Ares Capital Corp (ARCC) 2016 Q1 法說會逐字稿

Good afternoon. Welcome to Ares Capital Corporation's first quarter ended March 31, 2016 earnings conference call. At this time all participants are in a listen-only mode. As a reminder, this conference is being recorded on Wednesday, May 4, 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 forward-looking statements. Please also note that the past performance or market information is not a guarantee of future results.

During this conference call, the Company may discuss core earnings per share or core EPS, which is a non-GAAP financial measure as defined SEC Regulation G. Core EPS it 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, the most directly comparable GAAP financial measure, can be found in the accompanying slide presentation for this call by going to the Company's web site.

The Company believes that core EPS provides useful information to investors regarding financial performance because it is one method that the Company uses to measure its financial condition and results of operations. Certain information discussed in this presentation including information relating to the portfolio of companies was derived from third-party sources and has not been independently verified an accordingly the company makes no representation or warranty in respect of this information.

As a reminder, the Company's first quarter ended March 31, 2016 earnings presentation is available on the Company's web site at www.Arescapitalcorp.com by clicking on the Q1 2016 Earnings Presentation link on the Home page of the Investor Resources section. Ares Capital Corporation earnings release and 10-Q are available on the company's website.

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

Thanks, operator. Good afternoon and thanks to everyone for joining us today. I'll start by providing a quick summary of our solid first quarter earnings results.

We delivered basic and diluted GAAP and core earnings per share of $0.42 and $0.37 respectively, including net realized gains of $0.09 per share. Our net asset value grew sequentially from $16.46 at December 31, 2015, to $16.50 at March 31, 2016. Our credit statistics also improved as our loans on non-accrual declined from 2.6% at cost at the end of 2015 to 1.3% at cost at the end of the first quarter.

At fair value our non-accruals are now at 0.6% of our total assets. Overall we're pleased with how the portfolio and the Company as a whole are performing. We declared a second quarter dividend of $0.38 per share, which is consistent with our first quarter dividend.

When we held our last earnings call a few months ago, we were experiencing significant volatility in the capital markets, amidst uncertainty around oil and other commodity price declines, questions about the slowing of global economic growth, and general confusion regarding the direction of interest rates around the world. Since that time the credit markets in the US have generally experienced a modest recovery in terms of pricing, but we continue to see a slowdown in transaction flow, in the broader loan and the high-yield markets, as well as the middle market.

We're happy to see the fear in the market that was so prevalent in the fourth quarter and the early first quarter subsiding a bit, which eases concerns that we are headed for a more significant market correction in the near term. But with that being said, we believe this recovery is largely technical and without a meaningful change in fundamentals, our attitude and our approach is generally unchanged.

We remain cautious but confident that we can find select transactions with strong relative value attributes amidst the broad opportunity set that our team is able to access. As you know, the first quarter tends to be a seasonally slow period for new originations and amidst the market volatility this year was no exception. We funded approximately $490 million in new loans during the first quarter of 2016, a mix of exits, syndications, and pay downs on existing facilities led to roughly $480 million of repayments.

I'd like to turn the call over to Penni Roll, our CFO, to discuss our first quarter financial results, and to provide details on recent financing activities.

Thank you, Kipp.

Our basic and diluted GAAP net income per share for the first quarter of 2016 was $0.42, compared to $0.05 for the fourth quarter of 2015, and $0.32 for the first quarter of 2015. Our basic and diluted core earnings per share was $0.37 for the first quarter of 2016, as compared to $0.40 for the fourth quarter of 2015 and $0.37 for the first quarter of 2015.

Our first quarter core earnings were reflective of the seasonality of our slower deal volume that we often see during this time of the year. And while lower than the fourth quarter, they were in line with core earnings in the first quarter of 2015. Our higher GAAP earnings in the first quarter were primarily driven by net gains of $0.06 per share, compared to fourth quarter net losses of $0.42 per share.

The net losses in the fourth quarter were mostly unrealized and primarily driven by widening spread environment, whereas during the first quarter of 2016, spreads were generally stable from year end. For the first quarter of 2016, our net realized gains on investments totaled $26 million or $0.08 per share, and we had net unrealized losses on investments of $5 million or $0.02 per share, which included $18 million or $0.06 per share of reversals of net unrealized appreciation related to the next realized gains on investments.

We continue to generate solid net realized gains from our portfolio. As of March 31, 2016, our portfolio totaled $9.1 billion at fair value and we had total assets of $9.4 billion. At March 31, 2016, the weighted average yield on our debt and other income-producing securities at amortized costs was 10.1%, and the weighted average yield on total investments on amortized costs was 9.2%, as compared to 10.1% and 9.1% respectively at December 31, 2015.

Stockholders equity at March 31 was $5.2 billion, resulting in net asset value per share of $16.50, up 0.2% compared to a quarter ago. As of March 31, 2016, we had approximately $5 billion in committed debt capital, consisting of approximately $2.7 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 54% of our total committed debt capital and 67% of our outstanding debt at quarter end was in fixed rate unsecured term debt.

We believe that this majority fixed rate funded liability structure, combined with our predominantly floating rate asset mix leaves us well positioned for a rising rate environment. During the first quarter of 2016, we repaid $575 million aggregate principle amount of our 5.75% convertable notes at their maturity. The repayment of these convertible notes helped to reduce the weighted average stated interest rate on our drawn debt capital to 4% at March 31, 2016. Down from 4.4% at December 31, 2015. We anticipate that the repayment of this higher cost debt should continue to provide earnings benefits going forward as it did in the first quarter.

In April, we amended our senior secured revolving credit facility to, among other things, extend the reinvestment and maturity dates by one year to May 2020 and May 202,1 respectively, for $1.2 billion of the total facility amount. We are very appreciative of the continued support of the 20 banks in our line of credit. During the first quarter of 2016, we repurchased approximately 393,000 shares of our stock, a total cost of $5.5 million, at an average price of $13.94 per share.

While we would have liked to purchase more at these levels, the stock recovered from these levels quite quickly. We stand ready to take advantage of any additional weakness in the stock going forward, with active share repurchases initiatives in place. We believe it is important to have this tool in place and we recently amended our $100 million stock repurchase program to extend the term of the program from September 2016 to February 2017.

As of March 31, 2016, our debt to equity ratio was 0.78 times and our debt to equity ratio net of available cash of $57 million was 0.77 times. At March 31, 2016, we had approximately $967 million of undrawn availability, primarily under our revolving credit facilities that are lower cost, subject to borrowing base, leverage and other restrictions.

Finally, as Kipp stated, we announced that we declared a regular second quarter dividend of $0.38 per share. This dividend is payable on June 30 to stockholders of record on June 15, 2016. In addition, we estimate that undistributed taxable income carried forward from 2015 into 2016 was approximately $258 million or $0.82 per share. We believe that our current dividend levels, while supported by our earnings, but this spillover income does provide additional cushion in that regard.

And now I'd like to turn it back to Kipp for some additional comments.

Thanks, Penni. I'd like to spend a few minutes discussing the positive developments in the portfolio that I referenced earlier in the call.

As I discussed in our year-end call in February, our portfolio management team has been hard at work for quite some time on the small handful of challenging situations in the portfolio. To that end, I'm pleased to report the two of the larger investments previously held on non-accrual, Universal Lubricants and Competitor Group, returned to accrual status during the first quarter.

We valued our debt investment in Universal Lubricants above our cost basis as we expect near-term asset sales at the company to generate a meaningful paydown on our loan. And we believe further recoveries from future activities should deliver incremental value. This investment is likely near a positive resolution, after much hard work.

In regards to the investment in Competitor Group, we achieved a balance sheet restructuring in the first quarter, which allows this company more operating flexibility and we continue to work with our partners at Competitor Group to maximize the long-term value of the business. Competitor Group's a solid company with an exciting portfolio of enthusiasts, athletic events that can be repositioned for growth without the constraints of over leveraged balance sheet. With these loans back on accrual status, we have only a few investments of any meaningful value on non-accrual.

The non-accruals now sit at 1.3% of the portfolio at amortized costs, as I mentioned earlier, 0.6% at fair value at March 31, 2016. These levels are very low by comparison, both to our own history and to the experience of other lenders and we commend our team, who've done a fabulous job working through these situations. We believe that our ability to manage through our non-performing loans is a meaningful competitive advantage for ARCC and it's helped differentiate us as one of the few BDCs that's been able to consistently deliver NAV growth over time.

Switching gears to our recent investment activity. The first quarter demonstrated a modest level of new activity and we remain focused on deploying capital flexibly and what we see is the most attractive opportunities. As part of this strategy, we continue to build our portfolio for the SDLP, our joint Varagon with AIG. As of quarter end, we have closed seven transactions that total approximately $670 million in funded commitments, that are earmarked for sale to the SDLP and our current investment in these loans totals roughly $355 million today.

We, and our joint venture partners, continue to see a healthy pipeline of new investments, appropriate for the program, and we're getting closer to the diversification required to convert these assets into a fully ramped program that we believe will deliver improved risk-adjusted returns to ARCC.

Before I conclude, let me provide some quick comments on our post-quarter-end investment activity. Despite light volumes in the middle market and our continued patient approach, we continue to leverage our strong direct origination platform to find attractive, new opportunities. From April 1 through April 27 of 2016, we made new investment commitments totaling $123 million and sold or exited $335 million during the same period. Allowing for some post-quarter-end deleveraging.

Two of these exits, Netsmart Technologies and Napa Management Services, generated meaningful realized gains for us that will be recognized in the second quarter. As of April 27, our total investment backlog in pipeline stood at approximately $260 million and $210 million respectively. These investments are all subject to final approvals and documentation, and we can assure you they'll close.

So in closing, we're very pleased with the performance this quarter, with a modest increase in book value and a decrease in our non-accruals. We're beginning to see the benefit to our earnings from a lower cost of capital, and our share repurchase program provides us with an effective tool to opportunistically enhance EPS and shareholder value.

We're confident that ARCC is well positioned today and we continue to believe this is a transitioning market that is likely to offer increased opportunity to ARCC to achieve attractive, risk-adjusted returns as we move forward through this credit cycle.

That concludes our prepared remarks. We'd love to open the line for questions.

(Operator Instructions). Our first question is from Hugh Miller of Macquarie. Please go ahead.

Hi. Good afternoon. Thanks for taking my questions. Wanted to start off on asset quality. I appreciate some of the color you guys gave regarding the shift in the non-accrual status. In terms of, you know, sectors, as we look at, you know, we've started to see outside of energy, a little bit of deterioration in retail, and some other areas.

As you guys look at kind of the landscape in the coming quarters, you know, how are you guys thinking about it in terms of, you know, is it just really looking at individual credits in terms of risk or are there certain verticals that you're less enthusiastic about and seeing greater risk. If you could just provide us some color as you think about asset quality.

Yes, sure. I would tell you that when we look at the existing portfolio on the Investor Presentation that's out there for the quarter on page 11, it will show you, sort of that diversification by industry. We've always I feel outperformed by avoiding certain sectors, so you'll see that we de-emphasized things like oil and gas, media, you know, retail and restaurants at certain parts of the cycle. You know, construction, home building, auto, the things that tend to be very cyclical.

Where in our view, if you're just making what to performing alone you really don't get paid for that risk. Again we've seen some weakness in our oil and gas portfolio, but it's very small. We haven't seen any meaningful weakness across any other industry sector, Hugh, that I would say is systemic or worthy of a conclusion. For us it's all about having built a portfolio that we think withstands, you know, an economic and/or credit cycle and we think we have that today.

Okay. That's helpful. Thank you there. And I guess looking at the portfolio activity, it looks like you guys were a little bit more active in kind of exiting second lane positions in both the first quarter and into April. You know, wondering is that just kind of a coincidence or, you know, given how light the origination opportunities are out there, you know, were you just seeing more of an appetite out there for second lien assets in the marketplace? Any color there?

Well, the two substantial exits in April, Netsmart and Napa, you know, were both deals where we're marginally involved in one going forward, not so much in the other one so there's an exit there on the second lien side. I would tell you that, you know, two of the new deals that we did in the quarter, one was actually exited within the quarter.

So we did a deal for a company called Met Assets that actually came in and out during the quarter, it was $100 million second lien deal that was really a bridge to a future financing. Sorry, we did $100 million of $500 million but it was exited in the quarter so that probably skews the numbers a touch.

Another exit in the quarter was in an existing portfolio company called Sarnova, where we remain in the credit, but have a smaller final hold in the new deal. So probably just more circumstance around particular names than the market or any desire to exit second lien.

Okay. That's helpful. Thank you. And then just a question or two on the SDLP. You started to give us a little bit of color on kind of the opportunities there. What are you seeing in terms of yield for those assets relative to the overall portfolio and to the SSLP?

Just so I'm clear on the question, I'll answer it the way that I think you're asking, which is when we're originating those loans with our partner, you know, they're whole loans. You know, first lien or unitranche loans that, obviously, tend to have yields that are lower than the aggregate portfolio today. So to pick a range, call it, you know, LIBOR six, maybe LIBOR five even on the bottom end to LIBOR eight.

When there's a conversion of SDLP, obviously it will eventually take on the same treatment as SSLP, which is that portfolio of collateral gets put into a program and then by taking on significant capital in a structured fashion from around IG and from Varagon, there's the ability to improve returns on those assets. Hopefully I'm answering the question the way that you're asking it. But if I didn't, feel free ask a clarifying question.

Yes. No. No. I mean, hat gives good color. I'm thinking in terms of the effective yield for ARCC, you know, when you consider the additional fees and things like that. I'm just trying to get a sense of, you know, with the appetite in the marketplace right now, you know, and kind of a shift in some of the credit spreads, how are you thinking about in terms of as we see a wind down of yield coming off the SSLP and seeing the ramp up of the SDLP, you know, how should we be thinking about it in terms of incremental yields, you know, as we see that transformation occur over the next several quarters?

Yes. There are two benefits obviously in that as we exit -- the way that the treatment for the conversion works, right, is we effectively exit those loans as ARCC on balance sheet investments. They exit and because we're generally holding about half, as I mentioned in the detail, of the warehoused assets, that converts into something less than half. So upon a conversion, we will see a return of capital to ARCC to use that terminology right, we'll effectively see a repayment.

So the size of our investment in the same pool will go down. And the returns on the smaller investment, which remains, you know, it will eventually be a single-name investment into the SDLP, the same way that you see SSLP, we'll see dramatically higher yields. So obviously you get the benefit of removing lower yielding assets, you get the benefit of incremental capital. And you get the benefit of the remaining investment, clicking through it or roughly at a meaningful higher yield.

Thank you very much.

Also meaningfully higher yield to where SSLP currently stands right as well..

Perfect. Thank you very much.

Our next question is from Ryan Lynch of KBW. Please go ahead.

Good morning. Thank you for taking my questions. So, you know, broad-based loan balance were clearly down in Q1 and that's, you know, pretty typical of the Q1 season. It looks like so far quarter to date your guys loan volumes, your origination volumes, I should say, are down and are pretty weak.

Are you seeing any market dynamics change to potentially increase, you know, the amount of originations you guys can put out in Q2? And, you know, if not, you know, what sort of market dynamics need to change do you think where we can maybe get more buyers and sellers, of businesses to engage and kind of help further loan volume growth.

Yes. We're not -- thanks for the question, Ryan. We're not seeing frankly a whole host of changes. I'd tell you, you know, we've been busy on a handful and I mean that, just a handful of deals. A lot of those deals are competitive. I mean, these are obviously the things that get through the screen. So the quality names are more competitive, I'd say that.

I think that the dynamic that needs to change right now is, you know, number one, the fourth quarter and even into the first quarter, you're seeing a really, really dramatic decline in the bank's involvement in the leverage finance markets, in particular, in mid-market. So there is just less and less activity there. I'd say there's also been lack of any appetite on the behalf of investors for dividend or recapitalization deals.

So it's really been a focus for six months on new money deals. And the issue around new money deals is I think an equity issue on the LBO side, multiples have gotten very high for private equity firms. And as they look around at, you know, the B quality and below companies, you really want to pay less and/or see more growth and they haven't had the ability to pay less and/or see more growth.

So I think for us it's less transaction flow right now from private equity, because there really is a buyer/seller dynamic, where they're not meeting in the middle. And that usually clears itself up over time one way or the other. But I think we're just at a little bit of a pause here as those dynamics get sorted out.

It's really not for a lack of capital in the direct lending markets. There's plenty of capital, I think, from ARCC and from others to support high-quality transactions at reasonable multiples with good pricing. But there are just fewer of those today, I think amidst all of the volatility, uncertainty that we're feeling a little bit of a pause from here after call it four to six months.

Got it. That's great commentary. Just following up on the question with the SDLP. I mean, you guys are obviously building a pretty sizable portfolio, it sounds likes you're well on to having your portfolio almost the size to drop into the SDLP. Can you provide any guidance on potentially the timing of when you guys plan on dropping that in?

Is that something we should expect in the near term or is that something you guys are going to be continually building for the next couple of quarters and maybe kind of a back half of 2016 type of event?

Yes. I mean, without providing guidance for a heck of a lot closer. I mentioned that we've got some good backlog in pipeline around names that could work for SDLP. So, you know, it's really the next couple of deals that we are, you know, hunting right now for that program actually come through or not.

You know, it could be pretty soon if we go kind of three for three or four for four on those names. If you go one for four, it will (inaudible) back and I'd say very certain, I think, at least from my perspective, based on the warehouse portfolio and what we see in the pipeline, that it's the next six-month event.

Okay. Great. I have a couple of technical questions. So this quarter looks like Ivy Hill contributed about $10 million dividend. It looks like over the previous two years in Q1, Ares received about a $20 million dividend from Ivy Hill. So this quarter in Q1 it dropped down to $10 million now.

Typically the remaining quarters two through four have been $10 million dividend so how should we be thinking about that dividend from Ivy Hill? Should we expect to remain at the $10 million like it has been, you know, typically the Q2 through Q4? Or should we expect any uptick in these -- in Q2 through Q4, considering that the Q1 dividend was kind of lower from a historical standpoint.

Yes. You remember, I've lost track of how many years ago now.

(Inaudible)

Yes. No. No. A couple of years ago, Penni is saying two-straight years of actually taking some capital out of Ivy Hill. Those Q1 kind of incremental $10 million dividends on top of the regular $10 million we viewed as special dividends coming up to ARCC out of Ivy Hill, because there had been significant, you know, realized earnings because of gains at Ivy Hill.

Their performance had really allowed them to be more capital efficient. They had excess capital and obviously dividend that back up. You know, that excess capital is sort of less plentiful having done that a couple of times already.

And I would tell you that we look at Ivy Hill as actually something that is the market here changes, may be more of a growth avenue for us going forward. We're assessing that right now. But again the quarterly dividend that we targeted from Ivy Hill, based on their earnings, is $10 million a quarter and I would just think of that $10 million that had come through in the previous two first quarters as truing up retained earnings from the past.

Sure.

And we've gotten asked lots of questions about, you know, do you expect to do that every year. And we said, well, the Company has done so well, we're in a position to do it now, which was this time last year and we had done it the prior year. I think we just made a determination with that company that they were better off, perhaps, retaining some of that capital for potential growth this year and beyond.

Sure. Makes sense. Just one more (inaudible) question. So you guys have the June 2016 convertible notes or are obviously going to be due in June. Are you guys comfortable with drawing down additional capacity from your credit facility to replace those and have that, you know, additional draw downs on your credit facility or would you guys like to replace that with some more unsecured debt?

Penni will give you a more detailed answer but my answer is yes. We're comfortable with it.

Yes. That would probably be my answer, too. Yes, we're comfortable. We have ample liquidity to meet that obligation in June with our needing to go to the term markets. But over time, you know, we would like to go back in, term out our liabilities in the term markets. But no concern on the near-term maturity.

Okay. Great. Thanks for answering my questions.

No problem. Thanks, Ryan.

Our next question is from Jonathan Bock of Wells Fargo. Please go ahead

Good afternoon, guys, and thank you for taking my questions. Kipp, as I look at controlled affiliate company investments, in particular the interest income line in that, which I believe has a heavy amount or sole amount of SSLP running through it. Can you walk through why the line declined by about 15% from $74 million to a run rate of about $63 million this quarter?

We're just taking a look at the financials, Jonathan, to pull out. Thanks for the question. To pull out exactly what's there, other than SSLP, if anything.

Yes. We had some other items but I would have to go back (inaudible).

Yes, we'd actually have to go back and reconcile the numbers, Jonathan. I don't know off hand.

Sure.

We obviously disclosed a modestly declining yield on SSLP. I'm sure that's a portion of it but I don't think it's all of it. So we'll go back and take a look.

That help only because the 15% decline is -- I was also curious, does the rising impact -- does the impact of a rising LIBOR put additional pressure on SSLP returns in that you likely have floors on your unitranche investments, but my guess would be that the liabilities of GE holds would rise in the event that LIBOR, you know, went from 30 to 60 bits?

Yes. There's some modest sensitivity and I don't want to get into the proprietary sort of building of that document from way back when. But there's a sharing of LIBOR floors mechanism in that document, that mitigates that a bit. No, you're right. Because there are, you know, floating rate assets with floors, liabilities without floors and that they don't correspond one to one. There's some modest deterioration as LIBOR goes up.

Okay. So looking at that. Then, you know, a question -- I appreciate the commentary on the dividend as it relates to Ivy Hill. Kipp, Penni, does Ivy Hill actually own a CLO equity collateral on its balance sheet?

Ivy Hill owns no third-party (inaudible).

I mean, meaning like for risk retention? Sorry, Kipp. Maybe rephrase. For risk retention purposes, do they hold control stakes in the CLOs that they manage?

I'd have to go back name by name. They obviously have both debt and equity investments at Ivy Hill in their own funds. The purpose is not for risk retention compliance, it's frankly just a mechanism for that company and then obviously consolidates up into our financial results, our Company to invest in their vehicles, because we think they provide really attractive rates of return whether it's the triple B's down through the equity. But driving compliance is risk retention is not the initiative. It's really an economic decision.

No. Fair enough. I'll switch it. If there is some form of collateral CLO equity held at Ivy Hill, how are we still able to maintain the same fair value for the last year, when CLO equity has fallen precipitously?

Yes. I would tell you if you go through the portfolios that Ivy Hill holds and the funds that they manage, they're managing exclusively middle-market deals.

Okay.

So the typical middle market deal tends to have meaningfully lower leverage, call it anywhere between two and a half and five turns of debt, depending on where you set it up vis-a-vis a larger capital CLO, which obviously can be leveraged ten to 12 times. So that equity inherently is meaningfully more volatile in a large cap CLO than you would see in a middle market deal.

Okay.

I think also that a large cap CLO tends to see its assets be more volatile, because they're in liquid assets, right. Ivy Hill has quite a lot of its assets in middle market names, which don't trade, right. And really get modeled differently than perhaps, you know, just on market price. And, third, they've done a really, really great job managing the collateral.

So their track record, in terms of asset level underwriting, is meaningfully better than what you'd see in terms of asset level quality in most CLOs. You know, importantly they have, you know, virtually no oil and gas investment at all in their funds, which obviously compares quite differently to what you'd see in other CLOs. So that's just one example on the asset side. So there are a couple of different reasons than you'd probably suspect. We know the CLO business pretty well, right.

Just as a reminder, we manage, at Ares, about $20 billion of CLOs today. And we also have, you know, investments here at the firm outside of ARCC managing about $3 billion of structured products and investment in other people's CLOs. So we're very much in that business, we just don't organize the business inside the BDC, because we don't see it as the right place to own CLO investments.

So there are a whole handful of thoughts around that, is we debate valuation with that group. But those are some of the highlights that we discuss with Ivy Hill as we think about valuing the investments that we have in their funds.

Got it. And I also understand that the management fees that come off of that for the collateral that, you know, they (inaudible). So, you know, maybe jumping to two more. So as it relates to non-qualified assets, you know, kind of a question arises. With SSLP and when and how that's fixed, TBD but right now it's still a great investment, a diversified investment. But we start to butt up against, you know, the ability to take on other non-qualified assets, right.

Now certainly you can do it -- you could do it if you wanted, but in terms of replacing something or putting something on of similar size, that just cannot be done at this time with SDLP. And so the question is how are you trying to manage your non-qualified bucket and do you see that as a limiting factor to earnings growth going forward?

I think you asked me this question six months ago. And my response was carefully. So I'll repeat my response. So we think based on our modeling today and obviously things move forward, that we have the ability to convert the existing warehouse loans in SDLP at the size that we're targeting as, I mentioned during Ryan's question, within the next six months.

It's obviously a very significant constraint, as anybody models out to see that once you contribute those assets to SDLP and it creates bad assets out of good assets that were very, very tight on the 30% basket. So it is a constraint. We've got a whole lot of ideas as to how we're managing it. But for the time being, we do see the ability to make that conversion without having an issue on the 30% basket.

And I think we have some tools that you'd probably imagine are in process right now to mitigate that going forward, because it is a constraint, it's something that we spend a lot of time thinking about and working through right now.

Sure. This tees up another question that I didn't ask would be -- or maybe I'll ask it in a different way, because it's still somewhat similar. This is a limiting factor and clearly what fixes it is growth. Right? Growth in equity. Now growth in equity can be done two day ways.

It could be done through issuance below NAV which is not a good idea or issuance below NAV to acquire someone else. And the question that I would put out there is that, do you believe it's appropriate for investors to experience NAV dilution today for the potential for earnings growth tomorrow, when we know that the loans that get put on the books are of fairly limited life.

And so, as a result, earnings impact over time, I mean, unless stuff is bought at deep discounts, it could be an earnings decretive or earnings negative event. Help us understand book value dilution in relation to earnings growth through either issuance below book or through issuance buying competitor at a higher price than stated price to NAV.

I think to your point, I don't view -- look, growth would be an easy way to solve your question about the 30% basket. So, you know, if the stock was trading at 1.3 times book, we'd be in a different world than I guess we're in right now. We're not.

So we're managing the Company as if we have no access to the equity markets. And that's why we're doing it carefully. Right. I don't particularly like the idea of, you know, issuing stock below book, period. Would we consider it in certain circumstances, I think we would. But it would have to be very accretive.

If you see book value dilution, you would have to cure it very quickly to, obviously, make it make sense to shareholders I would think. You know, I don't think you should expect to see us look at the 30% basket and say, wow, doing a dilutive equity deal so we can raise equity to ramp SDLP, because it can generate a 15% cash on cash return and may lead to earnings growth, I wouldn't expect that one from us.

Got it. Appreciate it, guys. Thank you for taking my questions.

Our next question is from Rick Shane of JPMorgan. Please go ahead.

Hi, guys. Thanks for taking my questions. Most of them have been asked and answered. But I wanted to follow up on Hugh's question related to the funding strategy. By my estimates, there's about a $20 million savings replacing the February 2016 converts and putting them on the revolver. There's another, I don't know, $7 million or $8 million from replacing the June 2016 converts on the line. Penni, you alluded to the idea of going back to the term market. Given where we stand right now and how attractive those facilities are and some of the challenges in the unsecured market, does it make more sense to just think about plain vanilla swaps as a way to effectively lock in the rates on those facilities?

I mean, you know, I think what we said -- we agree with you, Rick, we talked about this. Thanks for the question. We talked about this quite a lot last year. That we had real opportunity to lower our cost of liabilities and we've been doing that. And your math is pretty good.

We thought that there was, you know, $0.05 to $0.10 of earnings accretion in the company on a pro forma basis just from sort of mowing through the near-term liabilities. Obviously it depends as to whether you draw down roughly 2% floating rate money versus borrowing fixed rate 4% money. You know, I think we'll do both.

You know, with the markets there for a five or ten-year high grade deal at what we deem are long-term rates that are attractive for the Company, I think we'll take advantage of them. Trying to again be oriented towards more than just the next quarter. But there's no doubt, obviously, that being in the revolving facilities on a funded basis saves you a couple of pennies over the course of the year and it's just a question of what do you sacrifice to earn that couple of pennies versus what do you actually get.

Do you think there's enough efficiency on the swap market that could you potentially sort of split the difference, give up some of those economics but still wind up in a better situation than you were before? Better situation meaning accretive. I'll use Wall Street speak.

We're sort of shaking our heads at one another. It's not something we spend a lot of time with bankers on or with our lenders on. Not something that we get pitched on a whole lot. That doesn't mean we couldn't get smarter and go see. But as Penni and I and some others in the room are shaking our heads at one another, I'm not sure it's super obvious to us as to how we accomplish that, Rick.

Okay.

Yes. It's nice to have the (inaudible) he revolver capacity to be able to repay at any point in time to use that for funding flexibility and terming out liabilities. So you have to be mindful of how much you want put deriviters around something you want the flexibility to repay.

You gave us a homework assignment.

Okay. Who knows, it's really out there question or a smart question. Time will probably tell.

Yes. Thanks.

Thanks, guys.

Our next question is from Arren Cyganovich of D.A. Davidson.

Thanks. You mentioned a little bit of, I guess, competition for higher quality investment opportunities. Are you seeing that more on the unitranche side or broadly across first and second lien middle market investments?

You know, it's just different from situation, Arren. It really depends. At the end of the day, we don't dictate to our clients what solution they take. They dictate to us their preference for borrowing.

The flexibility of our capital, obviously, is a hallmark of how we like to communicate with our partners and it continues. But it really, you know, we're agnostic. We'll look at situations in every way and obviously we build the portfolio on a name-by-name basis and what we think are the right capital structures. So it really changes from deal to deal.

I can't say there's any, you know, indication that it's better to do unitranche or first, second lien or any of that. Obviously, a first lien deal tends to have better security provisions and more collateral than a second lien deal. So that's why you get paid more to own second lien in junior capital. But we look across the entire continuum and we're interested in high-quality transactions with any of those assets in the mix.

Okay. I mean, in terms of the competitors that you're seeing at the table, has it changed much over the past six months or so? Or is it a lot of the same folks you typically see?

It's a lot of the same people. You know, in the first lien business we continue to see [Gallup] and now (inaudible), what used to be [GE] is probably the folks that we bump into at the most meetings. The banks I'd say, as I mentioned earlier in the call, are less relevant. Deal to deal they're really focused on bigger deals, companies that are rated, you know, certainly single B or better but more often than that double B or better. And they're really not focused on the middle market today in any consistent way. And the junior capital side same group of people, just much more fragmented.

You know, so second lien, mezzanine, et cetera, has always gotten provided by a group of alternative firms and private asset managers, et cetera. And largely it's the same group of people. So not a lot of change there.

Great. Thanks. Just lastly on the SSLP, as that continues to naturally deleverage, you know, how long is this going to be a bit of a drag for you? And is there a point where you'll be able to, you know, releverage that or find a solution for that to improve the profitability there.

Yes. I think so. As I mentioned in the past, you know, that program was set up, when it was active to be three parts capital from GE and one part from Ares, right. So the advance rate, if you think about it, that we had from GE was about 75% and as that's come down, it becomes each quarter much easier to provide them with a solution.

So I'm still hopeful that one of these days when we show up with a committed financing at GE and tell them we can take them out at par, that they'll be amenable to that. But for the time being, you know, we're kind of status quo as the program winds down and there's really nothing to report there.

Okay. Thank you.

Thanks for the questions.

Our next question is from Chris York of JMP securities. Please go ahead.

Good morning, guys. Thanks for taking my questions. Most of them have been asked and answered but I did want to get a clarification on buybacks. The press release references the stock repurchase program yet appears to reference a program with multiple expiry dates. So do you have two stock repurchase programs?

Yes. We segregated into the 10b18, which is obviously just our voluntary, you know, at the market program and then we have a 10b5 that is a more programmatic sort of automatic buying program I would say that has constraints. So the 10b18 is always available, as long as we're not in a window. So obviously after we got off the call today, we'd be able to purchase stock in the market today under the existing 10b18. And, correct me if I'm wrong, Penni, the existing 10b5 is about to expire and we're about to go just with that program back in place, so that it's available whenever the wind to this quarterly period closes that obviously allows us to buy back stock during periods where we are outside the window and outside the discretion of management to just buy back stock at the market.

Right. Yes. Just to be clear it is one program, we just go at it two different ways on executing on it.

Got it. That's what I thought. That's it for me, thanks.

Thanks, Chris.

Our next question is from Derek Hewitt of Bank of America Merrill Lynch.

Kipp, could you talk about the pricing environment since middle market spreads continue to lag the broader market, specifically are you still seeing tail winds from the rising spread in Q4 up to mid-February? And then additionally, since high yield spreads have come in since mid-February, when will we see this dynamic flow through your new originations?

Yes. Sure, I think we have taken, because of the lack of activity, a little bit of a pause of that widening that you saw. And that we described through Q4 and probably into, you know, maybe the second week in February or something like that, right around, I guess, our earnings call from the last quarter, towards the end of February.

Sadly, almost immediately after that, there's been a pretty significant technical rally that I referenced. So you're seeing it kind of plateau out, where I'd say a regular, you know, regular middle market bank deal/unitranche price is between L5 and L7 depending on the credit quality and the assets behind that flow from there. It was definitely tight of that six months ago.

So hopefully that's some helpful guidance. And then with high yield coming back in, I don't see that having a meaningful impact to see spreads decline. But I did say something about that the capital availability, there are definitely fixed income managers, whether they have loan money, high yield money or middle market money looking to put it to work.

And, you know, it's May 1 and I think people are anxious with limited transaction volume. So it's possible. But we don't know yet. I think there's a lot of price discovery in the market right now around new transactions.

Okay. Great. And then big picture. At least for the bigger BDCs industry, valuations continue to trade at a discount to book. So really what's it going to take to get industry valuations to effectively kind of pull to par?

I don't know. All I do is fly around the country and ask people the same question. Maybe you can tell me. I actually don't know.

Okay. Thank you very much for taking my questions.

Yes. You're welcome. Sorry I didn't have a better answer but if I had one, I'd give it.

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

Hi. Good afternoon. I just had two questions on two sort of distinct parts of the market. First on the high end. What is the pipeline of syndicated bank debt deals look like, for Ares in particular? I know you said the banks have actually pulled back from the market. And I know that this was sort of a promising area of potential fee income, plus some lower risk assets, I didn't know how, you know, if banks pulling away, you had the opportunity to step in or if the whole market was shrinking and your opportunities were lower along with the market.

Yes. I mean, I would think about it this way, which is the banks are obviously not really participating in those types of deals. So our, you know, market share in these, you know, larger, middle market syndicated deals, where obviously we have the capital and we have the team to originate and syndicate that paper is very much in place. That being said, deal flow is very light.

So I don't want to confuse anything by saying that we've got a couple of, you know, $600 million, $700 million transactions that we're playing to underwrite and syndicate in the next couple of weeks. We don't have that right now. The activity levels remain low.

Okay. And my follow-up question on a very different part of the market. I noticed you've been booking a few more subordinated loans. And obviously they always have a part of the -- a role in the portfolio. I'm just wondering if there's a particular industry or sector or structure which makes subordinated loans attractive, given their less collateral protection for Ares and why you pursued these particular loans?

Yes. I mean, we're pretty choosey on sub debt you know in the first quarter, we did one mezzanine deal that was in a power, project finance situation, we're helping a developer build a power plant. It's an in-construction asset.

But, no, I would say, look, we look for when we become subordinated in a company for a very, very high level of contracted cash flow, because obviously the biggest risk when you're the sub debt and have the ability to get interest payments blocked, which you typically don't have in first and second lien deals, you want to make sure there's plentiful cash flow in any case that you underwrite.

So I think that's first things first. And, look, you'll see us, secondly, gravitate towards only making mezzanine investments in what we think are the absolute highest quality companies. So your point, you're certainly taking more risk. That's why you're getting paid higher rates of return, but you really can't be wrong in those situations, because it's much more difficult in a downside or in a workout. So it's just very transaction-dependent and we're very selective in those names.

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

Thanks so much.

Our last question today comes from Robert Dodd of Raymond James. Please go ahead.

Hi, everybody. Thanks for taking the final question. Going back to a comment you made earlier about the private equity multiples are high. They've been high for a while now obviously through much of 2015. And I'd hoped maybe that some of the market shakeout would scare some -- maybe some rationality back into the price points so people would be willing to take a lower multiple to get their money and run, so to speak.

Do you have any theory, idea about what it would really take for those multiples to come back to more reasonable levels and what you're willing to put more of the money out. And activity to pick up.

Yes. I mean, look, there are a lot of answers to that question. I'll make one point, which is something that one of the guys here just mentioned to me as you were asking that question, we've seen a very heavyweighting of dealing in the private equity business and the software space over the last six months. Where multiples are extraordinarily high like 14, 15 times EBITDA kind of stuff.

Because that's one of the few sectors where you actually continue to see growth. So I think playing off that point, and the reason for the light deal flow, as I mentioned earlier, is there's a real disconnect on the private equity side between buyers who are being asked to pay 12 times EBITDA for companies, who on the selling side, are growing 2% a year. Right. Or 5% a year. It's very difficult to make the unleveraged or leveraged return on equity work.

So, look, it's like any market goes, either the buyers keep paying the market price or the market price comes down and sellers achieve lower multiples and that's how it resolves itself. I'm not probably the right person to ask that question. It will probably be a little bit of both. But I think if you ask the guys running mid-market, private equity funds, they'd say there's a little bit of disconnect on multiples today and that's slowing activity down.

Got it. Thank you.

Thanks, Robert.

This concludes our question-and-answer session. I'd like to turn the conference back to Kipp deVeer for any closing remarks.

We don't have anything to add, other than to thank everyone for their time and I hope you all 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 play of the conference call will be available approximately one hour after the end this call through May 17, 2016, to domestic callers by dialing 877-344-7529 and to international callers by dialing plus +1-412-317-0088. Please preference conference number 10082737. And archived replay will be available on a webcast link located on the home page of the Investor Resources section of our website.

The conference has concluded. You may now disconnect. Thank you and have a nice day.