Ares Capital Corp (ARCC) 2015 Q4 法說會逐字稿

Good afternoon. Welcome to Ares Capital Corporation's fourth-quarter and year-ended December 31, 2015 earnings conference call. At this time all participants are in a listen-only mode.

As a reminder the conference is being recorded on Wednesday, February 24, 2016.

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 capital gains 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 to 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 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 fourth quarter and year ended December 31, 2015 earnings presentation is available on the Company's website at www.arescapitalcorp.com by clicking on the Q4 2015 earnings presentation link on the homepage of the investor relations section. Ares Capital Corporation's earnings release and 10-K 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. Please go ahead, sir.

Thanks, operator. Good afternoon and thanks to everyone for joining us today.

I would like to start by quickly summarizing our solid earnings results. During the fourth quarter and full year 2015, we generated basic and diluted core earnings per share of $0.40 and $1.54 respectively. 2015 was a record year for net realized gains, as we had the opportunity to exit a number of our investments at meaningful gains while recording minimal realized losses.

We generated net realized gains of $0.05 per share for the fourth quarter and $0.37 per share for 2015, marking our sixth consecutive year of net realized gains and the 11th year out of the last 12. We attribute the strong investment performance to our careful and patient approach, our long tenure investing in middle market companies and our highly experienced and proactive investment team. With this strong quarter behind us, we declare a dividend payable to shareholders of $0.38 in the first quarter of 2016.

Moving away from our Company specifically, it is worth providing some color on the significant dislocation that the credit markets have experienced since we last gathered on our third-quarter earnings call in November. September and October were both very difficult months in leverage finance and the markets have become more challenged since then. Loans finished 2015 with returns of negative 0.7%, only the second year of negative returns in the 19-year history of the S&P leverage loan index.

Similarly, high yield finished the year with returns of negative 4.6%, which was the first negative year since 2008. You heard from us as early as the beginning of last summer that we saw a change in market dynamics coming and, in fact many equity analysts and investors commented at our September 2015 Investor Day that we were among the most pessimistic managers in terms of market outlook when compared with our peers.

The good news is that these views on the markets led ARCC to be increasingly selective throughout 2015. We increased our focus on managing risk and preserving capital rather than chasing the market. We chose to pass on a lot of new investment opportunities and stayed away from investing in new deals with structures we felt were too aggressive.

We also continued to be very selective on credit. We believe that volatility in the high yield leveraged loan markets has been driven largely by declines in oil and other commodity prices, outflows of capital from both markets and concerns around the specter of higher interest rates and increased defaults in the future. We also believe this is a lasting change and unlikely to reverse itself anytime soon.

Given our experience in volatile markets and our strong performance during the last downturn, we are confident in our ability to manage through these changes. We've built the Company to weather this environment through careful asset selection, a strong balance sheet and a conservative dividend policy focused on consistently achieving a level of core earnings generated from fees, net investment income and net realized gains, which meets or exceeds our dividend. We believe the current markets will allow us to make new investments with higher returns that more than compensate for the risk should this current market volatility continue.

We also see the potential for acquisitions becoming more interesting. I will discuss this a bit later in the call. As should be expected, we recognized some unrealized depreciation in the portfolio in the fourth quarter, the bulk of which resulted from negative mark-to-market yield-related valuation adjustments rather than markdowns dictated by credit issues at underlying portfolio companies. We will speak more in depth about the portfolio during the call, but at a high level we continue to see stability and growth at our underlying portfolio companies.

I would like to turn the call over to Penni Roll, our Chief Financial Officer, to discuss our fourth quarter and full-year financial results and provide some details on our recent financing activities.

Thanks, Kipp.

Our basic and diluted core earnings per share were $0.40 for the fourth quarter of 2015 as compared to $0.41 for the third quarter of 2015 and $0.42 for the fourth quarter of 2014. Our basic and diluted GAAP net income per share for the fourth quarter of 2015 was $0.05, compared to $0.37 for the third quarter of 2015, and $0.49 for the fourth quarter of 2014. Our lower GAAP earnings in the fourth quarter were primarily driven by the unrealized losses in the portfolio that Kipp mentioned earlier.

As of December 31, 2015, our portfolio totaled $9.1 billion at fair value and we had total assets of $9.5 billion. At December 31, 2015, the weighted average yield on our debt and other income-producing securities at amortized cost was 10.1% and the weighted average yield on total investments at amortized cost was 9.1%, as compared to 10.3% and 9.4% respectively at September 30, 2015, and 10.1% and 9.3% respectively at December 31, 2014.

The decline in our weighted average yield since September 30, 2015, is primarily a result of the decline in the yield on our subordinated certificates in the SSLP, but also reflects the lower yielding first lien senior secured loans that we expect to sell to the SDLP once we have built a sufficiently diversified portfolio. For the fourth quarter of 2015, our net realized gains on investments totaled $24 million, or $0.08 per share and we had net unrealized losses on investments of $154 million, or $0.49 per share, which includes $12 million, or $0.04 per share from reversals of net unrealized appreciation related to net realized gains on investments.

As Kipp mentioned, the net unrealized losses in the fourth quarter of 2015 were primarily driven by a widening spread environment for the securities in which we invest, along with some credit-driven markdowns in select underperformers. The largest unrealized loss in the portfolio for the fourth quarter was a $50 million write-down to our subordinated certificates in the senior secured loan program. The underlying loans in the SSLP portfolio continue to perform well from a fundamental credit perspective and we do not currently foresee any credit events in the portfolio.

The write-down simply reflects that, in the current environment, we believe from a mark-to-market perspective, that an investor would require a higher yield on these junior securities, thus reducing their fair value. Our stockholders equity at December 31 was $5.2 billion, resulting in net asset value per share of $16.46, down 2% compared to both one quarter and one year ago.

For the full year, our basic and diluted core earnings per share were $1.54 for 2015, compared to $1.55 for 2014, and basic and diluted GAAP net income per share was $1.20 for 2015, compared to $1.94 for 2014. For the full year 2015, we had net realized gains on investments of $121 million, or $0.39 per share and we had net unrealized losses on investments of $249 million, or $0.79 per share, which included $60 million, or $0.19 per share from the reversal of net unrealized appreciation related to net realized gains on investment.

One important measure we track for dividend distributions is core earnings plus realized gains and losses. This is the actual cash earnings generated by the Company that can be used for dividend payments. Based on this metric, we generated core earnings plus net realized gains per share of $1.91 for 2015, which is well in excess of the regular and special dividends we paid in 2015 of $1.57 per share. We continue to be satisfied that our distributable earnings meaningfully exceed our dividend and we feel we have been quite conservative with the dividend paid at the current level.

As of December 31, 2015, we had approximately $5.6 billion in committed debt capital consisting of approximately $3.3 billion in aggregate principal amount of outstanding term indebtedness; $2.2 billion in committed revolving credit facilities; and $75 million in committed SBA debentures. Approximately 59% of our total committed debt capital and 79% of our outstanding debt at quarter end was in fixed-rate unsecured term debt. We believe that this predominantly fixed-rate funded liability structure combined with our predominantly floating rate asset mix leaves us well-positioned for a potential further rise in LIBOR.

During the fourth quarter of 2015, we completed the early redemption of the entire $200 million of aggregate principal amount of our 7.75% unsecured notes, which were originally scheduled to mature in 2040, but became callable during the fourth quarter. These notes were redeemed at par, plus accrued and unpaid interest and we recognized a realized loss on the extinguishment of this debt of approximately $6.6 million, due to the write ff of the related unamortized debt issuance costs.

The early redemption of the 24 notes helps to reduce the weighted average stated interest rate on our drawn debt capital to 4.4% at December 31, 2015, down from 5% at September 30. We anticipate that this lower cost of debt should provide some earnings benefits going forward. As of December 31, 2015, our debt-to-equity ratio was 0.81 times and our debt-to-equity ratio net of available cash of $229 million was 0.77 times.

At December 31, 2015, we had approximately $1.4 billion of undrawn availability under our lower cost revolving credit facilities and SBA debentures, subject to borrowing base leverage and other restrictions. On February 1, 2016, we fully repaid our $575 million of aggregate principal amount of 5.75 % unsecured convertible notes at their maturity. We primarily used borrowings under our revolving credit facilities to repay these notes. The repayment of this higher cost debt also benefits earnings.

Finally, this morning we announced that we declared a regular first quarter dividend of $0.38 per share. This dividend is payable on March 31 to stockholders of record on March 15, 2016. Our cumulative taxable income earned continues to exceed our cumulative dividends paid and we estimate that ARCC will carry forward approximately $257 million, or $0.82 per share, in undistributed taxable income from 2015 into 2016. We believe that our current dividend level is well-supported by our earnings, but the spillover income does provide additional comfort in that regard.

Now I would like to turn the call back to Kipp for some closing comments.

Thanks, Penni.

I would like to spend a few minutes discussing the portfolio and sharing some additional thoughts on the environment for BBCs and ARCC specifically before opening up the call for questions.

We feel good about the aggregate credit quality of our $9.1 billion portfolio, which is highly diversified and consists of investments in 218 companies. The weighted average EBITDA of our corporate portfolio held steady this quarter at $59 million, and EBITDA growth as measured on an LTM basis for these companies, continues to be strong at 9% year-over-year.

Nonaccruals remain low at 2.6% of the portfolio at cost and 1.7% of the portfolio at fair value at December 31, as compared to 2.3% at cost and 1.7% at fair value at September 30, 2015. Looking at the current composition of our nonaccruals, over 80% of the value of these investments on nonaccrual is attributable to loans to four companies. We have significant firm resources and expertise dedicated to these situations and a strong track record of achieving favorable outcomes with nonperforming investments.

Turning to the fourth quarter numbers, we made $972 million in new investment commitments and exited or saw repayments totaling $569 million. The weighted average yield on our debt and other income-producing securities funded during the quarter was 9.8%, above the 8% weighted average yield on the debt and other income-producing securities exited or repaid during the quarter.

We continue to emphasize investments in senior secured loans with 81% of our new commitments during the fourth quarter in first or second lien loans. And in addition, we've continued to leverage our incumbency and our client relationships with approximately half of our new commitments during the fourth quarter made to existing portfolio companies.

Finally, we are happy to report that we completed several transactions with Varagon this quarter and as of year-end we have closed six first lien loans, totaling over $300 million, and we continue to actively review new investment opportunities together. Although we are still in the process of building the initial portfolio for SDLP and determining the exact timing of the sale to the SDLP, we remain excited about this opportunity and recognize that the partnership has already produced tangible benefits.

I would also like to provide some quick commentary on our post quarter end investment activity. Despite light volumes in the middle market and our patient approach, we continue to leverage our direct origination platform to find attractive investment opportunities. From January 1 to February 18 of this year we made new investment commitments totaling $338 million and sold or exited $339 million of investment commitments during the same period. We realized approximately $9 million of net gains on our exits through that date, as well.

The weighted average yield on debt and other income-producing securities funded during the period at amortized cost was 9.9% and the weighted average yield on debt and other income-producing securities exited or repaid during the period was 9.6%.

As of February 18, our total investment backlog and pipeline stood at approximately $255 million and $140 million respectively. These investments are all subject to final approvals and documentation, and we can't assure you that any of them will close.

So amidst all of this market volatility and the ensuing declines in the stocks of many financial companies, I would like to make a few comments on the BDC sector and ARCC specifically. We have seen most BDC stocks trade meaningfully below book value and ARCC stock has followed suit. We believe many of the stocks in the BDC space today are oversold and we feel that this is particularly true as it relates to ARCC.

Unfortunately certain companies that we're often compared with have not met the expectations of investors and we are sympathetic with the sentiment of disappointed investors. Investment performance and dividend stability has been quite poor for a number of our peers. Many smaller BDCs have not built competitive advantages and questions continue to be asked about certain management teams alignment with and regard for shareholders. This is unfortunate and we believe these factors have negatively impacted both the sector and our stock.

But turning specifically to ARCC, we believe there is a significant disconnect between the current trading price of our stock and the fundamentals of our Company. Accordingly, we continue to see potential opportunities for stock buybacks in the open market. To that end, last year our Board of Directors approved $100 million stock buyback plan, which we used during the fourth quarter to purchase approximately 122,000 shares of our stock in the open market.

In order to increase our flexibility under this plan going forward, our Board has recently approved the implementation of a 10b5-1 trading program. While the specific parameters of the program are still being determined, we are confident it will immediately provide us with expanded flexibility around the timing and frequency of our stock repurchases. In considering buybacks, we will, of course, continue to identify other potential uses of available capital, including making new investments, pursuing acquisitions and other strategic opportunities.

In closing, we are keenly focused on delivering long-term shareholder value. We will continue to do this by deploying capital in what we believe are attractive investments and by prudently managing our capital base, both our liabilities and our equities. We continue to seek new investments, but we expect a better market to take some time to develop and we are preaching patience internally as spreads widen and structures improve. Our team has a successful track record in different market environments and we are confident that we can manage risk in the portfolio while navigating through the changes ahead.

Finally, we believe that investors need to take the time to evaluate and differentiate managers based on fundamentals and to support managers and companies that have proven that they know how to operate in these markets. Based on past experience, we strongly believe that Ares Management is one of these managers, and accordingly that ARCC is well-positioned to navigate the continued volatile markets and to deliver improving returns to shareholders. Make no mistake that we are aligned with our shareholders and that we continue to work on your behalf.

That concludes our prepared remarks. Operator, could you please open the line for questions.

(Operator Instructions)

Ryan Lynch, KBW.

Good afternoon, and thank you for taking my questions. My first question is an update on the SSLP. I know nothing's formally been announced with the SSLP, but can you give us any color? Are you guys still having progressive conversations around that program and is there still any active dialogue going on with trying to find a solution other than a slow wind-down of the program?

Good afternoon, Ryan. Thanks for the question. Not much of an update. We are still in continued dialogues. I can't say they're deeper or particularly substantive at this point. So ongoing for sure, but nothing really to report.

Okay. It looks like the assets in that program dropped about $500 million in the quarter as that winds down three payments. Is that a decent or reasonable run rate we can think about going forward of how that program is going to wind down in the near term?

Sure. I think obviously if you're trying to get to your model, we are doing the same thing here is we assess that investment in that program. You can be sure that we have run a whole bunch of different cases. But, yes, I think if you wanted to pick a round number, it seems reasonable. The issuers obviously in that program probably are an two camps. They either continue to deleverage and don't really require any solution and are just sort of waiting for a potential private equity exit.

As you know, all of the names in that program are sponsored deals. The alternative is that certain folks are earlier in their investment cycle and are looking for a more dynamic facility than perhaps SSLP can provide today. So outcomes all over the map could lead you to the $500 million last quarter, and I think it is a reasonable assumption to model going forward.

Thank you. Just turning to your debt structure for a minute. You guys had one convert already repay and in February you guys, I think, funded those repayments with drawing down your credit facility. You guys have another convert coming due later this year. Do you guys plan on funding that second convert with a credit -- drawing down your credit facility?

And the first one that you guys just repaid with drawing down your credit facility, do you guys expect to draw out more leverage on your credit facility or do you guys expect to eventually term out the convert that just came due? And then potentially the convert coming due later this year?

I would say you know there are a bunch of different options for us. Obviously using the credit facilities and obviously the liquidity that comes through the Company through repayments to satisfy that maturity works for us. We do still have access to the high grade and convertible markets, but, one, obviously have access to those markets at a price that makes sense for the Company on a long-term basis, of course, because those are longer-dated liabilities.

So those markets did not perform all that well through the end of this year and through the early parts of this year either, did not offer us what we thought were attractive pricing opportunities to do a longer-term deal. So I would tell you that it's not a maturity that we have any concern around satisfying, but how we will satisfy it, I think -- I cannot tell you we know for sure now. It really depends on how the markets evolve between, call it now, the middle of February and the end of June.

Appreciate that. And just one more. I know you talked about you guys are seeing pretty decent trends, stable to some growth, in your underlying portfolio companies. But when I look at slide 16 in your presentation, it just shows the underlying debt to EBITDA and kind of cash interest coverage charge. It looks like debt to EBITDA is trending higher in your portfolio and interest coverage is trending lower. So how do we as investors and analysts balance looking at these statistics with the fact that you guys are saying that underlying portfolio trends are fairly strong?

Obviously we're looking at the credits on a name-by-name basis, certainly acknowledging 16, those numbers have ticked up, I would say, a little bit over the course of this year on the leverage multiple side, not by much. And on the interest coverage side down and, again, not by much, not material.

The key we have always found is selecting the right credits and, frankly, selecting away from certain industries that tend not to either generate free good cash flow and/or perform well in a tougher market environment. It's sort of an interesting environment that we're in that I think if we gave a broad view on the economy, we would tell you that we see a reasonably flat but reasonably sturdy economy across a lot of the industries we are in.

So we, generally speaking, feel good about our portfolio and about the credit quality. The markets, based on September to now, are a lot more spooked. And I will say this, I think those markets continue to be spooked and led, both in terms of trading levels being down but also potential for default being up by oil and gas, by mining and metals and increasingly by industries that are cyclical, whether it's retail, restaurants, manufacturing, specialty chemicals, et cetera. Those are all places where we are meaningfully underinvested relative to a benchmark index, whether it's a loan or high yield index, so I think that we position what we feel to be a much more adorable portfolio for rockier times than maybe the indices might let you believe.

But to page 16 in our investor deck, that modest change, it just doesn't cause me a lot of concern. The thing that we get wrong in our business is really misassessing business risk. And as we always say, making a mistake on credit rather than on particularities of a coverage ratio or a loan coming in here or there, it's really all about business risk. And as I mentioned, we are happy with how businesses are performing in the underlying portfolio.

Thanks, Kipp. I appreciate the commentary.

Arren Cyganovich, D.A. Davidson.

You had mentioned that you are waiting for spreads to widen and structures to improve. What are you seeing thus far as we have been in this kind of weakening technical type of situation for the past several months?

Maybe I will come from where we were discussing things in November around the last quarter. I mean, I think it's safe to say that spreads probably since September or October in most of the assets we are investing in have probably widened 100 basis points. That's slower to have widened than even the high yield market, which is off substantially more than that. But it is following suit with the larger cap loan market.

The issue right now is there is not a lot of volume. There is a lot of price discovery going on in the middle market and folks say this, including ourselves, the mid market really does tend to lag. So because of some of the transactions close in, let's say, transactions that may close now in February are often negotiated with borrowers in October, right, because of the sales cycle and the closing cycle and middle market is so long.

The key is that you were cautious in September, October, November, as the markets really were transitioning. I think if you are closing a deal now in February, you are looking back saying, well, I wanted to do by right by my relationship, but it's maybe a touch off where you might think you think about issuing a term sheet today.

In terms of leverage, obviously leverage is a bit higher than it has been for a while, not very close to the limit, but still higher than, say, post crisis. What are your thoughts there as you sell into the SDLP, would that kind of naturally deleverage the portfolio? Is that what is kind of the process you are thinking about there?

Both, yes. I don't think we will want to see the leverage ratio any higher and I do think that SDLP is a transaction once it is in full formation that lowers that ratio. So both.

And you lastly you (inaudible), it's very small, La Paloma, which appears to be some sort of gas-fired cycle plant. How does that relate to your gas turbine power generation because you have quite a few more investments in that side of the business or that industry?

We took some marks, frankly, in our project financing PowerBook which you see, which I would say is generally true across the space, whether it is larger cap names or middle-market, lower gas prices has led generally speaking across the country to lower power prices. And I would also just say that the bid on some of those assets have come out of the market a bit for project finance assets generally.

Specific to La Paloma, there has been some performance decline at that asset. It is an operating power asset in the California market. California power market's a little bit weaker as more solar has come online. But again it is something that we are working through today and feel that we have good solid ability to collect interest payments for a while, but it is just weaker in terms of where we see the market.

Thank you.

Terry Ma, Barclays.

Good afternoon. I appreciate the color on the market environment. In your prepared remarks you mentioned you expect a lasting change. Can you elaborate a little bit more on what makes you think this change will be lasting? And maybe can you just give us our best case outlook for the economy as well, whether or not you expect a recession or a muddle-through scenario?

As long as you don't think I am an economist, maybe I will try. I, for one, but I think we as a team have a pretty strong view that 2016 is a transition year for the credit markets. We see a lot more stress and distress as we look across the credit business here in areas that manages $60 billion-plus of corporate and structured credit.

We have 200 people around the globe looking at markets and I think that the view is implemented simply by being late in the cycle, by more and more technical defaults in portfolios, whether it is large cap, midmarket, [ars] competitors, just situations that we are seeing in the market. But, again, back to a comment I made earlier, I think that the problems that the oil and gas markets, in particular, are going to present in particular for the high yield market is -- not misunderstood, but maybe not being currently considered in the right way by many folks that aren't invested in high yield and in some of the larger cap credit markets the way we are.

We expect defaults will go up this year; they are already going up. If you look back historically, when defaults go up, spreads tend to widen and defaults are a lagging indicator. So obviously when you see more stress and distress in the market, it obviously has investors saying I'd price my capital today to higher returns that I did in prior years or prior quarters. And I think also there is less capital in the market. So anytime there is less capital chasing the same opportunity, it does not compete as aggressively for price.

So capital flows in the loan markets over the last, call it, six to eight months, $10 billion-plus of outflows, that is a big number. Similarly, very large numbers in the high yield market and that transitions its way into the middle-market, despite its good relative value still to the larger markets. It's true when BDCs trade below book value and they can't raise capital and grow that constrains capital.

It is true when CLO investors are less interested in supporting CLO new issuance, which is also happening right now. Most of the investment banks are in the midst of downsizing their forecast for CLO issuance for 2016 from what were ranges of $60 billion to $80 billion down to $30 billion, $40 billion, $50 billion. My guess is that continues to go down as the year progresses.

I think with more distress in portfolios and less capital in the market, we just see a real lasting change here rather than a blip where you kind of buy on the declines and wait for a rally, we're really not expecting that. So that is good news for us.

Longer-term, it allows for us to invest money with much less risk being taken and with higher returns. And as I mentioned, the key is that you have a portfolio that can weather the storm as you look for those opportunities going forward.

So those changes in the market are happening and, again, not to play economist, but I'll answer your question. We don't see the prospect of a near-term recession in the US. That is not, generally speaking, something we are considering here at Ares. I'm not going to say it is not possible if things get worse, but our current view is that we do not expect to see a recession in the US. We do see, as I mentioned, very flat growth. Obviously Q4 GDP growth was revised downward, I am not surprised, and we expect slow growth going forward.

Got it. That is very helpful. Thank you.

Chris York, JMP Securities

Good afternoon, guys, and thanks for taking my questions. Kipp, you mentioned acquisitions a couple of times in your prepared remarks. And we noticed that Ares again asked for shareholder approval to issue shares below NAV on the recent proxies. Can you talk a little bit about situations where you would realistically seek that approval, especially considering your current balance sheet leverage to fund the purchase of another BDC or a strategic deal?

Sure. In terms of the permission to sell stock below book, that is something that is ordinary course for us at this point and it's something that we have done, I want to say six or seven years now in a row. So really nothing new on that front in that proxy that was filed recently. We think about acquisitions, frankly, as being more interesting today because things are a lot cheaper than they used to be. We are value-oriented. Period.

I really don't like buying financial assets that we can originate at [97] at prices above book value. It's why we've spent so much money and so much effort building out strong origination. When you do see assets at companies, whether they are controlled by BDCs or by other companies that trade below book, that starts to make us sniff around a little bit and think there is value buying performing asset, generally speaking, at discounts.

And how do we think about potentially using our stock to do that? We think long and hard. To be honest, we think very cautiously and very carefully about issuing stock below book. We have really done it kind of once on an elected issue below book deal and we did that in advance of buying Allied Capital and that worked out reasonably well for us.

That was obviously an in the rear view mirror deal that we did it, substantial value to this Company. We generated fantastic returns for shareholders, I think about it much the same way. And I would tell you that back in 2009 when we did that, there was a lot of hand wringing about selling stock below book to do that and I am glad we did it. We will evaluate things on that same basis, i.e., is it good for the existing shareholders? Is it good for the new shareholders that would potentially be buying the stock below book? And, of course, what would we be using it for is pretty critical.

That make sense. That was the genesis of my question, given your past history there and the formality of asking for approval has been done over the last couple of years.

Switching gears, you talked a little bit about the CLO market and it appears that Ivy Hill was marked down for the second consecutive quarter and was one of the biggest drivers of unrealized losses. The case stated that total AMs were flat sequentially, so I would be curious to get an update on how you are thinking this slowdown in the over CLO market in terms of new issuance? And then maybe risk retention rules in December may affect the business and the valuation of Ivy Hill?

Sure. I will hit on the last point first, because it is not really a big issue for us. Risk retention obviously creates problems for folks who don't want to own equity in their own vehicles. We obviously retained significant equity in almost all the vehicles we managed at Ivy Hill. That was the point of creating a Company we owned and controlled and obviously could help monitor and shepherd in terms of strategic guidance.

There is definitely a decrease at Ivy Hill in the value of our equity positions. You should expect it with declines in the CLO equity and debt markets broadly. I would just highlight, though, that the decrease at Ivy Hill was not all that substantial this quarter. It was a couple of percentage points, it was less than $10 million value and something we will continue to watch. But not a big issue there. That company continues to chug along, do well, pay as dividends on a regular quarterly basis, so we are happy with their performance as it is.

What are your expectations for new issuance at Ivy Hill in terms of middle-market deals for 2016?

Ivy Hill, they just don't manage -- they manage more than CLO structures, so they are able in the middle-market take in other accounts, whether they're leveraged or unleveraged, that are just focused on middle market bank loans. And I expect they will continue to be able to do that as spreads widen out.

There is really no material update there, it's all going to be market driven. Their ability to collect assets, I'm sure, will come in line with the ability of other middle-market managers to collect assets, too, probably in line with some of the comments I have already made on the call.

One quick comment just tying those two things together. I remind people that through the downturn in and around the Allied transaction and other, there was significant growth in Ivy Hill through the acquisition of troubled CLO managers and capital constraint CLO managers.

So when people think about the acquisition opportunity and the history of the Company, I think the question around capital constraint as a risk also has to just be thought of as a significant opportunity as other people, to Kipp's point, who are less well-capitalized, I think are going to become really addressing acquisitions and not just for ARCC but for Ivy Hill as well.

That makes a lot of sense, thanks, Mike. Last here, question on buybacks. It looks like you guys haven't bought back stock in the current quarter despite your views of an oversold industry. Can you provide us with your thought process on the practical use of the 10b5-1 considering that balance sheet is high? And then potentially further increase in the required yield on the SSLP, so potentially further unrealized losses [in the] quarter.

So we have not bought back any stock this quarter because obviously we have been in a window where we are coming into an earnings announcement (inaudible) today. I'll just put a period on that one.

Look, there was some missed opportunities for this Company around the amount of stock, and I will say it, that we bought back in Q4. We didn't have a 10b5-1 program in place. We do now. I think that is a very good thing. I think you will see us use it, as I mentioned in my prepared remarks, our prepared remarks, we are setting the parameters of those as we speak.

And I will just reiterate that I think the stock at its current price is very attractive, either to the Company or to shareholders, whether they are existing shareholders or potentially new shareholders. So this Company will look at it the same way we would if (inaudible).

That is it for me. Thank you for your comments.

Robert Dodd, Raymond James.

If I can just follow up on the acquisition question because obviously Allied worked out very, very well. One of the reasons, though, it was purchased at a steeper discount to book than the equity was issued at. So is that -- obviously with the stock trade in the [77] here, which I do think is undervalued, but it is at 77, is one of the parameters you would look at from an acquisition that it be trading at a steeper discount than your stock currently is? Or is there any color on that issue?

Consideration, yes, for sure. In a public company merger, you obviously have an exchange ratio which is the relationship of two stock prices to one another. And, of course, that has reference back to each company's trading price relative to book, Robert, so certainly that is a important consideration, putting that through a model [ski]. That is just financial modeling. I don't think we are anywhere on that one yet.

Got it. If I could, on the SDLP, obviously timing hard to figure out in terms of you growing that portfolio to hit a certain size before it's really ready to be contributed. Are there any rules that would prohibit discussions between, say, SDLP buying SSLP assets? Like anything in the bylaws for either of the entities or any obscure 1940 Act Rule that I don't know about or is there anything that would be a problem there? Or obviously, as you said, you're having discussions with GE, but they're not particularly productive. Is that issue off the table right now?

SDLP could do a new transaction with an SSLP existing borrower; no issue.

On the other issue, I presume the SDLP is going to have industry concentration buckets as well, so you need a diversified portfolio. Is there any prospect where the reaching the right scale with the right diversification in the portfolio might hit some low buckets if the assets are not out there. Because, as you say, volumes are pretty low right now. And is industry diversification an issue for that getting up to scale as well?

Again, we want to balance that with industry diversification. It is key in getting the initial portfolio right for the contribution of the program, but we don't foresee any issues there. We see plenty of deal flow and obviously are in a bunch of existing names, too, that can work for the program. So, a consideration, but we don't think a problem in any way, Robert.

Great. One housekeeping one, if I can. Obviously the bulk of your unrealized losses or unrealized markdowns related to mark-to- market. You did have one new nonaccrual. Can you give us -- is it 90/10 markdowns versus credit issues, 80/20, any kind of rough figure you can give for that?

Rough numbers, about 80% mark to market.

Got it. Thank you.

You are welcome. Thanks.

Doug Mewhirter, SunTrust.

Most of my questions have been answered. A follow-up on the buyback 10b5 program. Is there something that you would anticipate would be an algorithmic related program that some of your competitors have used? So if it's below -- as long as the stock trades below X% of book value, you would buy X amount? Or is it more discretionary -- would it be more discretionary than that?

That is a basic idea. So the point is is that in the past quarter it was a buyback program solely subject, obviously, to Management's discretion in price. What we experienced in the quarter was that it limited our ability to take action during certain periods where the Company simply restricted.

So it's exactly that. It is meant to be something that is built around a set of mechanics that allows the Company to buy back stock, even during windows when it otherwise couldn't. So it's exactly that. The details of the algorithmic approach, I tell you, are still coming together right now, but that's the construct of a 10b1-5 program and why we are putting it in place.

This is probably a little bit too obvious, but I assume that you would have to keep leverage in mind with the buyback pursuant to an earlier question where you are already sort of kind of up against the comfort zone and if you can't sell down to the SDLP in time, you might paint yourself into a corner if you buy back too many shares too quickly in concurrently with a lot of investment activity.

Just remember we have natural repayments coming in that are deleveraging the Company. We have a lighter investment pipeline, I think, than you have seen in prior quarters. But, yes, certainly anytime you are buying back stock, it increases the leverage ratio. Folks don't talk about all that much, so it is a good point. Having flexibility in the balance sheet today is important. So, yes, certainly it's a consideration as we look at buybacks and the quantity of buybacks going forward.

Thanks. My last question. Pertinent to investment activity, obviously there is unusually low number of exits, and I realize a lot of that relates to the reason that you did not have a lot of originations either, is there is a lot of fear out there, a lot of companies that just can't get access to capital because there is just not a lot of activity. So would that be your expectation for maybe the first half of 2016 is you would have low exits or lower than normal industry exits and refinances and lower deal flow coming in?

It's episodic, of course, so it moves quarter to quarter. Actually it is funny that you observed that. I really did not view Q4 over the year-to-date period as particularly slow. I think it is $339 million of exits in repayments in the first 45 days of the quarter is a pretty big number. We have not really seen a meaningful slowdown, I tell you, in repayments because of the market.

I would expect that we could. That's usually the way it goes to the point of your question which is if there is less financing activity, you see fewer repayments. But the numbers we have seen, both Q4 and year to date 2016, don't really show me any indication of that yet.

Great. Thank you. That's all my questions.

John Hecht, Jefferies.

Thank you. I really appreciate your comments in the market earlier. First question is that just looking at, I guess the last three -- the new commitment terms have been tightened in terms of the months and it looks like there is a little bit more fixed rate assets this quarter. Just wonder if there is any color around the strategy behind that?

I hate to say it, but there was not.

Fair enough. That is the opportunity you see in the market it sounds like then.

That is right, John. Nothing to it.

On the SDLP, I understand there is a lot to think about in terms of when you would transfer that to the new fund and the [sneppet], and we talked about that your leverage would decline on the period of time when that occurs. Is there anything else we should look for, either whether it is real or just accounting in terms of impacts in the business when you make that transfer?

No. Nothing that we have not covered in some of the prior questions about it. It is going ordinary course now as expected, so --

Would there be any fluctuations of I guess the average yield in the portfolio when you make that transfer occur, just given kind of the waterfall of payments?

It goes up obviously with the current market, but --

As we sell loans that are lower yielding today into the SDLP to have economics similar to the SSLP, then clearly we have a benefit on the lower (multiple speakers) as well as an improved yield on the capital commitment.

(Multiple speakers). Right. Maybe I misunderstood the point but, yes, Penni, obviously when you take this portfolio of assets and you contribute it to the program, it creates capital and the structure of the program takes in more capital from our partner and, of course, increases the yield on the existing pool that we are holding today outside of the program. I think you know that there, too. I did not realize that was (multiple speakers).

Yes, I just wanted to confirm that beyond the leverage we would see some type of effect to that regard as well.

Yes.

Then last question is you guys had a fairly substantial -- and I know there is tax estimates and so forth in there (inaudible), so significant spillover. Given the market and the opportunities and leverage and so forth, I'm sure there is lots of considerations, but how do you think about that? And I guess specifically, how do you think about that with potential special payments?

I think, as you know, in the past we have made some special dividends using that number as it has gotten larger. I am a little bit cautious around it now as the markets are transitioning to be a bit more difficult. Look, I have also thought about it or we have also thought about it as a more important safeguard for the dividend maybe than ever, and tried to emphasize that in our prepared remarks.

We are fortunate in that strong investment performance at our Company has put us in a position that, frankly, not really any other company is in today in the space. A couple of others do have some spillover and I commend them for obviously generating that on the backs of good investment performance. And we will continue to keep it for a rainy day, I think for the next little bit.

But, yes, I will take your point, John. It is getting to be a large number and in past periods we have tried to say that comes out as a special dividend based on the cycle of realized gains and this was a good realized gains year, there is no doubt. But I think based on what is happening in the markets, we are choosing for the time being to be cautious around that number and retain it rather than pay out specials at the end of Q4 as we have done in the past.

Great. Makes sense. Appreciate the color.

Thanks a lot.

Jonathan Bock, Wells Fargo Securities.

Good afternoon, and thank you for taking my questions. Wanted to perhaps ask the question Mr. Dodd's question a little differently. Kipp, you mentioned that dilution was a consideration as it relates to purchases. My question will be a little bit more straightforward. Are you willing to dilute investors on a NAV basis overall to make an acquisition?

I am not sure I can answer that in sort of a general statement and in a vacuum, Jonathan. I mean, look, if we pursue acquisitions and use our stock to do it, we will want to make sure it is good for shareholders. And obviously the way we think about that is it is good for the existing and future dividends; it is good for book value; and certainly that it would be accretive from an earnings-per-share perspective. Of course, modeling issuance and stock below book creates a risk of book value dilution, so it really just depends on the math of a certain situation.

Okay. So turning next to Varagon, can you walk us through the ability to actually form the entity as it relates to capacity constraints tied to nonqualified assets? Where do you sit and how do the guardrails of that 30% of assets, nonqualified asset limitation, how does that factor into your ability and willingness to move forward with the Varagon transaction?

It is certainly one of the constraints. We actually feel that we are in a pretty good position today, Jonathan, to work through the contribution into the program. I am looking at Penni now. She has the numbers in front of her and we don't have them in front of us exactly around the 30% test going through the end of the year, but we very much view it as on track for this year.

It really depends more on the warehouse portfolio, the diversity of that portfolio and all that. But I think I was more concerned about that nine months ago than I am now.

You mentioned last quarter that there is a close number related to diversification of assets that's less of par value to get this done, but more 8 to 10 assets that you are originating or so could then be a key number. You mentioned that today you are at 6 for the Varagon partnership. The question that we would have is when you look at six investments near-term, you look at liquidity, you look at the potential for asset marks as well as increasing usage of your balance sheet revolver to be used for the debt payments that are likely coming due in 2016. How do you have capacity to hold some 7%-ish paper to kind of get you over the finish line if you're going to keep leverage constant?

It's a good point. One of the things I will say is the deals that we are, generally speaking, working through for SDLP have focused on slightly smaller deals than maybe you are used to for SSLP as it trucked along for maybe 2013, 2014 where, I think as you know, we were buying and hold $300 million, $400 million deals.

SDLP in the early deals there were focused on slightly smaller names, obviously building both industry but also issuer account diversity. It is easier to do it just the smaller final holds. But all your points are well taken. Those are the balances we are working through as a Management team today. We are obviously committed to the success of that program.

As we deal with the challenges that you laid out, they are all considerations. We are taking our time. We're working on slightly smaller deals there are pushing forward as advertised.

One item as it relates to the SSLP is, I believe the partnership recently kicked out an investment to you, Instituto de Banco, I believe is the name you've talked about, the private school operator in Puerto Rico. The one thing I am trying to understand is why a senior lender in this partnership would effectively divest collateral to you to allow you to pay down the sub notes of the security and then you put that Instituto on balance sheet? Can you walk through that October distribution and why it occurred?

There is some complicated accounting here, too, so I am going to have to invoke Penni on this. Let me talk about [Eduque] specifically because it's been a point of discussion in the past, and I think there is a worthwhile update. We actually did complete a restructuring of Eduque in Q4. One of the key components of that restructuring was actually SSLP's divestiture of its participation in that loan.

I would tell you that that divestiture, which was for the benefit of ARCC today, came at a very attractive price but I think most importantly allowed us to kind of control this from a go-forward basis. So SSLP no longer has an investment in Eduque. The entire loan at that Company today is held by ARCC. I think a small portion also resides at Ivy Hill, but the good news there is we have converted the entire investment into a preferred equity investment.

It remains on nonaccrual and that we restructured it to be a preferred equity investment with a pick coupon. The preferred equity is the highest ranking security in the capital structure and we just feel that this capital structure with no debt puts the Company in a much better regulatory position as it relates to accreditation at the schools. Puerto Rico has been a difficult backdrop and obviously the oversight of the DOE on a Company with a difficult balance sheet has not helped the Company operate or turn around. And I think we finally achieved an outcome that positions us for a much improved recovery down the road.

So I will stop on that and say that we will welcome any further questions on the point. I could turn it over to Penni for a moment just to help us all with some of what was a somewhat complicated accounting issue as it relates to that loan coming out of SSLP.

We did have a good outcome with GE on how to deal with this and to get control of the asset, but from an accounting perspective, I will walk you through the steps that we took. But if you have any questions, anyone on the phone after this, we are happy to walk through it with you one-on-one.

Basically prior to the restructure of Eduque, we and the SSLP were both invested on a peri passu basis in the same first lien loan in Eduque. So to effectuate the restructuring, GE consented to us buying the loan out of the SSLP for a nominal amount, and thus the SSLP distributing the full loan to ARCC.

Then what happened for GAAP accounting purposes is it was accounted for as a distribution, so the SSLP distributed its Eduque loan to ARCC at fair value which at the time of the transfer was $67 million, thus reducing our cost basis in the SSLP by $67 million and increasing our cost basis in the Eduque first lien loan by the same $67 million. Then in the restructure, ARCC then exchanged our total first lien loan exposure with an aggregate cost basis of $121 million into the small first lien and preferred equity that Kipp mentioned.

You asked the question of why did the senior notes in the program sell so uneconomically. The answer is, number one, they do not have a lot of interest in the business anymore. They are not in the sponsor finance business. They are doing things, perhaps, in a transaction of that nature that they view as difficult that they might not do otherwise, and I think that is good for us. It's a positive outcome.

I think also, look, when you think about how conservatively built that program is today in terms of its underlying ratio of senior notes to sub notes, I think they just view, GE does, views -- and I think rightfully so, very much rightfully so -- their senior notes as having limited to no risk and it can incur collateral coming out of the pool at virtually no value and still not impairing them. We're creating a lesser security for them in any way.

I think it is worth mentioning that GE still incurs its proportional loss (multiple speakers) so economically they still incur their loss on the loan, so we are not disadvantaged in that way. But we could potentially benefit to the extent that any future recovery on the former interest of the loan comes to us, because we now own and control the full restructure and asset.

Eduque, for better or for worse, with a better balance sheet with less scrutiny from the DOE, I think continues to be something that we feel, while it has been challenged, is something that we can fix. It is a very important educational provider in Puerto Rico and for a lot of Hispanic-speaking students, and it is something we are committed to making sure we achieve really solid recovery on and I think this quarter we accomplished something pretty important towards that goal.

Thank you for the description. Kipp, you also made a mention early on that in the summer and certainly you made the comment at the Investor Day that Ares is perhaps one of the most conservatively focused managers. And totally understand the statement in light of past and to the extent that past is [prologue] makes total sense.

The one thing I'm trying to balance is that the proportion of second lien and subordinate debt that you invest in even as of 6/30 to date, you take the 9/30 results and now the 12/31 results. There is a high proportion of second lien. And there's no judgment call one way or the other, I'm just trying to understand how do you balance that when, in some cases the circles that we run into as very uneducated analysts, all of us might not understand, what are we missing? Because when I look at that that seems more of a subordinate move which would run contrary to your views of conservatism.

It seems like we have this conversation every quarter. I would tell you, first things first, pick the right company. Secondly, in our second lien, we structure and underwrite all of our second lien, Jonathan, so that not every second lien is created equal. In fact, our second lien performance, whether they were investments we made in 2005 or 2009 or 2012, have actually performed quite well and we've emphasized in the past, too, that they are in larger companies than most of the other folks you will see as you analyze the BDC space.

I would argue in better borrowers and larger companies, more stable results. The problems, if you look at the underperformance in our portfolio during the last downturn really came in mez investments, right? It really came in unsecured positions where, number one, you had interest payments blocked.

You can't have interest payments blocked in second-lien securities. They're secured. If you do, you can accelerate immediately and you're a secured creditor as -- the same as you were as a first lien creditor. So long as you actually write your own documents and write good documents.

Secondly, being secured versus unsecured is really, really important in achieving recoveries. And I can't emphasize that enough. So while that number has gone up a bit, we continue to focus people on saying or on looking at kind of what the total second lien and mez exposure is at this point in the cycle relative to where we were as a Company back in 2008. And it is about half of where we were back in 2008, so we do think that we are much more conservatively positioned, even today, than we were going in to potentially more difficult environment.

Thanks for the color. It makes complete sense. Finally, if you think of the CLO equity markets, I know a lot of people have discussed that Ivy Hill and risk retention. Some folks in the BDC are marking CLO equity down to where it's close to their mark to market.

The question that I would have for you is of that Ivy Hill value, how much of that is actual CLO equity asset, because you invest in the own equity of your deal, so Ivy Hill holds the CLO equity on its balance sheet and its general relative mark, and how you are thinking about that value next quarter in light of where CLO equity trades today?

We said this in the past, so I'll say it again. The value at Ivy Hill is really twofold. It is the value of the manager, which obviously comes from net profits we generate from managing vehicles as well as investments that we have in funds, that's the second source of value. And I said this in the earlier question around risk retention, I think it was Chris York, a lot of what Ivy Hill is doing today is managing non-CLO money. So I think that we have less valuation risk in some of the securities that we have there because our vehicles are lower leveraged, we feel that we have better visibility into the portfolios.

We know that those portfolios have less oil and gas and commodity exposure than many. We know that they have lower CCC baskets and CCC exposure than most. So a significant portion of the value obviously is investing in our own funds, but we think we have built the right structures and we think we've built the right collateral basis at Ivy Hill -- I should give them credit for having done that for the past couple of years on our behalf -- that allows them to withstand the markets a little bit better than maybe some other CLO managers who don't have those benefits.

Understood. They have an excellent track record. Speaks for itself. So thank you for taking my questions.

Thanks, Jonathan.

Robert Dodd, Raymond James

Just a follow-up on the market color. In terms of -- obviously spreads have started to widen, but your color seemed to indicate that attachment points are still, if anything, drifting up a tiny bit. Obviously last cycle CLO activity dries up, scarcity capital typically (inaudible) that attachment point has tended to head south as well on new deals. There is obviously a lag in the middle market versus broader parts of the market and the broad market is not seeing that come down yet. Is there any color you can give us on whether we should expect that to happen with a bit of a lag or whether you think it's not going to happen this time around?

I think what you are seeing is our Q4 numbers and there is a lag. I would tell you that we have already seen a quarter to half a turn of leverage reductions in new deals, even through now to the middle of February and I expect that to continue to go down. So I think that what you are seeing in Q4, I am hopeful represents the peak for the portfolio. And I would expect the market will help us walk that weighted average debt to EBITDA down and we think that happens in connection where, at the same time, the spreads widen as well.

Perfect. Thank you.

Maybe wishful thinking. I don't think so.

We can hope.

Ladies and gentlemen, this will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Kipp deVeer for any closing remarks.

I really don't have anything further, but I will thank everybody for their time and look forward to seeing everybody now that the quarter is behind us. And we will probably see folks out on the road. So have a great day.

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 March 9, 2016, 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 10078263. An archived replay will also be available on our webcast link located on the homepage of the investor resources section of our website.

Thank you for attending today's presentation. You may now disconnect.