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

Q2 2019 Ares Capital Corp Earnings Call

NEW YORK Aug 23, 2019 (Thomson StreetEvents) -- Edited Transcript of Ares Capital Corp earnings conference call or presentation Tuesday, July 30, 2019 at 4:00:00pm 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

* Michael Lewis Smith

Ares Capital Corporation - Co-President

* Mitchell S. Goldstein

Ares Capital Management LLC - Senior Partner, Partner, Co-President & Co-Head of Ares Credit Group

* 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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* 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

* 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

* Ryan Patrick Lynch

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

* Terry Ma

Barclays Bank PLC, Research Division - Research Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to Ares Capital Corporation's Second Quarter ended June 30, 2019, Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded on Tuesday, July 30, 2019.

I will now turn the call over to Mr. Carl Drake, Head of Public Company, Investor Relations. Please go ahead.

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Carl G. Drake, Ares Capital Corporation - Partner/Head of Public IR & Communications [2]

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Thank you, and good afternoon. Let me start with some important reminders. Comments made during the course of this conference call and webcast contain forward-looking statements and are subject to risks and uncertainties. Many of these forward-looking statements can be identified by words such as anticipates, believes, expects, intends, will, should, may and similar expressions. The company's actual results could differ materially from those expressed in such forward-looking statements for any reason, including those listed in its SEC filings. Ares Capital 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 Reg G, such as core earnings per share or core EPS. We believe that core EPS provides useful information to investors regarding financial performance because it is one method we use to measure our financial condition and results of operations.

A reconciliation of core EPS to the net per share increase or decrease in stockholders' equity resulting from operations, which is the most direct comparable GAAP financial measure, can be found in the accompanying slide presentation for this call. Reconciliation of these measures may also be found in our earnings release.

Certain information discussed in this presentation, including information related to portfolio companies was derived from third-party sources and has not been independently verified, and accordingly, the company makes no representation of warranty in respect to this information. The company's second quarter earnings presentation can be found on our website at www.arescapitalcorp.com, by clicking on the Q2 '19 Earnings Presentation link on the homepage of our Investor Resources section. Our earnings release and 10-Q are also available on our website.

I will now turn the call over the Kipp DeVeer, Ares Capital's CEO.

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

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Thanks, Carl. Good afternoon, everyone, and thanks for joining the call today. I'm here with most of our management team, including our Co-President, Mitch Goldstein; our Chief Financial Officer, Penni Roll; and other senior professionals from the finance, investment and IR teams.

I'd like to start by highlighting our second quarter results, then hopefully put them in context with some thoughts on recent market conditions, and finally turn the call over to Penni and Mitch, who will cover our detailed financial results, our investment activity and some portfolio metrics.

This morning, we reported strong financial results for the second quarter, with core earnings of $0.49 per share and GAAP earnings of $0.47 per share. Our earnings benefited from increased interest and dividend income, strong fee income and stable credit performance. We also had another quarter of increasing net asset value, reaching a record for the company of $17.27 per share.

The market continues to rebound following the tremendous volatility we saw at the end of 2018, and this has helped us continue to improve the earnings picture at the company. However, volumes do remain well below the prior year's levels. The market remains competitive, supported by continued inflows of capital, and this is increasingly leading to more aggressive lending behavior by other market participants.

This gives us some concern as we believe some of these managers lack the scale and experience required to be successful over the long haul. We believe the scale and informational advantages that come from our platform and our experiences over many years position us well to drive differentiated results through cycles and to potentially weather a market like this better than others. We also believe it can put us in a position to be a consolidator eventually if and when there's a shakeout.

In these types of aggressive markets, we become even more selective. Our selectivity ratio this quarter was 2%, which is about half of our historical average of approximately 4%, and we refer to that in terms of the percentage of deals that we see -- that we close, rather, versus those that we see. It has been trending lower over time and that's reflective of our disciplined approach.

While our approach to underwriting has remained consistent, we're well-positioned to benefit from the long-running trend towards private capital and away from public capital. Our fairway continues to widen as we see more opportunities from companies that used to be financed in the high-yield and leverage-loan markets.

For instance, in the second quarter, we were a joint lead arranger and book runner on the $3.5 billion first- and second-lien tranches of Hellman & Friedman's take-private of publicly traded Ultimate Software, a SaaS-based human capital management software provider. We believe that our ability to be a meaningful and stable source of capital, with large buy and hold capabilities, enhances our position as markets evolve.

I'm going 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, and good afternoon. As Kipp stated, our core earnings per share were $0.49 for the second quarter of 2019, up compared to $0.48 for the first quarter of 2019 and $0.39 for the second quarter of 2018. Our GAAP earnings per share for the second quarter of 2019 were $0.47 compared to GAAP earnings per share of $0.50 for the first quarter of 2019 and $0.60 for the second quarter of 2018.

Our second quarter 2019 core earnings were largely driven by increased interest income, given the growth in our average portfolio over the quarter and strong capital structuring fees. In addition to our core earnings, we reported net realized and unrealized losses on investments and other transactions for the second quarter of 2019 totaling $8 million, which included $18 million of net realized gains from investments.

As of June 30, 2019, our investment portfolio was $13 billion at fair value, an increase of 13% from a year ago and basically flat with the prior quarter. Also at June 30, the weighted-average yield on our debt and other income-producing securities at amortized cost stayed flat with the prior quarter at 10.4%, and the weighted-average yield on total investments at amortized cost was 9.2% compared to 9.3% at March 31.

Moving to the right-hand side of the balance sheet, our stockholders' equity at June 30 was $7.4 billion, resulting in a net asset value per share of $17.27, an increase of over 1% over the prior year. As of June 30, our debt-to-equity ratio was 0.83x, and our debt-to-equity ratio, net of available cash of $535 million was 0.76x compared to 0.86x and 0.79x, respectively, at March 31.

The Small Business Credit Availability Act became effective for us in June. Given our disciplined and opportunistic approach to investing, we continue to believe that it could take 12 to 36 months from now to move meaningfully into our new target leverage range of 0.9 to 1.25x and that depends on market conditions.

Now that the FDA -- CAA's higher leverage limit is effective for us, we are already benefiting from greater structural flexibility, which we believe reduces our risk and enhances our ability to invest throughout the cycle. We remain investment-grade rated from all 3 major rating agencies, with a positive outlook from both S&P and Moody's reflecting our commitment to operate in a manner to be a strong investment-grade-rated company.

While it will take some time to move into higher leverage, we have already been working on expanding the company's liquidity to be prepared to take advantage of investing opportunities. During the second quarter, we closed on approximately $2.2 billion of additional debt commitments from various banks and institutional debt investors.

Anchored by the incremental $1.5 billion of increased borrowing capacity from our bank credit facilities, we also completed a $650 million 5-year investment-grade unsecured note issuance in June. Therefore, as of June 30, 2019, our total available liquidity, including $535 million in cash, was nearly $3.7 billion, which positions us to reach the high end of our debt-to-equity range.

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

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 therefore, these amounts remain subject to change.

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

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Mitchell S. Goldstein, Ares Capital Management LLC - Senior Partner, Partner, Co-President & Co-Head of Ares Credit Group [5]

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Thanks, Penni. And again, good afternoon to all. I would like to spend a few minutes providing more detail on our second quarter investments and our portfolio performance. I will then provide a quick update on post-quarter end activity and our backlog and pipeline.

During the second quarter, our team originated $1.3 billion of new commitments across 33 transactions, and our focus remained on defensively positioned high-quality companies. Our large origination team and diverse credit platform enables us to source a broad range of new transactions across the middle market. However, we often find superior risk-reward in backing our existing portfolio companies. This was clearly evident in the second quarter as 25 of the 33 investments made were to existing borrowers.

Let me highlight 2 recent transactions to give some context to this advantage of incumbency. In the second quarter, we led a commitment to support TPG's acquisition of Entertainment Partners, which simplifies payroll, production management, scheduling and accounting processes in the entertainment industry. Underscoring the power of our platform, not only is TPG a repeat sponsor for us, but Entertainment Partners was also an existing portfolio company.

Given our knowledge of the company and our ability to provide a scaled commitment across our platform, which included drawing on the capabilities of the SDLP, we were awarded the mandate to lead the financing. This also illustrates how our complementary pool of capital benefit ARCC.

We also led a $75 million senior secured financing credit facility to support Behrman Capital's acquisition of Waterline Renewal Technologies, a division of one of our former portfolio companies, Triwater Holdings. Waterline is a leading provider of engineered products that enables the repair of sewer systems and wastewater lines. Again, here, we've had a very long relationship with Behrman and were able to effectively underwrite a new portfolio company, with the benefits of incumbency.

Now let me shift to the portfolio quality. Our portfolio of 345 different borrowers remains highly diversified, with an average hold position at fair value of 1.3%. The weighted average to EBITDA of the portfolio increased to $135 million, reflecting our ability to provide scaled solutions to larger companies.

Comparatively, the average borrower EBITDA was $71 million for the quarter ended June 30, 2019. As Mike Smith and I have discussed in previous quarters, we believe this metric illustrates our continued focus on our historic core middle market, even as we opportunistically invest in upper middle market companies that have higher EBITDA and, thus, require larger dollar commitments.

Credit quality continues to be very stable. Our portfolio continued to generate weighted-average EBITDA growth of 4% over the past 12 months. We did not add any new portfolio companies to nonaccrual in the second quarter, and our nonaccruals remain stable at 2.3% of the total portfolio at amortized cost and 0.2% at fair value.

Before I turn the call back over to Kipp, let me provide a brief update on our post-quarter end investment activity. From July 1 through July 24, 2019, we made new investment commitments totaling $801 million and exited or were repaid on $617 million of investment commitments, generating approximately $17 million of net realized gains.

As of July 24, our backlog and pipeline stood at roughly $850 million and $105 million, respectively. As always, these investments are subject to approvals and documentation, and we may sell a portion of these investments post-closing. Please also note that there is no certainty that any of these transactions will close.

I will now turn the call back over to Kipp for some closing remarks.

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

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Thanks, Mitch. In closing, we're pleased with another strong quarter of performance. Our earnings are running well in excess of our recently increased dividend. Our book value is up again and credit performance remains stable.

As we discussed at our recent Investor Day, we continue to believe our addressable market remains an attractive place to invest, particularly with low and perhaps even lower interest rates in the U.S. We also feel that our platform is well-positioned to invest opportunistically in high-quality businesses and to generate compelling investment returns for our shareholders. That concludes our prepared remarks.

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) Our first question will come from John Hecht with Jefferies.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [2]

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Kipp, just regarding the kind of selectivity and discipline that you referred to, is it more tied to being disciplined on pricing or is it deal structure or is it business quality? And what kind of color can you give us on -- with the competitive environment?

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

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Yes, I mean, I think it's all of them, John. I think for us it always -- we've said this for 15-plus years, that the one -- the first thing that -- the easiest thing to get wrong is picking the wrong company. So we focus first on quality of company, and I think you're seeing real bifurcation in the market even in the large-cap space, where deals for what everybody perceives to be high-quality credits are heavily competed for.

And I think there's very limited tolerance for things that are not perceived to be very good credits, and the reason for that follows along to your other point. It's less about pricing, it's more about, for us, I think, lower-quality underwriting. Again, the dialogue about lots of adjustment against EBITDA, where you're underwriting higher leverage multiples on an absolute basis than you probably are on an adjusted basis, and it's a weakening of documentation too.

So we're trying to find the best companies. It's not so much about pricing; it's more about folks competing on Cub-light for a smaller deal or a weak document or a set of lender protections in a credit agreement that we feel uncomfortable with.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [4]

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Okay. That's helpful. And then second, I know you guys referred to some of the EBITDA performance of the companies -- I guess the portfolio companies. I know back at the Analyst Day, you had referred to, just on a defensive basis, spending more time monitoring. Have you guys seen any signals or changes in kind of trends at the portfolio company that are worth calling out?

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

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I think we're seeing the same slowing growth narrative that you're seeing in the newspapers. The number that we laid out for Q2 about EBITDA growth in the portfolio is a 4% number for Q2, which was 5% in Q1 and 7% at this time last year.

So we're seeing that, but for us now, that feels more like an equity issue in that there have been some very high purchase prices particularly in sponsored buyouts. And it's years later, if you built a model, where you were modeling out, whatever, pick a number, 8% growth for your portfolio company, and all of a sudden, that's just 2%, 3% or 4%, you have a little bit more of a challenge for the equity story.

And certainly companies that have covenants, and most of ours do, are probably experiencing a little bit more pressure because of that slowing growth. So more time monitoring, maybe just out of an abundance of caution, a slightly longer watch list.

But again, we really have no new problems, right? All our nonaccruals are established. We don't have any new nonaccruals this quarter. If you look at the cost value of our nonaccruals against the fair value, most of them have been written down to de minimis amounts. So we're pretty positive, actually, on a slow growth economy. We think it works just fine for our company. So...

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Operator [6]

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Our next question will come from Rick Shane with JPMorgan.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [7]

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Penni, just wanted to talk to you about the funding strategy. You guys did a notes deal earlier, in June. Your balance sheet is more asset sensitive than many of your peers, given a higher percentage of fixed-rate debt.

I'm curious if this is really a function of building that fixed-rate funding capability in anticipation of levering up over the next 36 months and that we should see the mix shift more towards floating as you take advantage of lower base rates.

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Penelope F. Roll, Ares Capital Corporation - CFO [8]

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Yes. I think one of the reasons why, if you look at what we have been working on is we've substantially increased our floating rate borrowing capacity, coming into the expectation of moving into higher leverage over the next 2 to 3 years. So we have thought about how we can use floating rate liabilities against a predominantly floating rate portfolio and realize we could benefit from that.

We do want to continue to be in the unsecured fixed-rate note markets from a capacity point of view, because we do have a big balance sheet and we want to have resources of debt capital or sources of debt capital from a lot of different places. But we are balancing out the opportunity to have more floating rate capacity right now, given trends or expected trends in interest rates.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [9]

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Got it. So the way to think of it that you will -- as fixed rate instruments come -- mature, you'll go into the market and replace those, but the growth in the increased leverage on the balance sheet will really be funded on that increased capacity on the floating rate side?

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Penelope F. Roll, Ares Capital Corporation - CFO [10]

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Well, I think it will be both. But I think if we be patient around how we think about refinancing fixed-rate debt and think about how we like to layer in fixed-rate debt, we could also, in a declining rate environment, have an opportunity to issue additional fixed-rate debt as time goes by that's lower cost than where we just recently issued the $650 million 5-year deal at 4.2%.

So I think we have to have the right balance of both to provide capacity. We also think a lot about our investment-grade rating, which would look for us to continue to issue in an investment-grade, unsecured-notes market as well. So we'll strike the appropriate balance, and hopefully, we'll think about timing of doing the issuances in a way that we manage our cost of capital.

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [11]

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Yes. I'll just -- Rick, I'll add something. This is Kipp. The uncertainty and, frankly, my lack of understanding about why -- this is just my own opinion -- why we would have a rate decrease in the face of 2-plus-percent GDP growth is a little bit confusing to me.

So I think we're trying to be as agnostic around rates right now as we've been. I think we had taken a view that rates were likely to increase, which they did. It took a little bit longer than we might have expected. And I think for now, there are some things that rates do have an impact on today, and we're going to try to not be directional about rates. We're going to try to be very balanced as we see how this unfolds.

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

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No, that's actually helpful context in terms of overall rate outlook. And I think this is the second time I've said this during earnings season, but sometimes we fall into the category eventually being right and I understand the uncertainty there.

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Operator [13]

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Our 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 [14]

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Just a first one on equity. Looking at recent presentation, you talk about the equity co-investment strategy at 10% to 15% of investments, if I'm reading correctly. Can you break this down, if suitable, between preferred or income-producing versus common equity? Because if you combine them both, they stack up into that range, but it's a pretty even split. Any color there you could provide?

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

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Sure. I think we have some of both. We don't have any directional strategy of preferred versus common necessarily. I think most of those decisions are made on a company-by-company basis. I think the only real construct -- and, I mean, Mitch or Mike can jump in, too -- I think we never wanted to run the portfolio with more than that range of 10% to 15% of the portfolio being in some composition of equity thus feels appropriate so that we're not building an asymmetric debt portfolio with no upside to take care of some of the losses that are inevitable with companies like ours as times are tougher.

So there's really no stated strategy of we want to do this versus we want to do that. It's much more on a deal-by-deal basis and then you just manage the overall basket on a company-wide exposure basis.

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Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [16]

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Okay. That helps. And then if I could tack one on that. Was Shock Doctor this quarter, was that a regular refinancing or was that a restructuring of sorts?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [17]

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It was a refinancing.

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Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [18]

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Okay. And then just one more, if I may be uncourteous and ask a third question. On allocation, does the adviser ever take any form of upfront fee, like a capital -- part of the capital structure and fee, for example, that would've gone to the shareholder before allocating to the BDC and other funds.

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

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No. All of our fees here follow our capital. So if you're investing in a deal, you get a fee on the origination side. Our adviser doesn't keep any origination fees.

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Operator [20]

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Our next question will come from Terry Ma with Barclays.

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Terry Ma, Barclays Bank PLC, Research Division - Research Analyst [21]

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Just a question on the capital structure and fees. It was about 3% of commitment this quarter, which is on the higher end of the range historically, I think, just part of that was driven by larger transactions in portfolio companies. So was that just a function of the deals you saw this quarter? Or is that a trend we should expect to continue as you increase your balance sheet size over the next 12 to 36 months?

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Michael Lewis Smith, Ares Capital Corporation - Co-President [22]

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Yes. I think -- it's funny, Terry, we -- it's a good question. We actually dug around a lot on this to -- and people sort of are coming up with different conclusions.

Let me just give you a couple of thoughts on fees in general, and then I'll tell you what I think it is, which is if you look at our 16-quarter average, so for the last 4 years, we've generated about $0.08 a share per quarter of upfront fees. This quarter was a little bit north of that at $0.09, and on a total dollar basis, was obviously down versus last quarter, and, again, that's because the gross commitment number was down.

So as much as we kind of wrangled around trying to figure out what it was, I think it was nothing more than just the natural mix of the deal flow that we happen to close, new versus existing and that the activity this quarter, even though it did generate a higher net fee, i.e. dollars divided by net commitments, just seems like it's circumstance. There's really nothing to it.

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Terry Ma, Barclays Bank PLC, Research Division - Research Analyst [23]

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Okay. Got it. That's helpful. And then just a follow-up on the rate outlook. So rates have been a tailwind for earnings the past couple of years, but just given the current outlook, it looks like it's more of a modest headwind, at least going forward.

So can you just kind of talk about how you think about managing that? And at what point will you maybe start to get more cautious of where -- you probably have a little while to go before you hit your floors, but will you end up worrying at some point if rates continue to move down?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [24]

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I mean, it's definitely a headwind. It's not a meaningful headwind for us here. It's a 25 basis point reduction, perhaps, this week, and then it will see -- so I think we're a ways off worrying.

I think the question will be if rates do go materially lower, will spreads widen to compensate and try to keep absolute return in a lot of the asset classes more anchored to where they are today? That's typically what happens. The same way that you don't get the full benefit of LIBOR increases on the way up; you tend to get some offsetting spread widening as rates go down. So we'll see.

Again, it's very -- I made the comment before -- I personally am a little bit confused and I think the team is spending real time looking at our -- kind of our forecast, but I'm not worried today. I think we'll see where it takes us. But definitely a change. Definitely something that, I think, 6 months ago everybody thought was quite unexpected.

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Operator [25]

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Our next question will come from Chris York with JMP Securities.

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Christopher John York, JMP Securities LLC, Research Division - MD & Senior Research Analyst [26]

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So Kipp, I got a strategic question about the SDLP, which has grown quite attractively. So I think the JV was set up in 2016, so you essentially provide larger unitranche loans, maybe up to like $300 million. I think the market has evolved over the last maybe 3 years, with sponsors seeking larger deals directly from the scaled lenders that can write checks above $100 million.

And then in the second quarter, it appears SDLP financed a larger deal at $300 million for the first time. So the question is at what size of commitment do you think is truly differentiated by a direct lender today? And then how do you balance the need of sponsors to write these larger checks while adhering to good portfolio management at the JV?

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

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Yes, I think there are plenty of people these days who can write $200 million, $300 million commitments. I think north of that, $500 million-plus, it becomes a differentiator. It's a very limited group of folks.

I think your question on SDLP, is how do we use that? Obviously, we try to use it to deal with transactions that we source with our partner in that joint venture. But at the end of the day, it's really at the client's choice, right? We have a whole host of different products that we can offer, be it first lien, second lien, unitranche. We can show them SDLP, and it just is a circumstance by circumstance sort of situation as to where the things end up or how they end up being structured. I hope that answers your question, and if it doesn't, feel free to follow-on.

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Christopher John York, JMP Securities LLC, Research Division - MD & Senior Research Analyst [28]

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No, it does. So yes, I was thinking that it moved away in terms of size from maybe $200 million, $300 million to $500 million, so your insight there is much appreciated. And then a follow-up question on modeling, so what drove this sizable increase in Ivy Hill's assets under management? And then is the increase in the dividend by $3 million a new run rate? Or were there success fees or other longtime fees in there?

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

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The increase in the dividend's really -- the dividend income's really driven by 2 things. There was a modest increase in the dividend coming up from Ivy Hill. Because of its increased scale and profitability, the company's doing well. And then secondly, it was this athenahealth transaction we participated in in Q1, which does have a preferred equity security with a contractual coupon that comes through as dividend income.

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Operator [30]

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Our next question will come from Ryan Lynch with KBW.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [31]

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First, just kind of want to go retouch the topic of declining rates. So if I look at Slide #16 in your presentation, it looks like floating rate, new investments decreased a little bit this quarter as a percentage of your portfolio -- or as a percentage of new investments made this quarter. It's still the overwhelmingly majority of new investments you made, but it looks like it's ticking lower.

So is that a coincidence? Or are you guys starting to focus some of your new origination efforts with fixed rate structures? And if that is the case, what is -- what has been the feedback from borrowers?

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

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Yes, I'm looking at it. I don't -- there's not a lot of discussion on the investment team. Mitch and Mike and others can certainly jump in about let's go try to source fixed rate paper because rates are going down. So I think it's coincidence for now. I don't think it would be met that well, but we haven't been trying.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [33]

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And then from a competitive landscape standpoint, I was a little surprised to hear that your selectivity ratio -- you guys are being more selective, moving down to 2% from 4%. And I think you said 25 of the 33 new investments were made to existing borrowers. We know it's been competitive for a long period of time, but I feel like the comments made this quarter really highlighted that. Would you say the competitive environment today has significantly changed from where it was a year ago?

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

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I don't think that per the earlier conversation, I think it was just -- it's really not pricing. It's really -- we're just -- we're seeing a lot of folks compete on terms and loan documentation and lack of covenants thereof, things just that are not conventional in this market. And obviously, markets change, and they institutionalize.

But we've built a pretty long track record of sort of doing things the way that we like to do things. So we're trying to stick to the playbook that we've had for a long time of having conservative structures with real covenants and loan documents that actually allow us to enforce in a position where we need to. I think it's allowed us to achieve better recoveries and fewer losses than competitors.

So it's much more those things than it is anything else. And I don't know, maybe we're old school, but we're just trying to resist as much of that as we possibly can. The good news is, we've got a very robust origination team and a strong network of relationships where we can source a lot of deal flow. But it's -- yes, so it's challenging today, no doubt.

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Operator [35]

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Our next question will come from Michael Ramirez with SunTrust.

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Michael John Ramirez, SunTrust Robinson Humphrey, Inc., Research Division - Associate [36]

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We understand you now consider the remaining ACAS investments as core assets, which implies limited opportunities for additional rotation into, I guess, your higher-yielding investments. But could you please give us a sense of if these current assets are below the, I believe it was, $644 million that you disclosed in the fourth quarter last year? And additionally, could you please give us a sense of the M&A market? And if you see another ACAS-like acquisition on the horizon?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [37]

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Okay. So I'm sorry. So the first question, just so I'm clear, is what's remaining from ACAS? Does it pay a yield that's below the current market? Yes. I mean, I think, it's a -- it's, frankly, not a lot of assets left. But yes, I would deem it core. I mean, I think it's there, and it'll see its natural refinancing activity, but not through any particular "let's go get this out of the portfolio as quickly as we can" sort of thing or push it harder.

Acquisitions are challenging. We've done a couple. I mean, as I've said in the past, we bought a company that got into trouble with its lenders. We think that with the SBCAA, it's probably less likely and that folks have a lot more financial room to operate with and, inherently, it's more difficult for that to happen.

The ACAS situation was one where, I think, after many years of success, there was a belief that just sort of the governance wasn't there, and the equity over time transferred and transferred into the hands of folks who were looking for a new management team. So I definitely think there are situations out there of not-wonderful performance. Some BDCs and perhaps boards or shareholders move to do something similar to what happened at American Capital, but it's super hard to predict.

I mean I don't think that you'll see us just go run around looking for acquisitions. And as I've said in the past too on calls, do something hostile around the competition, it's just not the way that we view our job day-to-day.

We've got a lot of room for growth without acquisition, right? I mean, I think, about having tremendous amounts of debt capacity to invest, and we'd rather do it at better relative value or scale more quickly at better relative value. And if an acquisition comes along, that will be part of the discussion. But I don't see anything on the horizon that would accelerate that in a material way.

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Michael John Ramirez, SunTrust Robinson Humphrey, Inc., Research Division - Associate [38]

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Okay, great. And one more if I may. I know there might have been sort of 2 questions in the last one. But it seems like we've been hearing we're getting toward the end of the cycle for quite a bit now, especially conference calls over the last 6 to 8 quarters. So aside from your senior lien position, could you please give us a sense of how defensible your portfolio is constructed, I guess, in regards to like, say, the underlying industries your companies operate in?

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

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Yes. I mean obviously, we've laid out in our prepared materials, we've been doing this a long time. Our portfolio, which is on Page 12, and we think that industry selection is key. And we think not being, frankly, in unsecured positions at this stage in the cycle are the 2 keys, and to stay away from cyclical industries and, frankly, stay away from sub-debt for now.

So we think it's the same playbook from the last go-around. And we've been spending years as it continues to be late in the cycle trying to exit the companies from our portfolio that were not performing to plan. So we're happy with where we are. We don't see anything here in the near term that's going to change what today is an attractive place to invest, where there's a lot of income relative to the risk-free rate and good credit quality.

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Operator [40]

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Our next question will come from Robert Dodd with Raymond James.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [41]

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Can you give us some color on your appetite for second lien? Obviously it's been -- it increased a slight over the last year, a tiny bit as a percentage of the portfolio, not much. But obviously also, your weighted-average EBITDA has been going up. So can you give us any color on what -- yes, what is your appetite for second lien relative to, say, the size of the company?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [42]

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Yes, I mean, generally, we've said this to you in the past, Robert, the -- we're trying -- most of our large second-lien deals are in companies that have been with the portfolio for a long period of time. We tend to be in larger businesses that we think have better downside protection and they tend to be in industries that we think of as very defensive, i.e. not cyclical.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [43]

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Got it. Got it. And what -- and then, kind of paralleling that, what's the appetite for second-lien kind of with regard to structure? Like, I mean, is there -- obviously if you do -- you've got the scale to do a large unitranche deal either on the balance sheet or on the SDLP. Or you can do first-lien, second-lien structure, put a -- maybe with a higher credit quality business, i.e., the first lien's quite low yield, and do a first out or a last out on the first lien.

But I mean, so how -- has that evolved in terms of how -- your willingness to structure those kind of deals for larger businesses in terms of keeping more of the higher yield, not indicating higher risk, necessarily, depending on how you structure it, on the balance sheet, and taking the larger check to your point with scale and having the ability to write those very large checks, keeping the high-yield piece on the balance sheet, maybe even getting some excess fees from how you structure it? But I mean, has anything evolved over -- with your appetite to do that over the last year or 2?

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Robert Kipp DeVeer, Ares Capital Corporation - CEO & Director [44]

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I would just say, certainly, things have changed as folks like Ares Capital and others have more capital to bring to bear. The way that we think about structuring first and foremost is we want to bring a preferred solution to our client, whether that's a private equity firm or a family or an owner of a power project or whatever it may be. And they often have pretty different views about how that works.

And all I'd say that's changed is the ability to have a [bought] $300 million to $500 million unitranche solution is much more readily available today than perhaps it was, pick a number, 7 or 8 years ago, right? We can certainly do that as can others. And we found as far back as SSLP, it was really the magic of that way back when that bought deals for private equity funds that are trying to buy companies quickly or without sharing a lot of information with a whole host of lenders, if you can do that, that's changed the game.

So I'd say that there's probably less second lien in the middle market because -- and by the middle market, I'd define it as $50 million of EBITDA and under. I think above $50 million, and really, clearly, $100 million these days, you start to talk about deals on the first lien side that are truly going to get rated and underwritten by the banks and sold to investors. And obviously, in doing that, you are achieving a lower cost of capital on the first lien.

I think the only trend there, which we talked about on our Investor Day too, is a lot of the second lien and junior capital in those transactions are tending to get placed directly with folks like us and some others, right? Less syndicated by the banks, so bigger deals, combination of rate and syndicated first lien and junior capital.

And the good news is, we're not just buying paper from the banks; those are situations where we're stepping in. We're leading those deals, we're structuring them, we're negotiating loan documentation, et cetera. So they feel much more private and much more solutions-oriented in nature. Hope that's helpful.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [45]

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Got it. I really -- yes, I really appreciate that color. One more quick one if I can, unrelated, have you done any analysis yet on how much exposure your portfolio companies have to Brexit, since it's back in the news again?

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

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Yes. We're doing a lot of work on both the tariff question and on the Brexit issue. I'm going to save that for another day, if that's all right, because I don't have a great answer for you.

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Operator [47]

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Our next question will come from Casey Alexander with Compass Point.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [48]

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That's okay. My questions were asked and answered.

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Operator [49]

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This concludes our question-and-answer session. I would 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 [50]

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I'll just thank everyone for their time, and I'll echo everyone's sentiment here that we sure hope the Yankees end up with another starting pitcher. Have a great afternoon.

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Operator [51]

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Ladies and gentlemen, this concludes our conference call for today. If you have missed any part of today's call, an archived replay of this conference call will be available approximately 1 hour after this call at the end of the call through August 13, 2019, at 5:00 p.m. Eastern Time, to domestic callers by dialing (877) 344-7529, and to international callers by dialing (412) 317-0088. For all replays, please reference conference number 10131888.

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