finance the company.

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Operator [52]

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The next question comes from Chris York of JMP Securities.

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Christopher John York, JMP Securities LLC, Research Division - MD & Senior Research Analyst [53]

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Kipp, or maybe even Michael or Mitch, it seems like lending to middle market software companies has been the source of Ares' portfolio growth over the last year. So I'm curious, in these cases, are you extending credit as a function of recurring revenue as opposed to free cash flow? And then if so, why do you think the returns and repayment characteristics of SaaS lending to these rapidly growing companies is attractive today?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [54]

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Yes, look, so when we look at the sector, what we're predominantly doing is trying to lend against subscription-based cash flows so that's the lion's share of the portfolio in software. It's around 6% of the portfolio at cost. Carl is telling me he thinks it's 5%.

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Carl G. Drake, Ares Capital Corporation - Partner/Head of Public IR & Communications [55]

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4% or 5%.

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [56]

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4% or 5%. In any case, the general rule is, and you've seen a lot of growth, both in software lending, I think, as you're referencing, and in software private equity, a lot of firms, ourselves included, have done a lot of work on this space because it's exhibited very high rates of growth. And obviously, there's been tremendous amount of private equity coming into this space. But for the most part, we're lending to what we see as companies that have strong recurring revenue streams and subscription revenue over time. There is another market that I think you're referring to, which is kind of the AAR lending market, which is looking at just recurring revenue and lending against revenue. And typically, those companies are such rapidly growing businesses that they don't have EBITDA because they're putting so much money back into sales and marketing and R&D. We've done a couple of those deals. I think we've done 5. We're one of the less active lenders in that space relative to the competition. But we do both, but primarily the first kind rather than the second kind you're asking about.

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Christopher John York, JMP Securities LLC, Research Division - MD & Senior Research Analyst [57]

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Got it. The distinction is clearly helpful. And then you anticipated my follow-up question in getting to the portfolio size. There are some private equity sponsors that are raising growth capital there in newer strategies. So I'm curious, is there, and it's a bifurcated portfolio, but is there a portfolio max size that you would want to get at for tech lending? And then the other question would be is what's the typical LTV of this portfolio?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [58]

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Yes, sure. So max size on most industries tends to be 20%. Once it gets to 20%, we start to think critically about whether there's too much allocation to a particular industry. The LTVs, I'd say, are comparable to low in the space because the purchase prices of these rapidly growing software companies are so high. But that's the debate, right? The leverage multiples are also high. So it's not unusual to see lenders lending 6 or 7x EBITDA and a company that's getting acquired for 22x EBITDA. And you can compare that to a regular way LBO where there's 6 turns of leverage against maybe 12 turns purchase price so -- because of a handful of characteristics of these companies, i.e., high growth, very high free cash flow, no CapEx, no working capital, in fact, deferred revenue, right?

So they often generate cash flow ahead of actual revenue recognition. They're just great, great growing cash flow businesses, which is why they're selling for such high prices. But it does keep loan-to-value pretty low based on that, kind of, quick snapshot of the math I gave you.

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Michael Lewis Smith, Ares Capital Corporation - Co-President [59]

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And I would also add that the software portfolio is well diversified in its end market, and we do a lot of diligence around the end market before we make an investment to make sure we understand the competitive dynamics on that end.

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Christopher John York, JMP Securities LLC, Research Division - MD & Senior Research Analyst [60]

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Awesome. The color is helpful. And I guess just concluding there, so if you're at 4% to 5% of the portfolio, 20% is your max size, this could be theoretically an area of growth. Is that an appropriate conclusion?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [61]

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It has been an area of growth, yes. I mean it's a very active sector, and we've got some great relationships with some of the leading private equity firms out there. And we've also been more active, going direct to company in that space.

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Operator [62]

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The next question comes from Robert Dodd of Raymond James.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [63]

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Just on the point in your opening remarks Kipp, the 47% of your commitments in the third quarter were to existing portfolio companies. I mean can you give us any color on what the -- I mean, obviously, the basic underwriting is the same when it's a follow-on. But is there an additional dynamic of maybe other competitive lenders who've been raising capital trying to poach your deal, so to speak, and try and force you out driving the add-ons?

Each additional add-on, obviously, increases your bite-size in a particular portfolio company, which reduces diversification a little bit, right? So it changes the risk portfolio dynamics. I mean, can you give us any more color on how much appetite you've got for doing those follow-ons and what you'd like to see that be as, kind of, maybe 1% of the origination mix?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [64]

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I mean it's kind of -- we, I'd say, love financing our best high-quality borrowers because we think they have less risk because we obviously know them and have a relationship there and aren't conducting a new set of due diligence on a new company. We also think that because we have the existing relationship, we're insulated on pricing. We think that the maximum leverage ask, which is often the way private equity will go in a new transaction, is typically not what comes through as leverage is getting added during buy-and-build strategy, so we think that there are a lot of attractive dynamics as it relates to continuing to finance our existing borrowers.

Hopefully, that answers the question a little bit on are we getting poached. The answer is usually not because it's more likely you bring a new lender into a deal, so if we're sole lender, you bring a partner in, if we're starting to get larger on exposure. And the reason for that is if you're a company that has $300 million of debt outstanding, you've already paid a 3% fee on that $300 million of debt and you're 2 years into an investment, you're probably unlikely to want to go pay $10 million of new fees to refinance us so you can save 50 basis points, right? Because the alternate proposal is a bit cheaper, plus you'd be working with somebody you didn't know.

We also, kind of, like to think that we establish good relationships with our borrowers and they want to stay with us because we're value-added and know the market and all of those things.

So I think it'll stay in line with where it's been, around 50%, and that's some color on why we think it stays that way.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [65]

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Got it. I appreciate that. And then another question, sort of, related, it's all about originations. There's been some, obviously, some -- to your point, in the BSL market, some issues on getting some deals done on the syndication side. In the past, you have occasionally stepped in and done those kind of deals, which obviously, can create nice fee income plus a big bite-size all at once. So what's your appetite to maybe approach that? I mean your color seems to indicate it's the weaker deals that are struggling, which I think is always the case to get done, so I presume that impacts your willingness to look at that area of the market at this point in the cycle.

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [66]

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Yes, I'd say, I think you may have answered your own question. I mean you -- most of the things that are tough that are difficult to get done now are things where borrowers are worried about ratings, right? Either single B or particularly CCC, where there is a bit of a buyer strike these days for a whole handful of reasons. We obviously don't require ratings in our transactions. So to the extent we find a company that we think is not being evaluated well potentially in a rating agency process or a potential rating agency process that would lead to a not-so-great or poor syndication, it's a great opportunity for us to jump in and provide a private unrated solution.

We hope that improves, right? And we've been doing that at the company for a long period of time. So in choppier markets, those opportunities tend to be more plentiful. That's a little bit of what we were referencing on the -- in the prepared remarks. But obviously, to your point about adverse selection, it's time -- it's definitely time to be careful. As I said be a credit picker, and we think we have a lot of experience doing that.

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Operator [67]

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(Operator Instructions) The next question comes from Ryan Lynch of KBW.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [68]

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My follow-up question has been asked and answered. Thanks.

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [69]

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Thanks, Ryan.

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Operator [70]

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(Operator Instructions) There are no more -- we have one other one on queue. Mr. David Rothchild -- I'm sorry, 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 [71]

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I don't want to cut off questions, so if there's an additional question, we're happy to take it.

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Operator [72]

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Absolutely, sir. We have a Mr. [David Rothchild], a private investor.

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David Rothchild, - Private Investor [73]

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I'm not an analyst, I'm not as in-depth as the analysts are. My one concern I had was in your announcement of your more recent yields that they were coming down for the most recent quarter. Will that -- will your expense side on that debt go down so that net investment income won't change going forward or is that a concern for the dividend?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [74]

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You definitely have the relationship right. So with decreasing yields will be a little bit of decreasing revenue. But we do, of course, with floating rate debt, get the benefit of lower LIBOR on the portion of our debt that's floating rate. So that should provide some comfort. And we don't have any concern whatsoever that the investment income is continuing well in excess of the dividend. So thanks so much for your question.

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Operator [75]

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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 [76]

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Nothing in particular. Just thank everybody for your continued interest in the company, and we'll catch up with you next quarter.

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Operator [77]

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Ladies and gentlemen, this concludes our conference call for today. If you missed any part of today's call, an archived replay of this conference call will be available approximately 1 hour after the end of the call through November 13, 2019, at 5 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 10134441.

An archived replay will also be available on a webcast link located on the homepage of the Investor Resources section of Ares Capital's website.