Ares Capital Corp (ARCC) 2015 Q3 法說會逐字稿

Good afternoon. Welcome to Ares Capital Corporation's third-quarter ended September 30, 2015 earnings conference call. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded on Wednesday, November 4, 2015.

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 any such forward-looking statements. Please also note that past performance or market information is not a guarantee of future results.

During this conference call, the Company may discuss core earnings per share, or core EPS, which is a non-GAAP financial measure, as defined by SEC Regulation G. Core EPS 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 to such realized and unrealized gains and losses, and any income taxes related to such realized gains and losses.

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. 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 related 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 third quarter ended September 30, 2015 earnings presentation is available on the Company's website at www.arescapitalcorp.com, by clicking on the Q3 2015 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.

I will now turn the call over to Mr. Kipp deVeer, Ares Capital Corporation's Chief Executive Officer.

Thank you, Operator. Good afternoon, and thanks for joining us.

Our core and GAAP earnings per share for the third quarter of 2015 were $0.41 and $0.37 respectively. We're very pleased with the financial results for the quarter and the attractive total returns that we've delivered to shareholders.

Q3 was another period where we recognized substantial gains from our portfolio, with $45 million of net realized gains on investments. The company's year to date net realized gains on investments now total $97 million, which puts us on track for a record year in this respect. In periods like this when we have high multiples and sustained interest in our assets, we typically seek to harvest net gains which supplement the income we generate from fees and interest payments on our debt investments.

Dividend coverage remained strong, and year to date, our net investment income plus net realized gains have meaningfully exceeded our dividend. Penny will spend more time on our balance sheet and certain initiatives on this front, but we remain conservatively positioned with what we feel is a strong balance sheet with a net debt to equity ratio of 0.65x.

At the end of the third quarter, we had cash and available liquidity of $2.3 billion, leaving us in a comfortable position from a capital standpoint. With another successful quarter behind us, we announced that we declared a fourth quarter dividend of $0.38 per share this morning. Despite this strong quarter, we find ourselves navigating through volatile markets. Capital continued to leave the leveraged finance markets as investors fear the impact of future interest rate rises and the potential for a negative credit migration. We concur with most investors that we are in the later stages of what has been an extended credit cycle. Funds flows in the leveraged loan market year to date are decidingly negative as almost $10 billion of capital has been redeemed from retail loan funds in the first 10 months of this year. The high yield market has been clobbered since June 30, and returns are only narrowly positive for the year. As a data point, double-B new issue high yield spreads were in the 7% range at the end of September, a level not seen since 2011. Leveraged loan issuance is also down year-over-year, with the majority of transactions being centered around M&A and new acquisitions.

Opportunistic refinancing and dividend recaps are very difficult these days. We believe that supply/demand dynamics are shifting back in investors' favor. However, as we've always said, the middle market typically is slow to adjust, and we remain very cautious in this market with a high bar on credit in order to make new investments. An interesting case in point is that we've seen several of our portfolio companies sold or refinanced this quarter that we would have liked to support, but we passed on these transactions, because the underwriting levels were simply too aggressive for us.

As we navigate through this environment, we intend to remain cautious, with a focus on managing hold sizes and the overall risk adjusted return of the portfolio. We have had the opportunity to originate larger investments for our clients, and we have often made these investments with a plan to syndicate a portion of these transactions to manage our ultimate final holds, particularly for investments with lower yield.

While our originations in the third quarter look fairly significant, with $1.5 billion of gross commitments, we syndicated over $550 million of these commitments during the quarter and ended the quarter with an additional $170 million that we intend to sell at a later date. In most of these situations, our clients look to us to lead and underwrite their deals in full, which we're thrilled to do. We typically remain a significant investor in these companies, which is also an advantage when selling portions of our loans to the market. Beyond this, syndication can be an important tool to generate fees, particularly in the current market environment.

We discussed our American Seafoods transaction on our last call, and this is a prime example of how we are operating today on the new deal front.

Now, I'd like to turn the call over to Penni Roll, our CFO, to detail the third quarter financial results and to discuss some of our recent financing activities.

Thank you, Kipp.

Our basic and diluted core earnings per share were $0.41 for the third quarter of 2015, up $0.04 from the second quarter of 2015, and $0.01 from the third quarter of 2014.

Our basic and diluted GAAP net income per share for the third quarter of 2015 was $0.37, compared to $0.47 for the second quarter of 2015, and $0.57 for the third quarter of 2014. For the third quarter of 2015, our net realized gains on investments totaled $45 million or $0.14 per share, and we had net unrealized losses on investments of $61 million, or $0.19 per share, which includes $39 million, or $0.12 per share from reversals of net unrealized appreciation related to the net realized gains on investments.

As of September 30, 2015 our portfolio totaled $8.7 billion at fair value, and we had total assets of $9.2 billion.

At September 30, 2015, the weighted average yield on our debt and other income-producing securities at amortized costs was 10.3%, and the weighted average yield on total investments at amortized costs was 9.4%, as compared to 10.6% and 9.7% respectively at June 30, 2015, and 9.9% and 9.1% respectively at September 30, 2014. The decline in our weighted average yield since June 30 is primarily a result of a decline in the yield on our subordinated certificates in the SSLP and an increase in lower yielding investments where we've invested with either the intention to sell the loans at a later date or with the expectation that they will be sold to the SDLP once we've established a sufficiently diversified portfolio for the program.

Our stockholders equity at September 30 was $5.3 billion, resulting in net asset value per share of $16.79, up 0.5% year-over-year versus September 30, 2014 and just a penny lower than our NAV per share of $16.80 at the end of the second quarter of 2015.

As of September 30, 2015, we had approximately $5.8 billion in committed debt capital consisting of approximately $3.5 billion of aggregate principal amount of term indebtedness outstanding, $2.2 billion in committed revolving credit facilities, and $75 million of commitment Small Business Administration ventures. Approximately 60% of our total committed debt capital and 94% of our outstanding debt at quarter end was in fixed-rate unsecured term debt. This predominately fixed-rate fund in liability structure combined with our predominately floating rate asset mix leaves us very well positioned for a potential rise in interest rates.

As we highlighted at our investor day a month ago, we remain focused on the right-hand side of our balance sheet and lowering our cost of debt capital as we begin to have more opportunities to replace or refinance higher cost debt. To start, last week, we completed the early redemption of the entire $200 million of aggregate principle amount of our 7.75% percent unsecured notes which were originally scheduled to mature in 2040 but recently became callable. These notes were redeemed at par plus accrued interest, and we will recognized a realized loss on the extinguishment of this debt of approximately $6.6 million in the fourth quarter due to the write-off of the related unamortized debt issuance costs.

We borrowed money under our revolving credit facilities to repay these notes, and if we were to continue to use our revolving credit facilities to be the refinancing source for this debt, the pro forma annualized benefit to net income resulting from this early redemption would be approximately $0.03 per share.

We are also looking ahead to maturity of the $805 million of convertible notes due in 2016, $575 million of which matures in February, and $230 million of which matures in June. The February maturities have a stated rate of 5.75%, and the June maturities have a stated rate of 5.125%, both of which are well in excess of where we've more recently been able to issue similar duration unsecured term liabilities. For example, earlier this year, we issued five-year investment grade bonds which have a stated interest rate of 3.875%. If we were able to refinance both series of convertible notes at a similarly attractive yield, we estimate the annualized benefit to net income would be approximately $0.08 per share. Of course, we can't assure you that we will be able to refinance such that at the same yield we received earlier this year.

The weighted average interest rate on our drawn debt capital at quarter end was 5%, which remained flat with the rate at June 30, 2015. If we had borrowed all of the amounts available under our revolving credit facilities as of September 30, 2015, our fully funded weighted average stated interest rate would have been 3.9%, which is consistent with the rate at June 30, 2015 and 20 basis points lower than the rate at September 30, 2014.

On our drawn debt at March 31, 2015 versus year-end 2014, reflects that we had nothing outstanding on our lower-cost revolving credit facilities as of March 31, 2015, partially offset by the repayment of the 7% unsecured notes during the first quarter.

Upon the repayment of these notes, we realized a small loss on the extinguishment of debt of $0.01 per share. If we had borrowed all of the amounts available under our revolving credit facilities as of March 31 2015, our fully funded weight average stated interest rate would have been 4%, down from 4.1% at December 31, 2014.

As of September 30, 2015, our debt-to-equity ratio was 0.69x and our debt-to-equity ratio net of available cash of $234 million was 0.65x. As of quarter end, the weighted average remaining term of our outstanding debt was 5.9 years, and we had approximately $2.1 billion of undrawn availability under our revolving credit facilities and (inaudible) [ventures], subject to borrowing base, leverage, and other restrictions.

Finally, as Kipp mentioned, this morning, we announced that we declared a regular fourth quarter dividend of $0.38 per share. This dividend is payable on December 31 to stockholders of record on December 15, 2015. We believe that our regular quarterly dividend is supported by an investment portfolio that has historically produced strong current income as well as net realized gains. In addition, we carry forward approximately $171 million, or $0.54 per share, in undistributed taxable income from 2014 into 2015.

And now, I would like to turn it back to Kipp for some closing comments.

Thanks, Penni. I'd like to spend a few minutes discussing our portfolio and sharing some additional thoughts before wrapping up.

We currently have a diversified $8.7 billion portfolio consisting of investments in 216 companies. Financial performance has been strong at the underlying corporate borrowers in the portfolio with year-over-year EBITDA growth continuing in the double digits at approximately 11%. Our non-accruals remain low, with 2.3% of the portfolio at cost and 1.7% of the portfolio at fair value on non-accrual at September 30.

And fortunately, we did place one new investment, Petroflow, in non-accrual during the quarter, which represents about 0.6% of the portfolio at amortized cost. Petroflow is one of the three portfolio companies we consider to be true oil and gas related investments, which in the aggregate total less than 3% of our investment portfolio today. We under wrote the Petroflow financing in July of 2014 prior to the dramatic decline in oil prices. Fortunately, we're in a first lien position where we are working with the company and our lender group to restructure the company's balance sheet due to lower prevailing oil prices. We feel confident that we can reposition the company for the longer term with a better balance sheet that should allow us to focus on seeking to achieve a par recovery over time.

As a reminder, we currently have three portfolio companies that we consider to be in the oil and gas sector, Petroflow, Vista Sand, and PRIMIX, which we underwrote during the third quarter. This is performing nicely, and PRIMIX is a transaction we underwrote opportunistically with the lower commodity price deck in plain view. PRIMIX saw its reserved base loan from banks downsized and looked to bring us in as an institutional lender to supplement its capital base. We feel good about the investment, and we think the company is well positioned in today's market.

Returning to the overall portfolio, we continue to emphasize investments in senior secured loans, with 95% of our new commitments during the third quarter in first or second lien loans. We completed several transactions with Varagon as a co-lender during the third quarter and anticipate that these investments will form the foundation for a portfolio for SDLP.

As we've discussed in the past, our strategy for SDLP is for us and Varagon to build a sizable, diversified portfolio of loans which are initially capitalized on our respective balance sheets and ultimately expected to be sold into a joint venture. Given our activities with Varagon to date, we believe that our joint venture is off to a strong start.

Finally, since I know it's in the front of people's minds, I'll simply say that we have no substantive update regarding the SSLP and GE other than what's been disclosed. We continue to manage that portfolio with the team that remains at GE, and the portfolio is healthy. We've seen some repayments in the SSLP portfolio, and as a result, the GE senior notes are starting to be repaid. Our view is that while our returns on this investment with the current structure will decline with time as portfolio repayments are directed entirely to GE's senior notes so will the risk of our investment. We continue to pursue alternatives to the current situation and continue to believe that the overall health of the SSLP portfolio will give us time to thoroughly explore these alternatives.

In closing, middle-market leveraged loan volumes are light for this time of the year, and capital is generally constrained for BDCs and institutional lenders. Despite this, our team continues to find attractive investment opportunities, and from October 1 to October 29 of this year, we made and funded new investment commitments totaling $305 million with a weighted average yield at amortized cost of 11.4%. During that period, we also had sales, repayments, and other exits totaling $152 million with a weighted average yield at amortized cost of 8%, on which we realized approximately $14 million of net gains, further contributing to our net realized gains year to date in 2015. As of October 29, our total investment backlog and pipeline stood at approximately $630 million and $425 million respectively. These investments are all subject to final approvals and documentation, and we cannot assure you that they'll close.

We continue to position the business for strength as we head into next year. We believe the investment portfolio is performing well with growing cash flows and low non-accruals. In addition, our balance sheet is conservatively positioned with an attractive funding profile and several upcoming opportunities to lower our funding costs. While we are taking a cautious approach to these uncertain market conditions, times over volatility often present some of the most interesting investment opportunities for our company.

As previously announced at the end of the third quarter, our Board of Directors approved our first ever stock buyback program, and we have the tools in place to purchase stock, should the opportunity prove compelling relative to our investment opportunities. While we're pleased to have this program in place, we also feel that we are well positioned in a market that is beginning to look more attractive for new investing.

That concludes our prepared remarks. We're happy to open the line for questions. Operator?

(Operator instructions). John Hecht of Jeffries.

Kipp, first one is, you mentioned that your agreement with others that were in the latter stages of the credit cycle, yet you're non-performing assets are pretty low, you're EBITDA, you see a decent performance within the portfolio. I'm wondering first, what kind of tempers your commentary on the overall market at this point of the cycle.

Thanks for the question, John. It's a little bit of a conundrum here as we sit around and just debate new investing. We're seeing, again, higher leverage multiples relative to the average across the cycle. You're seeing tighter spreads, or at least you have. A lot of that is widening out. So typically, that makes you more cautious. That being said, when you have good underlying portfolio performance, and you see a general stable US economy as we do, I'm not saying there's loads of growth but a generally stable economy, and we credit select in what historically have been the most defensive sectors, we're still finding plenty to do. I think the caution is just an understanding, having been in the business a long time, that as the tides may go out here, things can look better in the future than maybe they did in the rearview mirror, and we want to conserve capital for what we hope are some more opportunistic things going forward. But we've gotten the question obviously in the past, and I think I've answered it pretty consistently. I think we're going at sort of a measured pace today would be how I describe it.

Okay. That's helpful. And then the second, and I'm not sure you'll be able to answer this perfectly, but you had a lot of originations, and it looks like some of them were in anticipation of pooling it all into the SDLP, and I assume that affected both the volume as well as the yields. I'm wondering, can you just aggregate out, if you kind of eyed what might go in the SDLP when that's ready to form, what the yields and volumes would have been like?

Yeah, so I made the point, just to reiterate, gross originations about $1.5 billion, exits around things that were planned exit, $500 million plus. So generally speaking, the assets that are going to go into SDLP are first liens and/or unit tranche, and they'll tend to be assets that have yields that are lower on average than some of what remains on the balance sheet. So I'm not going to go name by name. If you looked at what came onto the SOI this quarter, going to be a reasonable assumption that, if you saw a name that was $50 million to $150 million in hold size in a first lien security with a sub 8% or 9% coupon, those were the types of assets that are targeted for SDLP.

Okay. Great. Well, we'll look through Q to determine that, but thanks very much.

Sure.

Greg Mason of KBW.

Wanted to touch on Penni's comments about using the revolver to buy back the current debt or retire the current debt. What do you view as your optimal use of the revolver? With only $200 million drawn on it today, that's about 5% of the $7.7 billion of debt outstanding. What do you think is the optimal usage of your revolver going forward?

Thanks for the question. We've always say that our target leverage ratio is somewhere between 0.6 and 0.8, so you can kind of back into that. I don't think, Greg, we necessarily have a target. And I can let Penni answer the question directly, too. As we think about some near term debt maturities, we have two options. We can obviously use the revolver to deal with those, or we can go out into the market and look for alternate capital. So I'd tell you at this point, we're evaluating both. The benefits, obviously, of taking down more revolver are, of course, its lower cost. But I would tell you that we still view the markets for longer-term debt issuance for our company as pretty attractive. Under 4% money on a five-year basis, which is, generally speaking, where our latest high grade notes trade, is pretty attractive over the long haul. But sorry to not give you an answer. We don't really have that answer. We want to keep that revolving facility to be flexible. Again, I mentioned trying to be opportunistic in the markets on a go forward basis. We use it for liquidity. So the reason to not just fully draw it down and forego any further debt issuance is obviously to continue making investments and/or using it to buy back stock.

Great. And then on some of the volatility that's happened here in the quarter, we've been hearing about hung deals that are on banks or brokers' balance sheets. Historically, you have been just a primary originator and want to control the deals. What do you think about opportunities for some of these hung deals? Does that appeal to you?

So we did definitely see a series of banks who didn't have such wonderful quarters on the execution front on syndications. Our new names, we really didn't play a role in any of those names, because frankly, we didn't like the credits in particular that were hung. I can't say I know exactly how many paper continues to be on the banks' balance sheets around those names. It's definitely changed their behavior around new underwriting, where they're substantially less aggressive, substantially less interested in middle market transactions than they were, call it, six months ago. So I think that's all a benefit for us.

And then I think, look longer-term when you have wounded banks and a capital provider like Ares Capital that has the ability to step into what historically could have been a bank-led transaction a la American Seafoods or others, we think we're one of the few companies that's really well positioned to take advantage of the fact that the banks definitely took some hard knocks during Q3 and even into Q4. But none of the new investments that we made were coming into any of those deals. I don't expect it will be either.

Okay. Great. And then one last question on that. As you're getting into doing more syndications, how are you kind of differing your syndication process versus some of these banks so that you don't end up getting some type of a hung deal on your balance sheet?

Yeah, I mean, look, the first difference in the way that we underwrite and syndicate is that we tend to be a very substantial holder in the names that we underwrite and syndicate. We're usually the largest holder of the paper that we underwrite. That's, generally speaking, the rule around here. That helps us in syndication. It's very different, the confidence level, when you go to an institution and say, we underwrote 500, and we're holding 250, we think you should come into our deal, than if you say, we're underwriting 500, and we're holding nothing, and the terms aren't so good, and yeah, I know you're complaining that the covenants are wide and pricing is a little light. We structure deals to hold them, and I think other people like to follow along in our deals. So it just is a little bit of a different mentality. I would tell you, too, look, I mean, we're not a global bank with hundreds and hundreds of billion dollars of assets, so I'd tell you we'd be more cautious, I think, on a lot of these transactions. Some of the deals that the banks underwrote at the end of Q2 into Q3, they got greedy on. They were tough credits. The leverage multiples were too high, the flex language was too tight, and the market went away from them. So I think those were the two elements of how we think differently.

Okay. Great. Thanks, Kipp. Appreciate it.

Thanks for the question.

Jonathan Bock of Wells Fargo.

Maybe jumping on along with John Hecht real quick, on the SDLP, my apologies for missing it, wanted to get a sense of the size that you effectively needed in order to transfer this into the SDLP, get leverage on, and effectively recreate the SSLP. I apologize if you've mentioned it before, but do you have a sense of sizing to date, Kipp?

Yeah, sure. Thanks for the question, John. It actually is more because a lot of the stuff is similar to the way a structured financing might look. It tends to be more dependent on number of loans, instead of principal value. It mocks a lot of the securitization examples, which is it tends to start to work at, call it, eight to ten names.

Okay. Great. And then very quickly turning to the syndication strategy for a moment, only because we've seen one BDC in particular syndication strategy come back and bite them on (inaudible) transaction, and so the BDC goes alongside, brings along Jeffries, Jeffries gets hung, blows out the deal, and now, all of a sudden, that BCD that bought it in 1998 is looking at a mark-to-market at something like 90 day one. Question for you is, Kipp, is when you think about the syndication capabilities that you've built out, do you include member banks to take hold positions in deals that you do, thus, you're going to run the risk of a bank absolutely blowing out the loan and perhaps forcing a technical mark-to-market on your position, or are you focused elsewhere in the market with who you're syndicating your deals to, like American Seafoods?

Yeah, well, American Seafoods is a fine example. I think as we described to people, it's a whole host of different participants there, their banks, their funds, their CLOs, etc. In that circumstance, we're placing that paper with banks that were holders of paper, not the JPMorgans or BofAs of the world. I tell you look, it's unfortunate, that was a very aggressive transaction. We passed on it. It didn't get done well. These things happen. I would tell you that typically, when we are lead arranging and syndicating, we tend to handle that on our own. We occasionally are put into a position where we're co-underwriting and co-syndicating with the bank, but there are pretty detailed syndication agreements that govern the way that you sell down relative to your co-agent sell down. We don't expect to be in that position. I don't know how to put it otherwise. I mean, our experience underwriting and syndicating transactions as a team over 15, 20 years, that's not something that's been an issue for us.

Got it. And then another question just as it relates to the top end of the middle market, because with several players going away or being consolidated, etc., there's really three main players that compete with you or alongside you, Golub, yourself, and then [Teres]. And if we think of all three, they're a bit different in that one can self-syndicate very easily amongst funds that are all a part of the franchise, and one can easily syndicate to a number of partner funds that are outside the fund complex. And so the question for Ares is, you have the ability to portfolio if you need, you also now have demonstrated an ability to syndicate, what's the right mix, when you present to a sponsor, of your ability to hold transactions of current size? Are you happy with that? Does the BDC not need to grow? Or do you believe that the BDC should perhaps get a bit bigger to date in order to hold bigger size transactions. Just kind of curious on which side of the aisle of self-syndication versus syndicating out, if you look at your competitors on two opposite spectrums, where is really that sweet spot for ARCC, where are you going to drive that going forward?

That's maybe a one hour response on that one for another time, but let me try to give you some direction on how we think about it. Company today has about $10 billion of capital. So just to answer your last point, ARCC doesn't require any growth to underwrite the transactions that we want to be in. Our middle of the fairway transaction could be a $10 million, $15 million EBITDA company that needs $50 million or $60 million of debt that we can hold all of. It can also be a $75 million, $80 million, $90 million company where we'd likely look to syndicate a portion of that.

Look, we've tried to make ourselves user friendly and flexible to our clients. We built Ivy Hill as a way to be active in holding more senior paper years ago. We've raised some private capital around the BDC to do that as well. So syndicating to ourselves, so to speak, or keeping it in our own system is something that we can and very much do do today. On the other hand, we've established partnerships in the past with GE, today with Varagon, such that it gives us the ability to hold certain assets in ways that might have been uneconomic or less economic for the BDC as it's built. And we've also built out a substantial capital markets team that allows us to distribute paper, if that's the right answer. So I can't tell you we have any optimal mix or perfect formula for that, John. It's kind of on a deal by deal basis. Each circumstance that we encounter with a client is different, and their preferences are different. So I'd tell you, we think we have all the tools in place to do all of the things that you mentioned and to be responsive and helpful for our clients and obviously to have it benefit our shareholders.

Got it.

There's no best answer here, goes on a deal to deal basis.

Got it. Appreciate that. And then one last question is, and I think I perhaps owe a mea culpa here, so please tell me if I'm wrong, I think I actually referred to the BDC legislation, H.R. 3868, that was set to mark up yesterday as completely dead. I think I did that perhaps a month ago, month or two ago. Did that BDC bill effectively pass with bipartisan support? And Kipp, just because Ares has been such a major part of the process, could you give us a sense of what the next steps are to the extent that that bill did pass, I believe, 53 to 4 in favor? So just your thoughts there, and then you can please tell me I was wrong.

I won't do that. The folks who have carried the most water on that, frankly, are [Mike Aragettes] in China and Josh Bloomstein, our general counsel, who is here with us today. Josh can go into more detail. I would tell you this. Look, there was overwhelming bipartisan support. I think the vote was 54 to 4 or something like that coming out of the financial services committee. What that does, in terms of process, we hope, is that it fast-tracks it into the House, we hope this fall, for something that gets passed by the House, and then it's onto the Senate. So I saw your note this morning that if you're in a football game, you're in the first quarter. I think that's right. I mean, there's still lots of work to do and lots of things that need to happen, but this was a very, very positive first step and one that we're happy about.

Great. Thank you.

Yep. Sure. Thanks for your question.

Doug Mewhirter of SunTrust.

Just building on Jonathan's question about the SDLP, actually, my phone rang halfway through your answer, so I missed part of it. I apologize if I make you repeat yourself. So if you imagine the pool of loans that you would want to sell into the SDLP or transfer to the SDLP as sort of a bucket of a certain size, and I think you said eight to ten names at a minimum, where are you now in terms of percentage terms of how much you filled up that bucket, and what's sort of the fill rate, if you would?

Yeah, I mean, generally, we're about half of the way there. I think we said that we've closed some transactions that are earmarked, obviously, for that program. Some of them are in process right now. Generally speaking, we're about halfway towards that ten number.

Okay. Thanks. And the second question, maybe more generally speaking, talking about syndication, what's the pipeline look like for the sort of large syndicated deals that you currently have at the table that maybe are similar in size or structure to the American Seafoods deal? Are there any sort of bigger ones looming, either in your pipeline or backlog or however you want to term it?

Yeah, I mean, unfortunately, I can't say there's anything that looks quite like an American Seafoods size deal. Generally, yeah, in that backlog and pipeline of $1 billion-ish, round number, yeah, we have a couple of larger transactions that are upwards of $150 million, $200 million in size where we would syndicate, but I don't think we see anything today, based on where the markets are, that is a really substantial $500 million, $600 million, $700 million type deal.

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

Okay. Thanks, Doug. Sure.

Arren Cyganovich of Bida Investments [sic].

There's some stuff that's right in there. The comment you made, Kipp, about opportunistic transactions and recaps kind of not really getting done today, can you maybe discuss the quality of the pipeline today versus maybe how it's been over the past, I don't know, 6 to 12 months? And you've talked in the past about a kind of slow ramp of getting the credit spread widening and getting into the middle market there. Are we starting to see that open up a bit for your pipeline?

Yeah, I think we're definitely seeing spreads widening as a sort of response to the not so easily executed deals of September, October for sure [in the] outflows that I mentioned in the prepared remarks. In terms of quality, late in the cycle, it tends to be low. I mean, my own personal view, I'm sure if you looked around our investment table, people might disagree a little bit, I perceive the quality to be pretty low today. And our selectivity has to be very, very high, because as we always mention, the one thing that we can do wrong in this company is pick the wrong credits to underwrite and hold. If you're off a little bit on pricing, you're off a little bit on leverage, whatever it may be, it doesn't tend to hurt you much over time, it's really when you pick the wrong company. So we emphasize qualify over everything else and underwrite business risk before we do anything else. And yeah, I think late in the cycle, and I would say particularly now, the quality of things in the backlog and pipeline are better than what we're seeing generally in the market, which is why we selected them to be in the backlog and pipeline, but the quality is a little bit low, yeah.

Okay. That's fair enough. And I know this is a small investment, the PRIMIX, it's only I think 1.4% of your portfolio, but it's a second lien investment, and obviously, it's structured with current commodity prices, can you add a little bit of color as to how that investment was structured to give you protection against further volatility in the oil and gas segment?

Yeah, I mean, without going, obviously, into too much detail on a particular company as it relates to some of the confidentiality provisions that we have with most of our portfolio companies, this was a widely marketed asset, frankly, that we understood extremely well, very, very, very high quality assets that remain incredibly economic, even at $45 oil today, in the Permian Basin, some of the best assets there, assets that our oil and gas team down in Texas know quite well. The protections, obviously, that we have are, while it's second lien, it's behind a dramatically downsized reserve based loan from the banks that obviously got downsized because of the commodity price deflation in oil. I would tell you that we think we're in an incredibly conservative loan to value as relative to the assets. And while it's second lien, full covenants, both related to the price of oil and, obviously, the to the company's performance.

So I did say either last quarter or prior that we were hopeful to find a few opportunities here and there in the oil and gas base where really, really high quality companies and really, really high quality assets needed to bring in some intermediate capital that was not dilutive to deal with the fact that lower oil prices means lower borrowing bases. And we're obviously being incredibly selective in choosing those assets, but PRIMIX is one of the companies that we think is absolutely best and class and something that we're excited about, even with lower oil prices.

Very helpful. Thank you.

Sure. Thanks.

Chris York of JMP Securities.

So my questions on mitigating syndication risks have been asked and answered, so I'm going to switch gears a little bit. Risk retention rolls are set to take effect at the end of the year, so I'd be curious to learn about how you guys are thinking about allocating additional capital to Ivy Hill to support new issuance, say, maybe over the next 18 months.

Yeah, right, we're already risk retention compliant is what everybody is saying here, which is (inaudible). We already own more than 5% of the equity in those vehicles.

My question is, so if you need to support new issuance at Ivy Hill, let's say, in 2016, you would potentially have to allocate more capital there, and so I'm curious on how you guys are thinking about managing capital, ARCC, and whether or not that makes sense to support the allocation of capital to Ivy Hill to support CLO issuance.

Yeah, I mean, we think it does. Usually, Ivy Hill's path is they do one or two new funds a year in a traditional sort of levered CLO format. We'll obviously invest in Ivy Hill managed CLOs if we think it's good for ARCC and for the shareholders and the returns are there. I don't think that risk retention point has changed our view at all of Ivy Hill and whether we see it as attractive or economic. We do. The arbitrage in CLO land is a little tighter, obviously, than it's been in the past couple of years, so we've been cautious is growing Ivy Hill meaningfully, which I think we've said in past calls. But typically, deals will come off, and new deals will start at Ivy Hill. And we're happy to continue to support growth there.

Great. Thanks for the color, Kipp. That's it.

David Chiaverini of Cantor Fitzgerald.

Question for you. So you made cautious comments on the credit environment, mentioning we're in the later innings and so forth, but yet ARCC's second lien and sub debt exposure has increased by 10 percentage points year to date while first lien is down by a like amount. And post quarter end, 73% of new originations were second lien and sub debt. Can you just comment on that dynamic?

Yeah, again, I mean, the credits that we're selecting, obviously, for investment in this company are less than 2% typically of what we're seeing, so with the obviously understanding that first lien assets tend to have lower risk than second lien and mezzanine assets, we think that we found some pretty interesting things to invest in this year that are accretive to the company and its earnings. I think there's sort of a misperception sometimes that every first lien is created the same or every second lien deal is created the same. If I make a first lien loan in a bad company, it had have just as high a probability of entering a default situation as if you make a second lien loan in a bad company. So while we obviously look at that mix and we think about it as to where we are in the cycle, our kind of second lien mezz mix is about half of what it was back in 2006, 2007, so we still think that the portfolio that we've crafted is pretty conservative in its make up.

Okay. Thanks very much.

Thanks, David.

Henry Coffey of Sterneagee CRT.

In sort of listening to a lot of the Q&A, how critical is size to the equation going forward in terms of whether you have to put more money into other funds, whether you have more opportunities come your way, more leverage, or is this going to be a business that can just comfortably keep regenerating existing capital. And as part of this, and I'm just asking this because I got asked it yesterday, would you ever step out again, as you've done in the past, and make a major acquisition as a way of achieving that size goal?

Yeah, sure. That's a good question. It's one that we talk about a lot around our company and with our board, etc. Look, I mean, first things first. Being a relatively large company we think has significant competitive advantages we outline all the time. We're more valuable to our counter-parties. Our solutions are full solutions, not partial solutions. Being at the table early allows you to dictate pricing, terms, etc. It allows you to select yourself into the assets that you want to be in and syndicate the assets that maybe are less of a good fit. So we are clear believers that our scale is a competitive advantage.

How do we think about growth maybe is how I'd characterize some of the follow on comments. With the stock below book today, I don't think that we, unfortunately, are well positioned to grow our capital base today. And you asked if we're content to recycle our capital, reinvest it, and try to drive earnings that way. We're very content to do that. We think we've got a great business if we just do that. But we think that there's a fabulous market out there for this company to continue to grow. As we look around at the landscape of what the opportunities exist in direct lending and in private credit generally, we usually see somewhere between $100 billion and $150 billion of new issuance and refinancing in our market per year. Our originations tend to be somewhere between $3 billion and $4 billion per year over the last couple of years. So while we're a large company, we remain a reasonably small market share player in a very large market, and we think that a lot of the advantages that we have allow us to grown and become a more meaningful player in the market.

But to your point on acquisitions and when to do that, we're pretty cautious here, and I'd tell you that we're very value oriented. So most of the growth that we've had, we've had during opportunistic markets, and the acquisition that we did was obviously a highly opportunistic acquisition in a very different kind of a market. So I do think that the excitement around here is that volatility will lead to more opportunities for growth. I'm hopeful that shareholders of our company, but also in the BDC space generally speaking, don't miss the boat of being in a lot of these companies that have improving opportunities and not allow us to obviously grow when the vintage is good. That's how we think about growth. I think we'll continue to pursue organic growth, and if it makes sense, growth through acquisition, but we'll do it in a careful and value oriented way, and obviously, as it relates to the existing stock price and the existing shareholders, one that is good for our existing shareholders, i.e., that's not dilutive and positions the company and the existing and potentially new shareholders for good returns.

So you'd wait for a replay of last time, of a 2008, 2009 kind of crisis environment, or given where some of these -- one of your larger peers has absolutely just [kind of stopped], and this specific question was whether that would be an opportunity you would look at.

Yeah, that's quite an interesting situation, isn't it? I hope to never really see 2008 or 2009 again. It wasn't a lot of fun from my perspective. It certainly afforded some opportunities for us, and we emerged reasonably well from that period. I don't think we need to see periods of distress that were that significant for us to perhaps be more opportunistic and more aggressive. Look, I would tell you that, I think in regards to the situation that you're referencing, we're taking a high degree of interest from the sidelines. Having actually done one of the few acquisitions ever done in the BDC space, I would tell you that we understand how difficult and how complicated some of those transactions are and that we would only pursue that if we thought that there was a clear path that added value for our company and obviously for a potential target, and we tend to be collaborative in those types of situations. Never say never, but I don't think it's front of mind for us to go hostile and launch takeover type discussions on companies that are not hoping to be taken over.

Thank you.

Sure.

Rick Shane of JPMorgan.

A couple of things here, and my time is going to get a little bit muddled, but I'm going to say that back at the end of 2011, you guys articulated a strategy which you've executed of moving up the capital stack, doing a lot more first lien senior, and it was very consistent with some things that we were seeing in terms of attractive risk pricing here. Chris York brought up a good point about the transition in the portfolio this year. I am curious, should we see this as just idiosyncratic and opportunistic as opposed to a shift in that strategy?

Yeah, no, again, we don't see it as a shift at all, Rick. Most of the reposition in the portfolio towards first lien that we did was during kind of the shake out of the last credit cycle. I'd say actually the most opportunistic we probably ever were on the sub debt asset class was coming out of the last downturn. One of the, I think, hallmarks of what we have done, and I haven't said it today, so I'll say it again, but we continue to obviously engage with a lot of our existing borrowers. So a high degree of where you're seeing us be, opportunistic and second lien and in mezz, are in companies that we've known and been invested in for a very long period of time. And obviously, you know, the risk, as most people that lend money to LBOs and private equity guys knows, is that your first 12 to 18 months with a new company is your highest risk period. That's where the surprises tend to be. Once you've been invested for five-plus years, you pretty much know what the risks are and probably can change the way that you think about underwriting that company relative to maybe where you thought about underwriting it at first pass.

So I think if you look, a high degree of those [senior] capital investments are in names that have been in the portfolio for a long period of time, and I think that's how we feel that risk is mitigated. But again, there's no shift in strategy. We remain super, super selective around picking the right credits and just have a high degree of confidence in the portfolio.

Okay. Thank you. Second question. One of the more interesting slides or data points that I've seen in the last year was provided at your investor day related to the percentage of bank loans and bonds that are trading at discounts. And obviously, there is a significant contribution there from oil and gas. But I'd love to get your thoughts, and we talked about this a little bit at the time, but I'd love to pursue it some more, how much of this do you think is really technical versus how much of it is fundamental? And to the extent that it's technical, are there opportunities for you guys in secondary markets?

Yeah, I mean, look, as you know, we manage $60 billion of corporate and structured credit here, so we're pretty opportunistic around the markets and pretty knowledgeable, obviously, of secondary markets, but liquid, [no liquid]. Again, our BDC, Ares Capital really is focused on originated private transactions, unlike some others that maybe focus on some larger cap flow secondary names. So while we do see that, I can't say that it's going to be our likely source of new investments. On the technical versus fundamentals, you haven't seen a dramatic uptick in defaults. We continue to believe that you will, and the defaults are a lagging indicator, not a leading indicator. I think the oil and gas situation, as well as the mining and metals situation around both the loan and high yield market has been the leading contributor to fundamental issues in those markets, and we think that they are long from over, i.e., they will continue throughout 2016 and beyond and be increasingly painful for those who have heavy exposure to those sectors, and of course, we don't by design.

A lot of the other pressure in what I consider to be more defensive industries is technical. And I don't have a crystal ball and I think won't make a prediction as to where secondary market prices go in 2016. It will be highly dependent on what large global [industrials] want to do, both retail and institutional relative to credit and other ideas they may have. But I think there is a very real looming increase in defaults on the way, and that's probably not so good for the markets, and it's one of the reasons that we continue to be cautious.

Okay. Kipp, thank you.

Thanks, Rick.

And this concludes our question and answer session. I would now like to turn the conference back over to Kipp deVeer for any closing remarks.

I would just say thanks to everybody for taking the time, and we'll follow up with you all next quarter.

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 November 18, 2015 to domestic callers by dialing 877-344-7529 and to international callers by dialing 1-412-317-0088. For all replays, please reference conference number 10073071.

An archived replay will also be available on a webcast link located on the home page of the investor resources section of our website. Have a great day.