Ares Capital Corp (ARCC) 2008 Q4 法說會逐字稿

Welcome to the Ares Capital Corporation earnings conference call. At this time, all participants are in listen-only mode. As a reminder, this conference is being recorded on Monday, March 2nd of 2009. Comments made during the course of this conference call and web cast and the accompanying documents contain forward-looking statements and are subject to risks and uncertainties. Many of these forward-looking statements can be identified by the use of the words such as, anticipates, believes, expects, intends, will, shall, may, and similar expressions. The Company's actual results can differ materially from those expressed in those in the forward-looking statements for any reason including those listed in its SEC filings. Ares Capital Corporation assumes no obligation to update any such forward-looking statements. Please also note that the past performances and market information is not a guarantee of future results.

During this conference call, the Company may discuss core earnings per share or core EPS which is a non-GAAP financial measure as defined by SEC's Regulation G Core EPS and the net per share increase or decrease in stock quarter's equity resulting from operations less realized and unrealized gains and losses any incentive, management fees attributed to such realized gains and losses and any income tax to such realized gains. A reconciliation of core EPS to the net per share increases and decreases in stockholder's equity, resulting form operations the most directly comparable GAAP financial measure can be found in the Company's earnings press release. The Company believes that core EPS provides useful information to investors regarding financial performance because it is one method the Company use to measure its financial condition and results of operation.

At this time, we would like to invite participants to access the accompanying slide show, presentation by going to the Company's website at www.arescapitalcorp.com. And clicking on the March 2nd, 2009 presentation link under the stock information section of the investor resources tab. Ares Capital Corporation earnings release and annual report are also available on the Company's website. I will now turning the call over to Mr. Michael Arougheti, Ares Capital Corporation President.

Good morning, everyone and thanks for joining us. I'm joined today by Rick Davis our CFO, Carl Drake and Scott Lem from our Finance and Accounting team and Eric Beckman, Kipp deVeer, Mitch Goldstein, and Michael Smith, Senior Members of our Investment Advisors Management team. I hope you have all had a chance to review our press release and investor presentation posted on our website.

Before Rick gets into the financial details of the quarter, I want to take a few minutes to comment on current market conditions, and describe how we are managing through these turbulent times, I will finish by highlighting our results and touch on our dividend. As you all know, the fourth quarter was one of the most challenging periods all of us have seen in terms of credit and stock market volatility as well as economic deterioration. The credit crunch that began in the summer of 2007 entered its most serious phase during the fourth quarter as the economic recession and financial crisis deepened. The broadly syndicated leveraged loan market came under severe technical pressure as CLO and hedge fund unwinds triggered forced selling of loan portfolios. The fourth quarter set a record with over $5 billion in loans from liquidating portfolio sold at auction versus an average of $2 billion per quarter for the first nine months of the year.

On the demand side, funds flow were negative with CLO issuance down 85% for the year and with prime rate funds experiencing redemptions from retail investors. In addition, repayments available for new investments slowed to the lowest pace in six years. As the quarter progressed these technical pressures gave way to weakening fundamentals as default raise began to rise. Although, defaults remain most pronounced in cyclical industry sectors where ARCC has minimal or under weighted exposure, lagging 12 month industry defaults as measured by S&P increased from about 3.3% to 4.4% based upon the number of issuers defaulting. Default rates have continued to increase significantly in 2009 and overall S&P's index of broadly syndicated leveraged loans which had been under pressure in the third quarter declined roughly 23% during the fourth quarter and 29% for the year.

Within the loan market, and S&P's leverage loan index in particular, asset performance was bifurcated meaningfully based upon quality in certain portfolio attributes. For example, defensive industry sectors within the index such as healthcare and food and beverage which represent nearly a third of ARCC's portfolio collectively end of the year with average sector bid prices nearly 30 percentage points higher than more cyclical sectors such as auto, building development, publishing and home furnishings which represent less than 5% of ARCC's portfolio. Overall, approximately 78% of ARCC portfolio industry weighting were above the median price performance within the index. Importantly, the types of loans more represented in our portfolio, 2008 vintage, full covenant and middle market all out performed their respective index counterparts, pre2008 , covenant light and large corporate. As we described last quarter, ARCC's portfolio is not directly comparable to this index. In fact, it has positive characteristics not exhibited in the index such as significantly higher LIBOR spreads, stronger covenant protection and mostly lead agent or control positions of a particular tranch within credits.

As far as market conditions in the first quarter recent federal reserve and government actions to stimulate broken credit markets has slowly improved credit market activity. We have recently seen the credit markets dealing from the equity markets. Forced auctions of portfolios have slowed significantly and net investor inflows to the sector are positive year to date. This is evidenced by the improvement in the broad leveraged loan market indices since year end which are up about seven percentage points, the surge in investment grade issuance and lately the reopening of the high yield market. Government action has also improved the tone in current credit markets and credit spreads have declined for investment grade and high yield asset classes since year end. However, financials and BDC stocks have continued to underperform reflecting fears regarding liquidity and covenant compliance, credit weakness, and potential dilution. Recent equity market trends are a reminder that despite some easing in the credit markets we still face some pretty severe economic headwinds.

At ARCC we were clearly impacted by this economic and market environment, most notably by the lower market pricing for loans and the declining new issue market. Neverthless, we remain confident in our strategy and positioning. We believe our defensively positioned portfolio together with our efforts in managing the business in three key areas, balance sheet and liquidity, aggressive credit management and the pursuit of strategic initiatives to enhance shareholder value will all enable us to weather this turbulent market.

Let me now take a few moments to remind you and update you on these key focus areas. Regarding balance sheet priorities, our goal is to enhance our financing flexibility and maintain a prudent degree of leverage. During the fourth quarter and into the first quarter of the year, we made significant progress on this front. In December, we relaxed our net worth requirement on our CP funding facility to create an additional $200 million of cushion. At year end, this covenant was less restrictive than our two to one asset coverage test and more in line with the covenant of our larger revolving credit facility. Following quarter end, we increase our then, $510 million longer-term revolving credit facility to $525 million using the facilities accordion feature to bring in a new financial institution into our bank group with no change in terms. While we recognize the attractiveness of share repurchases in the current environment, we have chosen not to buy back stock as we are laser focused on managing our leverage limitations; therefore, we are concentrating on using our available capital to repurchase our CLO debt as a way to reduce leverage on an accretive basis for our shareholders. As disclosed in the release this morning we recently executed and are closing on multiple opportunistic debt repurchases of our on balance sheet CLO notes, totaling $27 million at a total cost of $6.6 million. These 2009 transactions reduced our debt by a net $20.4 million and also created a distributable realized gain of $20.4 million or $0.21 per share. Importantly, these transactions increased the cushion under our asset coverage ratio by $40.8 million bringing the total cushion on a pro forma basis to $276 million for an adjusted net debt to equity ratio of 0.75 times using our 12-31-08 balance sheet. This calculation nets out the $48.6 million in cash not restricted for our dividend paid on January 2nd. However our work is not done on the financing front as our annually renewable $350 million CP Funding facility which had a $114.3 million drawn at year end matures in July of this year. Our hope is that we will renew or modify and extend that facility ahead of its July renewal date and while there can be no assurances to the outcome, we are currently having very productive and preliminary discussions with our banking partner to do this.

From the credit side of things, our strategy is to be proactive with respect to potential restructurings, repricings, repayments and future funding needs within the portfolio. As such, in addition to our normal course portfolio management, we are in the process of reunderwriting all of the credits in our portfolio, a process which involves among other things, site visits, management interviews, customer and supplier diligence and reforecast of all of our portfolio companies financial and operating plans as well as associated covenant compliance. Many benefits come from this process but the most important one is the fact that we arm ourselves with the knowledge to be proactive, we are not simply reacting to situations as they occur. These actions may uncover potential future repricings or necessary balance sheet restructurings, which could result in new capital injections, the reduction of unfunded commitments or debt pay downs and since we are lead agent or have a blocking position in this significant majority of these situations we are often in a position to drive this process. From a repricing standpoint, we continue to make progress in Q4 by completing several and we are also getting an increase number of LIBOR floors in our credit as we reprice. We now have LIBOR floors in approximately 17% of our floating rate assets.

Lastly our strategic initiatives to enhance shareholder value, include continuing to focus on raising new managed funds, pursuing selective asset sales for diversification and deleveraging, rotating our portfolio and harvesting equity gains where possible. We hope to continue raising additional managed funds to compliment our over $650 million of assets, managed in Ivy Hill Funds I and II, and we continue to believe that investment opportunities are compelling for those with capital.

These managed funds are beneficial to our shareholders as they provide management fee income, additional capital to support ARCC portfolio companies, and allow us to maintain an energized and active organization. We continue to rotate our portfolio, we are pleased that 67% or $1.3 billion of our portfolio has now been either originated or repriced since the credit dislocation began in July of 2007. We did harvest a small realized gain during 4Q of $0.02 per share.

Turning to our results for the quarter then, please turn to the Summary Slide three in our presentation. As you will see, we reported fourth quarter core earnings per share of $0.33 versus $0.37 a year ago and $0.34 last quarter. Including net realized gains of $0.02 per share our core earnings per share and net realized gains totaled $0.35 per share, providing about 83% dividend coverage in the fourth quarter. However, due to the fact that certain management incentive fees were accrued but not paid and were therefore not tax deductible expenses our distributable income for 2008 was higher than our dividend in 2008. These incentive management fees were earned by investment advisor and accrued on our financial statements but will not be paid until there is a minimum 8% increase in book shareholders equity over a trailing fourth quarter period. deferral of these incentive fees, aligns the interest of our investment advisor with those of our shareholder, and provides additional liquidity until the benchmark shareholder return is met. Accordingly, we are carrying over estimated $0.16 of distributable income into 2009, despite the lower transaction activity during the quarter that we will discuss later, our core EPS was essentially flat with the third quarter when deducting the $0.01 of excise tax we paid on the carry over.

The decline in our net asset value per share from $12.83 to $11.27 resulted mostly from marketing our portfolio to market as of 12/31, and to a lesser extent from credit and performance weakness in a select number of our portfolio companies. During the fourth quarter, we also increased our use of independent third-party valuation firms who, during this period reviewed more than 60% of our portfolio. Factoring in the Company's independently reviewed at September 30, 2008 over 80% of our portfolio companies are either new additions or have been reviewed by third parties since September 30. We feel good about the overall health of the portfolio with five issuers on nonaccrual out of 91 total, up from four last quarter. Now representing approximately 1.6% of the portfolio at value and 4.4% at cost. Our weighted average portfolio credit rating of 2.9 was unchanged from last quarter.

Now a few words about our dividend. As you may know, BDC [regs] are required to pay out at least 90% of annual taxable income and dividends. But BDC may elect to pay out more than 100% in any quarter or even in a year and return capital to stockholders if it deems it is in the best interest of all stockholders and has the liquidity to do so , or expects the shortfall to be temporary. Now, at ARCC, as you know, we have a policy of not providing dividend guidance; however, as we did last quarter we want to continue to provide investors a framework to understand how we think about the dividend and how current market conditions could impact dividend levels.

As you can see in the release we paid our fourth quarter dividend of $0.42 and this morning we declared our first quarter dividend to $0.42 consistent to prior levels. As I stated for the tax year 2008, we fully covered our dividend from distributable income and generated an estimated carry over of $0.16 per share into 2009. Although, our core EPS and net realized gains totaled $1.49 for the year versus our $1.68 dividend our spill over taxable income from 2007 of $0.09 and the accrued but unpaid incentive fees I mentioned earlier total $0.26 provided the excess. Going forward these same variable will be at play. Our core EPS and net realized gains or losses will be measured against important balance sheet and market considerations. If you consider our current level of core EPS and our net realized gains announced thus far in 2009 we believe there is a path to full dividend coverage. However, there are a number of other factors that can affect our dividend levels going forward. The positive factors that may help us are the deployment of capital for accretive uses such as new investments, debt repurchases or potential share repurchases, thirdly, continued portfolio rotation and repricing, potential realized gains and a recovery in a loan market which could trigger unrealized depreciation. Potential negative factors could be further material mark-to-market losses, a weakened economy, which may caused increased realized credit losses, non accruing loans or further credit write downs and lastly, a significant increase in our borrowing spread or lack of available financing. We we continue to actively monitor all of these variable as part of our dividend policy and ongoing dividend discussions and we recognize the importance of dividends to our shareholders but as we noted in our 10-K filing, at some point in the future, we may determine in the best interest of our shareholders to reduce the dividend.

I will discuss recent portfolio activity and credit quality in a few minutes and then conclude our prepared remarks following Rick's comments covering our Q4 and full year 2008 financial results in detail. Rick.

Great, thanks, Mike. Please stay on Slide three in our presentation. As Mike outlined, our basic and diluted core EPS and net investment income were both $0.33 for the fourth quarter, $0.01 decrease versus last quarter and a $0.04 decline from the same period last year. However, for the year we earned $1.42 in core EPS versus $1.40 in 2007, a slight increase despite the over 30% increase in shares outstanding. Adding in net realized gains, we earned core EPS plus net realized gains of $0.35 for Q4 versus $0.41 in Q4 of 2007 and for the full year we earned $1.49 versus $1.50 in 2007. As Mike stated our core EPS would have been flat with last quarter's excluding the excise tax we paid on our estimated carry over of $16 million of distributable income into 2009. On a GAAP basis we incurred a loss of $1.56 per share for the full year 2008 versus $1.34 in earnings in 2007.

Despite significantly lower originations of $76 million in Q4 versus $183 million in Q3 and well below the $477 million in the fourth quarter of 2007 , our fee income held steady quarter-over-quarter partially on higher percent fees on new deals and the strength of higher management and minimum related fees. Accordingly, our recurring interest and dividend income was 90% of our revenues for the quarter. Our net commitments were essentially flat with $76 million in gross new commitments off set by an exit of $75.1 million in existing commitments. From a funding standpoint, our gross and net fundings were $111.2 million and $12.7 million respectively.

Despite market conditions, we continue to experience a relatively healthy level of exits and repayments total under $100 million of which only $11.5 million were asset sales to our Ivy Hill Funds. We experienced one repayment of about $35 million at 107% of par for an airport retailer resulting in a realized IRR of 34%. The remaining $52 million was related to portfolio amortization, prepayments or revolver pay downs from existing portfolio companies. Consistent with our objectives our gross new commitments provided an aggregate yields of over 15% versus our exit commitments with a yield of 11.5%. The total return profile on such commitments is higher when including fees and call protection.

Despite the over 250 basis point drop in LIBOR during the fourth quarter which impacted our floating rate portfolio, our fixed rate portfolio which makes up 57% of our assets, LIBOR floors and a higher yielding new investments allowed us to hold our yield relatively stable. Specifically, the weighted average yield on our debt and income producing securities for the fourth quarter was 11.73% at cost, compared to 11.83% at the end of Q3 and 11.64% during the fourth quarter of last year. On the other hand, our cost of debt declined 98 basis points from 4.01% to 3.03% sequentially and was down 263 basis points year-over-year reflecting lower LIBOR rates and our attractive low cost funding. Putting it together our investment spread involved were to 8.7%, 88 basis points sequentially and 278 basis points from a year ago. We closed the fourth quarter with a $2 billion investment portfolio add value covering 91 portfolio companies that have a weighted average of EBITDA of $45 million. Excluding cash and cash equivalents, our quarter end portfolio was comprised of approximately 54% in secured senior debt securities with 32% in first lien and 22% in second lien assets, 31% in senior subordinated debt securities and 15% in equity and other securities.

Now turning to Slide four, although we reported net realized gains of $0.02 for the quarter we reported net unrealized losses of $1.49 per share which contributed to our GAAP net loss of $1.14 per share. Our net asset value per share was $11.27 at the end of the quarter down from $12.83 a quarter ago. Reflecting primarily lower mark-to-market values in our portfolio and to a lesser extent some credit related write downs.

As shown on Slide six, we had $142.6 million of net investment losses which included $144.2 million of net unrealized depreciation partially off set by $1.7 million in net realized gains. Our net unrealized depreciation is net of approximately $15.2 million of unrealized appreciation primarily due to either strong company performance or M&A valuation indications of certain portfolio companies. Of the unrealized appreciation for the quarter, we think of these as occurring in three general categories, mark-to-market write downs, some combinations of mark-to-market write downs and some element of company under performance and primarily credit related write downs. When combining our credit related write downs net of our write ups due to stronger performance and expected gain activity this amounted to less than 15% of our total net write downs for the quarter.

Slide eight shows the summary of our debt facilities. As of December 31, we had $908 million in total debt outstanding with approximately $265.2 million of capacity available for additional borrowing under our existing credit facilities, they are subject to leverage and borrowing base restrictions. In February of this year, we also increased our borrowing capacity by $15 million by increasing the size of our revolving credit facility to $525 million. We also had $89.4 million in cash on hand but when you deduct our dividend payable of $40.8 million which was paid on January 2, our cash would have totaled $48.6 million at year end. Reducing debt by this $48.6 million in cash, our net debt to equity ratio at year end was about 0.79 times.

In addition, as Mike mentioned earlier and as noted in our earnings release, since beginning of 2009 we have also reduced our debt by a net amount of $20.4 million and recognized a $20.4 million realized gain by purchasing our CLO notes at a 76% discount. Inclusive of these repurchases our debt, net of cash on hand has declined to $840 million, using our 12/31/08 stockholders equity, this would place our adjusted debt to equity ratio at 0.75 times and our asset coverage ratio at 233% or $1 cushion of $276 million. What is not shown in this slide is our investment capacity in our managed funds. The Ivy Hill Middle Market Credit Funds I and II. At year end, these funds had approximately $34 million and $214 million of investment capacity respectively.

Our next debt maturity is July 21 of 2009 when our CP facility is scheduled to mature. As Mike mentioned, we are actively engaged in discussions with Wachovia, Wells Fargo, the service of this facility to renew or modify and extend the facility ahead of its July renewal date. We have no other scheduled maturities until the end of 2010. At year end, we were in compliance with the covenants in each of our three debt facilities. WE continue to believe our most restrictive financial covenant is either our two to one asset coverage test or our net worth test in our revolving credit facility, calculated at $873.8 million or a pro forma cushion of about $242 million.

One other item I want to mention on the topic of our liabilities, while we fair value our assets each quarter under FAS 157, we elected not to fair value our liabilities under the FAS 159 election during the short window of time we had the option. Given the long-term, lower cost liabilities, we enjoy our reported net asset value would be significantly higher had we made this election. By marking our liabilities to market prices as of the end of the fourth quarter as disclosed in our 10-K, we estimate that the unrealized gains and the fair value of our debt would exceed $186 million indicating that over $1.91 per share of value is not reflected in our net asset value as of year end. This value reflects the attractive, below current market interest rates on our long-term funding and in place has been substantiated by our recent debt repurchases.

Turning to Slide nine, we paid our regular fourth quarter dividend of $0.42 per share on January 2, and we have also declared our regular first quarter dividend to $0.42 per share payable on March 31, 2009 to stockholders of record as of March 16. I will now turn the call back over to Mike.

Thanks, Rick. Now a few words about our recent investment activity and touch on our portfolio performance before concluding. As Rick mentioned earlier in the fourth quarter, we closed $76 million in new commitments across five companies with four commitments to existing portfolio companies and only one new commitment. Our one new commitment involved a $44.5 million commitment to one of the largest canned seafood manufacturers in North America. As part of the transaction, we were paid an arrangement fee for leading and structuring a $135 million senior subordinated facility. Our other activities during the quarter, were all opportunistic debt purchases of existing portfolio companies at attractive prices.

Slide 10 outlines our new investment activity. Of our new commitments, 40% were in first lien senior secured debt, 53% in senior subordinated debt, and 7% in equity securities. The vast majority of the new commitments were fixed rate with only 24% of such commitments in floating rate assets and from a repayment standpoint, 32% were in first lien, 55% in second lien with 13% in senior subordinated debt.

Now turning to Slide 11 for updated portfolio quality statistics, as the data here reflects we are investing in larger companies at higher net investment spreads. We have accomplished this by bringing our average total portfolio leverage down, now at 4.2 times versus 4.6 times a year ago and holding our interest coverage flat to trending higher, now at 2.6 times versus 2.2 times a year ago and 2.8 times last quarter.

I would like to point out a couple of important points. Number one, the portfolio average EBITDA has increased significantly from $26.2 million in the fourth quarter of 2007 to $45.2 million in the fourth quarter of 2008 as larger company investments increase the average. During the fourth quarter, the average EBITDA for new investments totaled $66.7 million. What is not shown, is the positive outcome of our majority senior debt portfolio strategy, we are lending on a weighted average basis beginning at 1.9 times cash flow through the 4.2 times EBITDA. Accordingly, we believe our recoveries on defaulted loans should be superior to a typical subordinated debt investor that may have invested between four times and six times or in certain cases higher in the capital structure.

This quarter to give investors more transparency into portfolio quality, I'll provide some summary performance information. Using the average for our portfolio, underlying company level year-over-year revenue in EBITDA increased 5% and declined just over 1% respectively. Importantly, on a weighted average basis giving credit to our most significant investments year-over-year revenue and EBITDA both increased over 10% respectively. So, while some of our portfolio companies are no doubt experiencing some weakness, given the overall market conditions, in the aggregate performance in the portfolio has held up quite well particularly, in our largest positions.

Turning to Slide 12, consistent with our views on the credit and economic environment, we have continued to focus our investments in more defensive, noncyclical, and service oriented businesses. For example, at the end of the fourth quarter our three largest industry concentrations now at 43% of the total and each representing 10% or more of our portfolio were healthcare at 20%, food and beverage at 12%, and education at 11%. Our overall portfolio sector weighting compare very favorably to the sectors within the broad leveraged loan market indices, in terms of price performance and default experience. Accordingly, we continue to believe that our portfolio will continue to be less volatile, compared to the broadly syndicated loan market given our negligible exposure to real estate, autos, gaming and lodging, transportation and media and our under weighted exposure to publishing in favor of over weights in healthcare, education and food and beverage.

Slide 13 provides another view of our portfolio quality, as a reminder, we employ an investment rating system which Grades one through four, with one being the lowest Grade for investments that are not anticipated to be repaid in full and with four being the highest Grade for investments that involve the least amount of risk in our portfolio. At the end of the fourth quarter, the weighted average grade of our portfolio investments remained at 2.9 unchanged from the last two quarters. We did have some movement with a few new two and one credits and since we had a realization and gain on a four rated credit and we left a small equity investment in place we downgraded that investment from a four to three. Overall, we have 2.4% of our portfolio at value and our lowest rating category of one, where we do not expect a full recovery against 5.7% at value in our highest rating category four.

Regarding our equity portfolio which represents about $250 million at fair value, 99% of the portfolio is rated three or four with approximately 1% rated at two, 86% rated three, and 13% rated four. The equity portfolio carries an overall rating of 3.1. Continuing on with the quality discussion, other than our five portfolio companies on non accrual, one of which was new this quarter, representing about 1% of cost we have no companies in payment default.

Lastly, turning to Slide 15, I will discuss new investments to date. Since the end of the fourth quarter, we closed $9.6 million of new investments yielding 16.5% at cost and we exited $21.7 million yielding 13.5% including the $19.5 million in asset sales to Ivy Hill I and II, for a net reduction of $12.1 million. At this point in time, we have no significant backlog or pipeline to speak of and this is a reflection of our stated balance sheet strategy and liquidity management, as well as a reflection of the general market slow down.

So in conclusion, we recognize that we are in a prolonged recession and and the difficult part of the credit cycle with industry defaults heading higher, we clearly face many challenges ahead with respect to the difficult economic and market conditions and tight liquidity. Although we have seen improving credit markets thus far in 2009 liquidity still remains tight particularly for financial issuers; however, we continue to believe that we are well positioned at ARCC given the current market. Our cautious optimism is based upon a number of things. Our defensively positioned portfolio both from an industry, leverage and asset class standpoint, our affiliation with Ares Management which provides invaluable expertise, capital relationships and industry knowledge. Our lead agent or control position which gives us the ability to control repricings and restructuring. Our capital position with a pro forma net debt to equity ratio of 0.75 times and we believe we have the flexibility to sell assets for further liquidity needs if necessary. Fifth, our capability to recycled capital into higher yielding assets over time and lastly the potential growth opportunity in our managed fund business given the compelling market opportunity for those with capital and strong investor relationships. To reiterate our strategy, we plan to work to maintain a prudent level of leverage and financial cushion against our asset coverage test and financial covance. We will aggressively manage our credit profile, and we will opportunistically explore ways to improve shareholder values in keeping with such priorities. Rest assured we will continue to evaluate all our options and seek to make appropriate adjustments to our strategy that are in the best interest of our shareholders. We would like to thank all of our shareholders for loyalty and confidence in us through these very difficult times and we would more importantly or as importantly like to thank our entire team of professionals here at Ares for all of their hard work and dedication in these challenging markets. With that, that covers our prepared remarks and we would love to open up the lines for questions.

(Operator Instructions.) Our first question comes from Greg Mason of Stifel Nicolaus.

I know you mentioned your gains will help cover the dividend shortfall for the next quarter or two. Can you give us a little more color on your plans of getting core EPS and the dividend more aligned? Assuming that the market stays where it is today, what is your timing and execution of the plan to get those realigned?

It is an ongoing day-to-day analysis of us as we mentioned last quarter we strategically raised capital in April of 2008. We feel we are very far along in that plan. As we mentioned in the call, it is really a constant monitoring of our income statement and our ability to drive core earnings through increased investment, repricings and restructurings, capital gains, et cetera measured against our liquidity picture. So right now we can't really predict where it is going to go and where it is going to come from. What we can say, and we tried to lay out in the call is we have a lot of levers to pull both from a balance sheet and income perspective that we are working to pull and we will keep an eye on the market and see how things develop.

You have the ability to buy back CLO debt. What was the opportunity to buy back more? Was that a one-time distressed seller or are there lots of opportunities? Was there a hint in your commentary that you alluded to potential buy back of stock in the future?

Taking the first part of your question, we think it is a very significant opportunity for us to continue to explore debt repurchases. The total size of our CLO facility was about $314 million at face. In that market I think as everybody on the call knows, almost everybody is a distressed seller given a lot of the pressures that the leveraged and structured products buyer are under, the prices at which you can accumulate that kind of paper are very low and in our personal opinion not a real good indicator of fundamental value. It is something we will continue to pursue and pursue aggressively. The reason we are doing it as we mentioned in the call and in the earnings release, it has the benefit of providing realized capital gains that are distributable as part of our dividend strategy, number 2 and most importantly it reduces our leverage and increases our leverage cushion by the amount of the profit. And obviously as a result, the book value goes up. The reason I mentioned share repurchases was a juxtaposition to the debt repurchase. As attractive as share repurchases are from strict IRR standpoint, buying back stock with capital in this environment puts a lot of pressure on liquidity and on the asset coverage test. We believe given our balance sheet that focusing on buying back our debt right now is a much better use of capital.

I was surprised to hear you mention what the impact of a mark-to-market of FAS 159 would be. Are you hearing something out of Washington that that window may re-open and are there any other regulations potentially coming out of Washington that have you excited?

We have been mentioning the FAS 159 adjustment in all of our filings since the FAS 159 window opened and closed at the beginning of the year. You can look every quarter as to what that number is. The disclosure is not new. I think the disclosure has a little bit more weight behind it in light of our debt buy back strategies as a good indicator of what that value really is. There is a lot of discussion in Washington around BBCs and financed companies and banks in general and there are a lot of things that get us excited but people have their hands full down there. We are not managing our company, relying on any relief from Washington but are hopeful as the government continues to look for ways to get capital flowing in our economy again, that we may not be over looked.

Sir, do you have a follow-up question?

No, thank you.

Our next question comes from Vernon Plack of BB&T Capital Markets.

Michael, you mentioned on adjusted basis debt to equity is 0.75. Where would you like to see that number today?

I would like to see it as low as possible. Historically we have operated at about 0.6 times leverage. Running with the low leverage that we did put us in a position to absorb some of the mark-to-market accounting issues that the industry is facing. Obviously it is a balancing act. You have to make sure that you are maintaining a prudent amount of leverage so you are not jeopardizing the balance sheet. You want to make sure you are staying invested so you can maintain your EPS and dividend.

That's why I was asking --

We feel good where we are right now. We will continue to reduce it through debt repurchases and general portfolio run off. Given the fact that we are the lead investor in most of the deals that we are involved with, we have very good visibility to the liquidity portion of our portfolio. If there is ever a point of time where we feel the liquidity is tightening, as we look forward, there are other things we are -- 0.75 times feels more than comfortable. Lastly, fourth quarter ' 08 was a severe dislocation in the credit markets and we saw that across the financial sector in terms of mark-to-market valuations while Q1 economic indicators are at that the economy is continuing to weaken. The credit markets are actually strengthening a little bit and have de-linked from the credit markets. With a month left in the quarter my sense is that Q1 will probably not be as severe as Q4 given some of the trends we are seeing in the broader capital markets for debt.

I want to make sure I understand the discussion on the deferral of payment of incentive fees. Could you go over that one more time, please?

Yes, the way that our -- the incentive fees are calculated, as you recall the first part you go through -- from a performance standpoint they were earned.

Right.

There is also a second piece on payment of those -- on payment of those incentive fees.

Right.

That is essentially -- you have to have a minimum of an 8% increase of booked shareholders equity of over a four quarter trailing period and from a -- so those incentive fees were accrued -- the incentive fees from the first quarter were paid. For quarters 2 through 4 they were deferred. The total amount came to about 25.3 million and from a tax standpoint we were not able to deduct those. That increased our distributable income for 2008 and when those reverses those are actually paid in the future, they will be deducted for tax purposes.

Last question, Mike, bigger picture in terms of balance sheet management and one of the things that has gotten some of the BBCs in trouble is -- this is an over simplification -- you are lending long and borrowing short and while it is nice to buy some of your longer-term debt at a material discount, which has plenty of benefits, what about the thought in terms of how you manage your balance sheet and are there -- are you thinking of alternatives in terms of just the short-term facilities that you have in terms of funding your portfolio?

Sure. I would agree, I think that is a little bit of an over simplification. A lot of issues some of our piers have gotten into I think have to do with portfolio construction and underlying credit quality than they do, frankly with asset and liability matching. If you look at the weighted average life of our underlying portfolio I would venture to say it is a four-year duration versus a six year stated maturity. When you think about our weighted average life of our liabilities and we have this in our investor presentation we are quite nicely matched. Number one priority right now is obviously to deal with our July maturity. We are in active discussions to do that. We have very good relationships with our banking partners and our lenders. While we can't promise anything, we are hopeful that we will get that renewed ahead of the July maturity date. The challenge that we face is we are an investment grade rated company.

Ares Management manages in excess of $30 billion of assets in total around the globe and we have very deep lender relationships. The reality is that the capital flows to investment grade financial right now is challenged to say the least. Rest assured we are spending a lot of time on planes talking to our banking partners, talking to other financing partners and alternatives. As we sit here today, the markets are challenged and constrained. We hope when the markets open -- we hope they will open given all the government intervention that is going on and some of the signs of life were seeing in the credit markets that when they open they will flow to companies like ourselves. Our goal is to make sure we are staying in front of people and managing their process as much as we can. Unfortunately we cannot force people to lend to us.

Thanks.

Our next question comes from Jasper Birch of Fox-Pitt Kelton Cochran Caronia Waller.

First of all, it is nice to see some solid earnings this time of year. Following up on your CP Funding facility, how much capital do you have on hand if you do have to pay it down today?

Well, at the end of the year we had about $85 million of cash on hand and roughly half of this was set aside for the payment of our dividend on January 2. The facility out standing at the end of the year were about 114 million.

And then in terms of your asset management, are both the IVY Hill funds fully invested right now?

They are not. We mentioned in our call we have capacity in those funds about $250 million in the aggregate.

In terms of expanding your asset management business sort of I'm assuming a little more longer-term, would you be looking at raise a new fund yourself or are you looking at the market right now at maybe picking off CLOs from managers that aren't performing so well.

Both. It is not just CLOs. Given the capabilities and the breadth of our platform we feel very good there will be an opportunity to consolidate the industry and some sub scale asset managers. That is less of a capital out lay and fund formation as it is just entering into management contracts and merger discussions. With regard to the fund formation, again, Ares Management is a very large well established manager of credit globally and what we have tried to do and hopeful it is appreciated bring our private investor relationships to the table for the benefit of the public shareholders given all the constraints in the equity and debt markets today. Hopefully, it will be a combination of both where we are raising new funds and looking for ways to use our platform to manage other assets.

One last thing, in terms of your investment activity, I think it was Slide 15, you gave some great color. Is that sort of an appropriate run rate for what we can expect for the last month of this quarter?

Again, we are being very stingy with our capital. It is one of the great frustrations that we have. We still have capacity in our Ivy Hill Funds, We are actively investing those but right now we are focused on preserving liquidity and preserving balance sheet. I would expect our new investment activity, at least on balance sheet to be fairly low for the foreseeable future until the market stabilizes and we have a better view towards asset market reversing.

In terms of your 22 million of assets, what sorts of bids were you seeing? Were they pretty much in line where you had things valued at the end of the year?

Yes, they were. Remember, 95 plus percent of what we do, we exit through the M&A market which is one of the frustrations of trying to shoe horn our assets into a FAS 157 framework. In a context where most of our exits are coming from the M&A market, there is a sale of the company and we get repaid. Our one gain this quarter came from a second lien investment we made where the company got acquired by a strategic acquirer and we got taken out. We got taken out significantly above our mark for two reasons. Number 1, we had marked the asset on a FAS 157 basis, but as importantly there was call protection in that investment and one of the challenges of marking credit assets to market is you don't get to write them up to account for call protection. As we talked about on previous calls we have a number of assets where we have embedded gains where the company gets called out with call protection. That is not reflected in the balance sheet.

That's all I have.

Our next question comes from Sanjay Sakhrani with KBW.

Most of my questions have been answered but I have a couple. On the dividend understanding the goal is not to cut but if at some point you think reducing the dividend is the best course of action, how should we think the level of the dividend should we think you should cut to what current income is or some where below that to incorporate kind of the weaker economic trajectory.

I don't have a good answer for you. This is something that will develop over time. Our hope is that we maintain it and do everything we can to maintain it. We feel we have done as well a job as we can protecting the balance sheet and the enterprise value of the Company so long as we don't believe that maintain the dividend jeopardize the enterprise or not in the interest of our shareholders we will do everything we can to keep it. We don't have the data to evaluate where the markets are going and how our company is going to look relative to those markets.

Understood. This came up in a competitor call earlier, along the lines of FAS 159 is there any way to restructure the debt as you can qualify for FAS 159 even though you didn't elect it last year? Are the covenants based off of GAAP in the revolver?

The second part of the question was --

The covenants in the revolver on the debt side, are they based off of GAAP or some other measurement?

They are based off of GAAP to the extent that there was some change in GAAP or ruling as to what our assets of GAAP were it would have a beneficial impact on our financial statements and our covenant requirements. With regard to 159, it has to be a material restructuring of a loan agreement or a new loan facility. For example, if we opened up a new line somewhere, we could theoretically adopt 159 for that line but the value of 159 would negligible because you would be borrowing at current market rates. The real benefit of a 159 election would have been to capture the value in some of our longer dated, lower yielding debt we originated 3, 4 or 5 years ago. Any new facilities would get repriced to the existing market and wouldn't have a beneficial impact.

Thank you.

Our next question comes from Faye Elliot of Bank of America.

Thank you. Is that 250 million from the Ivy Hill Funds fully available to you. Are there any restrictions on what they could buy from you or if they are available even to buy your debt or your equity?

As per the Regulations being that they are in our corporate chain, there are no restrictions in CO-investment. As fiduciary of those funds manage those funds with appropriate concentration and diversification limits. No, there is nothing legally or from a tax standpoint that would prohibit co-investment between Ares Capital and those funds.

Would they be able to buy Ares debt? In theory they would.

Our next question comes from Greg Mason of Stifel Nicolaus.

As we look at your portfolio and cash turn over how much of your portfolio matures in 2009 and what type of payment back facility can you see in terms of exits in portfolio?

We are digging through the maturity number. I will approach the second part of that question as we dig up the number. M&A activity has slowed dramatically as everyone knows and would expect. However, we have been plenty surprised both in the third quarter of last year and the fourth quarter of last year at the amount of payments excluding the amount of our own managed funds. In Q3 we had about $175 million of net repayments and in Q4 it was about 100 million on a percentage of portfolio basis it is pretty high given the market conditions. We attribute that to the strength of the underlying portfolio companies and some of the industries that tend to be healthier and have a strategic amount of M&A activity. While we recognize activity will be slow we are cautiously optimistic that we continue to see repayments through strategic M&A activity through the portfolio. Obviously the question back to the dividend and investment strategy here is when we get that capital back we have to make sure we go through the analysis and evaluate what the best use of those funds would be.

While you are checking on the maturity for 2009, can you comment on your thoughts of paying the dividend and stock or maybe the shortfall between core EPS and the dividend in stock?

We don't think we have any material maturities in 2009 and off line we can get that information to you to the extent the answers different. The stock dividend question is something we have considered and looked at and evaluated given the market environment, this is the kind of world where you have to consider all things and evaluate the positives and negatives. It is a very good thing for the industry because a lot of the liquidity issue that the industry is facing are mark-to-market accounting issues that is outside the control of certain companies and having the opportunity to create incremental liquidity on a balance sheet in this kind of market environment is obviously pretty significant. I think you put out a very good piece of pluses and minus of issuing the stock at current levels. I direct people to that. It is one of many tools we have in our tool kit to manage through these difficult markets and we will continue to play by through ear.

Hypothetically assuming the stock was at this level if you were faced to cutting it or paying the dividend in stock, what would your thoughts be?

I would view that as dividend guidance and I would be reluctant to answer that on this call.

You talked about your investments in existing portfolio companies, you were able to buy at pretty steep discounts, can you talk to us what the average discounts were for those investments.

We can't specifically but again you can probably infer the types of levels we are talking about based on where the industries are trading and the types of levels that get publicized when people are selling assets in distress. One last question -- we were looking through the K. It looks like you have 280 million of unfunded commitments and 100 million, you have the discretion over, can you talk about the remaining 180 million, what type of timing that you guys are thinking about on those unfunded commitments?. This question came up last quarter as well. I will reiterate the framework for understanding those. You have to think of those in two big buckets. One are traditional revolving facilities or capital facilities where the borrower has the ability to borrow at a day's notice subject to borrowing base compliance. and the other bucket is what we would call delayed draw or multi year acquisitions lines or CapEx facilities. If you look at the $182 million, roughly $93.5 million is traditional working capital facilities. Of that 93.5 based on the most recent borrowing basis about $86 million was available to be borrowed. While we can't five you the exact sense of where the cash position is company-by-company day-to-day as we mentioned last quarter of those companies in the aggregate there is about $87 million of cash on hand as of the date of their most recent financial statements. All of the revolvers are out to some of our strongest portfolio companies. During the fourth quarter which arguably the most difficult quarter we faced we saw $8.4 million of net borrowings in the aggregate under those facilities and the number was at or slightly below that in Q3.

The second bucket is more strategic types of capital lines and those tend to be used in tandem with things like making acquisitions or paying earn outs. Given the economic environment that we are in, we are in as you can imagine a lot of the triggers to free up that capital will probably not be met. As for the contract there is an ability on the part of our borrowers to borrow that as we look at the company performance and see where these companies are heading. We don't perceive a material risk in those funding either. As part of our under writing discussions and ongoing process any chance we get to reduce unfunded exposure to our portfolio companies without jeopardize the health or liquidity position of those companies, we take it and you can see that over time we have been bringing that number down naturally over the last three quarters.

As we look at your balance sheet and we see the management and incentive fees payable now at 33 million. That the build up of the incentive fees that you haven't had to pay each quarter?

Yes.

So at some point when the markets come back and you exceed your hurdle rate, when that becomes payable, I assume that entire amount is due in cash immediately?

Correct.

Can you remind us what the hurdle is?

It is an 8% increase in shareholders equity through distributions over a trailing four quarter period.

Thank you.

We have a question from Adam Waldough. He is a private investor.

I wonder if you can spend a little more on the liquidity issue around the CP facility that matures in 2009. You have talked about the extensive conversations you are having with Wells Fargo, Wachovia, and presumable with other banks about renewing and/or extending that facility. I was wondering if you anticipate near-term conversations with non bank potential lenders, the Feds Commercial Paper Facilities, Family Offices, Insurance Companies and like, if you can spend a minute on that.

As I mentioned, we are talking to anybody that will talk to us. There is a lot of things that a management people needs to do in this time of environment. We are spending a lot of time managing our existing lender relationships and try to cultivate new ones. Liquidity is severely constrained in all of the public and private markets and credit is not flowing normally or the way that it should. That said, we think through a lot of the government programs that are put in place that credit will start to flow. We hope that given our performance in the breadth of our platform that we will see some of that capital. I would just characterize the nature of the conversations we are having with most parties as, people are very supportive of what we are doing. They are supportive of the business model and complimentary of the strategy but are dealing with our own liquidity issues and reluctant to part with capital right now.

Have you formally submitted or do you plan to submit an application to participate in the Feds Commercial Paper Lending facility?

We have not and as of today, we do not.

Thank you very much.

Our next question is from Dennis Foss, Private Investor.

My name is Dr. Dennis Foss . I am a credit investor and I would like to echo your last comments. My sense is that things are thawing a little bit and mass psychology is a funny thing but a great fear that has been gripping people could turn around quite easily and actually become quite positive over the coming months. I think you are wise to keep your options open. I would like to congratulate you gentlemen on the prudence of which you have approached your portfolio, the way you have harbored your resources, the kind of defensive portfolio you have built. It is an impressive portfolio I think fitting the times. I would like to comment a little bit on the dividends. I'm a dividend investor. It is an important part of my investing style. I think the fact that you have maintained your dividend is sending a very clear, positive, psychological sense of your own belief in your practices and your own belief in your investments and your own belief in your future.

The gentlemen who had mentioned the study they had done in giving stock in lieu of cash dividends, what I have seen happen is it is absolutely disastrous to the stock. A, you are diluted and B, people are looking for income and sell that stock when they receive it and you are giving out stock at a very low price. I would rather see, if you had to make a cut, rather see the dividends cut to preserve the cash and forget giving out additional stock. I'm really pleased to hear that your goal is to try to maintain the dividend. Again, you can't send a stronger psychological message to the markets than maintaining your dividend and I'm sure that your stock prices will reflect that once we reach calmer days. Again, my primary thrust is to compliment you on your prudence and your good judgment.

We appreciate the kind words.

Nick Capuano of Imperial Capital.

Good morning. Just a quick question on the size and quality of the backlog of potential of investment opportunities you are seeing in terms of the quality and terms how is it trended, how does it look today? One quick follow-up after that.

Sure. I will give you a slightly longer answer than maybe you want. As we have talked about before, we think about our origination channels in four key buckets. One is the general new issue market.... i.e. new buyouts, and new opportunities in performing companies to put capital to work and changes controller growth financing, as we have said a couple times this morning, that market a very slow right now and there is a pretty wide disparity between seller expectations and buyer expectations and given the general liquidity and valuation picture the highest liquidity companies are not coming to market right now.

Secondly, is opportunities in our existing portfolio, as we mentioned of the 5 investments we made last quarter, 4 of them were in our existing portfolio and one was a new company. Companies where we have a relationship with management, where we have visibility and to the operations and underlying financial performance of the business and situations where we can bring new capital to improve our existing situation by changing our investment structure or by repricing our existing investments. We will continue to look for ways to accretive invest in our existing portfolio.

Third, general secondary market purchases, obviously there is a press and discussion about opportunities to buy bank debt and high yield and other debt securities at deep discounts from distressed sellers. That opportunity is very significant but a little harder to execute on than the newspapers would lead people to believe. We did see a lot of forced selling towards the end of last year. We have not seen a lot in the new year. While it is an attractive economic opportunity we are not sure how it fits in our core strategy much we are tending to use the Ivy Hill Funds when it comes to buying smaller positions in broadly syndicated loans at a discount. That opportunities is attractive and you get a sense for what those IRRs are when you look at the indices are trading.

The fourth is what we would call generally distressed investing or rescue capital or refinancing opportunities where as a new issue, we have the ability to bring capital to bear to shore up a balance sheet of an over leveraged company or provide capital to an under capitalized business. Given the fact that a lot of the technical pressure we have saw in the last year has given way to fundamental weakness, our expectation is that in '09 and '10 that we will see a fair amount of that type of activity. For those that know us well know it is a core competency of ours.

That covers it, thank you.

(Operator Instructions) We have no further questions in the queue.

Thank you, operator and thank you all for taking so much time with us this morning. Again, we want to thank you for your continued support and loyalty and we again, want to thank the team for all of their hard work and dedication over the last couple quarters and we will keep at it and will talk to you all next quarter. Thank you.

Ladies and gentlemen that does conclude our conference call for today. If you missed any part of today's call a recording of this conference will be available until March 23, 2009. To access the replay you can call 1-877-344-7529. To call internationally you can call 412-317-0088. For all replays the ID number is 428049. Thank you for your participation you may now disconnect.