Ares Capital Corp (ARCC) 2011 Q3 法說會逐字稿

Good morning. Welcome to Ares Capital Corporation earnings conference call. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded on Tuesday, November 8, 2011.

Comments made during the course of this conference call and webcast and the accompanying documents contain forward-looking statements and are subject to risk 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 its SEC filings. Ares Capital Corporation assumes no obligation to update any such forward-looking statements. Please also note that past performance or market information is not a guarantee of future results.

During this conference call, the Company may discuss core earnings per share or core EPS, which is a non-GAAP financial measure as defined by SEC Regulation G. Core EPS, excluding professional fees, is another cost related to Ares Capital Corporation's acquisition of VALIC Capital Corporation is the net per share increase or decrease in stockholders equity resulting from operations less professional fees and other costs related to the Allied acquisition. Realized and unrealized gains and losses, any incentive management fees attributable to such realized and unrealized gains and losses, any income taxes related to such realized gains and other adjustments as noted. A reconciliation of core EPS excluding professional fees and other costs related to the Allied acquisition to the net per share increase or decrease in stockholders equity resulting from operations. The most directly comparable GAAP financial measure can be found on the Company's website at AresCapitalCorp.com. 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.

Certain information discussed in this presentation, including information relating to portfolio companies was derived from third-party sources and has not been independently verified. And accordingly, the Company makes no representation or warranty in respect of this information. At this time, we would like to invite participants to access the accompanying slide presentation by going to the Company's website www.AresCapitalCorp.com and clicking on the Q3 2011 investor presentation link on the homepage of the investor resources section of the website. Ares Capital Corporation's earnings release and quarterly report are also available on the Company's website. I will now turn the call over to Mr. Michael Arougheti, Ares Capital Corporation's President. Mr. Arougheti, the floor is yours, sir.

Great. Thank you. Good morning to everyone and thanks for joining us. I'm joined today by the Senior Partners of Ares Management's Private Debt Group; Eric Beckman, Kipp deVeer, Mitch Goldstein, and Michael Smith; our Chief Financial Officer, Penni Roll, and Carl Drake and Scott Lem, who head our Investor Relations and Accounting Teams respectively. This morning we issued our third-quarter earnings press release and posted an investor presentation on our website that highlights certain financial data. We will refer to this information presentation later in our call.

I'd also like to first start with a discussion of recent market trends and how they continue to influence our business and strategy. I'll then highlight key elements of our third-quarter performance before turning the call over to Penni who will take you through our quarterly results in greater detail. Finally, I'll cover our recent investment activity, the state of our current portfolio, and update you on our backlog and pipeline before taking questions. Throughout this year, liquidity in the debt capital markets has ebbed and flowed, often influenced by macro economic and political events.

Rapidly changing fund flows that influence loan volume, repayments, pricing, and, ultimately, the risk adjusted return opportunity for capital providers. Following slowing inflows into bank loan and high yield bond funds during the second quarter, the market experienced a sharp reversal during the third quarter as investors reacted toward increased European sovereign debt issues, the fallout from the US Treasury debt downgrade, and signs of slowing economic trends. Ensuing volatility generally led to reduced loan and high yield bonds volume, increase credit spreads, and more conservative capital structures.

For example, according to S&P, third quarter broadly syndicated new-issue leverage loan volume declined 57%, and high yield new-issue volume dropped by 70% compared to second quarter levels. Also, during the third quarter, average credit spreads widened by approximately 200 basis points in the broadly syndicated leverage loan market and leverage multiples begin to hedge slightly lower. In addition, the S&P LSTA leveraged loan index declined about 5% and the Merrill Lynch High Yield Master II Index declined more than 8% during the third quarter.

Our core market, the middle market for leverage loans, was less volatile during the third quarter. As most investors in our market are buy and hold in nature and are less likely to quickly exit investments in reaction to global capital markets events. For example, according to Thomson Reuters Middle Market Loan Index, bid prices declined only 2.2% during the third quarter. That said, similar to the liquid credit markets, the overall middle market did experience softer loan volumes, wider credit spreads, and modestly improved capital structures, creating in our opinion, an improved climate for making new investments. Thomson Reuters also reported that middle market loan volume declined 23% quarter-over-quarter, but remained up 18% versus the same quarter a year ago, and sharply higher for the year-to-date period compared to 2010.

So despite softer market volumes, we utilized our scale and flexibility to make attractive debt investments in a number of high-quality companies. Generally speaking, credit spreads among primary new issues in the middle market increased approximately 100 basis points to 150 basis points in the third quarter. However, in certain situations, lower rated, higher leveraged credits flexed to levels above that range during syndication processes. Although LBO purchase multiples didn't change materially, total leverage multiples began to decline modestly toward the end of the third quarter, creating improved loan-to-value on new investments.

Interestingly, we saw better relative value at the upper end of the middle market than in the lower end, as a result of volatility in the high-yield and broadly syndicated markets and a reduced appetite for syndication risk from investment banks. Accordingly, we found several attractive investment opportunities in larger companies during the third quarter.

To give you a sense of current middle market terms, all-in-returns for regular rate senior secured loans are in the high single-digits. Unitranche loans have climbed into the low double-digits and second lien returns have emerged in the low teens. Given the supply/demand dynamics in the mezzanine markets specifically, mezzanine returns haven't materially changed from the low to mid-teens level.

The market is meaningfully differentiating high-quality companies from lower quality ones, as evidenced by recent loan syndication activity and the relative performance of loans by rating. In the current environment, we continue to focus on higher yielding, senior unitranche investments, given the greater principle protection from the first lien senior secured nature of these loans.

At this point in the fourth quarter, the flows out of loan and high-yield funds have either abated or reversed once again based on encouraging US macro economic trends and some signs of progress in the Euro zone. This has led to a partial recovery in the indexes that track secondary bid pricing. The tone in the market remains cautious. But recent events seemed to have improved investor confidence. From our standpoint, we continue to review a similar quantity of transactions. And the investment opportunities we are now seeing are more attractive compared to six month ago. Our backlog and pipeline remain at healthy levels, as we continue to have strong market visibility in this slower but still active market.

You may have seen that GE and ARCC recently announced an increase in the amount of capital that we have made available through the senior secured loan program, our joint venture through which we have been co-investing in unitranche loans. The program has been a success for both firms. And, consequently, we jointly agreed to increase the amount of the available capital in the program from $5.1 billion to $7.7 billion. Our portion of the capital that we have agreed to make available through the program was increased from approximately $1 billion to $1.5 billion. This increase in the program size should further enhance our visibility on transaction flow in the market and improve portfolio diversity.

Now let's turn briefly to our quarterly performance. We're pleased to report an improvement in our third quarter core earnings per share, which increased from $0.34 in the second quarter to $0.43 in the third quarter, excluding $0.01 of Allied acquisition related fees and expenses in both quarters. Our core earnings were driven primarily by strong investment activity, with approximately $1.4 billion in new commitments and $1.1 billion in new fundings. The increase in our commitments primarily reflects a jump in our average commitment size and the opportunity to commit greater dollars in new transactions.

We saw the continued benefit of incumbency this quarter with over 70% of new investment commitments going to existing portfolio companies. Despite the decline in market activity, we were able to exit nearly $1 billion of investments either through repayments, loan syndications, refinancings, or sales during the third quarter. And these exits included $105 million from the legacy Allied portfolio.

Reflecting the continuing strong performance of certain portfolio investments, we recorded net realized gains of approximately $49 million or $0.24 per share in the aggregate on all exits. These gains bring our total cumulative net realized gains to over $150 million since our IPO in 2004. The overall quality and performance of our investment portfolio also helped reduce the impact of yield based valuation adjustments as of September 30.

As of the end of the third quarter, we had a debt to equity ratio of 0.58 times and approximately $684 million of debt capacity, subject to borrowing base and leverage restrictions, and cash available to us to make new investments. As we'll discuss later in the call, we've been actively making new investments and we've increased our portfolio further since quarter end.

And finally, reflecting the continuing strength in our franchise and core earnings, we declared an increase in our quarterly dividend from $0.35 for the third quarter to $0.36 per share for the fourth quarter. I would now like to turn the call over to Penni Roll, our CFO, for more detailed comments on our financial results. Penni?

Thanks, Mike. For more details on our financial results, I will refer you to our Form 10-Q that was filed this morning with the SEC. To begin, please turn to slide 3 of the investor presentation posted on our website, which highlights financial and portfolio performance for the quarter. As Mike mentioned, our basic and diluted core earnings were $0.43 per share for the third quarter 2011, a $0.09 per share increase over core EPS of $0.34 per share for the second quarter, and a $0.05 per share increase over the same quarter a year ago. Our Q3 2011, Q2 2011, and Q3 2010 core earnings all excluded $0.01 per share professional fees and other costs related to the Allied acquisition.

The increase in our third quarter core earnings per share of $0.09 per share as compared to the second quarter, was primarily due to an increase in our interest and dividend income and structuring fee income, which was driven by our growth in investment assets and increased originations. As Mike mentioned, during the third quarter, we made significant commitments totaling approximately $1.4 billion as compared to gross commitments of approximately $890 million in the second quarter.

We have also exited commitments of approximately $972 million in the third quarter, resulting in net commitments of $458.1 million. Net fundings for the third quarter were $207.1 million. Our total investments at fair net value increase from $4.6 billion at June 30, 2011, to $4.8 billion at September 30, 2011. Our net investment income per share for the third quarter increased to $0.48 per share, compared to $0.21 per share in the second quarter, and $0.37 per share in the third quarter of 2010.

GAAP net income for the third quarter was $0.20 per share, compared to $0.18 per share for the second quarter, and $0.67 per share for the third quarter of 2010. Our net investment income and GAAP earnings per share for the third quarter of 2011 were positively impacted by a reduction in the GAAP accrual for capital gain incentive fees of $0.06 per share. This reduction primarily resulted from the third quarter's net unrealized depreciation which decreased our cumulative net realized and unrealized capital gain position under GAAP.

Comparatively, in the second quarter of 2011, the GAAP accrual related to capital gains incentive fees was $0.12 per share, which reduced net investment income and GAAP earnings per share. As of September 30, 2011, there continues to be no capital gain incentive fee payable to our investment advisor under the advisory and management agreement.

Net realized and unrealized losses for the third quarter were $0.28 per share, compared to $0.03 per share in the second quarter. Net losses for the third quarter of 2011 included $0.24 per share of net realized gains, offset by $0.52 per share in net unrealized losses. Net unrealized losses included net unrealized depreciation of $0.33 per share and the reversal of net unrealized appreciation related to net realized gains of $0.19 per share.

At September 30, 2011, our total assets were $5 billion and our total stockholders equity was $3.1 billion, representing an NAV per share of $15.13. Our investment portfolio was approximately $4.8 billion at fair value and included 141 portfolio companies, which represented a net reduction of seven portfolio companies since June 30. Our portfolio continues to reflect a higher percentage of senior secured debt. And as of quarter end, our portfolio at fair value was comprised of approximately 54% of senior secured debt securities, up from 49% at the second quarter, with 38% in first lien and 16% in second lien debt investments. Also, we had 17% in the subordinated certificates of the senior secured loan program. The proceeds of which were applied to co-investments with GE to fund first lien senior secured loans, 11% in senior subordinated debt, 5% in preferred securities, 11% in other equity securities, and 2% in CLO investments.

Now I would like to walk you through the changes in our yields and investment spread for the quarter. From a yield standpoint, our weighted average yield on debt and income producing securities at amortized cost, decreased from 12.5% to 11.9% quarter-over-quarter, primarily reflecting slightly lower yields on new investments funded, compared to investments exited during the third quarter. However, based upon our new investments funded relative to the investments exited since September 30 and through November 4, the yield on new debt and income producing investments was higher than the yield on similar investments exited or repaid as Michael will address later.

Our weighted average stated cost of debt capital decreased slightly from approximately 5.1%, to just under 5% quarter-over-quarter, as we financed our net investment growth with our lower cost revolving credit facilities. As a result of these changes in yield and cost of debt capital, our weighted average investment spread declined from 7.4% to 6.9% quarter-over-quarter. Of course, this spread will vary from period to period depending on the level of asset spreads available for new investments and the amount borrowed under our lower cost revolving credit facilities.

I would also like to point out that the yield on our debt and income producing securities, and therefore, our weighted average investment spread does not take into account the higher level of fees we have been to generate in the current market, nor the potential benefit of higher interest rates that was embedded in our asset and liability position as of the end of the third quarter.

On slide 6 we have set forth our fixed and floating rate assets and our non accrual statistics. Overall our floating rate debt assets on a combined portfolio basis at fair value increased from 57.5% in the second quarter to 64.6% in the third quarter. And our fixed rate debt assets declined from 24.8% to 21.2% over the same period, reflecting our continued emphasis on investing in senior floating rate assets.

Overall, we believe our portfolio credit quality was stable and remained healthy. The core ARCC portfolio's non accruals, as a percentage of the combined portfolio's, decreased from 1.9% and 0.6% at cost in fair value respectively at the end of the second quarter, to 1.4% and 0.4% respectively at the end of the third quarter. The legacy Allied portfolio's non accruals increased as a percentage of the combined portfolio from 1.6% at cost and 1% at fair value to 2.6% and 1.2% respectively. The combined portfolio's total non accruals on a cost basis modestly increased quarter-over-quarter from 3.5% to 4%, but remained unchanged on a fair value basis at 1.6% for both the second and third quarters.

The legacy Allied portfolio experienced two portfolio companies placed on non accrual, offset by the exit of two core ARCC non accruals. Therefore, on a net basis, there was no change in the number of investments on non accrual.

Now I turn to slide 9 for more detail behind the net gains and losses for the quarter. As Mike stated, we had a successful quarter of positive realizations on our prior investments. Net realized gains totaled $48.8 million as we exited several successful core ARCC equity coinvestments, namely DSI Renal, Industrial Container Services, and Reflexite. We reversed unrealized appreciation of $39.3 million when these net gains were realized.

On an unrealized basis, we recognized $67.2 million of net unrealized depreciation. The net unrealized depreciation resulted from a combination of debt yield valuation adjustments and some performance related write-downs, net of performance related write-ups. In total, our net unrealized and unrealized losses for the third quarter totaled $57.7 million.

Now turning to slide 10, as of September 30, we had approximately $2.5 billion in committed debt facilities and approximately $1.9 billion in aggregate principal amount of indebtedness outstanding. The weighted average maturity of our outstanding indebtedness was 10.6 years, with a weighted average stated interest rate of just under 5%. On this date, we had $383 million outstanding under our $400 million revolving funding facility, and $189.8 million drawn under our $810 million revolving credit facility. We also had available unrestricted cash on hand of approximately $91 million at the end of the quarter.

In total, we had approximately $684 million in available debt capacity, subject to borrowing base and leverage restrictions, and cash available to make new investments. In addition, after quarter end, we increased the capacity under our $400 million revolving funding facility by $100 million to $500 million. We continue to explore various options to further increase our committed debt capacity, although there can be no assurance that we will be successful. At September 30, 2011, our debt to equity ratio was 0.58 times and net debt to equity ratio, net of available cash and cash equivalents, was 0.55 times. This compares to a net debt to equity ratio of 0.49 times at the end of the second quarter. Now I will turn the call back over to Mike.

Great. Thanks, Penni. I'd like to start up by discussing our recent investment activity. Update you on our portfolio and highlight our post quarter and investments and backlog and pipeline before concluding. If folks could turn to slide 14, you'll see in the third quarter we invested approximately $1.1 billion with over 70% of our funded investments made to existing portfolio companies either through a change of control, an add on acquisition, a refinancing, or a recapitalization.

We have often talked about our strategy of leveraging our incumbent lead investor positions to drive additional deal flow. And I believe this quarter's investment activity illustrates the effectiveness of this strategy. It's often preferable to underwrite an existing portfolio company given our experience with a particular borrower. And in doing so, we believe we can enhance credit performance given the deeper knowledge we have obtained of the Company's market position, operations, historical performance and franchise value. We made 20 commitments this quarter, 11 to existing portfolio companies, 5 to new portfolio companies, and 4 to companies through the senior secured loan program. We also leveraged our scale and took advantage of the opportunity in the upper middle market to increase our average new commitments to over $70 million in the third quarter, compared to just under $50 million for the second quarter.

Turning to slide 15, you can see that 65% of our investment commitments during the third quarter were in senior secured debt and another 4% were to the senior secured loan program through which we coinvested with GE in senior secured floating rate debt. The balance of our investments were in second lien investments and a junior capital investment structured as a cash pay preferred equity investment. On the right side of the slide, you'll see that our exited investments by asset category were similar to our new investments, 63% in senior secured debt, 12% in second lien, and 9% in equity and other securities. Of the $972 million in commitment exits and repayments during the third quarter, we control the exit, either through a loan syndication or an ARCC led refinancing on over 70% of that total.

Hopefully this illustrates our capability to generate significant liquidity by leveraging our lead investor and incumbent positions. And also, as we discussed last quarter, our ability to underwrite and distribute in certain situations can lead to higher fee income, improved returns, and enhanced portfolio optimization.

On slide 16, you'll see an update on our progress repositioning the legacy Allied portfolio from April 1, 2010, through the end of the third quarter, a year and a half since we closed the acquisition. On a fair value basis, the size of the total legacy Allied portfolio stood at $859 million at the end of the third quarter, or approximately 18% of total investments, down from $1.83 billion, or approximately 45% of total investments on the April 1, 2010, acquisition date. The reconciliation at the bottom of the slide shows that we have received over $1.2 billion in cash from exits or repayments of investments in the legacy Allied portfolio. Including net realized gains of approximately $124 million and net unrealized depreciation of about $42 million for a total net realized and unrealized gains of approximately $82 million since the Allied acquisition. Keep in mind, these total net gains to date do not take into account the roughly $130 million purchase accounting gain we previously recorded on these investment assets to reflect our purchase of the Allied assets below fair value.

Also shown on the slide, we have made progress by significantly reducing non accruing investments by over 80%. Substantially reducing lower yielding investments and increasing the yield on the remaining portfolio. We continue to focus on exiting the $183 million in legacy Allied equity investments which yield about 0.4%. And we're currently exploring strategic options to exit a number of the remaining legacy Allied equity investments. Of course, there can be no assurance that we'll be able to exit these investments.

Now turning to slide 17, on a combined basis, the underlying portfolio Company weighted average last dollar net leverage decreased moderately from 4.4 times as of the second quarter to 4.3 times as of the third quarter, reflecting our emphasis on investing in senior secured debt. Our overall weighted average interest coverage declined slightly, but remained at a healthy 2.5 times. At the end of the third quarter, the underlying borrowers within the senior secured loan program had a similar weighted average total net leverage multiple of 4.4 times. But a more conservative weighted average total interest coverage ratio of 3.1 times.

On slide 18, you can see that we generally invested in larger companies with just over $44 million in weighted average EBITDA during the third quarter. The overall weighted average EBITDA of the companies in our combined portfolio increased from just under $38 million to over $41 million.

And now skipping over slide 19 to slide 20, you'll see there that the portfolio remains well diversified by issuer. Our largest investment at quarter end continued to be in the senior secured loan program, which was approximately 17% of the portfolio at fair value at the end of the third quarter. Within the program, there were 25 separate borrowers. And the program continued to have no non accruing investments as of September 30. The largest single issuer in the program represented about 8% in the aggregate principal amount of total investments.

Please turn to slide 23 for a summary of the grades for the core ARCC and legacy Allied portfolios. As a reminder, each portfolio is graded on a scale of 1 through 4, with an investment grade of 1 defined as having the greatest risk to our initial cost basis. And a grade of 4 having the least amount of risk to our initial cost basis. Each investment is initially graded a 3 at the time of investment or acquisition. On a combined basis, the portfolio experienced 2 ratings upgrades and 7 ratings downgrades. However, 6 of these 7 downgrades reflected a change from a 4 to a 3 rating. And 5 of those were triggered by a realization on an underlying portfolio company investment. Only 1 downgrade was to a rating falling below a 3.

In the aggregate as of September 30, the weighted average grade of the entire portfolio decreased from 3.1 at the end of the second quarter, to 3, primarily the result of our exiting a number of 4 rated credits. Now to give you a little information on how the companies in our combined portfolio are performing in this slow growth economy, weighted average revenue and EBITDA growth remained strong at approximately 10% and 12% respectively on a comparable basis for the year-to-date period versus the same period last year. These growth rates are relatively unchanged compared to the numbers we shared with you last quarter.

On slides 25 and 26, you'll find our recent investment activities since quarter end and our current backlog and pipeline. As of November 4, we had made additional new commitments of approximately $537 million of which $532 million were funded since September 30. Of these new commitments, 57% were in first lien senior secured debt, 29% were investments in the subordinated certificates of the SSLP, 12% were in second lien senior secured debt, and 2% were in equity securities. The overall weighted average yield of debt and income producing securities funded during the period at amortized cost was 12%. We may seek to syndicate a portion of these commitments to third parties although there can be no assurance that we will do so.

As of the same date, since September 30, we had also exited $183 million of investment commitments, of which $56 million were from the legacy Allied portfolio. Of these investments, 80% were first lien senior debt, 17% were in second lien senior debt, and 3% were in senior subordinated debt. Of this amount, 17% were on non accrual status. Since the weighted average yield on debt and income producing securities exited or repaid was 9.4%, we picked up about 260 basis points of incremental yield on the new investments, compared to the investments repaid or exited since September 30. And on these exits, we recognized $21 million in net realized losses in total, substantially all of which were associated with non accruing investments from the legacy Allied portfolio.

As shown on slide 26, as of November 4, our total investment backlog and pipeline stood at $140 million and $340 million respectively. As you know, we can't assure you that we will make any of these investments and we may syndicate a portion of these investments as well.

So, I'd like to conclude with a few thoughts on our third quarter and our outlook. In our view, our performance for the third quarter illustrates the core earnings capability of our business, particularly when our new investment activities is robust as it was this past quarter. We are pleased that we are able to provide shareholders with an increased dividend, reflecting the strength in our core earnings, and investment performance. As you may recall, we carried over $64 million, or approximately $0.32 per share, of undistributed taxable spillover income from 2010 for distribution in 2011, which provides further support for the dividend.

We believe our portfolio remains in solid condition, demonstrated by the revenue and EBITDA performance, the comfortable leverage and interest coverage statistics, the relatively low and stable trends in non accruals, and our continuing progress with respect to the legacy Allied portfolio. We further believe that our balance sheet is in solid shape, as our weighted average debt maturities are over 10 years and 65% of our debt consists of fixed rate unsecured funding against predominately floating rate assets. Also, we continue to obtain additional debt capital commitments as evidenced by our recent revolving funding facility upsize.

As for the market environment, we believe that risk adjusted returns have improved considerably since the beginning of the year. For example, expected returns on new senior unitranche debt investments are now generally higher by 200 basis points compared to 6 to 9 months ago. We continue to benefit from our strong market position, origination and scale and our incumbency across over 500 portfolio companies, including those managed by our wholly owned portfolio company, Ivy Hill Asset Management.

That said, given macro economic uncertainty and recent global capital markets' volatility, we'll continue to remain defensively positioned with investments in high-quality franchise businesses. And on a longer-term basis, we continue to believe that there remains a significant opportunity in our core market for non-bank capital providers with scale. There are a number of long-term factors that we expect will drive the need for additional capital in the middle market. The requirement for new capital created by maturing debt, uninvested private equity dollars requiring debt financing, declining funds available for reinvestment in the CLO system, and increasing bank regulation under Basel III and Dodd-Frank, just to name a few.

We believe that with our scale, flexibility, and origination and portfolio management infrastructure, we are uniquely positioned to take advantage of these opportunities as they develop. We thank you for your time and support today, as always. And with that, Operator, we'd like to open up the line for questions.

Thank you, sir. We will now begin the Question-and-Answer session. (Operator Instructions). Rick Shane; JPMorgan.

Good morning, guys. Thanks for taking my question. When we look at our model, I think the one area of variance that we don't necessarily know how to model going forward, was the increase in dividend income that went through the P&L this quarter.

When I look at it, it looks like control affiliate dividend income, which I assume is SSLP was pretty flat. And it looks like the increase was in non-controlled non-affiliate dividend income. Am I right in concluding that SSLP was flat on a sequential basis?

And can you help us characterize the increase in dividend that you received non-controlled, non affiliate this quarter? Is it recurring? And also is it a semiannual dividend? As we look at it going forward, we make sure we model it correctly.

Yes, Rick. It's Penni. We had a new investment come in to the portfolio this quarter that was partly structured as a preferred security that has a coupon on it. So, that increase in dividend income will be more recurring with respect to that investment.

So, you will see that going up going forward. Otherwise, we continue to have the other dividends. So, we have primarily the dividend the comes from Ivy Hill Asset Management running through there. So that, given the structure of that, that it is a preferred security, we did put that recurring income through the dividend line instead of the interest line.

Got it. And Penni, just a quick follow-up. There weren't any structuring fees that ran through that? So, it's a good run rate that we're looking at? And just want to confirm, it's a quarterly dividend not a semiannual?

Yes. It is a coupon that accrues very similar to a debt security. But it just happens to be on a preferred security.

Got it. Okay. Thank you.

Dean Choksi; UBS.

Good morning. Congratulations on the dividend increase in the environment. I believe you mentioned that you affected 70% of exits in the quarter. Can you just provide a little more color on what you can do as the senior loan holder, and how you think about those rights going forward?

I'm sorry, Dean, just to clarify. The exits in the third quarter or the exits since the end of the third quarter?

Which ever you referred to at the 70%.

Sure. Got it. So, we spent some time on last quarter's call just discussing a strategy of underwriting and syndication. And, as I mentioned in our prepared remarks, you get a couple of benefits when you get to scale and you develop distribution capabilities.

Number one is I think you see more of the market. Number two, in periods of volatility, when the investment banks retrench, and really are inactive underwriting and syndicating, we can come in and benefit by providing some very attractive capital to larger companies that may otherwise have gone for a distributed product.

When you control that underwriting and that distribution, you obviously have much more influence and control over the structuring and pricing of that security. You have the ability to participate much more fully in the underwriting and due diligence. And as we talked about, it gives you the ability to create liquidity with certain flexibility by either syndicating that security itself, or, as we walked through on last quarter's call, the ability to sell and certain cases the first out security to enhance the yield on your final hold, and really optimize the portfolio from a risk-adjusted return standpoint.

So, what we saw in the third quarter, in particular, was this retrenchment on the part of some of the larger underwriters. We used our scale to take advantage of it by providing loans to companies that we felt were of an extraordinarily high quality.

And given our scale, we were able to effectively take down the entire capital structure of those companies. And then through the quarter, distribute that risk into the market, either within that security, or by creating new securities to benefit the portfolio. That has always been a part of our strategies we talked about. But it gets amplified when we are in period of extraordinary volatility like we were in in the third quarter.

Great. Thank you.

John Stilmar; SunTrust.

Good morning. I guess touching on that same point of syndication. It seems that last quarter we were talking specifically about the investment of Anthony Zink. And I think it was $245 million.

I was wondering, if it's not too sensitive, if you could walk us through the story of that investment over the quarter and how relates to the scenes that you are painting. And if you can't go in to that specific investment, maybe talk about your opportunities with some of the larger investments that you made that might look like that this quarter?

And whether you are thinking about syndicating almost all of it or whether you are thinking about structuring as a last out? And what are some of the criteria that might go into making that decision under today's environment?

Sure. We can't speak specifically about any loans. So, again, I'll reiterate, if you think about syndication just for syndication's sake, we do benefit by increasing our fee income. But, in and of itself, that doesn't drive the value proposition.

The value proposition is in accessing the investment opportunity, controlling the structuring of that investment opportunity, and then having the flexibility either within the quarter or over time to manage the liquidity on balance sheet by distributing risk. I think one of the unique things that we offer as a platform is the origination capability. And even in a slow quarter, at least relative to the second quarter, we were able to demonstrate through the origination infrastructure and the incumbency, that we can continue to originate very attractive loan securities.

And so, that liquidity is available to us because we are seeing loans and able to invest in companies that other people aren't able to access. And so, there's really no single answer, or single strategy, John. It is a function of looking at the quality of the underlying borrower, the yield we're getting on that borrower relative to the risk that we're taking, and then evaluating the liquidity needs of the balance sheet on an ongoing basis.

And so, when we are syndicating, you'll see us syndicating to SSLP from time to time. You'll see us selling to Ivy Hill from time to time. You'll see us selling to third-party market participants. And that may happen, again, prior to us closing, or it could happen 6 or 12 month after as we continue to refine the portfolio. So, I wish there was a simple answer but there really is not.

Perfect clarity. And then my second question has to do with capital. And it seems like in the public markets, we can see either BDC IPOs or secondary offerings for raising capital.

How is the middle market in terms of capital raising from something we may not see, but you may have a vantage point in, in terms of sourcing private sources of capital that might come into the market? And has that changed some of the dynamics in how you are investing today? Thank you.

Sure. I think one of the long-term theses around this sector and this asset class has always been a difficultly in capital formation, both in the private market and the public market. And that has not changed.

So, while we are seeing an increase in global investor demand for credit, and in many cases private credit, because as I mentioned, you are accessing collateral that you cannot otherwise find. I think the challenges of capital raising are as real as ever.

I think those challenges benefit scaled platforms like Ares, because the reality is that a private investor looking to access this asset class, I think has looked at the experience of the sector and looked at the experience of the collateral and figured out that origination breadth and access to high-quality investments, deep portfolio management infrastructure, distribution capabilities, all of those lead to out performance.

And so where we are seeing capital formation in the private market, it's behind larger incumbents. But we are not seeing a real willingness on the part of the private markets, or, frankly, the public markets, as you know, to support new entrants without meaningful track record and meaningful scale.

Great. Thank you.

Joel Houck; Wells Fargo. Please go ahead.

Okay. Good morning. I'm wondering if you might be able to disclose the coupons, fees, and IRRs for the capital you put out in the third quarter by Senior Unitranche and Subdebt?

We cannot. But I can tell you generally, as we talked about in our remarks Joel, when you look at what we have put out since the end of the quarter, the weighted average yield was 12% across the $500 plus million that was put out between September 30 and November 4. And that excludes fees.

And as we have talked about, the income is higher in this current market environment than it has been quite some time. We continue to see market dislocation offer us investment opportunities, as we mentioned on the prepared remarks, that are at least 150 or 200 basis points wider than where they were 6 months ago.

And despite some stabilization here, week to week, we don't expect to have to give any of that back. So, as a general comment, my expectations is that the backlog and pipeline, once funded, will evidence a spread that it is in excess of what we have done to quarter to date, and also our current weighted average spread.

Okay. That's helpful. How should we think about or how do you guys think about, how much cash or capacity you need to kind of reserve for your unfunded commitments of $537 million as of November 4? Obviously, you guys are going to syndicate some of that. Not all of it will close. But how do you think about how much capacity have to save for that?

Yes. It is something that we, as you would imagine, look at daily. And when you look at the unfunded, it is a combination of traditional revolving credit facilities, with borrowers that we have a significant amount of experience with, in terms of their drawing needs and the cycles of their own business month-to-month.

A large portion of it is delayed draw or acquisition pipelines with a specified use of proceeds, where we have pretty good visibility into the utilization of those lines on a go-forward basis. And as you know, we have talked about this in prior quarters, a portion of it, as well, is net of unfunded commitments where we have discretion over whether or not those lines gets utilized.

So, I can't give you specific number. But we are looking at it all the time. Some of that makes its way through the backlog and pipeline on a quarter-to-quarter basis. When we are quoting numbers in the backlog and pipeline, oftentimes it will include drawings under some of those facilities, just based on an acquisition or a meaningful capital expenditure within the portfolio.

But it is something that we have to factor in when we are thinking about liquidity. That's one of the reasons that we do run at the leverage levels that we run just make sure that we have adequate cushion on the balance sheet to continue to meet those obligations.

Okay. And then the last question. In your 10-Q, I think you guys, there is a new disclosure with respect to Safe Harbor with respect to an illegible portfolio Company, you guys are now calculating the senior loan funding, if it's a nonqualifying asset, based on the concept release to the SEC.

But, if you had specific comments with the SEC, what is the risk that they would force you to consolidate the senior loan fund on balance sheet? And the reason I asked that is all of the other BDCs have basically been restricted from off balance sheet leverage. So is there something unique with Ares, whether it is an understanding with the SEC, or is there something unique with the specific program with the GE Unitranche fund?

Sure. I can't comment specifically on other people's conversations with the SEC or our own. What I can tell you is, Number One, is that the disclosure is not new to this quarter, Joel. The disclosure started, I believe, last quarter, or if not, two quarters ago.

We disagree with the SEC's position with regard to eligibility. But again, out of an abundance of caution, we are managing our 30% basket as though the SEC were right. And that is an ongoing dialogue. And I think that many people know there's a request for comment on this and other related issues that is in process. And I think after that process is completed, there will be hopefully more clarity one way or the other.

And without getting into details, we don't believe, and we have never had anybody tell us, that the senior secured loan program is leveraged. It is a joint venture between ourselves and GE, with all sorts of strategic benefits and administrative benefits. Both for us and for GE.

So again, I can't comment as to how our experience managing this program now over two and a half years with multiple registration statements and financial statements, impacts other people's strategic decisions, or what structures they are looking at. But, obviously, we continue to believe that the structure is appropriate, and you know, we have not consolidated nor have we anybody at the SEC or within the accounting profession tell us that it should be.

Okay, Mike. I appreciate it.

No problem.

Greg Mason; Stifel Nicholas.

Great. Good morning. Mike, on Slide 5 of your presentation, we have seen the average yield on your debt investments at cost go from upper 13% as of last year, to now down to 11.9% as you've focused more on senior secured assets. What is your expectation for the overall portfolio yield going forward? How much more kind of compression do you think there is going to be in that line?

It's always a function of the risk you are taking. So, if you look at Slide 5, I think you also have to look at it in conjunction with the slide that shows our weighted average leverage and coverage statistics. And you know, we have been able in what was a frothy environment, to maintain credit quality. In a very low interest-rate environment we have been able to effectively maintain yield.

And the total return proposition, as I mentioned earlier, shows up in other ways, like OID and fee income, et cetera, et cetera. I think spread is obviously very important and you have to stay focused on the net interest margin. But there are other components of the total return that hopefully is not lost on people.

As a talked about a couple minutes ago, when we look at the current market environment, and the types of yields that we are generating, particularly against the fact that those investments are getting funded with our lower cost revolving credit facilities, all else being equal, our expectation is that we shouldn't see more compression and that in fact that should reverse itself.

And then to follow-up on that comment on using the credit facilities. I think you have outlined in the past that you want to utilize the credit facilities as more of a short-term financing until you build up a large amount of those, and then convert those into a longer-term debt funding source. Is that still the idea with those credit facilities? And if so, what is the outlook for different debt opportunities for you in the CLO market or other long-term debt?

Yes. The markets are constantly moving. I think we have a demonstrated track record of accessing market windows when they are open and when they are open at attractive pricing and structure, and so that should not change.

Interestingly, as we saw post quarter end, we were able to upsize our revolver, and that's a market that we are seeing increasingly open to us, whereas given some of the issues facing the banking community, that market was probably less open to us six or nine months ago. And so you have to be constantly in those markets dialoging with investors and market participants to figure out were the most efficient capital is.

As a long-term strategy, you are right, our preference is to continue to push out duration on our liabilities to the extent that we can and to the extent that we can do it cost effectively. And that's always just a function of what is available in the market, and, obviously, looking at the structure of the asset side of our balance sheet as well.

So, without going through each market specifically, I believe that all of the markets that we could borrow in are open to us today at price. And for us really, the challenge and the task is to make sure that if we are looking at the debt capital markets, that we are going to the right market at the right time with the right asset mix to, again, maintain the net interest margin.

Great. Thank you.

Jasper Burch; Macquarie. Please go ahead.

Good morning, gentlemen. You just mentioned how leverage is at least somewhat contingent on the asset side of your balance sheet. Looking at leverages, 0.55 at quarter end, pro forma of the investments post quarter, it is probably closer to 0.66, which is in kind of that sweet spot range that you cited in the past, of 0.65 to 0.75 times.

And I was wondering if you could give us a little more color on your appetite for leverage? How comfortable you are bringing up leverage considering as you're moving into more senior secured securities? And also, how you are weighing leverage against your equity cost of capital and growing the balance and growing the portfolio?

Sure. So, with regard to leverage, I think we talked about this last quarter as well. Our appetite, or willingness to leverage the assets that we have on balance sheet is significantly in excess of the regulatory restriction. And as we have talked about, were it not for that, we would be comfortable running at higher leverage.

So, the 0.65 to 0.75 range that we continue to talk about has everything to do with prudent balance sheet management and managing regulatory risks, as opposed to a view on the quality or the risk of the underlying assets. So, that said, particularly when you are in volatile markets, you are going to see us running less levered or trying to run less levered than more levered in order to manage that risk.

With regard to equity and debt, you bring up a good point. And again, building off of Greg's question, when we are looking at the capital markets, the question is, can we invest dollars accretively against new capital raises, either equity or debt. And I think what we do well is, we have good visibility into all of the markets available to us, equity for debt, public or private, and we're constantly looking at where the most efficient place to raise capital is, if the capital is needed to continue to grow the balance sheet and grow the core earnings of the business.

So again, I cannot give you a simple answer that says we'd always rather raise debt than equity. It is all about relative costs and relative benefit at any point in time.

What you do see, particularly in volatile markets, is inefficiencies pop up were one market in particular, just given a supply and demand imbalance, is mispriced, and it is our responsibility to identify where that inefficiency is and make sure that that's the market that we access. And I think for example, we did that well with our convertible issuances earlier in the year.

Okay. That's helpful. And then on a different topic. Looking at your core earnings, after backing out the incentive fee reversal, and sort of what we consider above run rate structuring fees, it is still looking like your core earnings is at least a couple cents above the $0.36 dividend. I was wondering if you could give us a little more color on your, or the board's thinking, on what run rate earnings might be and what the outlook is on growing the dividend towards that?

Sure. I think at a high-level your calculation is right. And as we've talked about time and time again, I think it is important to put dividend stability and dividend predictability above dividend growth. And when we look at the issues that I think plagued our sector historically, it was irresponsible dividend policy.

And so as a Management Company and a Board, we are very focused on making sure that where there are dividend increases, that they are measured. And that they do come from a place of predictability and stability. But what we have been communicating really since the Allied acquisition, is that both through the rotation of that portfolio and the releveraging of the balance sheet, that there is a meaningful opportunity to grow core earnings.

And as we have begun to talk about through this year, given some of the balance sheet initiatives that we accomplished at the end of last year and earlier this year, going into a market dislocation, we continue to believe that there is growth opportunity within the business.

So again, our policy and strategy has always been one of conservatism and making sure that the dividend is well-covered from core earnings. I think we are in a position now, as I mentioned in the prepared remarks, given the spillover income from last year and into this year. We have further comfort and further confidence from which to have raised the dividend this quarter. And we will see how things develop.

Thank you. That's all very helpful. I appreciate it.

John Hecht; JMP securities.

Good morning. Thanks for taking my questions. Mike, you talked about that during the third quarter, large banks had exited the high yield markets. I guess they were concerned about syndication risk.

We have seen a little bit of recovery in the markets since the end of the quarter. Are big banks willing to take on syndication risk? And I guess at the high level, what I'm asking is, you talked about the 200 basis point widening since the quarter. Is that sticky, or is there upside to that? Or, is that going to ebb and flow based on the large bank behavior?

I think it is going to ebb and flow based on large bank behavior and fund flows into bank loan funds and high yield funds. I think the markets have stabilized over the last couple of weeks, but I would not say that they have healed necessarily.

Banks are still effectively out of the market. And where there is a willingness to underwrite and distribute, it tends to come with significant flex. I think the one difference now is, I think people have a much better view as to where assets will clear than they did 6 weeks ago.

But the risk appetite has not necessarily changed, because I think that despite some stability here in the last 10 days, I really don't think that the level of confidence is back on the part of the banks to meaningfully take balance sheet risks. So, you'll see through the end of the year, I think you'll see some pockets of willingness to take risk on balance sheet. But as a general rule, I wouldn't expect a lot of it. And where they do, I would expect to see meaningful flex and wide spreads

Okay. And then, of your exits, it sounds like 70% were syndications and sales. Does that mean of the exits that 30% is just sort of the core repayment level that we should think about? Or what is your expectations for just typical repayment trends at this point?

Yes. I don't know what the numbers is, including this quarter. But my recollection is our historical natural retainment rate was roughly 30% to 32%. So, seeing a 30%, annually. So, seeing a 30% number X active syndications is probably a good sense. Our historical experience has been depending on the MNA environment and the capital markets environment, somewhere between a 3 to 4 year average life on our collateral. So, 25% to 30%.

Thanks. I appreciate the color.

Thank you.

Well, it appears that we have no further questions at this time. We will go ahead and conclude our Question-and-Answer session. I would now like to turn the conference back over to Mr. Arougheti for any closing remarks. Please go ahead, sir.

Nothing other than to again thank everybody for spending the time with us this morning and for their continued support. We appreciate the dialogue and we'll look forward to talking to everybody next quarter.

And we thank you for your time, sir, and also to the rest of management. And, ladies and gentlemen, that does conclude our conference call for today. If you missed any part of today's call, an archived replay of this conference call will be available approximately one hour after the end of this call through November 23, 2011, to domestic callers by dialing 877 344 7529, and to international callers by dialing area code of 412 317 0088. For all replays, please reference account number 10004438. An archived replay will also be available on our webcast link located on the homepage of the investor resources section of our website. Again, we thank you all for attending today's conference call. At this time you may disconnect your lines. Thank you and take care. [ End of transcript ]