Ares Capital Corp (ARCC) 2009 Q4 法說會逐字稿

Good morning. 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 Thursday, February 25, 2010.

Comments made during the course of this conference call and webcast and the accompanying documents contain forward-looking statements and are subject to risks and uncertainties. Many of these forward-looking statements can be identified by the use of words such as anticipates, believes, expects, intends, will, should, may, and similar expressions. The Company's actual results could differ materially from those expressed in the forward-looking statements for any reason including those listed in the SEC filings. Ares Capital Corporation assumes no obligation to update any such forward-looking statements. Please also note that past performance or market information is not a guarantee of future results.

During this conference call, the Company may discuss core earnings per share or core EPS, which is non-GAAP financial measure as defined by the SEC Regulation G. Core EPS is the net per share increase or decrease in stockholders' equity resulting from operations, less realized and unrealized gains and losses, any incentive management fees attributable to such realized gains and losses, and any income taxes related to such realized gains.

A reconciliation of core EPS to the net per share increase/decrease in stockholders' equity resulting from operations to 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 uses to measure its financial condition and results of operations.

At this time, we would like to invite participants to access the accompanying slide presentation by going to the Company's website at www.AresCapitalCorp.com, and clicking on the February 25, 2010 presentation link on the homepage of the Investor Resources section of the website. Ares Capital Corporation earnings release and annual report are also available on the Company's website.

I would now turn the call over to Mr. Michael Arougheti, Ares Capital Corporation's President.

Great, thank you, operator. Good morning, everyone, and thanks for joining us. Here with me this morning are Rick Davis, our Chief Financial Officer, Carl Drake and Scott Lem from our Finance and Accounting team, Josh Bloomstein, our general counsel, Eric Beckman, Kipp deVeer, Mitch Goldstein and Michael Smith, all senior members of our Investment Advisors Management team.

I hope you've had a chance to review our earnings press release this morning and our investor presentation posted on our website. I'd like to start this morning by highlighting recent conditions in the broader market and any impact on us and then discuss our credit performance, balance sheet and earnings, all of which we believe position us as well as any company in our marketplace today. Rick will then walk through our fourth quarter results before I conclude our call with a discussion of our recent investments and our portfolio. We will then be happy to take Q&A.

However, while we understand there is a lot of interest in discussing Ares Capital's proposed merger with Allied Capital Corporation, we will not discuss the proposed merger and the ongoing proxy solicitations by ARCC and Allied Capital on this call. Instead, Ares Capital and Allied Capital have scheduled a joint conference call to discuss the proposed merger on March 3rd, 2010. You can obtain details about the call on Ares Capital's website at www.AresCapiralCorp.com. We also refer you to the information filed with the Securities and Exchange Commission regarding the proposed merger and the Ares Capital special meeting.

During the fourth quarter, the liquid credit markets continued to improve driven by a combination of positive technical and fundamental factors. Significantly stronger loan repayments outpaced new originations leading to a further reduction in outstanding institutional loans and continued investment appetite from existing market participations.

The higher repayments were driven in part by a robust high yield market which set records for price performance and volume in 2009. Fourth quarter new leveraged loan originations rebounded, reaching levels not seen since the third quarter of 2008 and additional liquidity also tightened credit spreads.

From a fundamental perspective, industry defaults began to decline during the fourth quarter and the industry outlook for 2010 improved significantly. Although the lagging 12 month S&P leveraged loan index principal default rate peaked in November at 10.8%, the rate declined to 9.6% by the end of the year and market participants and rating agencies currently expect the rate to potentially be cut in half by the end of 2010.

Year over year EBITDA growth for companies in the index has resumed principally through expense reductions. Positive performance is driving investor confidence and the net effect has been a modest increase in the asset values in the broadly syndicated loan market.

I remind everyone that while often taking cues from the broader market, our core middle market rarely sees the same volatility. Although the middle market has lately experienced some very modest tightening in spreads and higher leverage, spreads in the middle market remain near historical highs and in fact, the spread gap between middle market loans and the broadly syndicated loan market reached an all time high during the fourth quarter for S&P data.

In our core market, we still see first lien floating rate debt opportunities with unlevered total expected return profiles in the 10% to 13% range and mezzanine debt opportunities in the mid to high teens. Total leverage levels remain attractive by historical standards. We are still finding high quality company investment opportunities at less than 4.25 times debt to EBITDA for mezzanine and approximately 3.5 to 3.75 times debt to EBITDA for unit tronch investments.

We also witnessed a jump in primary middle market sponsor related activity which began after Labor Day and has continued into the first quarter of 2010. Although market activity has increased from a depressed base, volume still remains significantly below historical averages. However, we do expect that new issue and refinancing opportunities will increase as a significant amount of uninvested private equity is deployed and as the wall of maturing debt in 2011 through 2014 is refinanced.

Fortunately for capital providers like us, competition remains significantly reduced, particularly in our core middle market where many traditional players have exited and where access to the high yield market is often not available to most borrowers.

We took advantage of the increased market activity by making over $350 million in gross new investments during the fourth quarter of 2009, the highest quarterly investment activity we've experienced since 2007. Our fourth quarter new origination activity reflects our efforts to stay active in all of our origination channels despite the market slowdown over the past year. During the quarter we also experienced significant liquidity in our portfolio. We exited over $243 million of investments primarily due to improving liquidity in the market which provided us with new capital to reinvest, and additional flexibility to optimize our portfolio.

Importantly, during this period we were able to reinvest our capital at yields significantly in excess of the investments that were repaid during the quarter. Our new investments made during the quarter yielded approximately 15.7% on a weighted average basis compared to our repayments which had yields of approximately 10.1%. The incremental return on our portfolio rotation illustrates the strategic value of having capital available in this market.

Now let me highlight a few of our other recent noteworthy accomplishments. The first is our credit performance. While many of our peers and other banks and finance companies continue (inaudible) high level of nonperforming assets, we have generally seen improving credit and investment performance for the last two quarters. In the aggregate, our portfolio performance statistics have continued to improve. On a weighted average basis, our underlying portfolio company revenues and EBITDA increased more than 4% and 20% respectively over the prior year. In addition, the majority of our portfolio companies exceeded budgeted EBITDA on a weighted average basis.

This quarter was the second consecutive quarter that our non accruing loan ratio has declined. Non accruing loans reached a peak of 6.2% of cost and 2.1% of fair value during the second quarter of 2009 and have now declined to only 2.5% at cost and 0.5% at fair value. We have kept relatively low levels of delinquent and non accruing loans while at the same time we have reported substantially lower net realized losses versus the pure average. While we did realize modest losses this quarter from the exit of two loans on nonaccrual, we realized values in the aggregate on our exits that exceeded our fair value marks on such assets. With only 2.5% at cost of our portfolio in nonaccrual and with net realized losses totaling approximately 2.1% of our average portfolio during 2009 and only 1.2% cumulatively since the current credit cycle began in mid 2007, our credit statistics compare very favorably to our BDC peers.

Secondly we addressed one of our most strategic priorities in January when we expanded our debt capacity and extended the maturities of our revolving and CP funding credit facilities to January, 2013. We increased our revolving credit facility from $525 million to $615 million on a standalone basis with a further increase to $690 million that is available upon the closing of our Allied Capital acquisition.

In addition, we combined our $425 million revolving and term CP funding facilities provided by Wachovia Wells Fargo into a single $400 million revolving credit facility with no amortization requirement and better asset flexibility. We now have total debt capacity of $1.3 billion with a blended pro forma cost of 2.4% using our debt balances as of 12/31/09. None of our credit facilities possess a LIBOR floor. And we can increase the capacity on our larger revolving credit facility through an accordion feature which could provide an additional $282 million on a standalone basis.

At a time when many of our peers have been forced to reduce debt or shrink their balance sheets, these facilities provide us with the flexibility and a low relative cost of capital to grow our business in a profitable manner and to demonstrate the breadth and strength of our banking relationships.

We further strengthened our balance sheet during the first quarter of 2010 through an equity offering that raised about $278 million in net proceeds at a premium to our NAV. This is our 11th equity capital raise as a public company. On a cumulative basis since inception we've raised $1.8 billion in gross proceeds at an average multiple of 1.02 times our NAV. If we applied the offering proceeds pro forma to our December 31, 2009 balance sheet, this would decrease our pro forma balance sheet leverage to 0.39 times net of cash. We believe accomplishing these balance sheet initiatives has positioned us to exploit the attractive investment opportunities that we see in the current market.

Finally, a brief comment on our fourth quarter and full year results. We reported our third consecutive quarterly increase in basic and diluted core earnings per share which totaled $0.37 per share excluding $0.02 in professional fees associated with our pending acquisition of Allied Capital. This represents an increase of 12% versus a year ago.

Importantly, our quarterly core earnings per share, again excluding the $0.02 to professional fees, covered our quarterly level by approximately 106%. Our $0.64 in fourth quarter GAAP EPS were near record levels, driving a 2.5% increase in our net asset value per share to $11.44. And for the full year 2009 we reported GAAP earnings per share of $1.99, our highest level in our history, driven in part by solid net investment gains in our portfolio over the last two quarters.

And with that, I'd like to turn it over to Rick for more detailed comments on our Q4 financial results. Rick?

Great, thanks, Mike. Please turn to the Financial and Portfolio Highlights slide in our presentation, which is slide three. As Mike mentioned, our basic and diluted core EPS were $0.37 per share for the fourth quarter, excluding fees associated with our pending acquisition of Allied Capital, a $0.03 per share increase over the comparable metric last quarter and $0.04 per share better than the fourth quarter of 2008. This quarterly increase was aided by a higher weighted average investment spread and approximately $0.03 per share of structuring fee income.

Due to net investment gains of $0.29 per share comprised of net unrealized gains of $0.67 per share and net realized losses of $0.38 per share, we reported GAAP earnings per share of $0.64, compared to $0.62 last quarter and a loss of $1.14 for the fourth quarter of 2008. After paying our $0.35 dividend, our net asset value was $1.44, an increase of 2.5% from last quarter.

We experienced increased levels of new investments and repayments in the fourth quarter primarily due to the pickup in market activity. Gross fundings of $355.9 million were partially offset by repayments of $243.2 million resulting in net fundings of $112.7 million. The exits and repayments were combinations of prepayments, selected portfolio sales, normal portfolio amortization, and pay downs on revolving lines.

We ended the quarter and the year with 95 portfolio companies valued at approximately $2.2 billion. Excluding cash and cash equivalents, our quarter end portfolio was comprised of approximately 49% in senior secured debt securities, with 33% in first lien and 16% in second lien assets, 27% in senior subordinated debt securities, 16% in equity and other securities, and approximately 8% in a diversified pool of first lien unit tronch loans in the Senior Secured Loan Fund that we co-manage with GE Capital.

We were able to increase our weighted average investment spread by 10% during the fourth quarter, a 35 basis point increase during the quarter and 133 basis point increase over the past year. Our overall yield on debt and income producing securities at amortized cost increased to 12.1% versus 11.7% a year ago. Despite the decline in LIBOR, we were able to increase our portfolio yield at cost primarily due to higher yields on new investments and loan re-pricings that that took place throughout the year.

Our weighted average funding costs were essentially flat again at about 2% for the quarter and versus 3% a year ago. Our overall yield on debt and income producing securities at fair value was essentially flat at 12.7% versus 12.8% a year ago.

On slide four we provide detail regarding our fixed and floating rate portfolio assets at fair value. Our fixed rate assets accounted for 48.8% of our portfolio with 39.5% of our assets at floating rates. We now have LIBOR floors on approximately 44% of our floating rate portfolio.

During the quarter, third-party independent valuation providers reviewed approximately 50% of the portfolio based on fair value. Over the last two quarters, third-party independent reviews had been conducted on approximately $1.8 billion of our portfolio at fair value, with 81% of the portfolio at fair value either reviewed or new to the portfolio over this period.

On slide five, I'd like to highlight the improvement in our annual GAAP earnings per share. GAAP earnings increased from a loss of $1.56 per share in 2008 to earnings of $1.99 per share in 2009. This significant improvement was primarily due to the reversal of a portion of our mark to market unrealized losses incurred during 2008 as well as improved performance on our portfolio investments.

As shown on slide six, we incurred net realized losses of $41.9 million and net unrealized investment gains of $73.1 million for total net gains of $31.3 million in the fourth quarter. Our realized losses on investments were approximately $9 million less than our previously recognized depreciation on such assets. This is illustrated by the reversal of prior period unrealized appreciation of $50.8 million on investments where we recognized $41.9 million in net realized losses. These two realized losses consisted of a newspaper company investment and a consumer apparel company, which were two of the most cyclical companies in our portfolio.

Our net unrealized gains were broad based and reflect those slightly improved asset values including modestly tighter spreads on primary market loans and debt comparables and overall stronger credit and investment performance.

Slide seven shows a summary of our debt facilities. As of December 31st, we had approximately $969 million in total debt outstanding with cash on hand of approximately $99 million and approximately $250 million of capacity available for additional borrowing subject to leverage and borrowing base restrictions. At December 31st, 2009, our weighted average cost of debt was approximately 2%.

Now if you turn to slide eight you'll see our current debt structure after giving effect to our refinancings that took place in January of this year. This slide shows our increased $615 million revolving facility and the new 2013 maturities on both revolving facilities.

Longer maturities increased our weighted average maturity on our debt capital from 3.8 years to 5 years which allows us to better match fund our assets. You can see we accomplished this expansion and increase in debt capacity at only a slightly higher interest cost. On a blended basis, our new weighted average interest expense would have been approximately 2.43% versus 2.05%. We believe that our cost of capital will be an important competitive advantage for us over the next few years. Including the cash and equivalents on our balance sheet of $99 million, we would have had debt capacity and cash of approximately $418 million on a pro forma basis at year end.

On slide nine is our balance sheet. Our debt to equity ratio at quarter end was 0.77 times and including cash and cash equivalents, our net debt to equity ratio was a conservative 0.69 times. If you consider our equity raise of over $277 million in early February, our 12/31/09 net debt to equity ratio would be approximately 0.39 times on a pro forma basis and our cash and debt capacity would have increased to approximately $700 million. The time it takes for us to accretively redeploy amounts paid down under our debt facilities, using the proceeds from our recent equity offering may temporarily affect earnings per share in the short term.

Turning to slide ten, we paid our fourth quarter dividend of $0.35 per share on December 31st of 2009 and this morning we declared our first quarter dividend of $0.35 per share. The dividend is payable on March 31st to shareholders of record as of March 15. We've now declared or paid our current dividend level of at least $0.35 for the past 17 quarters dating back to the first quarter of 2006. During that period we covered our regular quarterly dividends with our core earnings per share and our net realized gains by over 100%.

Now I'll now turn the call back over to Mike.

Thanks, Rick. Now I'd like to say a few words about our recent investment activity and touch on our portfolio performance before concluding. If you would please turn to slide 11. In the fourth quarter, we closed over $344 million in new commitments across five new and five existing portfolio companies. Our new commitments included our $165 million investment in the Senior Secured Loan Fund purchased from Allied Capital, $46.7 million in first lien and subordinated debt in a portable moving and storage company in two separate transactions, $43.6 million in unit tronch debt to a for-profit post secondary education company, $32.5 million in unit tronch debt to a personal care products company, and a $33.6 million investment in Ivy Hill Asset Management related to its acquisition of interest in the Ivy Hill Senior Debt Fund from Allied Capital. All of these investments were made in our strike zone for leverage, expected returns, preferred industries, and size.

Given the significant contribution to last quarter's activity, I thought it would be helpful to highlight the mechanics and the strategic value of the two fund acquisitions that we made during the quarter. We believe the senior secured loan fund provides us with meaningful origination advantages and compelling economics which should hopefully be a catalyst for future earnings growth. Since we are partnering with GE Capital, one of the leading senior debt providers in the middle market, we believe the breadth of our already strong origination platform has been greatly enhanced. In addition, since the fund provides leverage for Ares Capital's investment, the underlying returns to Ares Capital on typical senior unit tronch debt of roughly 8% to 12% leverage returns that may range between 15% and 25%. Yet since the fund is providing senior debt to companies at modest debt to EBITDA multiples, typically less than four times, we believe the risk from the leverage is reduced providing a factor of risk adjusted returns for us. The unit tronch product has been an asset class that has historically performed very well for us. We believe that the $3.6 billion of capital in the fund, of which we have committed $525 million, is an important strategic advantage for us in the marketplace today and may help us combat potential spread compression while still generating very attractive returns.

Second, Ivy Hill Asset Management's purchase of the Allied Capital Senior Debt Fund is a continuation of our strategy to expand and leverage the strategic value of our asset management platform. Since raising Ivy Hill Middle Market Credit Fund I in late 2007, Ivy Hill Asset Management has grown its committed capital under management organically and through acquisition from $404 million to over $2.3 billion as of December 31, 2009. Funds managed by Ivy Hill have investments in over 200 middle market companies that are not also on Ares Capital's balance sheet. This provides us with potential opportunities for enhanced deal flow and valuable incremental market research and deal specific benefits which in turn enhances our underwriting skills and asset selection.

Now turning to slide 12 for an update on portfolio quality statistics, this data demonstrates our strategy of increasing our portfolio investment spread while reducing portfolio risk throughout the credit cycle. The left chart shows that our weighted average investment spread has increased while our weighted average leverage and interest coverage statistics have generally improved or held constant. Our average portfolio last dollar, total net debt leverage, declined from 4.1 times to 3.9 times and compared to 4.2 times a year ago. Our underlying portfolio interest coverage held constant at a healthy 2.7 times up from 2.4 times a year ago.

As you can see on the right-hand side, the average EBITDA for our portfolio companies has increased modestly from a year ago, but declined slightly during the quarter to approximately $46.4 million. The average size of our portfolio companies is expected to remain near our current range in the short term as we exploit inefficiencies below the liquid credit markets.

The improved economy has rippled through to our portfolio as well. As I mentioned earlier, our portfolio companies' weighted average revenues and EBITDA continue to increase versus the same period a year ago. For the full year, our portfolio companies' weighted average revenues increased in the mid single digits and their weighted average EBITDA increased over 20% versus the prior year, reflecting the improved operating leverage from cost cutting and some modest pickup in demand.

Slide 13 shows additional detail on the diversification of our portfolio by issuer concentration, asset class, and geography. We continue to be over weighted in defensive industries such as healthcare, education, other service industries, and food and beverage. The only notable change this quarter is in the financial category which increased from 8% to 16%. The increase is entirely due to our strategic investment in the Senior Secured Loan Fund which is actually comprised of a number of diversified investments in the unit tronch debt of 11 different issuers through our unique fund structure. These 11 issuers in the Fund are in nine different industries. Our overall portfolio remains highly diversified with no single investment other than the Senior Secured Loan Fund representing more than 4.7% of the portfolio at fair value and with the top 15 accounting for 45% of the total.

Slide 14 provides another view of our portfolio quality. As a reminder, our investment advisor employs an investment rating system which grades 1 through 4, with 1 being the lowest grade for investments that are not anticipated to be repaid in full, and with 4 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 3, unchanged from the last quarter. We experienced four performance related upgrades and three performance related downgrades. Such upgrades were related to companies with a fair value of $138.8 million, and our downgrades were to companies with a fair value of only $17.5 million.

We also experienced two downgrades of companies with an aggregate fair value of $29.4 million that changed from our highest rating of 4 which indicates an exit is likely to a 3 rating as it became clear that an imminent exit of these investments through an IPO or sale was less likely. Therefore, the aggregate fair value involved in rating changes was positive and we believe reflects positive credit performance in our portfolio.

Overall, we have just 0.3% of or portfolio at fair value in our lowest rating category of 1 where we don't expect a full recovery, and 9.8% at fair value in our highest category of 4. And as I mentioned earlier, we had just 0.5% of our portfolio in nonaccrual at fair value and only 2.5% at cost at 12/31/2009. And other than these portfolio companies on nonaccrual, we have no other companies delinquent in payment.

On slide 15 is our recent investment activity since quarter end and our backlog and pipeline. As of February 24th, we made additional investments of $151.2 million since December 31st, 2009. About 94% of these new investments were fixed rate with a weighted average yield of 15% and about 5% were floating rate investments with a weighted average spread of 11%. We had also exited $118 million of investments at lower weighted average yields of 12.7$ on fixed rate assets and lower weighted average spreads of 6.4% on floating rate assets. And on this date, our total backlog and pipeline stood at $75 million and $220 million respectively. Of course we can't assure you that we will make any of these investments, and we may syndicate a portion of these investments.

Now I'd like to just make one clarification related to our backlog and pipeline definitions. We define our backlog as committed transactions that are under a letter of intent. We define our pipeline as transactions with no formal commitment but where significant due diligence has been performed and there is a good probability of us consummating the transaction. Unlike some of our peers, our pipeline does not include other transactions that are currently being reviewed in-house. For example, we are currently actively reviewing investment opportunities representing over $3 billion in transaction value excluding secondary purchases and potential portfolio acquisitions.

So a few key takeaways before Q&A. We delivered yet another quarter of growth in our core earnings per share and we again provided 100% dividend coverage through core earnings per share. We incurred no new non accruing loans and experienced improved portfolio performance and increased our net asset value. We have continued to build on this momentum into 2010 by expanding and extending the maturities on our revolving and CP funding facilities at a modest incremental cost and further strengthened our balance sheet and capital with a recent equity raise of $277 million in proceeds.

We believe that our results, our credit, and our investment performance throughout the cycle and the current state of our portfolio and balance sheet clearly separate us from others in our industry and we hope that you share in the enthusiasm we have for our business and our excitement for the current market opportunity and what lies ahead. And with that, Operator, we'd like to open up the line for Q&A.

(Operator Instructions) Greg Mason, Stifel Nicolaus.

Hey, good morning, gentlemen. First, talking about credit quality, the decline in nonaccruals, you said you sold Courtside and Wear Me Apparel. Did you have any loans that returned to performing status in the quarter versus last quarter?

Yes we did, we had one loan that was reinstated.

Great. And then the exits that you had in the fourth quarter plus the $118 million in the first quarter, how many of those are related to moving investments in the GE Fund versus repayments from the Company versus you deciding you want to sell your investment? Can you give us where the exits are coming from?

Sure, we'll give you that at a very high level. Of the $120 million, close to $80 million of it was sold to other area's managed funds but not the GE Unit Tronch Fund. And the remainder were sold to other market participants and third parties.

Great. Can we talk about the payment of the deferred incentive fee? You have not been taking your incentive fee in cash for six quarters now and you probably can take it next quarter. What are you thinking about in terms of the payment of that I believe $66 million incentive fee?

Well it's been accrued through the income statement, so just remind everybody that all of the earnings over the last year and a half have been expensing that incentive fee. While we hope to turn it back on soon, our expectation would, be provided that the Company has liquidity, that that incentive fee would get taken.

Greg, the incentive fee is about $58 million. The other piece of that is the management fee for Q4.

And just a correction, I misstated. We had -- we didn't have loans that were -- we had a loan that we reinstated last quarter, we didn't have any loans that were reinstated this quarter.

Thank you, Rick. One final question and I'll hop back in the queue. I know you're not going to talk about your strategy with Allied on this call, but could you talk about your strategy if the Allied vote does not go through? What are your plans on a standalone basis? How does your strategy change going forward if you don't get Allied? What are your plans?

We're obviously going to be in a position to have much more fulsome discussion on the merger transaction next week, but as we've continued to say, Allied is really a point in time along a continuation of a strategy that we laid out six years ago. And from our perspective, we have every hope and expectation the merger will close. But in any event, we will continue to do what we've been doing, both in terms of how we're originating investments and how we're managing the existing portfolio.

Vernon Plack, BB&T Capital Markets

Thanks. Mike, investments after the quarter were very heavily weighted in sub debt and fixed rate investments compared to the rest of the portfolio. Was that just a function of the opportunities or can we expect more of that going forward? Will it be more heavily weighted in sub debt fixed rate products?

Yes, I think we talked about this last quarter. Our typical portfolio rotation sees us increasing meaningfully the amount of senior secured debt as the cycle peaks. And then obviously as we start to see reduced competition and spread widening and leverage reduction, we tend to gravitate more towards sub debt and fixed rate investing. We're mindful on the fixed rate side of the shape of the forward curve and in fact a lot of the mezzanine that we're quoting today is actually floating rate mezzanine just to make sure that we're not taking on interest rate risk.

But one thing I'd like to highlight and you saw this when you looked at the weighted average leverage statistics quarter over quarter, when we're investing in mezzanine now, we're doing it with the goal of continuing to deleverage the portfolio. So we have a willingness to give up our first lien position and go subordinated in an effort to capture inefficiencies and greater return. But we don't have a significant appetite to take on more underlying leverage. So what we see in vintages like this is we can invest in subordinated debt between 3.5 to 4 times EBITDA which is where senior debt was leveraging at the peak of the cycle. So when you think about our portfolio rotation, absolutely we're going to be focusing on sub debt. There is a huge opportunity in the mezzanine market today. But we're going to be doing it all with a focus on continuing to delererage while increasing our spread.

Okay, and you may have partially answered this or at least implied it given the response to one of Greg's questions, but cash on hand went up to $99 million. Just curious in terms of how much cash you plan on carrying on the balance sheet.

The cash that we had on hand at the end of the year was higher than we normally keep. It was, that was really a function of having some repayments and other things at the end of December and then some cash on hand to fund investments in early January. We typically keep anywhere from $25 million to $50 million of cash, so that was a little larger amount than we typically keep.

As you know, most of our credit facilities are revolving which gives us a lot of flexibility in how we manage our cash position.

Yes. And one final one, expenses related to debt. The Allied deal. In Q3 they were $2 million, in Q4 they were $3 million. It may be a difficult question to answer, but can we expect at least for the first quarter a $3 million type of number?

I would expect a number in the first quarter somewhere consistent with Q3 and Q4.

Okay. All right, thank you.

Don Fandetti, Citigroup.

Hi. Michael, obviously the returns in middle market lending are very attractive for you right now. Just trying to get a sense on how long you think that window is going to be open to you or do you run the risk of some compression and more competition. Obviously like you said, middle market spreads versus leveraged loans are very wide. I'm trying to get a sense on how you think that will play out.

Sure. Each cycle is different, but our historical experience has been, and we'll just talk a little bit about '02, '03, '04 which is probably the most comparable period to what we're experiencing today. There is a good two to three year runway where competition was limited, leverage was low, and spreads were wide. The structure of the middle market is much different today than it was back then. There's a lot less liquidity in the market. There's a lot of structural barriers to capital coming into our market. CLOs are having difficulty leveraging middle market collateral. The banks have a reduced risk appetite. They are changing requirements for regulatory capital against mezzanine and private equity investments within the bank context.

So we think that the opportunity for our market is as good as we've seen it and we actually think that the opportunity here will last longer than we've seen in past cycles. Now naturally where there is outsized returns available, capital tends to find its way into those markets which speaks a lot to why we have been so focused on scale and originations because as the market continues to improve and liquidity comes in, we will have continued to take market share and build our organization to out compete people that do come in. So we're very bullish on the market opportunity. We will see pockets of spread tightening as cash that's within the existing system goes to new investments, but we think fundamentally the supply/demand in our market is as good as we've ever seen it.

Thanks for the perspective. That's all I have.

Chris Harris, Wells Fargo Securities.

Great. Thanks a lot. I appreciate your comments, Mike, on your asset management initiatives here. And I'm just curious, how quickly do you think or do you expect the Senior Secured Loan Fund to really begin ramping and to be kind of a significant driver of earnings?

We made our first investment in the Senior Secured Loan Fund in the quarter, in January, which we were very happy with. Obviously it takes awhile to get the infrastructure and logistics in place to really use that fund effectively. The unit tronch product in today's market is an extraordinary competitive tool. As you can appreciate, if you limited competition on the senior debt side and limited competition on the mezzanine side, being able to provide a scale balance sheet solution to an issuer is a significant advantage. So in most of the situations that we're looking at, the unit tronch is a prominent offering and part of the dialogue. So our hope is that that will ramp very quickly and we'll start to see the benefit of it flow through the earnings throughout 2010.

Okay, great. And then in the quarter it looked like there was a nice decline in the amount of non cash or PIC income you received. And I'm just wondering kind of what's driving that. And I'm assuming it's from borrowers that had previously been PICing are now paying cash interest. Maybe if you can just share a little perspective on what's going on there.

The PIC was down to about $10.7 million in Q4 versus about $10.8 in Q3 and little higher levels earlier on. I think it's just a function of some things that rolled off with some of the rotation in the portfolio.

Okay, thanks, Rick. That's all I had.

Jim Ballan, Lazard Capital Markets..

Hi, Jim Ballan from Lazard. A couple of things. One is, it looks like you earned 15%, you mentioned kind of like mid to high teens, for sub debt. And I guess you also earned around 16% in the Senior Secured Loan Fund or the Unit Tronch Fund. How much of the returns that you're getting on sub debt is influenced by what you're making on the Unit Tronch Fund, or is that not included in that calculation?

Well it's not included in that calculation because again, in the fourth quarter the Unit Tronch Fund we invested $165 million, but we made no new investments. But it's an interesting question, Jim, because if you look at the levered rates of return on balance sheet for the mezzanine product versus the unit tronch product, what makes the unit tronch product so compelling is that we're actually able to generate cash on cash returns on levered first lien securities in excess of the cash on cash returns that we're able to generate on a levered basis for mezzanine. So as I mentioned, I mentioned two advantages when we were discussing the unit tronch product in our prepared remarks. One was the origination scale that it gives us. Two was just the earnings power. But I think what's important, too, is, on a relative basis we can drive higher cash on cash rates of return taking less risk in an underlying company's balance sheet. But the numbers that we quoted include all of the investments that we made including the blended rate on the $165 million.

Okay, great. And then one other thing. The $151 million that you put to work since beginning of the year, can you talk about how much of that was related to Allied assets? And if you have one, is there sort of a strategy around buying assets from Allied ahead of losing? What are your -- can you talk about that?

Yes, well Allied talked about it on their call yesterday and the significant majority of the assets that we purchased early in this quarter were in fact purchases from Allied that we had been working on through the end of the year that slipped into the first quarter. As we sit here today, our expectation is that we'll close the merger at the end of the quarter, so at this point we're not expecting a significant amount of continuing asset purchases as we move into closing.

Got it. And actually one last one if I may. The -- can you talk a little bit about what would enable you to exercise the accordion feature for the revolver? How would that work?

Yes, so the way the accordion feature is structured is, the existing $615 million credit facility can be upsized by bringing in new lenders without the consent of the existing lender. So anybody who is an existing lender under that credit facility has effectively preapproved our bringing in new investors without any change to the underlying documents. As we discussed on our last call, our expectation is that we will launch a syndication process to bring new investors into that vehicle.

Sometime after closing?

It's an ongoing discussion. As you can imagine, we're constantly having dialogue with our lending partners and developing new relationships. It doesn't all have to come in at once, so I remind you last year we brought in a $15 million commitment early in the year just as part of an ongoing dialogue we were having with an institution. And it doesn't go away. So I would expect to see increases in that facility over time as opposed to one large increase.

Got it. Great. Thanks a lot, Mike.

John Stilmar, SunTrust.

Good morning. Just really quickly, two points. The first one, Mike, can you comment a little bit about interest coverage? Obviously we have over 500 basis points of increased coupon. Part of that is moving further down the capital structure. The other part of it is potentially taking advantage of selling loans that were done in a more liquid environment and investing in a less liquid environment. But the other piece I guess I'm looking for a little color on is where are we on the interest coverage perspective? You certainly talked about leverage levels, and I'm comfortable there, but that's the other piece that's just missing and I'm wondering if you can provide a little context and color to that and what it's been.

Yes, on a weighted average basis, and we talked about this earlier, the interest coverage in the portfolio is about 2.7 times.

Yes, but on marginal investments, is it still in that same range?

Yes, new investments are being underwritten to those types of levels. And you can see it obviously, interest coverage is up quarter over quarter and a lot of that is the new market. Obviously with lower leverage levels in new capital structure as well as low interest rates, you expect to see an increase in the interest coverage in the underlying portfolio.

Perfect. And then the other question has to do with you had mentioned the syndication potentially for new origination activity. Can you talk to me about how capital is forming in the syndication market? Because to me, syndication feels like it's highly predicated on the structured markets or increased liquidity. I'm wondering what you're seeing there and what sort of indicators we can read from your comments of what seems to be a little bit more robust outlook for your ability to syndicate.

Yes, there are really two pockets of cash today. One is cash that's tracked within the existing system, think of that as cash balances in CLOs available for reinvestment in small size. And that ebbs and flows depending on where they are in their fund life and their investment pace. And then there are a number of smaller providers to the market, whether they're BDCs or private finance companies that have access to capital, but don't have access to capital in size where they can buy $10 million, $15 million, $20 million of a name but not really lead the deals the way that we can.

I don't want to imply that the market is flushed with liquidity, but there is enough capital and enough people looking for assets that we can use our origination capability to go after and drive fee income and optimize our portfolio. But as I mentioned, what makes us so excited about the opportunity now is not just the risk adjusted returns, but it's really our competitive positioning within the market. There really are few people that can provide a full balance sheet solution to a middle market company in the size that we can. And so having that breadth of product capability and having the experience investing up and down the balance sheet in size is really putting us in a position to drive the benefits through syndication. However, obviously as we grow there is no obligation to syndicate and I would expect to see syndications play a lesser role as we continue to build the book over 2010.

Okay, actually one more follow up question if you don't mind. With regards to financing options that you have, it seems like we're seen some bank sponsored asset based structured deals. Can you talk to me about how you would think about that as an option going forward? Obviously with the transaction with JPMorgan and Allied and you have some other peers where there was bank sponsored highly structured transactions to lead to a lower cost of capital. Is that starting to open up and something that you would consider from a marginal debt capacity above your revolver? Or are the structured markets with private going to come around? Or are we still kind of think about the unsecured market as the next step for these either independently or with Allied next steps for marginal debt capacity?

It's developing. Obviously with our performance in our issuer ratings, the unsecured markets are open to us today at a price. The nice thing about our balance sheet positioning now is we have no maturities for another three years. We have ample revolving capacity at very attractive rates, so we're not rushing into any financing market right now. But we're being very opportunistic.

On the structured side, as you can imagine given the breadth of Ivy Hill and more importantly given the breadth of the Ares Management platform where we manage close to $20 billion of liquid credit, if there is a structured financing alternative out there in a vehicle that makes sense, you should probably assume that we're looking at it and that we're on the short list of people that are seeing it. That market is opening up. We're beginning to see people offering us leverage on our collateral. We're still not at a point where we think the cost of the fund is attractive for Ares Capital Corp, but we're encouraged at some of the liquidity that we're seeing. What we do believe and are convinced of though, is that that marginal debt will not find its way to subscale managers. And we're already seeing it within the BDC space where the unsecured market and some of the more flexible structured products just aren't available to the smaller issuers.

So we spend a lot of time talking about the benefits of scale, but access to the financing markets, not just in terms of the cost of funds, but the structure underpinning those funds, is key. So we're looking at the unsecured market, public and private. We're looking at the unsecured market retail, and day to day we're having discussions on a whole number of other types of structured solutions.

Thank you so much.

Aaron [Taiginovich], Ladenburg.

Hi, guys. Just following up on Don's earlier question on the positive pricing and leverage environment and how long that might last, what do you think about the possibility of any secular benefits taking out some of the active institutional loan people that were in the market during the peak? Just wondering what your thoughts are, if there is going to be a longer term benefit or if it's going to return to a cyclical kind of norm after this cycle?

Are you talking about in the broader markets?

Yes, just broadly.

Yes, I think -- look, before this cycle, nobody thought that a bank loan would ever trade below 95. And we've even now seen that bank loans can trade to 50 and they can trade above par. Our view as asset managers has always been that where there is more volatility, there is an opportunity for us to make more money. And so while the markets have matured and institutionalized, they have become more volatile which drives periodic inefficiencies that we think we've been able to exploit to our collective benefit. We don't believe that there have been necessarily secular changes because I think what this cycle will show is that the loan asset class in particular is a very robust asset class. I think when people look at the loss given default ratios that come out of this cycle with leverage, you will see leverage come back into this market. I think you'll see it come back at much lower levels than we've seen historically, so think three to five times versus ten times plus. I think the cost and structure of that leverage will be much more rigid. But our expectation is that it will come back. But again, I think it will come back to a smaller number of market players. The larger players and those with infrastructure and track records through the cycle I think are going to get the benefit of that leverage. So in the broader markets, our expectation is, and we're already seeing it, liquidity is already finding its way back into the syndicated market, it's finding its way back into the high yield markets, and that's putting a lot of pressure on underlying structures and spreads. But because of some of the things I referenced earlier, we're just not seeing that spread tightening and leverage increase creep into our market. And we actually don't expect it to for the foreseeable future.

Okay, that's helpful. And then finally, I'm not sure if you can answer this, but I think the most recent disclosure, the pro forma NAV as of 9/30 was 13.32. Do you have any update on that or do you feel it's going to be materially different?

We can't talk about that today, but we'll try to address some of those types of issues on the call next week.

Okay, thank you.

Sanjay Sakhrani, KBW.

Hi, this is actually Steven filling in for Sanjay. Just a quick question trolling down on the investment income. I noticed that the management fees and the other income fee lines increased and I was just wondering, how should we think about the run rate going forward for those two lines?

Yes, those are predominantly being generated from Ivy Hill. I think the good news is that the underlying performance in some of our Ivy Hill vehicles are exceeding our expectations. And so we're seeing the dividend fees in dividends and other income coming off of that platform increase. And obviously as we've added funds, the fee income is increasing. You're also starting to see a slight increase in management fee from the Senior Secured Loan Fund. That will continue into the future and should grow as we continue to get that fund invested.

So that run rate is sustainable then?

Yes, I think it's sustainable and probably will grow.

Great. Thank you.

Fla Lewis, Weybosset Research

Might I ask, in your new, your various lines of credit, obviously it's very attractive to borrower fees and invest at much higher rates. Are the terms of your debt covenants changing? Are they about what they've always been or changed in any way?

The underlying structures are very flexible. And they have very few covenants. And the covenants did not materially change from what they were before our recent refinancing. If you think about what the covenant packages are, and the documents are available publicly, you'll see predominantly the covenants are geared to the regulatory requirement of 1:1 leverage. So as long as we're maintaining compliance with the regulatory leverage, the asset coverage test of 1:1 is really the governing covenant. What we're also happy with when we refinanced all of our facilities in January, we saw only a modest tightening in advance rates in some case from 85% to 80% for example on senior secured debt. But we were able to maintain most of the advance rates that we had had for the prior six years. I don't think that's true for some of our pers. Again, I think that the banking community and the capital markets are starting to differentiate between scale managers and really looking at people's credit track records. And so some of the other bank lines that have come out are seeing advance rates that are probably 50% of what we've been able to attract and it's coming at significantly higher cost of capital.

Good, thank you.

Rob [Schwarzberg], Compass Point.

Good morning. I had a couple of questions. One of them had to do with the $73 million of unrealized gains. Can you talk a little bit about one, what was driving the gains? And two, any best guesstimate as to when those might be realized?

Sure. The $73 million of unrealized gains, about $50 million of it was the reversal of previously recognized depreciation. As we talked about, we realized losses on two investments that had been non performers for us. But we had effectively over reserved those by about $9 million. And so there was a reversal of the depreciation of the reserve if you will to the tune of about $51 million.

And then there was the remainder just net appreciation in the underlying portfolio largely driven by credit improvement and a change in the mark to market environment. If you look at the amount of net appreciation that we've seen in the portfolio over the year, obviously we're very happy with it. We still have a ways to go against the total amount of unrealized appreciation that we took over the cycle, but we've obviously seen a fair amount of healing in the portfolio through the end of the year.

In terms of the gains in the portfolio, it's obviously a lumpy business. We do have a fair number of the portfolio in equity securities that we hope as the cycle matures and the economy gets on more stable footing that we'll be in a position to continue our track record of realized gains which I think as people know, since inception (inaudible) our losses.

And then if I could ask two other questions, one is a follow up to a previous question. Structuring fees, almost $3.8 million, there were really no fees in the September quarter and $600,000 in June and $1.2 million. Do you have any guidance about that or what drove that for the quarter and how we should look at that going forward?

Sure. We don't give guidance but what we have said and just so people can get a general sense for structuring fee income, it's obviously a function of new investment picks. So as the activity levels pick up and we're in the market originating new business, you should expect to see the structuring fee income sustain itself if not grow. In today's environment we are typically getting somewhere between 3% and 4% structuring fees on new dollars that we invest. So again, we can't predict or guide people to what our investment activity is going to be, but a good rule of thumb is that on new commitments we're typically getting 3% plus.

Right. And then -- so you did the offering in the middle of the quarter, but there won't be any contribution really from Allied because it's closing at the end of the quarter. So how do you feel about making up -- was the transaction still accretive on an earnings point of view for the quarter?

Our expectation, and we said this in our prepared remarks is we typically, it takes us a quarter or two to get back to where we were from a core earnings standpoint. Obviously it's all a function of how quickly we invest the proceeds and at what rates of return. Obviously raising capital at a premium to net asset value in this investment environment, our expectation going into that raise was that it would be significantly accretive, not just to NAV but to our earnings per share. But as you can appreciate, just given the timing of the raise, it will take us a little while to get back to where we were from a core EPS standpoint. And then I'd remind you our backlog and pipeline today in the aggregate as we talked about was about $300 million which was consistent with the sizing of the equity raise.

Got it. And then this might be a question for next week, but are you still comfortable with the pro forma asset coverage guidance which was given out I think at the time of the merger? Or do we want to talk about that next week?

We'll talk more about that on next week, but we are absolutely still focused on 0.65 to 0.75 times leverage ratio for the combined company.

Great. Thank you very much for your help

(Operator Instructions). We have no further questions at this time. Gentlemen, do you have any closing remarks today?

Only to thank everybody as always for their time and continuing support. Hopefully everybody can join us on next week's call on the 3rd and we look forward to discussing the merger then. And thank you for taking the time today. Appreciate it.

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 through March 12, 2010 at 9:00 AM Eastern time. To access the replay, you can call 1-877-344-7529. To call internationally, you can call 1-412-317-0088. For all replays the ID number is 43751. Thank you for joining. You may now disconnect.