Ares Capital Corp (ARCC) 2014 Q2 法說會逐字稿

Good morning. Welcome to 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, August 5, 2014.

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 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 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 is the net-per-share increase or decrease in stockholders' equity, resulting from operations, less realized and unrealized gains and losses, any incentive these (attributable) to such realized and unrealized gains and losses, and any income taxes 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 website at www.arescapitalcorp.com, and clicking on the "Q2 2014 Earnings Presentation" link on the home page of the Investor Resources section of the website.

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 second quarter 2014 Earnings Presentation is available on the Company's website at www.arescapitalcorp.com, and clicking on the "Q2 2014 Earnings Presentation" link on the home page of the Investor Resources section. Ares Capital Corporation's earnings release and 10-Q are also available on the Company's website.

(Operator Instructions). I will now turn the call over to Mr. Michael Arougheti, Ares Capital Corporation's Co-Chairman of the Board and President of Ares Management LP.

Great. Thank you, Operator, and good afternoon to everyone and thanks for joining us. It is with great pleasure that I announce some well-deserved promotions for three of my long-time friends and partners. Last week, our Board of Directors promoted our President, Kipp deVeer, to Chief Executive Officer; and our Executive Vice President, Mitch Goldstein and Michael Smith, to Co-President. These promotions reflect the great confidence that we have in Kipp's leadership, as well as the depth and quality of our Management Team. Kipp, Mitch, and Michael have been Senior Executives for the Company, generally, since its inception, and have been major contributors to the success of ARCC over that time.

I will remain on the ARCC Board and, in fact, join Bennett Rosenthal as Co-Chairman, and I look forward to continuing to help create value for ARCC shareholders in my new role on the Board. And I will absolutely stay very close to ARCC in my current role as President of Ares Management.

Kipp, Mitch, Mike and I are very proud of what we have built for ARCC shareholders, as we approach our ten-year anniversary as a public company this October. As you will hear from the Team today, we feel very good about our leadership position in the market, as well as the strength of our portfolio and balance sheet. And we believe that we are very well-positioned for future growth and anticipate a continuation of positive, secular industry trends in the non-bank lending sector.

So, now, let me turn the call over to Kipp so that he can walk you through some high-level second quarter results and our investment activity and, then, he can put our results in context with our views of the current market. Kipp?

Thanks, Mike. I really appreciate those comments and look forward to continuing to work with the Board and the entire Team in leading Ares Capital. We have had a consistent vision here for years and I don't expect much to change. Let me first start out here with some high-level comments on our second quarter results.

For the second quarter, ARCC reported GAAP and core earnings-per-share of $0.48 and $0.34, respectively. And growth in NAV to $16.52 per share. Our strong GAAP earnings-per-share reflect continued net investment gains and positive portfolio performance. While we are pleased with our GAAP earnings, which contributed nicely to growth in our net asset value, our core earnings-per-share were modestly behind our expectations, but within our previously-announced range. Core earnings were impacted by the timing of investments funded during the second quarter, which were more back-end loaded, and the timing of repayments, which were more front-end loaded.

Of course, the overall growth in investment during the second quarter should contribute to our third quarter and fiscal 2014 earnings, and we're off to an early start in the third quarter, with strong investment activity to-date, through July 31, of about $390 million in net new commitment. Despite the slow start in the second quarter, we had a very busy quarter for originations, with over a billion dollars of new commitments across 29 investments. Approximately, two-thirds of these commitments were to new portfolio companies, which highlights the breadth and depth of our origination platform.

We continue to focus on what we believe are the highest quality credits and continue to emphasize conservatively-structured transactions, with covenants. During the second quarter, 51% of our new commitments were in first lien senior secured debt; 20% were in the subordinated certificates of the senior secured loan program, which also funded first lien loans; and 28% were in second lien senior secured debt.

During the quarter, we exited $767 million of commitments from the portfolio. Some of these exits came as a result of continued rotation of certain lower-yielding assets, the strategy we've discussed in the past, and one that we continue to execute on. A few of the exits came from the resolution of certain lower yield, lower quality non-yielding investments, which I will discuss in a bit more detail later in the call. We were able to earn higher yields on our new investments, compared to the yields on investments repaid or exited during the quarter.

And despite the spread compression we have seen in the markets, and in our portfolio, over the last 18 to 24 months, we believe this spread compression has leveled off. We are able to maintain our weighted average yield on total investments and amortized costs at 9.2%, which is unchanged from the first quarter of 2014.

In addition to this interest and dividend income earned from the portfolio, we had net realized and unrealized gains of approximately $51 million in the second quarter. There continues to be significant investor appetite in the market for assets that we invest in. And while the capital flows to our market have definitely increased over the last couple of years, we continue to find what we feel are very compelling risk-adjusted return.

We're encouraged that we've recently seen more fund outflows, from both the loan and bond market, and this has led to a slight improvement in market terms on new deals. We believe capital has come into direct lending, due to the absolute return potential and a world of very low interest rates. However, it's important to note, this capital [has] also entered our market because of the general strength of the US economy.

We feel highly confident in our funding sources today and we believe we have one of the strongest balance sheets in our industry. We ended the second quarter with a net debt-to-equity ratio of 0.68 times, and with approximately $1.8 billion of available debt capacity under our credit facilities. We have locked in a meaningful amount of fixed rate longer-term debt over the past several years and we are pleased that the current market prices of our bonds have increased well above their par value.

We believe this indicates that our cost of borrowing new term debt is much lower today, and that the cost of incremental term debt capital may be meaningfully lower than the rates we currently pay. We hope to take advantage of opportunities in the future to reduce our funding costs, as we build in additional lower-cost term liabilities.

In addition, given our strong backlog and pipeline at the end of the second quarter, we executed a $258 million equity offering, at the beginning of the third quarter, to support our growth. Let me, now, turn the call over to Penni to highlight our second quarter financial results and to provide some details around our recent financing activities.

Thank you, Kipp. Our GAAP net income for the second quarter of 2014 was $0.48 per share, compared to $0.39 per share for the first quarter of 2014. And $0.50 per share for the second quarter of 2014.

Our basics and diluted core earnings were $0.34 per share for the second quarter of 2014, compared to $0.38 per share for both the first quarter of 2014 and the second quarter of 2013. The $0.04 per share decrease in our second quarter core earnings, as compared to the first quarter of 2014, was primarily due to lower dividend income. The core earnings this quarter were also impacted by the timing of originations and repayments during the quarter, which slowed the growth of interest income.

Our net realized and unrealized gains totalled $51 million, or $0.17 per share for the second quarter, largely driven by net unrealized appreciation in the portfolio. As of June 30, 2014, our portfolio totalled $8.1 billion at fair value across 202 portfolio companies, and we had total assets of $8.6 billion. Our stockholders' equity was $4.9 billion, resulting in net asset value per share of $16.52, up from $16.42 at the end of the first quarter of 2014.

From a yield standpoint, the weighted average yield on our debt and other income-producing securities at amortized costs, at June 30, 2014, was 10.1%, 10 basis points lower than at the end of the first quarter of 2014. This 10 basis points decline in yield was the lowest quarterly decline that we have experienced in almost two years, and highlights Kipp's earlier point about spreads leveling off in the market.

The weighted average yield on total investments at amortized cost, at the end of the second quarter, was actually unchanged at 9.2%. As of June 30, we had approximately $5.2 billion in committed debt capital, consisting of approximately $3 billion of aggregate principal amount of term indebtedness outstanding, and $2.2 billion in committed revolving credit facilities, which are subject to borrowing, based on leverage restriction.

Approximately 58% of our total committed debt capital, and approximately 89% of our outstanding debt, at quarter end, was in fixed rate long-dated unsecured term debt. As of June 30, 2014, our debt-to-equity ratio was .68 times, and our debt-to-equity ratio net of available cash of $200 million was .64 times.

As Kipp mentioned, subsequent to the end of the second quarter of 2014, we completed an equity offering of 15.5 million shares, resulting in net proceeds of approximately $258 million. Pro forma for this offering, out debt-to-equity ratio, as of June 30, 2014, would have been .6 times, and our total liquidity, including available cash, would have been nearly $2.3 billion. We've continued to proactively extend the maturity of our secured revolving credit facilities, and during the second quarter, we amended our revolving funding facility with Wells Fargo, extending the end of the revolving period and the stated maturity date, each by two years, to May 2017 and May 2019, respectively.

As part of the amendment, we reduced commitments under the revolving funding facility by $80 million, but, in turn, we upsized commitments under our lower-cost, JPMorgan-led revolving credit facility by $80 million during the quarter. So, as a result, our total debt commitments of $5.2 billion remained unchanged since the end of the first quarter of 2014.

After the completion of the extension with Wells Fargo, none of our revolving facilities have a final maturity prior to May 2019. As of June 30, the weighted average duration for our outstanding liabilities was 7.2 years. 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 interest rate on our drawn debt capital at quarter end decreased to 5.1%, as compared to 5.4% at the end of the first quarter of 2014. This decrease resulted from a higher level of borrowings under our lower cost revolving credit facilities at the end of the quarter, as compared to the prior quarter.

If at the end of the second quarter of 2014, we were to borrow all of the amounts available under our revolving credit facilities, our weighted average stated interest rate would be 4.1%. As Kipp mentioned, we believe our current borrowing costs for new term debt would be meaningfully lower than the coast of our existing term debt.

Finally, this morning, we announced that we declared a third quarter dividend of $0.38 per share, payable on September 30th to stockholders of records on September 15, 2014. As a reminder, at the end of 2013, we estimated we had approximately $0.82 per share of undistributed taxable income being carried over into 2014. We believe that this helps contribute to the stability and predictability of our dividend.

Now, we would like to turn it back to Kipp to discuss the portfolio and recent investment activity.

Thanks, Penni. Today, we have a diversified $8.1 billion portfolio, consisting investments in 202 portfolio companies. Our average commitment is less than 1% of our assets and our largest single main exposure, excluding the SSLP is less than 3.5% of our portfolio at fair value. At quarter end, the SSLP represented approximately 24% of the portfolio at fair value.

The SSLP is well-diversified with 50 separate underlying borrowers at quarter end. Excluding SSLP, the next largest 15 investments in the aggregate represented only 26% of the portfolio at fair value. Our portfolio has performed well and we believe the underlying health of our portfolio companies is quite strong. Our corporate portfolio companies had weighted average EBITDA of $54 million, as of the end of the second quarter, and have had solid year-over-year growth in EBITDA of approximately 8%.

For the second quarter, our portfolio experienced positive credit metrics in the aggregate. 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 increased to three times as of June 30 versus 2.8 times as of March 31.

The weighted average grade of the portfolio was stable at 3.1, at the end of the second quarter. Non-accrual ratios declined quarter-over-quarter, with 1.9% of the portfolio at cost, and 1.2% of the portfolio at fair value on non-accrual at quarter end, as compared to 3.2% at cost, and 1.9% at fair value at the end of the first quarter.

At June 30, 2014, we only had three companies on non-accrual of any meaningful value and no new names were placed on non-accrual this quarter. During the second quarter, we realized net losses from investment exit repayment activities, totaling approximately $47 million; however, these losses were already substantially recognized in our earnings through unrealized depreciation in prior periods.

These net realized investment losses mostly pertain to our disposal of two of our more difficult situations, [City Postal] and MVL Group, both of which came into the portfolio with the Allied acquisition. We're pleased with the resolution of these two investments. Net unrealized gains on the portfolio, at June 30, 2014, were approximately $51 million this quarter. These net unrealized gains were largely driven by several investments where we see potential near-term exits of meaningful gains.

Announcements have been made regarding certain of these exits, including Apple & Eve, Insight Pharmaceuticals, and Service King. While we remain in a low interest rate environment, we're encouraged by these results and the opportunity to continue to generate attractive low double-digit total returns on our investments. We will seek to drive returns to shareholders through a combination of current income from interest, dividends, structuring fees, and other sources of fee income, as well as the potential for realized gains.

Let me finish with a quick update on our recent investment activity since quarter end and our current backlog and pipeline.

As I mentioned earlier, we had a strong start to the third quarter, making new investment commitments of $492 million, of which $451 million were funded. We exited $102 million of investment commitments from July 1st through July 31, resulting in net new investment commitments $390 million.

We believe that the higher level of net new investments to begin the third quarter bodes well for higher interest income for the third quarter. As of July 31, 2014, our total investment backlog and pipeline stood at approximately $390 million and $500 million, respectively. Of course, we can't assure you that any of these investments will close, but we expect a busy finish to the year.

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. We look back with great pride on the level of shareholder value we have created since our IPO, nearly ten years ago. Since October 2004, we have paid cumulative dividends to shareholders, totaling $14.87 per share, and by reinvesting those dividends, a shareholder would have received an annualized total return of about 14%.

Going forward, we will continue to focus on creating long-term shareholder value through steady performance and attractive and stable dividends.

And I will close by thanking our Board for their support. We promise to continue to work diligently as a Team to continue the success ARCC has enjoyed, and to pursue strong returns for our shareholders.

Operator, can we open the line for Q&A, please?

Yes. (Operator Instructions). The first question comes from Greg Mason of KBW. Please go ahead.

Great. Hello, everyone. First, my question is on the equity raised post quarter end. You raised $258 million, kind of net your target leverage of .7, gives you $450 million of investment capital. And you just said in June, you have kind of net fundings of around $350 million, at an 8.1% cost. If I do the math at 8.1%, kind of fully levered net of fees, I get 7.5% to 8% ROE versus the 9% dividend yield on the new investment.

So, my question is, why the equity raise? And, ultimately, how can that be covering the dividend, or more importantly, accretive to shareholders on an earnings basis over the long-term?

Sure. Well, you got the point right on the equity. We're definitely trying to build flexibility for the remainder of the year. As I mentioned, we're busy. So, for us, that was an ordinary course raise and, of course, one done above book, as usual. But take some caution just looking at that one month of data. Number one, it's a months of data, so it's not particularly indicative of what the backlog and pipeline, in fact, looks like.

Going forward, that backlog and pipeline that I laid out does have aggregate yields that are materially higher than the yields that we funded in July. So, I think really taking that away and doing the calculation using the 8% isn't going to be all that helpful. When we took our Q1 and Q2 GAAP earnings and divided by where we issued stock, we were looking, really, at a company that is generating toward 10% to 11% return on equity, based on that earnings stream from the past two quarters, so I wouldn't take much away interest that 8.1%, I think is the key to the question.

And, then, just a broader thought process, back in 2006, 2007, you guys moved up the capital structure, put you in a great opposition during the downturn. You have been doing that again. You know, in a yield compression environment that we've been seeing, how are you balancing -- obviously, you're staying conservative, but, then, still growing and raising equity capital. Just kind of balancing what you're seeing in the market yields with your cost of equity capital today; and your thoughts on managing that going forward?

Sure. Well, we're not going to do anything that's not accretive to shareholders, whether it's investing new money or raising capital. We are in a fortunate position these days. With $8 billion of assets, we have absolutely no need to raise capital, which we remind people often. Our business is writing loans that range in size from [$50 million] to $500 million, and with the balance sheet and the availability that we have today, we have no need to raise equity.

So, as we have said, I think, individually in meetings many times, when we we're raising equity capital, it's because we see attractive opportunities on the investment front that we think are accretive to shareholders over time. It's really nothing more than that.

Great. Thanks, guys.

To answer your first question, I mean, I can and some color. There's a lot of discussion around the investment table here day to day about what the appropriate yields are. I think you have heard from us in the past, we want to be in the best credits these days. We service a lot of different customers and a lot of different clients in the business, with 202 companies, as well as a numbers of relationships we're dealing with. So, I do just want to say that your point isn't something that is lost on us. It's something that we talk about everyday here.

Great. Thanks, Kipp, and congrats on the promotion.

Thank you.

The next question comes from Terry Ma of Barclays. Please go ahead.

Hey, guys. Can you just give us a sense of what's causing yield compression to level off, as you mentioned in your prepared comments?

I think there are a couple of things. We have seen outflows, as I mentioned, from loans, generally speaking this year; and from the bond market, as well. I heard on one of the other calls, I think this week, that there has been meaningful ramping back up of the CLO machine this year.

It's been a very active issuance here for the CLOs, but most of that is larger markets. I think it's definitely outflows, is the key here, so. Retail seems to demand a base yield in bank loans and I think we may have finally reached it.

I'd also add, just quickly, that there's probably a leveling off of what was a supply/demand imbalance. I mean, you look at the amount of deal flow in the forward calendar, there's just more transaction volume to take-up whatever capital is available in the market.

I think that's right, Mike.

Alright. Got it. And just looks like repayments and exits have been pretty elevated the last two quarters on a year-over-year basis. Can you just comment on how much was repayments versus opportunistic exits; and maybe how you see that playing out the rest of the year, as you prune your portfolio?

Yes. I think we're always managing, as I think we mentioned on the last call, some of the lower-yielding investments in the portfolio and, of course, we look at that as one of our tools for access to capital. So, on the point raised earlier about the equity rates, we've been, again, pairing the portfolio back with some of our lower-yielding assets to maintain yield to preserve the dividend and interest margin over the last couple of quarters, but when I think about that rotation, there's room, but we have done through quite a bit of it.

In terms of exits otherwise, really nothing extraordinary other than what we mentioned. We did dispose of two names that had been problematic for us. And I think the real positive is we're expecting some other exits, as well, both in the quarter and some quarters to come here, on names that have done quite well for us.

We do take away from this quarter that people had some concerns and have mentioned the modestly lower core EPS, but I just remind people to remember that this is a total return game, and at this point in the cycle, our ability, I think, to generate gains on our investments is a pretty important part of the story. And we're happy to be seeing that. That's been going on now for a few quarters, but is particularly pronounced right now.

Alright. Got it. Thanks. That's it for me.

Sure.

The next question comes from Doug Mewhirter of SunTrust. Please go ahead.

Hi. Good afternoon. I just had two questions. First, given the updates on Ivy Hill, I know that you have been, over the past several quarters, even longer, you've been saying how there's just not as much opportunity; they've been sort of winding down a bit. Is that still going to be able to make a meaningful contribution to your dividend flow to Ares over the next year or so?

Yes, we expect that it will. I mean, Ivy Hill has been paying a regular dividend from its core earnings, so to speak, of $10 million a quarter. Just to be clear, also, in answering the question, we don't think Ivy Hill is winding down in any way. In my words, probably not growing as quickly as perhaps it did, during the downturn, when it was more opportunistic as a buyer, both of securities and of management contracts, which is not an opportunity today. So, that's just to be clear on that point.

Yes. We expect Ivy Hill will continue to do [what it's doing]. It's been a phenomenal performer for us. There's meaningful, unrealized appreciation there, for a reason the investment performance has been excellent, but the fund management business continues to be successful and provide a steady stream of earnings that we expect will benefit ARCC and its shareholders.

Great. My second question, second and final question, a little bigger picture maybe. I know that with your, I guess a more conservative stance, or higher on the capital structure stance with the loans you're putting on the books now, and I know in the past, Mike had mentioned if this legislation ever passed, to increase the approved leverage, that you would increase your leverage with the very senior secured -- very safe securities. But, [with that] being said, but keeping that same philosophy, have you reconsidered where the upper end of your leverage target would be, given that you're skewing your portfolio in a slightly safer direction, or is the shift not meaningful enough to really change how you look at your capital structure and your leverage targets?

Yes. The leverage target is ranged, typically, we say of between sort of .6 and .8 to 1. We think this is a point in the cycle, frankly, where you want to have flexibility. So, pushing our leverage meaningfully higher is not something that we think is a great idea these days. I don't know how far or how long we are in the credit cycle, but we're, with high-leverage multiples and tight spreads, we hope getting a little bit longer in the credit cycle, where we do want it maintain flexibility.

So, there's not a meaningful shift, frankly, in the portfolio. And it's mixed over the last couple of years, so when you take the assets and the context around the market, we really haven't wanted to increase the leverage or really have any change, in general, in our target leverage ratio. Obviously, if the legislation changed the game, we would consider that, but that's probably an entirely different discussion.

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

Sure. Thanks.

The next question comes from Robert Dodd of Raymond James. Please go ahead.

Hi, guys. On fees, first, if I can? Obviously, the structuring fees came in a little bit below what I was looking for--I don't know what you're talking about, obviously--but when I look at the rate on the SSLP, in particular, obviously, structurally high, chops around quarter to quarter, but it looks like a relatively low level, compared to the originations. Is that a function, or can you give us any more color on that, but is that a function of refinancings within the portfolio, maybe lower fee structures? Or is there a market shift in those larger, higher credit quality corporates that are getting these deals done now at somewhat lower fees; and was the case, say, last year?

I just want to make sure I completely understand the question, but I think -- are you asking SSLP, you see, as generating lesser yield?

Lower capital structuring fees, relative to originations. That's the last year capital structuring fees were 6.6% of originations; this quarter, 5.4%. So, is there anything structural there or?

No. We're scratching our heads here a little bit, just looking at the numbers. You're right. We have the same math you do. They're down modestly. I think the general answer is, there's no structural shift at all. SSLP, basically, is a mix of constant portfolio, again of 50 names; some entering, some exiting.

It can always be growing, but certainly if you're refinancing an existing borrower, you often charge less fee. Or if you are up sizing an existing credit, you'll take a smaller origination fee. So, there's those sort of things in the natural course and in the mix of the way that the program works that can impact that, but I don't think there's anything -- in fact, I know there's nothing meaningful there, in terms of the market or the types of companies that we're financing.

Okay. Great. And one other, if I can, on one of your material non-accruals? And I'm going to pronounce this horribly because Spanish isn't my keeper, but Instituto de Banca y Comercio, it has been marked down three quarters in a row now, it's on non-accrual. It's in Puerto Rico, , which, obviously, has its issues, but can you give us an update on anything that's going on there? Why you feel so comfortable, frankly, with it marked where it is, when it's on non-accrual, currently?

Well, I think we've talked about there one in the past a little bit.

Put a secondary school, which is a difficult business these days, and it also happens to resides in Puerto Rico, which is, obviously, people know, pretty difficult geography. This is a company that we have been involved with -- I'm going to guess, but I'm going to call it seven years. It has been a phenomenally successful investment, up until some of the recent concerns, both around the industry and some of its challenges, which are pretty well-publicized in the press, as well as in Puerto Rico, which I'm sure you've been reading about, too. We still think that this is a franchise business.

It's the leader in its space. There's a need for this company to exist in Puerto Rico. And we believe that it will survive as a business, basically, (inaudible) today, as it has just a difficult balance sheet for a lower run-rate of earnings. We are deeply involved with the company today, in terms of, both, internal portfolio management resources and external resources, and the good news is that the business continues to have the support of a very strong, private equity sponsor in [Avery Partners], engaged day to day with operating folks bringing new management in, et cetera. So, we just have a very high degree of confidence that it is a company with a tough balance sheet that we can fix.

Okay. Appreciate the color. Thanks.

Sure.

(Operator Instructions). The next question comes from Rick Suba, an individual investor. Please go ahead.

Hello. My question is, where the spillover income sits right now, would I be correct to believe that the net realized losses from quarter two, which was appreciable, you must have done some house cleaning, whatever, would offset some of your previous spillover income?

Well, if you look at the spillover at the end of 2013, it's really measured on an annual basis and we had about $0.82 carrying over from 2013 into 2014. If you look at taxable income, you really have to measure it on an annual basis. You can't look at it on just one quarter's activities. And while we did have some net realized losses in Q2, we talked a lot, also today, about some potential net gains on the horizon for some other investments that we think we will have an exit on during the course of this year, and we also had some net gains earlier in the year.

So, you can't really look at it in a vacuum, but when we get to the end of 2014, we will continue to do what we always do, and that's look at the taxable income for the course of the year, relative to the dividend that's been paid out, on a cumulative basis, and we will reposition where we are on the spillover at the end of the year. But, clearly, any realized loss will reduce your taxable income, but we have other offsets to that through realized gains or loss carry-forwards, et cetera, on the tax side that can, also, come into play.

Okay. So you don't have a number for it, [as it sits] rights now?

No, we don't. Because, unfortunately, we are only halfway through the year, so it's hard to predict where we will be for the spillover at the end of the 2014, but we will look at all of our taxable income generated and re-calibrate that at the end of the year. But like I said, we believe we have some other gains coming in for the rest of the year that could impact -- or I should say, offset some of the losses.

Okay. Thank you.

Next question comes from Jon Bock of Wells Fargo Securities. Please go ahead.

Good afternoon. Thank you for taking my question. Kipp, turning to pre-payment, maybe risk for a moment, if we look at the SSLP, which is amplified by the amount of leverage provided by GE, I notice that you're originating assets, we're looking between 6% and 7%, whereas the exits in that, whether it is coming from a [Pregis] or others, would be, roughly, around the 8% mark.

So, gauge for us, only because these are the transactions that are most susceptible to liquid loan market, we'll call stretched-out effect. Explain to us or maybe give us comfort around the pre-payment risk in that portfolio, given that it's amplified with a significant degree of leverage that benefits on the way up and can hurt when spreads come in.

Yes. I think we talked about this one, I think, with you, Jon, and with others before, which is, we don't see any difference, frankly, in the way that the underlying assets at SSLP work vis-a-vis the portfolio. Obviously, the vehicle itself is constructed in certain of the ways that you referenced, but the repricing and the refinancing activities that we have seen hot and heavy in the market for the last two or three years, generally speaking, has kind of played through the portfolio. That doesn't mean that we're not refinancing and repricing things --I guess it does mean we're refinancing and repricing things all the time, but there's no, in particular, sort of risk that we see, as it relates to SSLP, vis-a-vis the portfolio as a whole.

Just maybe approach it from a different angle, we have talked about this on prior calls. The pricing of the senior notes in SSLP is dynamic and it's meant to reflect the cost of capital available in the market at a particular time. So, not always the case, but generally the case, if there's and 8% asset, it's probably being financed at a higher cost of capital than a 6% asset today.

So, when you look at the net distributions to the subordinated certificates that ARCC holds, you're not experiencing that kind of spread compression, either when it's going in or coming out of that portfolio. And the best way to appreciate that is, if you look at the dividend income or the distribution income coming up off of SSLP, it's been surprisingly consistent, despite the spread compression that Kipp talked about earlier.

That makes total sense. Thank you, Mike.

And, then, if we are going to take a moment, I think Mr. Dodd mentioned this in his line of questioning, about the certain Puerto Rican loan that today you kind of look at. Notice that that is in the SSLP, that it's a relatively small investment, but kind of walking through the workout, or how one up approaches a potential workout, given the fact that you're in the first (loss) in this entity, can you maybe give us a little bit more color as to working this loan out for both, ARCC proper and, then, also having to work with the senior lender in the fund of which this asset is also included?

Yes. So, let me comment on that. Being first loss, so to speak, to use that terminology in SSLP, if you'd like to, it really has no impact on the way that underlying portfolio companies in the joint venture are managed.

Okay.

So, both areas in GE, I should have said, are deeply engaged in helping to fix educate, whether it's through operational improvements, helping with management, changes to the balance sheet, deferral of interest, whatever it may be that we're, obviously, providing to the Company, we're doing incomplete concert with GE, as if we, to make it simple, had a $100 billion loan together, where we each owned a $50 million commitment side-by-side, it works exactly as if that was the position.

So, we co-source for the program, we ratify investments, separately and, then, together and, then, manage them together. So, the way that the program work really has absolutely no impact or indication on the way that we're pursuing, educating, and fixing it.

Got it. Got it. And, then, one additional one. Kipp, of the deals that were done, let's go, in particular, in second lien, can you walk through, maybe, just on a percentage basis -- so, of the 40% or so second liens done this quarters, how many of those were you the true, sole structure and control investor? I know, normally, it's almost always 100%. I'm just kind of curious, are you still seeing that? Or do you, also, see opportunities to partner behind people, or partner in a BSL-type of transaction, that maybe was originated by a larger broker dealer?

I think you know our philosophy, which is, we really do like to lead and control our transactions. Second lien these days has more or less taken the place of the [mezz] market. And for people who have been in our business, you do see sponsors and sponsor deals bring in more than one relationship, occasionally. But in terms of the second lien that we booked this quarter, I think on [Totes], we were the entire deal; Sarnova, we're the entire deal. I think Ares, we were not. Young, we were, Pelican, we were not. And RegionalCare, we were not.

Okay.

It's a mix. And the reason for us being the lead versus not being the lead, have a broad range of reasons. As I mentioned, sometimes it's our choice around sizing of position; sometimes it's a sponsor bringing another relationship into a name. We think long and hard, frankly, about who our partners are in those names. If a sponsor says, we would like you to do 40, and so and so to do 40, it really does depends on who that so and so is.

So, when we don't lead things, we typically don't like to be one of seven people in a name. We have seen difficulty managing, but the downside when you have a larger group, so I guess, broadly speaking, we'd like to be the lead and only, or one of two, which I think is what you see in almost all of these names.

Got it. And, then, maybe just allowing us to drill one layer deeper, using a company as an example, so for example, Pelican Products, right? $175 million second lien, of which you took [$40 million]. I understand this is on a much larger portfolio and a broader context, but would that kind of fall in -- so, $40 million, other $40 million type partner situation? Or maybe just a little bit more on that one, in particular, about why you like it and invest it? Only because it might not, maybe, fit the same kind of items you've outlined, in terms of straight senior control, which we have all come to appreciate.

It's a portfolio company that we have known for a long time It's, also, one that the market knows well. So, I would tell you that we tried to do the entire thing and it didn't worked out that way. I think three or four other people felt the same way.

Okay.

It speaks to the merit of the credit. And I think at the end of the day, the sponsor chose to have a group of relationships. There are a bunch of private equity firms that only do a deal or two a year; right? And you can expect that they have five or ten people calling on them for opportunities, so where there's a good credit and they have room for a handful of different folks, they'll often make it. I think Pelican was one of those situations.

Okay. Great. Thanks for taking my questions.

Sure. Thanks.

And the last question today will come from Casey Alexander of Gilford Securities. Please go ahead.

Hi. Just trying to get a sense of what you're seeing in the decisions that your Investment Committee is making. I'm kind of curious about the deals that you're turning down. Are you turning down more deals because of credit; or are you turning down more deals that are good credit, but you're turning them down because of rate that you're being offered?

It's always some of both. I don't have the numbers in front of me, but we're happy to pull them off and follow-up on the details. I mean, typically, first and foremost we're looking at companies in terms of business risk. So, it's, do you like the credit or not? We are seeing a mix of good and bad, but the easy, first turndown is, we don't love the company.

But, certainly, beyond that, there are plenty of deals getting done in this market that are too aggressive for us. And that can mean the leverage is too high; that can mean the loan documentation doesn't work with our standards. Very often, we pass and/or lose deals because we won't revert to a covenant life structure.

So, it's really all of the above, but first things first, I think we have emphasized this over the last year or so, and did it seven or eight years ago. We think if the market does turn at all, really, the most important thing is that you have pick the right credit. And we do always say that the one thing we can do the most wrong in our business is, simply put, pick the wrong company. They're the ones that turn into meaningful problems. If you're a little bit high on leverage, or you're a little bit thin on spread, that's not going to kill you at the end of the day. It's when you pick bad companies to invest in that you get into trouble.

So, then, is it fair to assume in the post quarter activity that -- because the spread is a little upside down in the post quarter activity, which you said, we'll see somewhat corrective later on in the quarter. Was that because of the opportunities that you were able to close in the first month? Or people that you knew very, very well and so you were willing to go down, in terms of rate?

Hey, it's Mike. I just want to take a step back before Kipp gives you a little bit of detail and just, maybe, try to reframe the discussion. Because the conversation around spread-typing has come up multiple times on this call. I scratch my head a little bit because, as Kipp mentioned in his prepared remarks, we're still generating 10% to 111% ROEs on senior secured loans, at 50% loan-to-value, with very strong credit performance and very high free cash flow coverage. So, I think you have to put our asset classes and our business in the context of all other investment and yield opportunities available to people in this market, whether you're looking at MLPs, or yield cos, or REITs.

We're pretty happy that we're able to generate 8%, 9% current yield with fees and call protection, with a very high-selected portfolio. So, while we appreciate that nobody likes to go through two years of spread compression, I think we all need to just take a step back and understand that when you look at the risk adjusted returns available in almost every other yield-bearing asset class in the market, I think our asset classes really do stand out, in terms of the attractiveness of the value position.

Well, I don't think anyone is arguing with you on that point, but I, also, don't think that people are examining Ares within a vacuum that spread compression has been a reality, not just for Ares, but across the other BDCs in the space, and I think that's why you're seeing this level of scrutiny, particularly on the structure of the post quarter activity.

Yes, there's no doubt. I think as Kipp mentioned, the early quarter activities, probably not indicative of the full quarter activity. The key is, and we think we demonstrated this in 2006 and 2007, folks won't have a perfect sense for the risk-adjusted return in our business and others until we get through a credits cycle.

This is absolutely a market where you need to protect your best credits; you need to be a stock picker and invest in the best companies that you see; and you have to have a willingness to accept the market reality and take slightly lower return for what you think are the highest quality credits in the market at any point in time. And I'm pretty confident that that's what we're doing.

Okay.

And I took the chance just to add some details, just looking at our weekly summaries here, but this is a number that we disclose every quarter. It just so happens that it's lower than what people might like for 30 days, but the Company did almost a hundred deals last year. We have 202 portfolios the companies, along with the other 50 that we have in SSLP, and I think that number really is grounded in like three or four names. So, I would just tell you, it's a number that we do disclose, but it's not really material, frankly, or worth focusing on today.

Alright. Thank you for taking my questions.

You're welcome.

And at this time, I would like to turn the conference back over to Management for final remarks.

We didn't have anything further. Thanks, everyone, for your time. Enjoy the afternoon.

Ladies and gentlemen, this concludes our conference call for today. If you missed any part of today's call, an archived replay of this conference call will be available approximately one hour after the end of this call, through August 18, 2014, to Domestic callers, by dialing 1-877-344-7529; and to International callers by dialing +1-412-317-0088. For all replays, please reference conference number 10048348. An archived replay will also be available on a webcast link located on the home page of the Investor Resources section of our website.