Ares Capital Corp (ARCC) 2011 Q4 法說會逐字稿

Good morning. Welcome to the Ares Capital Corporation's earnings conference call. At this time, all participants are in a listen-only mode. As a reminder this conference is being recorded on Tuesday, February 28, 2012.

Comments made during the course of this introduction -- 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 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 and other costs related to Ares Capital Corporation's acquisition of Allied Capital Corporation, is the net per share increase or decrease in stockholder's equity resulting from operations less professional fees or other costs related to the Allied acquisition, realized and non-realized gains and losses, any incentive management fees attributable to such realized and non-realized 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, the net per share increase or decrease in stockholder's 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 at www.arescapitalcorp.com, and clicking on the Q4 earnings presentation link on the home page 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.

Thank you, operator, and good morning to everybody and thanks for joining us today. This morning we issued our fourth quarter earnings press release, and posted a supplemental earnings presentation on our website that highlights certain financial data. We will refer to the presentation later in our call.

We're pleased to report record fourth quarter core earnings per share of $0.48. For the full year, our 2011 core earnings per share increased 9.1% from 2010 to $1.56. This compares to dividends paid in 2011 of $1.41 per share, representing the strong dividend coverage from core earnings. We also earned $1.56 in 2011 GAAP earnings per share, and our net asset value increased from 2010 by approximately 3% to $15.34 per share.

We also earned meaningfully more taxable income than we distributed again in 2011. As you may recall, we carried over approximately $64 million, or $0.32 per share from 2010 for distribution in 2011. Subject to the finalization of our 2011 tax returns, we currently estimate that our undistributed taxable income carried over from 2011 into 2012 is approximately $170 million, or $0.77 per share.

Therefore, in light of, among other factors, our 2011 core earnings performance, our view on our core earnings power going forward and the estimated size of our excess undistributed taxable income carry forward, we have elected to increase the quarterly share dividend from $0.36 to $0.37. Penni Roll, our CFO, will provide more detail on our results a little bit later in the call.

Now I would briefly like to highlight recent changes in the market environment. At the time of our last call-in early November, markets were reflecting significant uncertainty, driven primarily by Euro sovereign debt and global economic growth concerns. On that call we also highlighted that despite the volatility, the market environment might present us with attractive investment opportunities. Specifically, the ability to provide full balance sheet solutions for larger high quality middle-market borrowers, as many large investment banks were unwilling to take underwriting and distribution risks.

As we will discuss later in the call, we took advantage of these opportunities by making approximately $853 million in gross commitments at an attractive weight average yield on debt and income producing securities of approximately 12.5%. Since that time, investor sentiment and market tone have steadily improved, and capital markets volatility as eased, primarily due to encouraging economic trends and more aggressive policy actions in the Euro zone. In the latter part of the fourth quarter, we saw slower fund outflows in the loan market, and actually very strong fund inflows into the high yield market. These trends helped drive a rebound in activity, higher asset prices and tighter spreads.

As we have stated in the past, our core market, the middle-market for leveraged loans, is less volatile and there is often and time lag or disconnect between broad leverage loan market trends and changes in our market. As an example, according to Thomson Reuters, all-in pricing on middle-market senior secured loans in the primary market ended the quarter relatively unchanged from prior quarter levels. Since the end of the fourth quarter, market liquidity and investor risk appetite has increased further, causing middle-market loan spreads to tighten.

That said, we are seeing comparable middle-market spreads at 150 basis points wide of broadly syndicated loans and with significantly better structural protections. While we have seen pricing tighten, the current environment has presented opportunities for us to raise capital efficiently. Since year-end, we accessed three different capital market channels to raise nearly $600 million in new capital, including approximately $252 million of new common equity and $344 million of attractively priced long duration debt capital. Our new debt capital included a $200 million, 8-year secured revolving funding facility from Sumitomo Mitsui, attractively priced at LIBOR plus 2.125% with no LIBOR floor, and approximately $144 million in 10-year 7% unsecured notes.

In addition to this new debt capital, we also extended by one year the reinvestment period and maturity date of our revolving funding facility with Wells Fargo, as well as reduced the stated interest rate on that facility by 25 basis points to LIBOR plus 2.5% with no LIBOR floor. Pro forma for this first quarter capital-raising activity, our available debt capacity would have increased to approximately $1 billion at year-end, positioning us well to execute on our backlog pipeline and future investment opportunities as they arise.

Given the speed with which news and capital flow these days, market windows can open and shut very quickly. We constantly evaluate the quality of these windows, both as an investor and issuer of capital. We leverage Ares' broad market view to inform not only our investment decisions and portfolio composition, but also our capital raising strategy. In markets like these, it is important as ever that we utilize all of our competitive advantages to drive asset selectivity, namely our broad and direct origination capabilities, significant scale, flexible capital offering and synergies derived from the broader Ares platform. And now more than ever, it is critical to remain highly disciplined on the underwriting and investment side.

To that end, we continue to focus primarily on senior secured loan opportunities where we can leverage the knowledge of the entire Ares platform, and where we can serve as the lead investor or agent in the transaction. As we've talked about before, this lead status allows to us perform more direct intensive up front due diligence, structure the terms of the investment and assume a more active role in the credit post closing. And ultimately, we believe that this approach leads to lower defaults and higher recoveries on defaulted loans, and positions us for incremental opportunities for well-performing companies.

I would now like to turn the call over to Penni for more detailed comments on our fourth quarter and fiscal year 2011 financial results. Penni?

Thanks, Mike. For those viewing the earnings presentation posted on our website, please turn to slide three, which highlights our financial and portfolio performance information. As Mike mentioned, our basic and diluted core earnings were $0.48 per share for the fourth quarter 2011, a $0.05 per share increase over core EPS of $0.43 per share for the third quarter, and $0.06 per share higher than the same quarter a year ago. The $0.05 per share increase in our fourth quarter earnings per share over the third quarter was primarily driven by the net growth in our earning assets, increases in our weighted average investment spread and higher structuring fee income.

On that latter point, our structuring fees as a percent of our gross commitments increased compared to the third quarter, partially due to the increase in co-investments through the SSLP, where we earn a greater percentage of structuring fee income on such co-investments. As we have stated in the past, our structuring fees vary from quarter to quarter, based on investment activity levels and mix.

For the year, we reported core earnings per share of $1.56 in 2011, compared to $1.43 in 2010 excluding $0.02 and $0.11 per share, respectively, in professional fees and other costs related to the Allied acquisition. During the fourth quarter, we made gross commitments totaling $853 million, as compared to gross commitments of approximately $1.4 billion during the third quarter. As we exited commitments of approximately $688 million in the fourth quarter, which included the termination of an unfunded commitment of $100 million, resulting in net commitments of $165 million.

Net fundings actually increased quarter-to-quarter, from approximately $207 million in the third quarter to about $297 million in the fourth quarter. Accordingly, our total investments at fair value increased from $4.8 billion at September 30, 2011 to $5.1 billion at December 31. For the full year, we made gross commitments of $3.7 [billion] with net commitments of $1.1 billion. On a funded basis, we had gross fundings of $3.2 billion, and net fundings of $0.8 billion, which drove an 18% increase in our total investment portfolio during 2011. The level of exits and repayments in 2011 was driven by continued proactive rotation of the Allied portfolio, the highly liquid market during the first quarter of 2011, and our more focused syndication strategy during the second half of the year.

Our net investment income during the fourth quarter decreased to $0.45 per share, compared to $0.48 per share in the third quarter, and increased compared to $0.32 per share in the fourth quarter of 2010. GAAP net income for the fourth quarter was $0.58 per share, an increase compared to $0.20 per share for the third quarter, but a decrease compared to $0.79 per share for the fourth quarter of 2010. For the full year, we reported 2011 GAAP net income per share of $1.56, compared to $3.91 in 2010. Our 2010 GAAP net income per share included the gain on the Allied acquisition of $1.10 per share, and a significant rebound in investment values as compared to 2009.

Our net investment income and GAAP net income per share for the fourth quarter of 2011 were reduced by an increase in the GAAP accrual for capital gain incentive fees of $0.02 per share. For the full year, our capital gain incentive fee accruals totaled $0.16 per share in 2011, compared to $0.09 in 2010. These amounts directly reduce our net investment income and GAAP net income per share, but are excluded from the core earnings per share.

As a reminder, the cumulative GAAP accrual for the capital gains incentive fee represents the amount that would be payable if we liquidated our entire portfolio at its most recent fair value, but it does not represent amounts currently payable to our investment advisor under our Investment Advisory and Management Agreement. No amounts are currently due under the agreement, regardless of the amounts we accrued, because only realized gains and realized and unrealized losses, and not unrealized gains are counted towards the capital gains portions of this incentive fee.

As of the fourth quarter, the cumulative deficit of realized gains, compared to unrealized and realized losses, was approximately $63 million. Net realized and unrealized gains for the fourth quarter were $0.13 per share, compared to a net realized and unrealized loss of $0.28 per share in the third quarter, and net realized and unrealized gains of $0.47 per share for the fourth quarter a year ago.

For the full year, net realized and unrealized gains were $0.18 per share, and included $0.38 per share in net realized gains, partially offset by $0.20 per share in net unrealized losses, which included the reversal of net unrealized appreciation of $0.10 per share on the net realized gains.

For the full year 2010, net realized and unrealized gains were $1.59 per share, and included $0.28 per share in net realized gains, and $1.31 per share in net unrealized gains, which included the reversal of net unrealized appreciation of $0.09 per share on the net realized gains. At December 31, 2011, our total assets were $5.4 billion, and our total stockholders equity was $3.1 billion, representing an NAV per share of $15.34. During 2011, our investment portfolio grew to approximately $5.1 billion at fair value, and included 141 portfolio companies at year end.

The majority of our portfolio companies continue to be in senior secured debt, and at quarter-end, our portfolio at fair value was approximately 52% in senior secured debt investments, and 21% 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.

Now, let me highlight the changes in our yields and investment spread for the quarter. From the yields standpoint, our weighted average yield on debt and income producing securities at amortized cost increased from 11.9% to 12.1% quarter-over-quarter, reflecting primarily higher yields on new investments funded during the fourth quarter, as well as lower yields on investments exited. Our weighted average stated interest rate on the debt capital decreased slightly from approximately 5% to 4.8% quarter-over-quarter, as we financed our net investment growth with our lower cost revolving credit facilities. As a result of the changes in yield and stated interest on debt capital, our weighted average investment spread increased from 6.9% to 7.3% quarter-over-quarter.

The weighted average stated interest rate on our debt at December 31 reflects a slightly higher weighting toward unsecured fixed rate debt, which carries a higher stated interest rate compared to our floating-rate debt. The asset and liability interest rate sensitivity included in our 10-K as of the end of the fourth quarter, demonstrates how our net income could potentially benefit from increases in interest rates.

We continue to seek to diversify our funding sources through a combination of lower cost floating-rate secured financing, and higher cost fixed rate unsecured debt with medium to long durations. We believe this allows us to maximize diversification, flexibility and duration at a reasonable cost. As Mike stated earlier, our new eight-year, $200 million revolving funding facility carries a spread of 2.125% over LIBOR with no floor. We matched this facility with new 10-year unsecured notes with a fixed rate of 7%. Therefore, the two new debt facilities combined, assuming the Sumitomo facility was fully funded, have a blended interest rate of approximately 4.5%.

Now, turning to slide six, you will find our fixed and floating rate assets and our nonaccrual statistics. Overall, our floating rate debt assets on a combined portfolio basis at fair value increased from 64.6% in the third quarter to 67.5%, and our fixed rate debt assets declined from 21.2% to 19.8% over the same period, reflecting our continued emphasis on investing in senior floating-rate assets many of which have LIBOR floors. At the end of the fourth quarter, 64% of our floating-rate assets had LIBOR floors, and 31% of the floating-rate investments were in the subordinated certificates of the SSLP. All of the underlying senior secured loans made through the SSLP at December 31, 2011 carried LIBOR floors.

As to credit quality, we believe our portfolio is stable and remained healthy during the fourth quarter. Core ARCC portfolio nonaccruals, as a percentage of the combined portfolio, were relatively unchanged from 1.4% and 0.4%, at cost and fair value respectively, at the end of the third quarter as compared to 1.5% and 0.3% respectively at the end of the fourth quarter. We experienced one new nonaccrual investment offset by the exit of another nonaccrual investment within our core ARCC portfolio. The legacy Allied portfolio's nonaccruals, as a percentage of the combined portfolios, decreased from 2.6% at cost and 1.2% at fair value, to 1.8% at cost and 0.6% at fair value.

During the fourth quarter, we incurred no new nonaccrual investments and exited three nonaccrual investments within the legacy Allied portfolio. Therefore, the combined portfolio's total nonaccruals declined quarter-over-quarter, from 4.6 -- 4% at cost and 1.6% at fair value, to 3.3% at cost and 0.9% at fair value at year end. In the aggregate, we reduced our nonaccruing investments in both percentage terms and in number of companies.

Now, let's turn to slide 11 for a discussion of our debt capital. As of December 31, we had approximately $2.6 billion in committed debt facilities in approximately $2.2 billion aggregate principle amount of indebtedness outstanding. The weighted average maturity of our outstanding indebtedness was 9.3 years, with a weighted average stated interest rate of about 4.8%. In total, we had approximately $405 million in available debt capacity, subject to borrowing based on leverage restrictions, plus $109 million in unrestricted cash available. At December 31, our debt-to-equity ratio was 0.66 times, and our debt-to-equity ratio net of available cash was 0.62 times.

Since year end, we increased our revolving funding capacity by $200 million, following the closing of the SMBC facility and extended the reinvestment period and maturity date, and reduced the interest rate on the Wells revolving funding facility. We also issued approximately $144 million in fixed rate notes and raised approximately $252 in million net proceeds from a common equity issuance. We used the net proceeds of the fixed rate notes issuance and equity issuance to repay outstanding borrowings under our revolving credit facilities. Pro forma for these activities, using our December 31 balance sheet, we would have had available debt capacity of approximately $1 billion at December 31, a weighted average maturity on our indebtedness of approximately 11 years, and debt-to-equity ratio of 0.53 times.

Our first quarter dividend of $0.37 per share will be payable on March 30 to stockholders of record on March 15. Since our IPO in October of 2004, we have paid or declared cumulative dividends per share of $11.23, including our first quarter 2012 declared dividend. For more details on the financial results, I refer you to our Form 10-K that filed with the SEC this morning. Now I will turn the call back over to Mike.

Great. Thanks, Penni. Now, I would like to discuss our recent investment activity, update you on our portfolio and highlight our post quarter end investments in backlog and pipeline before concluding. If everybody could turn to slide 14, you will see that in the fourth quarter we made 18 commitments totaling approximately $853 million. Five to new portfolio companies, one to an existing portfolio company and 12 additional companies made through the Senior Secured Loan Program, which included five to existing companies and seven to new companies.

Our fourth quarter investment activity reflected our strategy to leverage our larger scale and structuring capabilities to make attractive investments in larger, high quality borrowers during volatile market environments. For example, we let a $340 million senior secured facility for a leading discount grocery operator on the West Coast, utilizing syndication capabilities to reduce our commitment amount to $107 million at quarter end. Interestingly, this company was an existing investment in a fund managed by our portfolio company, Ivy Hill Asset Management, and our sourcing and consummation of this transaction is a perfect example of the strategic benefits that Ivy Hill Asset Management brings to ARCC.

We also led a $240 million senior secured facility to finance the acquisition of a former portfolio company of ours that is a leader in the student travel and supplemental education sector. Here, too, we syndicated $75 million of our exposure resulting in final investment of $165 million.

On slide 16, you'll see an update on our progress for the legacy Allied portfolio from April 1, 2010, the date on which we acquired Allied, through the end of the fourth quarter of 2011. On a fair value basis, the size of the total legacy Allied portfolio stood at $781 million at the end of the fourth quarter, or approximately 15% of our total investments at fair value, down from $1.8 billion, or approximately 45% of total investments on the April 1, 2010 acquisition date.

The reconciliation of the bottom of the slide highlights that we have actually received over $1.3 billion in cash from exits repayments of investments in the legacy Allied portfolio, including net realized gains of about $122 million and net unrealized depreciation of about $49 million, for a total net realized and unrealized gains of approximately $73 million. As a reminder, these total net realized and unrealized gains through the fourth quarter don't reflect the roughly $130 million noncash purchase accounting gain that we recorded on the acquired portfolio, reflecting the difference between the fair value of the investments at the time we acquired them and the purchase price we paid.

You can also see that we have made progress by significantly reducing both the nonaccrual investments and equity securities by 91% and 44%, respectively, at fair value since April 1, 2010. Our initiatives have substantially reduced lower yielding investments and increased the yield on the remaining portfolio. We have reduced the equity investments, primarily through the sale of several controlled portfolio companies. And we remain focused on reducing the lower yielding non-yielding assets acquired as part of the Allied acquisition, and we will continue to review strategic alternatives for the remaining equity investments.

Now, turning to slide 17. On a combined basis, the underlying portfolio company weighted averaged last dollar leverage remains steady at 4.3 times quarter-over-quarter. Our overall weighted average interest coverage improved slightly from 2.5 times to 2.6 times. At the end of the fourth quarter the underlying borrowers within the senior secured loan program had similar metrics, with a weighted average total net leverage multiple of 4.5 times and a weighted average total interest coverage ratio of 3 times.

On slide 18, you can see that we generally invested in larger companies with nearly $54 million weighted average EBITDA during the fourth quarter. The overall weighted average EBITDA of the companies in our combined portfolio increased from $41 million to approximately $45 million. At the end of the year, weighted average EBITDA for borrowers within the SSLP was approximately $45 million.

Dipping to slide 20, you will see that the portfolio remains well diversified by issuer. While our largest investment at quarter end continued to be in the Senior Secured Loan Program, which was approximately 21% of the portfolio at fair value, the program is supported by investments in 32 separate borrowers. The program continued to have no nonaccrual investments as of December 31. The largest single borrower in the program represented about 6% of the total aggregate principle amount of loans outstanding under the program and approximately 4% of the program's available capital of $7.7 billion. Excluding SSLP, our remaining largest 14 investments totaled approximately 33% at the end of the fourth quarter.

Please turn to slide 23 for a summary of the grades for the core ARCC and legacy Allied portfolios. On a combined basis, the portfolio experienced seven ratings upgrades and four ratings downgrades during the fourth quarter. In the aggregate, as of December 31, the weighted average grade of the entire portfolio remains stable compared to the third quarter with a three rating.

Our historical focus on lending to market leading, growing and high margin companies in defensively positioned industries continues to bear fruit. Despite the slow growth economy, our combined portfolio company weighted average revenue and EBITDA growth remains strong at approximately 9% and 14% respectively, and a comparable basis for the year-to-date period in 2011 versus the same period in 2010. These growth rates are comparable to the 10% and 12% growth rates that we reported on our last call for our underlying portfolio company revenues and EBITDA.

On slides 25 and 26, you will find our recent investment activity since January 1, 2012 and our current backlog and pipeline. As of February 24, we had made additional new commitments for approximately $190 million, of which $146 million were funded since December 31. Of these new commitments, 85% were in first lien senior secured debt and 15% were investments in subordinated certificates of the SSLP. The proceeds of which were used to fund co-investments with GE in senior secured floating-rate loans.

The weighted average yield of debt and income producing securities funded during the period at amortized costs was 10.3%. We may seek to syndicate a portion of these commitments to third parties, although there can be no assurance that we will do so. Also from January 1 to February 24, we exited $226 million of investment commitments, of which 97% were in first lien senior debt and 3% were in equity and other securities. The weighted average yield of debt and income producing securities exited or repaid an amortized cost of 7.6%, was substantially lower than our new investment commitments, and on these exits we recognized $7 million in net realized losses in total.

As shown on slide 26, as of February 24, 2012 our total investment backlog and pipeline stood at $280 million and $700 million, respectively. While the size of our pipeline in particular has increased since our last call, the recent market trends I outlined earlier could impact our ultimate execution. And as always, we can't assure you that we will make any of these investments or that we will syndicate a portion of any of these in investments that we do make.

Now, I would like to conclude with a few thoughts on fourth quarter and full year accomplishments as well as outlook as we progress further into 2012. In 2011, we recorded our strongest year of core earnings since our IPO in 2004. We also reported another year of positive net realized gains, making 2011 our sixth year to do so out of the last seven years. In addition, since our IPO in October of 2004, our cumulative realized gains in our investments have exceeded our cumulative realized losses on investments through the end of 2011 by roughly $147 million. We believe that our investment track record illustrates the benefits we received from the depth of origination, underwriting and portfolio management infrastructure, and the market insight and resources that we draw upon across the Ares platform.

We believe that our balance sheet is extremely well positioned, as we spent most of the last year extending debt maturities primarily by accessing attractively priced fixed rate unsecured capital. And as I mentioned earlier, we now have significant available debt capacity to make new investments. We expanded our investment portfolio, primarily with additional senior debt, while reducing our equity exposure and improved our overall credit quality by reducing nonaccrual investments. Despite the sluggish economy, we believe that the quality of our investment portfolio is reflected by the solid growth in revenue and EBITDA of our portfolio companies.

Although we remain focused on reducing the remaining low or non-yielding assets acquired in the Allied acquisition, we believe that the significant majority of our stated rotation strategy has been completed. And while the financial benefits from the Allied acquisition could be clearly seen in our results, we believe that it has also provided significant strategic benefits in the form of increased scale and strengthened competitive position.

As for the market environment in 2012 and beyond, we continue to believe that a compelling long-term opportunity remains for non bank capital providers. On the supply side, we expect capital to be constrained by increased bank regulations and stricter capital requirements, a weakened competitive environment as non banks struggle to obtain sufficient and cost-effective capital, and the expiration of reinvestment periods among outstanding CLO vehicles.

The significant amount of uninvested private equity capital seeking transaction financing, as well as the need to refinance the still significant amount of maturing debt for leveraged issuers is expected to drive ongoing demand. And as these trends play out, we see attractive risk adjusted lending opportunities arising in many sectors are the middle-market that are no longer effectively served by regional banks and other traditional providers.

To capitalize on these opportunities, we continue to review the addition of other investment professionals with unique industry and product expertise. As an example, we added a team of experienced professionals during 2011 to target investments in the power generation and energy space, and we continue to review the addition of other specialists in niche asset classes within private debt.

As for the immediate outlook, we are entering into a tighter pricing environment as improved investor confidence, low interest rates and central bank policy decisions drive liquidity, similar to what we experienced in the first quarter of 2011. Accordingly, we plan to continue to leverage what we believe are our competitive advantages to invest only in the highest quality companies available to us, and to remain selective and disciplined with our investment capital. As we all know, the market environment can change rapidly as our capital markets are increasingly sensitive to global events, and we remain patient and vigilant as we wait for opportunistic market windows to open.

Operator, we would now like to open the line for Q&A, please.

(Operator Instructions). Our first question from John Hecht at JMP Securities.

Good morning, guys, and thanks for taking my questions. First, just trying to characterize Mike's opinion on the market. Now, you mentioned a lot about the overhang -- excuse me, the private equity capital that has yet to be deployed, and the winding down of the CLL markets. You've also referred to the tight -- the tightening environment over the past couple of months and flows of the high yield. If things were to stabilize right here, how you would you characterize 2012 versus 2011, both in terms of spreads and supply of opportunity?

I would characterize it as stable as attractive. What we are trying to convey, and we had a similar dialogue on our first quarter conference call last year, is you have to think about our business in terms of long-term trends driving the investment opportunity, and then short-term trends that are being driven by what we referred to as the rapid flow of news and capital. One of the things that we think we have that others don't is a very broad global view as to how funds are flowing, where investors are putting their money, looking for risk adjusted return, and having that insight allows us to be very prudent raisers of capital but also know when good times to be in the market are.

What you will notice over the course of any given year, 2011 being the perfect example, is we will be in and out of the market raising capital and investing capital. We are rarely completely out of the market, but you will see us change the asset classes that we are targeting, sometimes the nature of the borrowers that we are targeting and also just the zeal with which we are in the market investing.

So when I look at where we are now, we are not overly concerned. We are still seeing, as demonstrated by our backlog and pipeline, a number of very attractive investment opportunities. We still see a very favorable capital raising backdrop, which will drive growth and hopefully net interest margin expansion for the Company, but when you see this type of rapid spread tightening and this amount of liquidity pouring into the liquid capital markets, you have to take pause.

And again, 2011 is the perfect example where our comments were almost verbatim the same and by the time we got to May of 2011, the market environment changed pretty dramatically and positioned us to have an incredible opportunity in Q3 and Q4. So, I think if it stays where it is, we will continue to be cautious and prudent. We are finding plenty of things to do but probably not going to be as aggressive as we otherwise could be.

Okay, great. Thanks for the color. Second question is can you characterize the backlog and pipeline? You know, the terms, the type of loan and the industries, is there any meaningful shift there?

There is no meaningful shift. When you look at the composition of the backlog and pipeline, it looks a lot like our historical investment backlogs and pipelines and the existing portfolio, both in terms of the industries we are going after as well as the risk adjusted return profile.

Thanks for answering my questions and congratulations on a successful 2011.

Thanks, John.

The next question from Arren Cyganovich at Evercore.

Thank you. The credit quality in the portfolio improved somewhat this quarter. Could you talk a little bit about -- it looks like there was one new nonaccrual and four that came off. Were the four that came off sold or were they restructured? How did those go through?

The one new investment is a company called Pillar Processing, which is a mortgage foreclosure processing company. There were both industry and company specific issues that caused us to need to restructure and try to move on from that investment, and that had about $19 million at cost. The name that came off was an investment in a company called Direct Buy, which we sold in the quarter, and then we also had an investment in a company called [HB and G], which is probably one of our oldest portfolio investments that we eventually sold as well.

Okay. Thanks. And also, maybe you could talk a little bit about the amount of refi activity versus M&A in the pipeline, and how that is kind of shaping up for your -- for your upcoming quarters?

Yes, it is a good mix. You know, if you go back to some of the comments that we had in terms of the fourth quarter activity, you will see a healthy blend of existing portfolio companies that are either executing on refinancings or M&A deals, and then what we would call new issue M&A trends. When I look at our stated backlog and pipeline of close to $1 billion, it as very similar mix of new issue and existing portfolio company deals.

There are very few opportunistic refinancings in the backlog and pipeline. I think we talked about this on past calls as well. Unlike in the liquid markets where when you see an oversupply of capital and an undersupply of new issue, there is a lot of opportunistic refinancing. You see some of that in the middle-market, but again, it is much slower to react. So a lot of the activity that we are seeing within the existing portfolio is actually change of control M&A sponsor to sponsor, which speaks a little bit to the trend of the demand driver from unutilized private equity capital.

Okay, and one last quick one. The dividend income that's been elevated the last two quarters, would you characterize that as normal recurring dividend from the portfolio, or would you characterize some of that as nonrecurring?

This is Penni. There are -- there is one significant preferred instrument that came into the portfolio two quarters ago for about $130 million that is coming through as dividend income, so you should characterize that as more recurring. And then there is just other dividend income that may not be as consistent or recurring in that bucket as well.

Great. Thank you very much.

Thank you.

Our next question from John Stilmar at SunTrust.

Good morning, guys. Just real quickly, and I know this might be a little bit of a technical question, but as I think about the originations and the mix of in between core Ares originations and those through the Senior Secured Loan Program, I'm wondering how we should be thinking about the ratio of those two, and what's forming my opinion is the basket ratio, and you guys have been very conservative in your accounting with regards to that basket ratio and wondering if we should be thinking about that as a guidepost for kind of like a three to one, if you will, core Ares originations relative to the Senior Secured Loan Program as we look out in 2012?

I would just maybe it is semantics. I wouldn't refer to it as a guide post, so much as I would refer to it as a governor. For those who don't know what John is talking about, if you look at the disclosures in the 10-K, we've adopted a conservative position by treating our subordinated certificates as a non-qualifying asset. So long as we continue with that position, which we frankly disagree with, there would be a natural governor on how big the program could grow as a percentage of our total assets.

But hopefully what is not lost on people, when you look at the new originations last quarter and you look at the backlog and pipeline there is no perfect mix, but we continue to originate a significant amount of on balance sheet senior secured (Inaudible) mezzanine investments that support the growth of the non-qualifying asset basket. Though it is something that we are obviously focused on, John, but I think the good news is, given the breadth of the platform, it's proved to be very manageable.

I'm sure it is, but should we think about it as three-to-one or four-to-one, or maybe a relative ratio as you look forward, or us trying to put too much level (Multiple Speakers) into the business.

Yes, again, to put a guard rail around it, I think given the -- if we continue to treat it as a non-qualifying asset, given some of the other investments that we have, seeing the program cap out between 20% to 25% of our assets is probably likely.

Okay, great. Then in terms of -- you talked -- the themes have remained consistent now for several quarters about the long-term trends and short-term trends and the opportunities of Ares to capitalize on both. I guess my question is, from where you have sat over the past three to four quarters, what has been the biggest surprise for you?

It seems like this market, both on a tactical basis and the eventual trends -- especially the comments coming out of JPMorgan today -- only reiterate these themes. As I sit here hearing some of these themes be reiterated, what has been the area that's been the biggest surprise for you over the past three or so quarters, and thank you for letting me ask my questions.

Thanks, John. I don't think there has been anything that quote unquote surprised us. I would just simply say I think we find it remarkable how short institutional memories can sometimes be in the capital markets, and also find a remarkable, frankly, how quickly the markets react to small pieces of good news and bad news. And the volatility that that obviously creates.

Part of what we are spending all our time thinking about is sifting through the noise to identify the long-term trend and that is not always easy, it is not always perfect, but that is how we have to go about managing the business, both in terms of the assets and the liabilities. So nothing has surprised us, per se, and I think that we have been well prepared to access market windows, both as an investor and a capital raiser when they open, but it is quite remarkable how quickly things can change and how surprised, frankly, other people are when they move that quickly.

Thank you.

The next question comes from Greg Mason at Stifel Nicolaus.

Great. Good morning. Could you talk a little bit about the SSLP, compared to your are current -- your on balance sheet portfolio? As you said 4.5 times leverage through our current portfolio, as well as the Senior Secured Loan Program, yet the coupons you get on your on balance sheet investments are 12.5% versus call it 16% plus for the Senior Secured Loan Program. It has kind of been our perception that the markets, the interest rates tell you the perceived credit risk with those investments. So can you discuss your thoughts on the credit risk of your investments in the SSLP versus your on balance sheet portfolio?

I think, as you highlighted, they are extremely similar. You know, the issuer size is in the mid $40 million range, the weighted average leverage is in the 4.3 to 4.5 times range. The interest coverage is in the 2.5 to 3 times range. So there is a surprising amount of consistency between the type of borrower that is accessing the senior secured loan program versus accessing the balance sheet. I think as people have understood from past calls, effectively the Senior Secured Loan Program was a vehicle designed for GE and Ares to invest in unitranches in a way that we had historically co-invested in the market, investing alongside each other either as partners on senior debt and unitranches, or partners in traditional senior secured and mezzanine investments.

While we obviously look at the program as a separate program, it really shouldn't by thought of differently or having a different strategy, but for the fact it's investing in unitranches alongside GE versus unitranches on balance sheets. So when you look at the 12.5%, that's a combination of the ROEs that we are generating on the sub certificates out of SSLP, and it's a combination of all of the balance sheet assets that we've accumulated that's a combination of first lien, second lien and mezzanine debt.

The other thing I would add, and I think that it speaks a little bit to our competitive positioning, I continue to believe that we are getting premium pricing on SSLP transactions because of the certainty of close that that product can provide an issuer, and that leads to some of the slightly higher returns on the sub certs relative to what you may be comping to a traditional market -- market deal. When you look at market environments like Q3 and Q4, where investment banks are not taking meaningful balance sheet risk, the ability for the Senior Secured Loan Program either alone, or in concert with the balance sheet, to come in and provide a $300 million or $400 million buy and hold commands a pretty significant premium, both in terms of upfront fee and spread, and obviously that excess premium inures to the benefit of our sub cert investment.

Great. One question on the dividend. Obviously with $0.77 of spillover, you have pretty dramatic leeway with what you can do with the dividend. So what are your thoughts in terms of long-term dividend level expectations relative to core EPS? Just what is your philosophy on the dividend going forward?

Sure. We have been asked the question before, and the answer is always the same, which is we think it is imperative that we can pay our dividend out of core earnings per share. And when you look at our history back to the IPO, you will notice that is actually what we have done. When you look at the amount of core earnings capacity within the business, given the structure of our balance sheet, and you look at our competitive positioning, we continue to believe that there is catalyst for further earnings growth.

In terms of the dividend, obviously once we feel that we are achieving a new level of sustainable core earnings, that is when we start to have conversations about dividend increases. You will notice, obviously, in this quarter the increase of the dividend from $0.36 to $0.37 came with a meaningful increase in core earnings, and so we are constantly looking forward at what we think the sustainable earnings level for the business is, measured against the risk of increasing the dividend, if you will, from a liquidity standpoint and just making extra sure that we are covered.

And I think that has been our consistent philosophy since the day that we went public, and we continue to think of the world that way. In terms of the spillover, we are obviously thrilled we are spilling over $0.70 into 2012, which is more than two quarters of our current dividend. We view that as, obviously, cushion for the business, but you that is just one thing that factors into our decision to raise or not raise the dividend, but were it just a one time spillover and we didn't feel there was a sustainable level of earnings to support the dividend level, we would not look at that spillover as supporting a dividend increase in and of itself.

Great. Thanks, Mike.

The next question comes from Joel Houck at Wells Fargo.

Thanks, and good morning. Sticking with the theme on SSLP, if you look at the environment, I don't know if you could characterize it as more normal this year, but to the extent it gets more competitive, what is your current outlook on structuring fees, particularly as it relates to SSLP and its approaching investment capacity?

You know, it is interesting, in the fourth quarter we actually saw structuring fees in pockets of the market going up in response to spread tightening. And when you look at the history of the Company as well as the history of the middle market, there has been a fairly consistent B-level between 2% and 3%. When the market dislocates we have actually seen the ability to generate incremental fee income in the 4% to 4% plus range, and in things like a grocery outlet -- which we discussed earlier in the call -- where we are providing meaningful underwriting and distribution solutions to people we get paid incremental fees over and above what a traditional market participant would be.

Any time you see a huge amount of liquidity coming into the market, you should expect a little bit of pressure on upfront fees, but there has always been kind of a natural floor on fees in the 2% range, and when you look at it quarter-over-quarter, there has been a surprising consistency in the 2.5% to 3% range. I don't expect a lot of tightening in fees. I do expect at the upper end of our market, if the liquid bank loan market and high yield market continue to exhibit the kind of froth that they are exhibiting now, that that would translate into tighter spreads. Then the question for us is whether or not we want to participate in that market environment because we think it is sustaining, or we feel that there is a little bit of a bubble, and we will wait it out like we did in the first quarter of last year.

Okay. Good, and then maybe to follow along that theme. So, to the extent we got in that environment and you decided well, it wasn't -- you were going to participate at a lower pace given longer term economic returns, that could potentially enter into some volatility with the fees. How do you look at that, with respect to -- I think this ties into Greg's question about setting the dividend -- and if you got into a six month period where things were [tighter] on the fee side, would you consider using the spillover as opposed to adjusting it during a -- more of a --

I would encourage all of you too take a look at our core earnings per share, excluding structuring fees and I'd also encourage people to look at structuring fee and other fee income on an average basis across the history of the Company. What is amazing about this business model is that, while you see increased fees in response to increased market activity, there is always a baseline of activity.

One of the things that hopefully isn't lost on people, when you look at the amount of activity that's resonant in the existing portfolio, we are investing in good high free cash flow companies that are growing. They naturally delever, and then either transact or relever. When you look at the amount of deal flow that comes out of the existing portfolio, it has averaged between 20% and 30% of our flow. There is a recurring natural baseline of business that occurs across the cycle.

One metric that I -- why I encourage you guys to look at it they that we are very focused on, is what is our core earnings per share just from the spread book, excluding structuring fees and quarter-over-quarter, that number continues to grow, and ultimately you want that number to grow and support dividend growth as well.

One of the reasons why the dividend is set at the level it is against much higher core earnings per share, is to your point, Joel, prudence against the potential for market volatility. But at the level that we currently set it against what we think the benefits to our existing portfolio and competitive position are we don't view that level as either unsustainable or in jeopardy.

Alright, thanks. And again, very good 2011.

Alright, thanks, Joel.

The next question from Rick Shane at JPMorgan.

Thanks, guys. A couple of quick questions, One is, and I apologize, I screwed up my notes here, the $100 million of unfunded investment commitments that were exited, was that in the fourth quarter, or was that in the up to February 24 period?

That was in the fourth quarter.

Okay. Great. Looking at the $226 million of investment commitments you exited post quarter, the yield on an amortized cost basis is relatively low, about 7.6%. Is that a function of there was stuff in that [cohort] that was nonaccruing, or is there something there just in terms of vintage why it is much lower yielding versus the rest of the portfolio?

Rick, it's Penni. It's just really the nature of the assets. They were more senior assets in nature, thus the lower yield relative to the higher yield of the new loans going on the books at 10%.

Got it. And is there anything we should -- we can conclude, in terms of vintage, because obviously now on the more senior stuff, you are getting better than a 7.6% yield. Is this just sort of pre-2008 vintage paper?

No, I wouldn't read into that. Again, one of -- sometimes we are investing in lower yielding senior and syndicating to the market, sometimes we are investing in unitranche and creating a first out or super senior piece. It is more that it is just traditional first lien very high up the balance sheet versus old vintage.

Got it. I want to make sure that I understood the last part of that comment fully. Does that mean there could have been parts of this that you retained a residual piece that is higher yielding then?

In theory, yes. Although I actually don't have the listings of the exits in front of me to confirm if that happened this quarter, but we can follow up with you offline if you would like.

Great. Thank you, guys.

So people know, we are coming up on noon, so I think we have time for one more question, and then, we apologize, but to the extent people have further questions we are happy to address them after the call. Operator, maybe we will take one more.

The last question from Fla Lewis at Weybosset Research.

Again, congratulations on a good year. I believe I heard you said you were say you were interested in making loans in the energy sector. Just like to know a little bit more are about that. What kind of loans -- what -- what are you seeing here that is of interest?

Sure, so we hired a team of investment professionals a little under a year ago. We have five people on that investment team now. Their core focus is on power generating assets, both in traditional power generation and renewable energy. These are not E&P loans, and oil and gas loans. This tends to be coal and gas-fired turbines, solar, et cetera. What we are seeing there, which is what we are seeing in all sorts of other corners of the middle-market economy, is that again based on changing risk appetites at banks or are changing regulatory capital requirements, assets that used to be attractive or generating attractive ROEs for banks are no longer areas of focus. Power gen and infrastructure being one of them.

People know, or don't on the call, European banks were historically some of the largest funders of capital, predominantly senior capital, into those asset classes, and given everything that is going on in the European bank landscape, there has been a pretty significant exit out of that asset class. And while we are not moving in to fill exactly where they were playing, it is obviously created a widening of spread, a dearth of capital, and therefore, for the right investments, a pretty attractive risk (Inaudible) return investment opportunity for us.

Makes sense to me. Thank you.

Thank you. We appreciate everybody's time today. As always, we are grateful for your support and loyalty, and we look forward to talking to you all next quarter.

Ladies and gentlemen, that does conclude our conference call for today. If you missed any part of today's call an archived replay of the conference call will be available approximately one hour after the end of this call, through March 12, 2012, to domestic callers by dialing 1-877-344-7529, and international callers by dialing 1-412-317-0088. For all replays, please reference account number 10008893. An archived replay will also be available on a webcast link located on the home page of the Investor Resources section of our website. Thank you, you may now disconnect.