Ares Capital Corp (ARCC) 2014 Q1 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, May 6, 2014.

Comments made during the course of this conference call and web cast and the accompanying documents contain forward-looking statements and are subject to risks and uncertainties.

Many of these forward-looking statements can be identified by the use of the words such as anticipates, believes, expects, intends, will, should, may and similar expressions.

The company's actual results could differ materially from those expressed in such forward-looking statements, for any reason, including those listed in its SEC filings. Ares Capital Corporation assumes no obligation to update any such forward-looking statements. Please also note the 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 is the net per share increase or decrease in stockholders' equity resulting from operations less realized and unrealized gains and losses, any incentive fees attributable such realized and unrealized gains and losses and any income tax related to such realized gains.

A reconciliation of Core EPS to the net per share increase or decrease in stockholders' equity resulting from operations, the most directly comparable GAAP financial measure, can be found in the accompanying slide presentation for this call by going to the company's web site at www.AresCapitalCorp.com, and clicking on the Q1 2014 earnings presentation link on the home page of the Investor Resources section of the web site.

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.

As a reminder the company's first quarter 2014 earnings presentation is available on the company's web site at www.AresCapitalCorp.comby clicking on the Q1 2014 earnings presentation link on the home page of the investor resources section. Ares Capital Corporation's earning release and 10-Q are also available on the company's web site.

I will now turn the call over toMr. Michael Arougheti, Ares Capital Corporation's Chief Executive Officer.

Great. Thank you, Operator. Good afternoon to everyone and thanks for joining us. For today's call I'll begin with some quick highlights on the first quarterbefore turning the call over to our President, Kipp deVeer, who will update everyone our investment activity and views on the current market.

Penni Roll, our CFO, will then walk through our Q1 results and financial position in greater detail. Kipp will then wrap up the call with some comments on our portfolio performance and recent investment activity before we take questions.

Before we begin I wanted to update everyone on an exciting development involving the parent company of Ares Capital's investment advisor. Last week, Ares Management LP priced its IPO on the New York Stock Exchange raising approximately $216 million in gross proceeds for general corporate purposes and to support growth initiatives.

Following its IPO,Ares management employees retained ownership of more than 70% of the Company, with a public acquiring approximate 5% ownership stake.

We strongly believe that this transaction is a positive for the future of Ares Capital as the continued growth of Ares Management will enhance its ability to attract and retain professional talent, strengthen the Ares platform and provide Ares Capital with a broader array of information, services and investment advantages.

Moving to ARCC's first quarter results we reported core and GAAP earnings per share of $0.38 and $0.39,respectively, fully covering our regular quarterly dividend of $0.38 per share.

We also continued to generate net investment gains, which cumulatively have contributed to the meaningful amount of undistributed taxable income that we have available for future distribution. At the end of 2013, we estimated that we had approximately $0.82 per share of undistributed taxable income being carried over into 2014.

We believe that this undistributed income is a meaningful asset that helps contribute to the stability and predictability of our dividend. From a balance sheet perspective, we believe that we are very well positioned.

We ended the quarter with a modest net debt-to-equity ratio of .6 times and approximately $2.1 billion of available debt capacity under our credit facilities.

Let me now turn the call over to Kipp so that he can walk you through our investment activity and provide some detail on our views of the current market. Kipp?

Thanks, Mike. While the first quarter tends to be seasonably slow for originations, we made $852 million of new commitments across 24 investments in the first quarter.

Over half of these commitments were to new portfolio companies, which highlights the breadth and depth of our origination platform. We do continue to focus on senior secured debt opportunities with strong loan to value metrics, with an emphasis on conservatively structured high quality cycle durable businesses .

During the first quarter 82% of the new commitments were in first lean senior secured debt and 7% were in the subordinated certificates of the senior secured loan program. During the quarter we also saw $849 million of commitment exits [to] portfolio.

A portion of these exits came as a result of our continued rotation out of some lower yielding assets, a strategy that we discussed on our fourth quarter earnings call and one we continue to execute on. On a funded basis we funded new investments totaling $826 million and, after repayments, we had net fundings for the quarter of $169 million.

[Though] the first quarter saw lower net growth and investments, we were able to earn higher yields on our new investments compared to the yields on investments repaid or exited during the quarter.

Despite the spread compression over the last year and, again, through the end of the first quarter our net interest in dividend margins has remained strong at 8.4% compared to 8.7% a year ago.

In addition to the interest and dividend income earned from the portfolio, we also had net realized gains of approximately $12 million in the first quarter. Since the Company's IPO almost ten years ago, our realized gains have exceeded our realized losses in every year but one, which has allowed us to build cumulative net realized investment gains of approximately $270 million.

On the competitive front we continue to see tremendous investor interest in private credit and direct lending as an asset class. We find that yield is of significant interest to most global investors today in a world where fixed income investments of all types fail to provide returns that many investors are seeking.

Remarkably, up until three weeks ago, loan funds in the broadly syndicated loan market had seen a record 95 straight weeks of inflows from investors per Lipper. However, three weeks ago, the tide began to turn and we are now in our third consecutive week of outflows.

While we don't believe that three weeks of outflows necessarily indicates a significant change in investor appetite for loans, we have witnessed some encouraging push back from buyers of new issue loans in the broadly syndicated loan market.

Leveraged loan buyers are seeking better structures and or better pricing in certain transactions, which we have not seen for some time.

And while we are largely insulated from the more aggressive structures in the larger market, due to our focus in the mid market, some of the [frothiness] in the larger leveraged loan market has tried to make its way into the deals that we review, particularly for the larger companies that we work with.

If these outflows continue and the flex activity develops into a more lasting reality, we believe it will be of benefit to us as a Company. On the fourth quarter earnings call we discussed our strategy of continuing to broaden our origination reach into new areas where we believe the banking sector is reducing exposure.

We continue to feel there's an opportunity to build specialty industry teams to invest in these asset classes. And during the first quarter, we expanded our energy finance capabilities and hired a team in Dallas to focus on senior and subordinated debt financing opportunities in the oil and gas industry.

Additionally, we expanded our traditional middle market sponsored coverage effort by adding two senior investment professionals in Chicago, who we believe will enhance our deal flow in the mid markets, particularly on the smaller end of our target market.

We do continue to explore other specialty lending segments, that have been de emphasized by the banking sector, that we believe could be additive to the business. The strategy continues to favor the recruitment of established teams with significant industry experience and expertise in new and complimentary verticals.

I'll now turn the call over to Penni to highlight our first quarter financial results and to provide some details around our recent financing activities.

Thanks, Kipp. Good morning. Our basic and diluted core earnings were $0.38 per share for the first quarter of 2014, compared to $0.41 per share for the fourth quarter of 2013, and $0.38 per share in the first quarter of 2013.

The $0.03 per share decrease in our first quarter core earnings versus the fourth quarter of 2013 was primarily driven by lower structuring fees in the quarter.

During the first quarter, we benefited from $20 million in dividend income from our wholly owned portfolio company, Ivy Hill Asset Management. Half of this dividend was a regular quarterly different dividend from Ivy Hill and the other half was an additional dividend paid to ARCC in the first quarter, which was paid from Ivy Hill's accumulated undistributed earnings.

Our net realized and unrealized gains totaled $4.7 million or $0.01 per share for the first quarter, which included $12 million or $0.04 per share in net realized gains. GAAP net income for the first quarter of 2014 was $0.39 per share, compared to $0.47 per share for the fourth quarter of 2013, and $0.32 per share for the first quarter of 2013.

We made gross investment commitments totaling $852 million in the first quarter compared to gross investment commitments of $1.2 billion during the fourth quarter of 2013 and $414 million during the first quarter of 2013. We exited commitments of $849 million in the first quarter, resulting in net commitments for the quarter of $3 million.

Net fundings for the first quarter were $169 million, as compared to $256 million for the fourth quarter of 2013, and $129 million for the first quarter of 2013. As of March 31, 2014, our portfolio totaled $7.8 billion at fair value across 195 portfolio companies and we had total assets of $8.2 billion.

Our stockholders' equity was $4.9 billion, resulting in net asset value per share of $16.42. From a yield standpoint the weighted average yield on our debt and other income producing securities at amortized costs at March 31, 2014 was 10.2%, 20 basis points lower than at the end of 2013.

The weighted average yield on total investments on amortized cost at March 31, 2014 was 9.2%, also a 20 basis point decline since year end.

As of March 31st, we had approximately $5.2 billion in committed debt capital, consisting of approximately $3 billion of aggregate principle amount of [term] indebtedness outstanding and $2.2 billion in committed revolving credit facilities, which are subject to borrowing base and leverage restrictions.

Approximately 58% of our total committed debt capital and approximately 97% of our outstanding debt at quarter end was in fixed rate, long dated, unsecured term date. As of March 31, 2014, our debt-to-equity ratio was .62 times and our debt-to-equity ratio net of available cash of $117 million was .6 times.

As you know, earlier in the quarter we issued an additional $150 million of our five-year [four and seven eighths] senior unsecured notes due to a -- due to a favorable market demand, allowing us to issue these additional notes adding nearly a 3% premium for an effective coupon of 4.25%.

These notes continue to trade well in the aftermarket,yielding about 3.9% as of the end of last week. We've also continually -- continued to proactively extend the maturity of our revolving secured debt facilities.

During the first quarter we amended our revolving credit facility, extending the end of the revolving period and the stated maturity date each by one year to May 2018 and May 2019, respectively. As a part of the amendment five existing lenders increased their commitments to the facility by a total of $110 million, bringing total commitments to $1.17 billion.

As of March 31st, the weighted average duration of our outstanding liabilities was 7.6 years. We believe our long dated liability strategy provides operational flexibility and financial strength.

Given our heavy emphasis on longer dated, unsecured fixed rate funding, compared to our largely floating rate loan portfolio, we believe we are well positioned for rising interest rates whenever they may come. The weighted average stated interest rate on our [drawn] debt capital at quarter end increased slightly to 5.4% as compared to 5.3% at the end of the fourth quarter of 2013.

This increase resulted from a reduced level of borrowings under our lower cost secured revolving credit facilities at the end of the quarter, as we issued additional term debt. However, as we [fund] new investments, our [blending profit] of borrowing should decline as we access our significant revolving credit capacity.

If, at the end of the first quarter of 2014, we were to borrow all of the amounts available under on our revolving credit facilities our weighted average stated interest rate would be 4.1%, down from 4.2% at the end of 2013.

Finally, this morning we announced that we declared a second quarter dividend of $0.38 per share, payable on June 30th to stockholders of record on June 16, 2014. Now I would like to turn it back to Kipp to discuss the portfolio and recent investment activity.

Thanks, Penni. During the first quarter, our portfolio experienced stable credit metrics in the aggregate as the weighted average total net leverage for our corporate borrowers remained unchanged at 4.6 times and the weighted average interest coverage for our corporate borrowers also remained unchanged at 2.8 times.

At these levels we feel we have significant protection from a loan to value and cash flow coverage standpoint. Non accruals remained low, with 3.2% of the portfolio at cost, and 1.9% of the portfolio at fair value on non accrual at quarter end.

And the weighted average grade of our portfolio improved modestly since year end, ending the first quarter at [3.1], versus [3.0] at year end. The portfolio also continues to be well diversified.

Given the size of our balance sheet our average commitment is less than 1% of our assets and our largest single (inaudible) exposure, excluding the SSLP, is less than 4% of our portfolio at fair value. At quarter end the SSLP represented approximately 23.6% of the portfolio at fair value.

The SSLP is well diversified with 46 separate underlying borrowers at quarter end. And excluding the SSLP, the next largest 15 investments in the aggregate represented only 27.5% of the portfolio at fair value.

Let me finish with a quick update on our recent update activities since quarter end and our current backlog in pipeline. From April 1st through April 30th of 2014, we made new investment commitments of $303 million, $223 million of which were funded.

And of the $303 million of new commitments, 90% were floating rate, 9% were fixed rate and 1% were non interest bearing. The weighted average yield of debt and other income producing securities funded during this period at amortized cost was 8.6%.

Over the same period we exited $401 million of investment commitments, 98% of which were floating rate. About a quarter of these exits were from continued proactive rotation out of lower yielding assets. The weighted average yield of debt and other income producing securities exited or repaid during the period at amortized cost was 8.8%.

And net realized gains on these exits were approximately $3 million. As of April 30, 2014, our total investment backlog in pipeline stood at approximately $235 million and $475 million, respectively.

Of course, we can't assure you that any of these investments will close but we do feel like we're seeing a lot of good opportunities and we believe we are well positioned for growth. We plan to continue to use our broad origination platform to source and invest in what we view as the best franchise companies, with a view to maximizing risk-adjusted returns.

And with any luck, some of the recent changes in the market that we discussed earlier in the call will provide an opportunity to make additional attractive investments.

Finally, as we approach our ten year anniversary as a public Company we look back with great pride in the level of dividends and the meaningful value we have delivered to our shareholders during this time frame. And, as always, creating long term shareholder value will continue to be our focus going forward.

Thank you for your time, and for your continued support. Operator, we can now open the line for questions.

Thank you. (Operator Instructions). Our first question is John Hecht from Stephens. Please go ahead.

Good morning. Thanks very much for taking my questions. Real quick, with respect to the IHAM, the incremental dividend at IHAM. We've seen this off and on over the past few quarters.

I'm wondering can you tell us what the net fee income is per [Core] there relative to what you consider the $10 million average dividend payment you get from them? And what would be the strategy, going forward, with respect to taking incremental dividends?

Yes. We don't disclose the number but let me to try to, at least, provide you with some color, John. I appreciate the question on this. And as we mentioned on past earnings calls Ivy Hill has had quite a lot of success investing through the downturn.

Back in the fourth quarter they, in fact, exited a position and have done a refinancing of one of their funds that's continued to add to what we described as already significant undistributed taxable income there that's sitting with the Company as retained earnings.

So I'd say that our goal is that each quarter -- obviously, Ivy Hill, through its fees and the income it produces on assets, will generate more than enough, example, more than $10 million, to pay that $10 million quarterly. But we do look to the Company occasionally and assess its capital position.

And in the case of Ivy Hill as it relates to this quarter we saw some modest reduction, I think, in their growth expectation, in their need for capital, hand in hand with a pretty significant, again, excess retained earnings balance and thought it was a good time just to -- from a capital efficiency standpoint, obviously, take capital out of the Ivy Hill balance sheet.

And the obvious beneficiary of that is ARCC as a recipient of that special dividend.

That's great color. Thanks. Sorry? Oh, I thought you said something else.

Kipp you also had comments you might be seeing some green shoots as a result of the kind of erratic fund flows into fixed income. You said both structural and pricing relief. Can you quantify those? And where is the change in competitiveness coming from at this point?

We think it's a handful of factors. I think the broadly syndicated loan market -- the most obvious sources of inflows and outflows are, number one, retail and, obviously, number two CLOs. The CLO market in the US continues to be pretty -- pretty significant. It's growing.

But the change in retail flows, we think, is really what's contributed to the push back, generally speaking, from loan buyers over the last few weeks.

Some of the deals that we've seen [flex], just to quantify, it's been pushing back on structure a little bit, example, demanding slightly lower leverage, often at the expense of -- you'll upsize a [second lean] deal and downsize the first lean deal. The pricing impact we see is 50 basis points over the last couple weeks.

So if the deal went at [L-3] [75] it would flex to [L-4] [and a quarter] or something. And, generally speaking. So, look, we hope that -- we hope that that's continued influence on the middle market. Three weeks is only three weeks but seeing a 95 week series of inflows at least kind of stop is a good start.

Absolutely. And last question, the average investment or commitment size over the past few quarters has dropped a little bit. I'm wondering is that -- is that part strategic or part where you're seeing opportunity in the market? Or just part the way the wind is blowing at this point this time?

I think it's a little bit the wind blowing. We mentioned, obviously, that we've focused on some smaller companies. That being said, our core market really is always kind of $10 million of EBITDA at the bottom end up to $100 million at the top end.

And in most of those deals, with our size, we can, obviously, originate and own the entire capital structures in any of those transactions, which has always been the goal. So, I think, there's no attempt to be more diversified,I guess, to answer the question directly.

And if we're focused a little bit on smaller deals, which we have been, that, frankly, doesn't impact the commitment size. So unless I went through in detail, I don't think I would come up with anything else other than the wind blowing, to be honest.

Great. Thanks very much, guys.

Thanks, John.

Our next question is Terry Ma from Barclays. Please go ahead.

Hi. Good morning. So you guys have spoke about opportunistically selling lower yielding assets in the past. Can you maybe give us a sense of how much additional opportunity there is for you guys to do that, and how we should think about that playing out the rest of the year?

Look, this is -- Thanks for the question, Terry. This is one of the things that we looked at, obviously, with -- with yields coming down here over the last year, two years. This is a way that we could take more out of the existing portfolio.

It, obviously, does limit the growth a little bit for the near-term but we wanted to optimize the portfolio and get it right. We do think, on a go forward basis, there will be some room but a lot of the sales that we've gone through over Q4 and Q1, I think, has gotten us to a position that we feel very comfortable with the existing portfolio .

Okay. Great. And can you maybe just give us an update on the activity in your project finance -- your venture finance vertical so far this year?

Sure. We'll see if we can pull a couple of numbers. So far this year? You mean since January, specifically?

Right.

No change, example, both very busy and meaningful contributors to the Company. I'd say that both groups have really hit their stride in terms of having the Ares brand out in spaces that were new and have originated their fair share in each of their respective markets.

But -- sorry, Penni, do you want to -- do you have that number handy? Not sure we have it. Not sure. Not sure if we have the number cut exactly that way.

Right. We don't.

I don't think have we have it exactly that way. Maybe we can take that one offline, Terry.

Okay. Sure. And just one last thing. Do you have any thoughts on the analysis that was put up by the Congressional Budget Office on the impact of the H.R. 1800?

Yes. Hi, it's Mike. We do. We actually think it is somewhat flawed. For those that are familiar with how the CBO and joint tax score legislation, effectively, it is managed to a zero sum output.

And so part is if you have a piece of legislation that is deemed to be tax negative, then it would have to be paired with a piece of legislation that is tax generative. The crux of the scoring, as we read it, was really around the flow of investment dollars out of C Corps into flow through or pass through entities.

The reason I say that it's flawed is if you think about the way that H.R. 1800 works, the expectation would be that leverage within the BDC sector would increase.

Our view is that the primary source of that leverage increase would actually come from the banking sector, with no change in the investment dollars being allocated in this zero sum universe between C Corps and flow through entities.

So it's my very strong belief that if you have the same amount of dollars but they are flowing through BDC at higher ROEs, generating higher taxable income to the Treasury as well as interest income through the banking sector, and then financially into the coffers of the US Treasury as incremental tax income both at C Corp level for the bank and dividend tax level for the bank shareholders, I find it hard to [craft] a scenario where it's actually not tax generative.

I think the other major flaw in the argument, which I think people will understand as they go through it, the premise is that the loan would flow out of the bank into a BDC or other pass through entity. I think that the fundamental premise of H.R. 1800 is simply that the banks aren't making these loans to begin with.

And so it's not really a case of something flowing out of a C Corp into a pass through entity but, frankly, from one pass through entity in the private market to another pass through entity that could, or may, be a BDC. So there's a lot of detail that goes into that kind of economic and tax forecasting but I think there are a couple of underpinnings to that piece of analysis that probably could be revisited.

Okay. That's good color. Thanks a lot.

Our next question is Doug Mewhirter from SunTrust. Please go ahead.

Hi. Good afternoon. My first question, actually, going back to the congressional bill and proposing higher leverage. Given the market conditions and the higher refinance activity, the net originations across the industry seem to be flowing if you net out gross fundings and refinances.

Can the industry absorb that extra leverage? Is that -- do you think that would have an immediate impact? Do you at Ares have the capacity to put that theoretical extra money to work --

Yes, I think --

For a reasonable period of time?

I'll make two comments and I'll see if Kipp has anything to add.

I think that the -- one of the things that may not be coming through, when you look at, at least, Ares, is net origination numbers, is as we manage through the seasons and the cycle we are active in rotating the portfolio, actively selling assets, actively selling lower yielding assets.

Frankly, letting certain portfolio companies in the portfolio go if we are negative on their credit prospects. And so that number is not just the market taking a share of our portfolio and refinancing it. There's a lot of activity and work that goes into the exits piece of the net origination number.

But with regard to the bill, specifically, and we've tried to articulate this on prior calls, our expectation, were the bill to pass, is that the incremental leverage would allow us to move into other parts of the middle market lending landscape that we can't currently service on a cost-effective basis given the lower asset yields.

So there are parts of the traditional cash flow space, there are sections of the traditional asset base lending space that would offer meaningful opportunity and white space for us to move into and still generate attractive leveraged ROEs to the shareholders.

So as we've always thought about life in a post H.R. 1800 world it's about growing share in markets that we're not currently in as opposed to increased capacity competing for the existing installed base of middle market cash flow loans.

Thanks. That was a very helpful answer. My second and final question. You break out first lean, second lean and subordinated. What percentage of your investment assets to your loans would you consider to be unitranche deals? And is that share still growing, given the popularity of the product?

Sure. Well, the primary vehicle, obviously, that we're using for our unitranche investing is the senior secured loan program, obviously, our joint venture with GE. So that's a piece of the business, obviously, that's grown substantially.

We think that we're, frankly, one of the leading providers in that asset specific type of lending. We do have the ability to do some unitranche as well, away from the joint venture if, for whatever reason, that joint venture chooses not to pursue the loan.

So you'll see that in our first lean numbers outside of SSLP. But I think unitranche continues to be an incredibly popular way for companies, obviously, to access leverage.

Our first lean loan book is still levered in and around four times against the weighted average total leverage on the book of [4.6].

Imbedded in that average is some unitranche lending within the first lean bucket. But, as Kipp mentioned, 24% of our assets are [finding] their way into SSLP as the primary unitranche vehicle.

Okay. Great. Thanks. That's all my questions.

(Operator Instructions). Our next question is Robert Dodd, Raymond James. Please go ahead.

Hi, everybody. Following up on the CBO again. Is there a formal appeals process through which you could get the CBO to review its scoring and maybe take a different approach?

Or does it necessitate going back and resubmitting an adjusted bill maybe, even if it's a small adjustment, to get them to (inaudible) score a new version and [for them] to get -- to look at that under a different framework?

Yes. So, generally, within the legislative process, there is a mechanism to appeal or challenge the scoring. That is altogether possible.

And the other thing I would mention is a negative score. The CBO scoring, just to put it all in perspective, highlighted a $350 million, ten year impact, example,$35 million per year. I find it interesting to be able to get to that level of precision when dealing with private markets of the size that we participate in.

But when you think about the order of magnitude, even in the absence of a positive appeal here, the [solid] four number is $35 million per annum. So I, for one, my personal opinion is that a negative score of that magnitude, even if an appeal were not successful in and of itself, does not jeopardize a successful passing of the bill.

Great. Thank you for that color. Just one more follow up, if I could. Well, not follow up but just a question.

On your exposure, between first lean and second lean itself -- in this quarter we saw the second lean portion of your portfolio in gross dollars [shrink]. (Inaudible) a little bit but net, obviously, you have [quite a shift] -- it continued to shift (technical difficulty) towards first lean.

Is that a commentary on the relative pricing or your concern about what the credit underwriting metrics are that are currently out there floating around in second lean, given that, obviously, it doesn't have the best recovery rate when things do go wrong?

Yes. Specifically, in the first quarter, we exited two substantial second lean positions that we were in. To your point, we exited them because they were both going through refinancing transactions, which we found, generally speaking, to be unattractive. We had thought that the loan documentation wasn't particularly high quality.

One of them turned into a covenant light deal. We didn't like the pricing. We thought the leverage was too high. So all the above. Yes. As you know, I think the second lean market, generally speaking, has come in and crowded out mezzanine over the last year or so again.

And it's always our belief that when that creeps into the $50 million of EBITDA Company and below, that you're talking about small tranches in smaller middle market companies with a tremendous amount of secured debt on them. And that's why the recovery rates in those smaller, second lean tranches tend to be not so good.

We've shied away from them in markets like this in the past and continue to do that today.

Okay. Thanks a lot.

The next question is Greg Mason, KBW. Please go ahead.

Great, thanks. Sorry to harp on the BDC legislation one more time here. But given the CBO scoring issues with the representative sponsor of the bill having some personal issues, a full calendar until the summer recess and then the November elections, what do you think is the likelihood of this bill getting done this year?

Or is it more realistic to assume we're just going to have to start the process all over again with the next congressional cycle? What are your thoughts there?

Yeah, I wish I knew, Greg. I think we spent a lot of time on this call talking about the scoring, and I gave my opinion on that. With regard to one of the original bill sponsor's current issues, I also don't believe that that jeopardizes the bill.

I think, as people know, the bill did get passed through the House already on partisan -- on a purely partisan basis. And since that first partisan vote I think people have picked up on the fact that there's been a lot of work, on both sides of the aisle, to come to bipartisan agreement.

And, at least from our vantage point, it does appear that leadership on both sides of the aisle have taken up the cause. And so the original bill sponsors, I think, at this point, given how evolved the dialogue has been and the -- how far the process is, I'm not quite sure, has an impact.

With regard to the calendar, it's really anybody's guess. I just don't know even how to -- how to handicap how the timing would play out.

Okay. Great. And then one question regarding the parent going public here. Do you think that puts any pressure on doing regular equity raises and focusing on growth? Does that change the bar at the price level that ARCC would be willing to raise new equity?

I hope not. I think, if we have demonstrated anything over our ten year history as a public Company, that we are good stewards of capital. We grow when it's appropriate to grow and we don't grow when it's inappropriate not to grow. And our expectation is that, as a public Company, the way that we manage ARCC will absolutely not change.

But, as I mentioned in my opening remarks, I think that it will bring a fair amount of positives to the table just in terms of the platform strength of Ares Management as we think about our relationships with our investors and The Street, our access to capital, our ability to hire and retain people, information advantages that we get.

So I think it's a net positive but you should not expect that anything will change in terms of how the BDC is run day to day.

Great. Thanks.

Our next question is Jonathan Bock, Wells Fargo Securities. Please go ahead.

Good afternoon, and thank you for taking my question. Starting with the senior secured loan program, can you give us, Kipp, a sense of spread compression on the assets within that vehicle? So, at times, there might be refinancing, et cetera, but when we see a driven brand go from [seven] to [six], or CCS also then move down, and several others.

Given that this is a levered vehicle and that, if it's not growing and generating an additional fee income that's taken up front, spread compression could put an undue or perhaps a larger than expected impact on interest income to the downside. So can you walk us through spread compression in that portfolio?

Sure. Generally speaking, obviously, all the numbers on SSLP are disclosed. I can review a couple of them, Jonathan.

The loans -- the 46 borrowers that we have in SSLP are experiencing lots of the same trends that we're seeing in the broader market, right. To the extent the yield on the portfolio here has been coming down,we've seen some modest portfolio yield compression in SSLP, as well.

I think the disclosed numbers or the yield on the entire portfolio went from 7.1% to 7.08%. We did, I think, as you could take from the disclosure, reduce the kind of percentage that we're taking into income. That's really just a prospective judgment call on Q2 going forward, to 14.5%.

Obviously, we look at the returns coming from SSLP as needing to support that. But I'd say, generally speaking, that yield compression that you referenced in a couple of those names, that is -- that's just an active market where you're seeing refinancings and new deals getting done.

So it's in line with, I think, everything that we've seen and other folks just in the business have seen, broadly speaking, for a while now.

That's fair, Kipp. And we see that the limited structuring fees, given that there's not a lot of activity in SSLP in a given quarter, I would say this one, you can offset that through extra dividends coming up from IHAM.

Maybe a more broad question as it relates to CLO equity, which would, I assume, account for the amount of assets or steady amount of assets that are owned by Ivy Hill.

Can you walk us through the value of those CLO securities as well as the value of IHAM in the event LIBOR goes up 100 basis points or -- excuse me -- goes up [to] of the 100 basis point level and stays there?

I'm sorry, John, just so we can maybe respond to the question. Are you trying to disaggregate the value of Ivy Hill between securities and the (inaudible) --

The value of the manager, perhaps?

Maybe I'll rephrase -- I'll rephrase this just in terms of the risk. So looking in CLO securities. [Their], say, heavy floating rate component for CLO assets that mostly have a floor, roughly 90%, alright. The -- that floor is roughly set at 100 basis points turning to liabilities, and liabilities free float.

In the event that LIBOR rises to the 100 basis point level you have, we'll say, significant NIM compression. And the question is if you're levering that NIM and CLO equity securities between seven to ten times, depending on that, my question is what happens to NAV of those CLO securities, which I assume Ivy Hill owns?

Yes. Just to clarify and, again, I'll put Kipp's earlier comments into context, and Kipp and Penni can chime in with some of the detail, but we are not actively investing in new issue CLO equity. As Kipp mentioned, the growth at Ivy Hill has moderated, given the existing market conditions. And I think we talked about this last quarter.

When we look at the returns on new issue CLO equity with some modest default assumptions, new CLO equities pricing in the 9% or 10% range, with spread risk, as you mentioned, just given where the liabilities are pricing.

So I think what you are highlighting is absolutely part of the dialogue around whether or not you think that new issue CLO equity represents attractive risk adjusted return.

The reason that we've been able to generate such significant gains off of the Ivy Hill portfolio is those are older vintage CLOs that were accumulated through the downturn at very low valuations. And as valuations have come up, obviously, we've either refinanced or exited some of those positions or the net asset value has come up.

So, clearly, if you are in an arbitrage vehicle that is levered, spread compression is an issue. But I think it is less of an issue in the Ivy Hill portfolio given the vintage of those CLOs and the cost of those liabilities. But also the leverage of the traditional middle market CLOs relative to the new CLO 2.0 leverage.

So when you talk about seven, eight, nine times leverage, the traditional middle market CLOs were coming in with less leverage than that.

John, I'll make one other point just as a reminder. The securities that we're investing in at Ivy Hill are in Ivy Hill managed funds, right. So we're not buying third party manager's liabilities and -- or equity in any way, shape or form.

And we made some commentary around it on the fourth quarter call and on this call. But we have been harvesting capital from Ivy Hill, to Mike's point, because we've seen the spread arbitrage on CLOs break down in the current market.

Ivy Hill, as a portfolio Company, has experienced less growth over the last 12 months and it certainly did during the downturn. And that's why we positioned that Company as a Company where we're harvesting gains, much as we are in the existing portfolio, and, perhaps, slowing its growth because we look at risk-adjusted returns there as we do across the other things that we look at in day to day and just view it as less attractive today. So maybe that's helpful.

I appreciate that. I think investors always, just because it is a nice offset to the event -- in the event that structuring fees in SSLP decline, people always wonder about the sustainability of the extra dividend that comes -- the recurring, non recurring item. And your commentary there helps a lot.

Last question. You talk about portfolio optimization, we appreciate that. And as we look, can you give us a sense of an absolute yield level on balance sheet that you would find in this current environment somewhat, we'll say, sub optimal?

No.

I think for people that follow the Company, and you're one of them, Jonathan, for a while -- [and] follow the Company closely we care most about risk-adjusted return across market cycles. We don't have a hurdle around here where we say if it's less than this or less than that we won't do it.

We try to be flexible in our approach and operate nimbly in different markets. So, as Mike put it, I think the answer to that is no, we don't have a specific number that doesn't work for us on a traditional deal.

Our clients keep coming back to us, hundreds of them, over years because we offer full product solutions. And telling people that we don't want to engage in certain transactions because a portion of that financing doesn't fit with what we're up to right now really doesn't work.

I'll make one contextual comment, too, to Kipp's point of view. Look at how we've managed through the cycle. As we sit here today, given the balance sheet [scale] that we've accumulated, 30% to 35% of our deal flow is coming from existing relationships.

And when you look at the length of those relationships and you think about the lifetime value of a borrower to Ares Capital Corporation in terms of fees, spread, call protection, equity co-investment gains, you have to have a long-term view as to the value of those loans throughout the cycle and throughout the lifetime of that borrower.

And we have seen that if you get wedded to a return construct at any point in the cycle, you may be adversely selecting risk or you may not be positioning yourself for long-term value creation. And that's always how we've thought about it.

That -- that makes complete sense. I think that the question is [as] people look for the portfolio optimization and as it takes place -- let's say there is $423 million of loans that are sub 6%, right, $119 million [Service King], et cetera.

Not talking about an individual company but when you say that it's the time to maybe prune and get some better risk-adjusted returns elsewhere, I think that that's typically where the BDC investor moves to gauge what potential growth could occur.

Well, I think if you -- if you look at the pruning in the first quarter, there was a 20 basis point positive differential between where we booked assets and where we exited assets, exclusive of fees, call protection and gains.

So I like that term pruning because that -- that -- around the edges you are optimizing the credit and the return on the portfolio. And you just highlighted some numbers that represent the opportunity within the portfolio. But it doesn't necessarily follow that if we found an 8% return that we liked that we would sell at [6%].

I think it's much more dynamic than that. But that's a -- that's a daily conversation here.

No. That works. Thank you very much .

Thanks.

Thanks.

Seeing no further questions, this concludes our question and answer session. I would like to turn the conference back over to management for any closing remarks.

Sure. I just thank everybody so much for their time and their support and we'll look forward to seeing people, I guess, over the next month or so in meetings and conferences as they come through. Thanks again.

Ladies and gentlemen, this concludes our conference call for today.

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For all replays, please reference conference number 10043782. An archived replay will also be available on a web cast link located on the home page of the Investor Resources section of our web site. Thank you.