Ares Capital Corp (ARCC) 2016 Q3 法說會逐字稿

Good afternoon. Welcome to Ares Capital Corporation's third-quarter ended September 30, 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, November 2, 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 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 guaranty of future results.

During this conference call, the Company may discuss core earning 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 professional fees and other costs related to the proposed acquisition of American Capital, 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 website. The Company believes that core EPS provides useful information to investors regarding financial performance because it is one method the Company uses to measure its financial condition and results of operations.

Certain information discussed in this presentation, including information related to portfolio companies, was derived from third-party sources and has not been independently verified, and accordingly, the Company makes no representation or warranty in respect to this information.

As a reminder, the Company's third-quarter ended September 30, 2016 earnings presentation is available on the Company's website at www.arescapitalcorp.com, by clicking on the Q3-16 earnings presentation link on the home page of the investors resources section. Ares Capital Corporation's earnings release and 10-Q are also available on the Company's website.

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

Thank you, Amy. Good afternoon and thanks to everyone for joining us today.

Before I discuss our third quarter results let me provide an update on our pending acquisition of American Capital. We've been working very closely with the team at ACAS, and collectively we've made considerable progress on our strategic and financial objectives. We remain enthusiastic about the immediate and long-term benefits of the merger, which will bring together the two largest business development companies in the industry, and what we believe will be a highly accretive transaction and should be beneficial to both shareholder bases.

In terms of timing, we recently announced that we will hold a special meeting for our stockholders on December 15, and subject to shareholder approval and other customary closing conditions, we're targeting as early as the first week in January for a closing. We expect the transaction will be immediately accretive to our core earnings per share and anticipate substantial long-term earnings benefits that we hope can serve as a catalyst for dividend growth at ARCC.

Pro forma for the transaction we estimate the Company will have approximately $12 billion of assets. We believe this increased scale will enhance our leadership position in the middle market direct lending arena, and that our ability to originate and hold even larger transactions will enable us to offer attractive returns to shareholders over the long term.

I'd like to change course for a moment and briefly summarize our third quarter results. We delivered strong basic and diluted core earnings per share of $0.43 and GAAP earnings per share of $0.35. And this morning we declared a fourth quarter dividend of $0.38 per share, which is in line with these results and consistent with the quarterly dividend we've paid shareholders for the last four years, beginning with the third quarter of 2012.

Overall we are pleased with how the portfolio and the Company as a whole are performing. We were quite busy in the third quarter despite a slower new deal environment. The third quarters was actually a relatively modest period of activity for middle market loan issuance and with this more moderate supply of new transactions, terms on most new deals have become more competitive with tighter pricing and looser structural protections in terms of documentation and covenants. Our view is that it has becoming increasingly important in this environment for companies like ARCC to screen the broadest market opportunity possible to achieve strong risk adjusted returns.

Our deep origination team and well developed business model of providing flexible capital have helped to mitigate some of these tougher market conditions and we managed to originate $1.5 billion of new commitments during the third quarter. This originations number may seem large considering our cautious market view, however, it is due to several factors.

First, we completed our initial funding of the senior direct lending program, or the SDLP, during the quarter which included new commitments to the SDLP of over $200 million. In addition, we are again involved in leadership positions in two larger transactions, Click Technologies and OTG Management, where we acted as agent on larger than typical financings and syndicated a significant amount of the loans that we committed to. Our lead role on these types of transactions has enabled us to expand our business with clients, to underwrite substantially more than our commitments, which can generate significant fee income and we can also manage our final hold positions effectively.

Before we move to a detailed discussion of our financial results, let me provide an update on the SDLP. As many of you know, this past July we formally launched our effort to build the SDLP, which is our joint venture with Varagon Capital Partners. Prior to the official launch we built a portfolio of loans to middle market companies, which we sold to the SDLP in July of 2016. At the end of the quarter, the SDLP portfolio was $929 million of fund investments, comprised of first lien, senior secured loans to 10 borrowers.

Initially, the program has investment capacity of approximately $2.9 billion and can invest up to $300 million in an individual loan. We're excited to have the program fully operational and to have this higher yielding asset in our portfolio.

With that, I'd like to turn the call over to Penni Roll, our Chief Financial Officer, to dig into our third quarter financial results and provide some details on our recent financing activities.

Thank you, Kipp. Our basic and diluted core earnings per share were $0.43 for the third quarter of 2016 as compared to $0.39 for the second quarter of 2016 and $0.41 for the third quarter of 2015. Our higher core earnings in the third quarter were primarily driven by higher structuring fee income as a result of the significant origination activity we had during the quarter.

Our basic and diluted GAAP net income per share for the third quarter of 2016 was $0.35 compared to $0.50 for the second quarter of 2016 and $0.37 for the third quarter of 2015. Our lower GAAP earnings in the third quarter were primarily driven by unrealized losses in [two names].

As of September 30, 2016, our portfolio totaled $8.8 billion of fair value and we had total assets of $9.1 billion. At September 30, 2016, the weighted average yield on our debt and other income producing securities at amortized cost was 9.7%, and a weighted average yield on total investments at amortized cost was 8.7%, as compared to 9.8% and 8.9% respectively at June 30, 2016.

Since the prior quarter end, our portfolio yields declined modestly primarily from the continued decline in the yield on our SSLP subordinated certificates. However, this decline was partially offset by the benefit to our portfolio yields as a result of the initial funding of the SDLP, where we sold assets that had a weighted average yield of 7% in exchange for SDLP subordinated certificates with a yield of 13.5%. The structure and economics of the SDLP are similar to how the SSLP operated prior to the start of the wind down.

As we continue to ramp the SDLP portfolio, both in terms of size and diversity, the yield on our SDLP subcerts has the potential to grow. The decline in the yield on our SSLP subordinated certificates is primarily due to the $1.5 billion of repayments in the SSLP during the quarter, which continues during the wind down to repay only the senior notes until they are repaid in full. Over the last year, the SSLP portfolio has declined $4.1 billion, from $8.8 billion at September 30, 2015, to $4.7 billion as of September 30, 2016.

Despite the fact that the yield on our SSLP subordinated certificates has declined over time as anticipated, we have continued to generate core earnings that are in line with or better than the second quarter of last year, the quarter before the SSLP began to wind down, and our LTM net interest and dividend margin has improved by 20 basis points to 7.8% since the second quarter of last year as we've continued to manage our margins by also focusing on our cost of debt capital.

Additionally, as the yield on our SSLP subordinated certificates declines over time, so too does the risk of holding this investment as the senior notes outstanding ahead of our subordinated certificates are repaid. Therefore, we believe we continue to receive a strong risk adjusted return on our investment in the SSLP and we remain content with the status quo as this investment winds down.

We continue to generate solid net realized gains from the portfolio as well. For the third quarter of 2016, our net realized gains on investments totaled $21 million or $0.07 per share, largely from realizations in Universal Lubricants and Primexx, which were both oil and gas related investments. We also had net unrealized losses on investments of $44 million or $0.14 per share. Our net unrealized losses on investments were primarily driven by declines in two companies that operate in the for-profit education space, which Kipp will discuss in more detail later in the call.

Moving to the right hand side of the balance sheet, our stockholders equity at September 30 was $5.2 billion, resulting in net asset value per share of $16.59, down 0.2% compared to a quarter ago, and cumulatively up 0.8% since December 31, 2015. As of September 30, 2016, we had approximately $5.4 billion in committed debt capital, consisting primarily of approximately $3.1 billion in aggregate principal amount of outstanding term indebtedness and $2.2 billion in committed revolving credit facilities.

During the third quarter of 2016, we returned to the investment grade notes market for a fourth straight year, issuing $600 million of 5-year, unsecured senior notes priced at 3 5/8%, a record low cost execution for our Company, or any VDC for that matter, in this market. We are pleased with the continued support from investment grade investors and believe that our significant size and scale benefit our ability to access this market.

At quarter end approximately 58% of our total committed debt capital and 81% of our outstanding debt capital at quarter end was in fixed-rate unsecured term debt. Our weighted average stated interest rate on our drawn debt capital was 4.2% at September 30, 2016, up from 3.9% at June 30, 2016, which is reflective of the unsecured notes issuance in September and the associated repayment of the lower cost revolving credit facilities from the proceeds of this issuance.

As of September 30, 2016, our debt to equity ratios was 0.73 times and our debt to equity ratio net of available cash of $99 million was 0.71 times. At September 30, 2016, we had approximately $1.5 billion of undrawn availability, primarily under our lower cost revolving credit facilities, subject to borrowing base leverage and other restrictions.

Finally, as Kipp stated, we announced that we declared a regular fourth quarter dividend of $0.38 per share. This dividend is payable on December 30 to stockholders of record on December 15, 2016. In addition, the undistributed taxable income carry forward from 2015 into 2016 was approximately $262 million or $0.83 per share. We believe that our current dividend level remains well supported by our earnings, but this spillover income does provide additional cushion in that regard.

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

Thanks, Penni. I'd like to spend a few minutes providing an update on the portfolio. We continue to see reasonable growth at our underlying portfolio companies with LTM EBITDA at our corporate borrowers increasing approximately 7% year-over-year. This is certainly better than what the broader market offers today, although our rate of growth is down from the low double-digit EBITDA growth that we saw a year ago.

Non-accruals generally remained low for ARCC and by industry standards, however, they did show a modest sequential tick-up this quarter to 2.3% of investments at cost, and 1.2% at fair value. We take comfort in the fact that they're still lower than the 2.6% of investments at cost and 1.7% of fair value at year end 2015. Overall, we moved one Company to non-accrual status this quarter and removed one Company from non-accrual status.

Our approach to portfolio and risk management remains consistent. We're fortunate in that we can originate and select what we deem to be the very best credits and do not manage to a benchmark like many others in global credit. We've largely avoided the industries that we see as more vulnerable and those that are starting to exhibit weakness.

For example, we've been meaningfully underweight the oil and gas sector. Today we have only two investments that we consider to have direct exposure to this sector. One has been restructured due to the lower commodity price environment, and we currently own that Company with the other lenders and the other one is performing quite well.

We don't have any direct exposure to metals and mining, auto or home building and have limited investments in other areas that seem to be weakening like retail, restaurants, and general industrials. This proactive approach to industry selection is a key differentiator for ARCC.

Despite the healthy realized gains, we did incur net unrealized depreciation during the third quarter. The unrealized depreciation was fairly concentrated in two positions in the for-profit education sector, where regulatory pressures in the industry have negatively impacted business models. The first Company is the Educate Group, which we've spoken about in the past. The second is InfiLaw System, which we placed on non-accrual during the quarter.

Both positions remain challenging, however, we have significant in-house expertise focused on managing these names and are working towards resolution over time. Our total portfolio exposure to the for-profit education sector is limited to approximately 2% of the portfolio at fair value.

We take pride in our ability to achieve solid outcomes in difficult investments and our results over time in this respect have added significant value to the Company. A good example is a positive recent resolution on the Step 2 Company, previously nonperforming portfolio investment. We were able to remove this investment from non-accrual in the third quarter and the Company was sold in early Q4.

If you recall, our Step 2 investment was acquired in connection with the Allied Capital acquisition back in 2010. Since then, there was a substantial balance sheet restructuring and we worked with the Company to position it for this successful sale.

It's through this type of active portfolio management over the last 12 years that we've been able to consistently generate realized gains in excess of our realized losses, which has resulted in annualized net realized gain rate of 1.1% since inception. We continue to believe that our ability to manage through our underperforming investments and to manage our watch list is a real competitive advantage for ARCC, and has helped differentiate us as one of the few VDCs to consistently deliver NAV growth over time.

Before I conclude, let me provide some quick commentary on our post quarter-end investment activity. From October first through October 27, we made new investment commitments totaling $73 million and sold or exited $182 million during the same period, with net realized gains of approximately $21 million. Beyond this, as of October 27, our total investment backlog and pipeline stood at approximately $540 million and $870 million respectively.

These potential investments are all subject to final approvals and documentation and certain of these investments may be syndicated or sold post closing. And in addition, our final holds may be lower and of course we can't assure you that any of these transactions will close.

In closing, we're pleased with the strong results for this quarter, and we feel ARCC continues to be well positioned today. Of course, given the length of this business cycle, we wouldn't be surprised to experience more volatility in the periods ahead. Defaults in a few industries, which I've said we've generally avoided, have crept up amidst continued slow growth in the US.

More complicating factors, including the uncertainty regarding global interest rates and currency fluctuations and continued political instability, continue to send mixed signals. That said, we've navigated successfully through complicated environments in the past and we have every confidence that we'll succeed as we move through this period of change. Our confidence is based on the strength and the experience of our team and the breadth of our platform at Ares.

Of course the one thing that we won't do on this call is provide any commentary on next week's presidential election. However, we will remind you to vote.

That concludes our prepared remarks. Amy, if you could open the line for questions we'd appreciate it.

Thank you.

(Operator Instructions)

Our first questions is from John Hecht at Jefferies.

Good morning, guys. Thanks very much. One question on the quarter, just details from the 10-Q. New term on loans of 94 months, I assume that was impacted by the subordinate piece of the SDLP. What was the term ex that of new loans?

You've got the cause right, but I'm not sure we can answer it once it's removed. Why don't we take it offline, John. We'll go get the answer to that and get back to you.

Okay. That's helpful. And then I'm just wondering if you can give us some -- because I know there's been some movement in the ACAS portfolio since we last looked at the portfolio. I know they've had some sales and so forth.

Can you just give us, for modeling purposes next year once the deal is complete, how we should -- what we should think about when we integrate that portfolio in terms of equity contribution and the average yield on their portfolio?

It's not something that we're going to give here. I'll tell you, our plan is actually to get the 930 financials on both sides, certainly, completed and then consolidated and get that out to folks as soon as we possibly can. That will be, of course, something that we hope will help all of you evaluate the transaction in terms of its accretiveness, both to NAV and to earnings.

But like I said at the beginning, I guess more qualitatively, John, of this call, we -- the early returns as we've worked with American Capital have been quite good. They had a lot of assets in place that they were active on in terms of sales and other activities, and I think we're pretty pleased with the results six months in. I think they've done a really nice job. I think we've collaborated well together and I think we're off to a very good start.

Wonderful. Okay. And the last question is, if you can gives us some framework, when you guys have a big transaction where you're the lead agent and you retain some and syndicate some, how much are you keeping in those big deals or is there a formula where we should think of?

It's usually not a formula. Click, because it was a publicly announced deal, was roughly a $1.1 billion deal where we ended up holding about $140 million at ARCC. OTG was a smaller deal, the hold there is around $155 million. Typically our final holds are governed more by just looking at portfolio diversification.

We tend to be the largest investor in those deals and that's really our goal. But there's no math to it. I'd say typical investments for us today in these larger deals range from $100 million to $250 million a name, roughly. Hopefully that's a guide post, but there's no science there.

Okay. Great. Thanks, guys.

Thanks, John.

The next question is from Arren Cyganovich at D.A. Davidson.

Thanks. Kipp, your comments about a little bit more of a competitive environment, I wonder if you could just contrast that with -- you obviously had a very big investing quarter in the third quarter and your backlog and pipeline looks like it's relatively full as well. Just maybe some thoughts on what competitive differentiations you have that's generating that type of activity while you're seeing some weakening of loan standards?

Let me comment on the environment afterwards. Just so everyone's entirely clear, the way that we describe our fundings is anything that we fund to. So it obviously doesn't include things that we plan to syndicate. And I tried to make the point in the prepared remarks. Maybe I wasn't entirely clear on it, that $1.5 billion looks pretty large, but what we ended up with net of the $1.5 billion is substantially smaller than that.

So I think that there is caution here. Having spent a lot of time getting ready for today with the team, I think the way a couple of us were describing it in a lot of different markets are the fundamentals and the surrounding economic and political environment feel mediocre and uncertain. And up until maybe a week or two ago, the stock market seemed to go up every day and spreads in virtually every fixed income asset seemed to tighten, leverage multiples in our market were are going up, pricing was flat at best if not coming in a bit, and we're seeing just weaker documents, more heavily adjusted EBITDA numbers being leveraged and just things that you typically see when, number one, the market has been, and number two, it's more competitive.

I think you've seen new capital come online in the space and I think that capital has to change the marginal deal -- has to chase, rather, the marginal deal. I think all we've emphasized is we've got a great franchise that allows us to the take leadership positions in the deals that we like and we're doing fewer new deals. We're focused increasingly on the existing portfolio and are willing to let a fair amount of the deal flow that we're seeing go to competitors simply because it just doesn't pass muster for us over the long haul.

Okay. Thanks. That's helpful. And then in terms of credit quality, obviously you're still kind of below normal in terms of non-accruals and your credit quality is quite good. But we're seeing, I'd say just across the industry, modest weakening.

Maybe, broadly, in your portfolio, are you seeing that? I know you said you had about 7% growth in EBITDA on the portfolio, but are you seeing any kind of signs of stress around different areas of the portfolio?

The good news is we feel like we're in a very conservative position on just weighted average basis, a little bit north of 5 times debt to EBITDA. So we think we've got great cushion in terms of loan to value.

In terms of our companies paying us interest, again, coverage ratios are near 3 times, 2.5 to 3 times interest coverage. So there's room for deterioration or (inaudible) in this budget. There's room for rates to go you up, and frankly, not create liquidity issues at portfolio companies.

So for us when we look at fair value and cost of non-accruals, the big numbers really have been Educate and InfiLaw. And away from that, it's a couple of small cats and dogs, to use that term here and there, that tend to lean towards just idiosyncratic issues in companies.

Overall, I made the point on industry selection, I think it's really important just to remind people that we can be incredibly selective in terms of industry and in Company. We think we've built a portfolio that withstands a change in the credit cycle which is likely to come. Again, I don't know when. But at some point it always does.

It's about being in the right industries and the right companies. We feel pretty confident having done this for quite a long time together as a team that we've built a very resilient portfolio, so we feel pretty good about where we stand.

Thank you.

Thank you.

The next question is from Ryan Lynch at KBW.

Good morning, Kipp, good morning, Penni. Just following up on Arren's question about portfolio trends. You mentioned the last 12 month EBITDA growth is about 7%. My question was, have you seen that decline recently?

We've seen some other statistics out there that may look like the third quarter, specifically year-over-year, might have been a little bit weaker. So obviously, the 7% last 12 months, EBITDA growth was 7%, that's fairly strong. But have you seen any weakening in those numbers over the last couple months?

No, not in particular. We actually spent a fair bit of time looking at Q3 valuations in our Company, but also across just our credit portfolios at Ares here, and actually Carl and Jan and others were talking about public companies beating or missing earnings and all of that and how we're comparing.

I think generally we see companies that are up year-over-year but maybe a bit behind budget, but it's probably reasonably on either side of 50% of beating budget or missing budgets. I think that's in line with a lot of the credit portfolios that's we're seeing across Ares and also I think what the public equity markets are seeing. So we don't view it as getting worse quicker.

I don't know if things slowed down again just because folks are nervous around next week's election. I continue to believe that they are. So we'll see if any of those trends reverse after that's resolved and into a new year. But, no, we don't see any sort of accelerating of the decline, if that's the question, Ryan, which I think it is?

Yes. Okay. Great. And then $73 million of commitments quarter to date, that's pretty light for what you've historically done. I know this quarter was very big, the $1.5 billion for reasons you described, originated deals and syndicating some of them out. But do you expect that number to pick up from the $73 million quarter to date to finish more what you guys have historically averaged over the last couple years of anywhere from $500 million to $750 million?

Yes, that's usually where we end up in an average Q4. Backlog and pipeline would indicate that there's a lot of deal flow out there that we're active on. But again, to the point of being selective, backlog are things that we generally speaking think that we're going to get closed. Pipeline is an available universe of probability adjusted things that we're working on. Some of them might go away. Some of them we might lose on terms, whatever it may be.

I think it will be a reasonably busy fourth quarter. I don't expect it to be an off the charts busy fourth quarter, because of the election, in particular. I think it should be in line with past Q4s. There's nothing unusual going on.

Okay. And then now that you have completed a couple large transactions, the Click, American Seafoods, and such, are you seeing any increased deal flow or increased discussions with sponsors that have a particularly large deal trying to bring that to you all, considering you have done several in the past, they seem like they've went pretty well, guys that are wanting certainty of close. Has that deal flow or discussions increased recently?

Yes, I think that Click was definitely a watershed deal where folks said, wow, I didn't realize that sort of financing was available. We've actually heard that comment specifically. So yes, I do. I think that the fairway has widened substantially for direct lending, particularly for scaled platforms. And we get the question a lot about why is size bigger?

These are prime examples of much larger, much higher quality borrowers coming to us instead of to the banks and looking to us to write very substantial transactions. We announced the other day that we are supporting a $1 billion-plus buyout in a first lien, second lien deal for a Company called Ministry Brands, that a sponsor called Insight Venture Partners is buying. It's another $1 billion financing that I would tell you three years ago I can't imagine would have come to us.

I can't imagine it would have gone away from the banks, and the reality is, we've been an incumbent there for a while and we've been able to lead that deal and it's always been our expectation that there are more behind that first deal that we did, and we're seeing evidence of that. I think we've built all the capabilities that we need to have our counter-parties have a lot of confidence in us leading those transactions. It certainly doesn't mean that we're doing them alone. We have partners in these deals.

It's not like we're committing $1 billion with all of the risk accruing to us, so we're able to bring in, early, co-agents on the deal and derisk these situations. But they're very, very attractive from a just client perspective, recurring business perspective, and obviously, an economics and ease perspective. So, yes, we're seeing more of it. We intend to continue to address it where he we like the credits and we're excited about that development.

Okay. Great. Those are all the questions from me.

Okay. Thanks, Ryan.

The next question is from Doug Mewhirter at SunTrust.

Hi. Good afternoon. Question on the structuring fees which were very strong this quarter, and I assume a big chunk of that was from your syndicated deals, to be expected. I had a question about how structuring fees come out with SDLP. I remember when the SSLP was growing you would earn structuring fees on a lot of the loans you would you arrange for the SSLP. I was wondering if the SDLP had any contribution to that nice structuring fee number this quarter?

Not in this quarter. It's mostly just regular way and then the couple of larger deals that we did. But we do get upfront fees on new SDLP deals that we do from here. The same that we would on a regular deal. I don't know if you want to add to that, Penni?

Just that the way the fee structure works in sharing is similar to what we had on the SSLP.

Okay. Thanks. That's all my questions.

All right, Doug. Thanks.

The next question is from Chris York at JMP Securities.

Good morning, guys. Thanks for taking my questions. So given the growth in the average EBITDA of your portfolio Company in the third quarter, and then maybe your ability to lead large buyout deals, have you guys had to concede to sponsors any of the issuer friendly terms that exist in either the high yield or the BSL markets like EBITDA add-backs or covenant-wide in the structures?

Look, I think generally speaking, the larger companies get the more large cap sponsors expect broadly syndicated lending terms. But again, our average EBITDA is in the -- I think it's the mid-$50-millions today, and the Q3 numbers were up to $66 million. So we're not quite there. Most of the broadly syndicated type of terms creep in at $100 million of EBITDA-plus. So we're not there.

I'm not going to say that there's not a modest difference between $25 million of EBITDA and $75 million of EBITDA because there's a difference. So, yes, you're always getting pushed on that and obviously trying to hold the line.

Okay. And then maybe staying on the competitive environment a little bit. We've talked a little about the incongruence in demand for private debt funds and then the demand for public VDCs. So I'd be curious to learn whether growth in private debt funds has affected your credit filter more broadly? And then maybe ability to win deals, some of these larger leads, at the VDC as fund raising for private equity platforms has been rather robust?

Meaning for new entrants into the private debt space?

Yes, I mean, there's more new entrants but also just private debt fund raising is up year-over-year already in 2016. So I'm seeing how that is flowing through to the largest VDC, being you guys.

Yes. We've raised money on the private side as well. I know others have too. There's definitely been capital flowing into the space. The way that I think about new entrants is they tend to be small and they tend to be adversely selected on new deal flow, so they just don't have the scale of platform in terms of origination, breadth and reach. We have people in seven offices. We've got almost 100 people dedicated to the business.

It's pretty different than what you'd see from some of the new guys. When you're a new guy you have to justify your platform, and explain who you are, explain your philosophy. Even if you have relationships from past firms it's never the same. You have no evidence to show your counter-parties how you're going to act in situations that don't work out as expected.

The new entrants, frankly, tend to focus on the smaller companies and we don't see them much. Lack of VDC fund raising versus private side capital hasn't had much of an impact. Our competition on the first lien side remains very solid. It really tends to be our (inaudible) in most first lien situations.

On the junior capital side it's a bit more fragmented. I would tell you it's probably a collection of 5 to 10 people that we bump into quite often and the nature of that competition hasn't changed much.

Okay. Fair enough. And then most investors in Ares are aware of the positive sensitive your balance sheet has to a rise in rate. But I'd be curious given the context that three month LIBOR here is just below 100 basis points, and there may be a potential 25 basis point rate hike, what is the incremental increase to net investment income from that 25 basis points as opposed to the 100 basis points you disclosed in your docs?

We'd have to do the math on that. You can see at least the range of values in the documents from where we are now. So 100 basis points is a net income affect of $45 million, but I don't know where the cut is for the 25.

I'm looking at something here that -- it's de minimis -- at the 25 basis points it is not going to move the needle. It's a couple million bucks. Remember that our floating rate liabilities have actually been a touch more expensive here over the course of the last few quarters as LIBOR's gone up, and we haven't gotten the benefit on the asset side.

So, obviously, getting through 1%, and whenever that happens will start to at least give us the asset side benefit. But a 25 basis point rise we think creates somewhere $3 million, $5 million of incremental net investment income, which I don't think is particularly material. It's $0.01. But if the longer term trend is to higher rates, I think we're very happy, and it's very good for our Company.

Got it. That's helpful. Lastly, maybe strategically. So, as you noted, the ACAS acquisition combines the two largest VDCs, and then pro forma for the purchase, your market cap will be something like $8.5 billion, which would represent roughly about 1/4 of the publicly traded VDC market.

I'm curious to learn how you're thinking about the responsibilities incumbent to lead VDCs as investment vehicle, and then maybe more broadly, private debt towards future growth?

Wow, that's a difficult question. I have a lot of thoughts on that so we can catch up off a public earnings call maybe on some of the things I think about the industry and where it's headed.

Look, it feels like a fair bit of pressure, but I think we're more than happy to try to handle it. It does put us in a different discussion, I think, than a lot of the other companies in the space. I think that we've shown our shareholders over a very long period of time that we've done what's right for them. As our Company's grown we've continued, at our external manager, to put significant resources behind the growth in assets at our Company.

When we started 12, 13 years ago I think we had eight people, and we've got about 100 today. We're in different industry verticals than a whole lot of folks. We have a much, much broader business both geographically and in terms of the types of deals that we're doing. So I'm not worried about running the business at all from the asset perspective. I think we're just growing into what's a very significant growing market.

I think there are a lot more complicated questions about how shareholders think about this large of a business. I do think that there are real benefits to our shareholders of the larger market cap and we hear this all the time. Folks inability to buy and sell positions in the Company, the aftermarket liquidity in our stock generates real value for them relative to other things that they can do with capital.

The scale of our Company has allowed us to do, I think, better than others in this space on the liability side. And you saw that with the bond deal that we did this fall. I think beyond that, there's a longer conversation about what it means for just being a larger market cap company, talking about things like future equity issuance if we ever have any, if there's an ability to be more adept on buybacks, to be more thoughtful there on being a larger business.

It's a really great question, Chris. I don't want to kill the earnings call with saying any more. But we take the responsibility seriously. I think we're up for it and I think there are a lot of issues there that we've shown we're in it to do right by the shareholders and we'll continue to operate under that framework.

Great. A couple of those characteristics are helpful. I realize we could probably have our own individual conference call on that. That's it from me. Thank you very much.

The next questions is from Rick Shane at JPMorgan.

Hey, Kipp, thanks for taking my question today. Most have been asked and answered. I guess the one thing we should talk a little bit about is higher rates. And obviously your balance sheet is constructed to be asset sensitive and that's been a big part of the strategy for a long time.

But there's a tradeoff there which is that ultimately that will put more pressure on your credits in terms of higher borrowing cost to them and reduction of cash flows. Can you talk a little about how you guys think about that and whether or not your portfolio companies are able to hedge out any of that interest rate risk?

They do. So, typically, most of the mid-market borrowers, most broadly syndicated borrowers, are required to hedge interest rate exposure to the tune of about 50% under a regular way credit agreement.

And again, in our portfolio, Rick, we think there's so much interest coverage margin today, up into the kind of 2.5 to 3 times coverage that unlike maybe some other downturns where rate increases really affect collateral from a liquidity standpoint, we don't see that as the driver of a worsening credit cycle. I think there's plenty of room for rising rates.

Just remember we have LIBOR floors on our assets. Most of our companies are already living in a world where they pay LIBOR equals 1%. So they hadn't been living off the 40 basis point LIBOR. And also the duration of our assets is reasonably short. So most of our loans are out somewhere between two and four years.

I think the companies will react appropriately to the extent they see rapid increases in rates, which I don't think anybody expects, but if they saw that I think there would be plenty of room to be nimble and make changes as needed. That's not one of the things that keeps us up at night.

Got it. That's perfect. Thank you.

You're welcome.

The next question is from Robert Dodd at Raymond James.

Hi. Just going back to the portfolio EBITDA question, you gave us a lot of color on that, but you did say it has slowed versus where it was in terms of EBITDA growth a year ago. That hasn't been recent. Can you give -- any more color on like any industry verticals that particularly stand out? There's the obvious candidates, but is there anything vertical-wise where that slowdown, modest as it has been, has stood out a little bit more than others?

I think our portfolio generally works in line with other portfolios, vis-a-vis, industries. Industries tend to walk together even though some industries have idiosyncratic risk. The first industry that showed real issues was certainly oil and gas, and folks say, what inning are we in?

That game is well into being over or extra innings, or whatever you want to refer to it -- The percentage of defaults in triple C, oil and gas high yield names, is extraordinarily high and continuing to go up. We've already seen what's happened there. Being under-exposed there has helped us.

Mining and metals has been a place that's been tough where we're not. I think some of the industries that we do participate in where I think folks would generally say there's weakness, definitely retail. Retail's tough these days, brick and mortar retail in particular with just changes in the way consumers and buying patterns are working in terms of online retail.

Restaurants, inevitably, I think see the weak consumer, if the consumer's slowing down, which I think consensus is they are, you're seeing a little bit of weakness there. But we're reasonably happy with the way the portfolio's sitting. 7% year-over-year EBITDA growth relative to what you're seeing I think in other portfolios and broadly in the market is something that we feel is very healthy and doesn't really give us significant concerns, so --

Got it. Thank you for that. On the syndication side, for lack of a better term, can you give us a little bit of color about how the fee income works there in the sense -- obviously if we look at one, Click, where $1.1 billion financing, you kept about $150 million. So you syndicated out about $950 million.

What's the fee -- obviously you get arrangement fees on the whole thing, and you keep some skim, et cetera, can you give us any color roughly on some ballpark numbers on how that plays out? Do you keep 50 basis points on the $950 million that you syndicate out or any -- that would be a little high, given I know what the capital structure are for the whole quarter, but any color there would be really helpful?

I mean, on underwritings I think upfront fees, depending on how large a deal is and all that, are pretty broad. Gosh, you could charge anywhere from maybe a 3 to 5 point fee if you were lucky in certain deals. It really depends on the value that your partners are bringing to you in a transaction. It's all about derisking your transaction.

You're able to skim more income the more risk you're willing to take in syndication. That I assume is obvious, but I'll just state it, right? So if you're doing a full underwrite and you're getting something rated and you're selling at the market, you'll retain more skim income versus if you're bringing partners in to be co-lead arrangers and then moving towards something that looks more like a club transaction. I just can't say that there's a number that's a general number that we end up with in different deals. It just varies from deal to deal based on size and circumstance.

Okay. Got it. Fair enough. Kind of following up on that, and this is my last question, obviously it's been an area you've been looking to grow for a while. You mentioned you've widened the fairway now after you've done a couple of these big deals. Is there, for lack of a better term, is this a business that you are you now going to be running on a budget or purely opportunistically?

I think you should consider this to be part of our business. This is something that we're very clear, hopefully with the team for sure, but also with investors, that when we saw GE sell their business, it really opened the floodgates for our ability to change the nature of our business. Before we were partners with them we were much more active on the senior side, and since not being partners with them in SSLP we've been very, very active on the senior side.

We have a team that's been doing this for 20 years, long before we got here at Ares, and we have every capability in house needed to do this. So this is very much part of the business plan and very much part of the budget. These larger deals keep showing up and I don't think it's by chance. I think it's because we're targeting these deals and I think our clients view us as providing real value in bringing them this service.

Got it. Thank you.

The next question comes from Christopher Testa at National Securities Corp.

Thank you for taking my questions. Just a question on InfiLaw holdings with the preferred on non-accrual at about 64% of cost, just curious if you could discuss what the exit opportunities look like for this company or for-profit Ed in general.

Not to comment too specifically on something that's obviously a more difficult situation in the portfolio and something that we're working with that Company on, it is a difficult sector. I don't expect many people to achieve near term exits on many or any of these assets.

I think that changes in regulations in for-profit education have made people go back to the drawing board a little bit and need to rework their business, which is what we're doing at InfiLaw with our partners. Beyond that I think we're just going to have to be patient and apply all the resources that we have here to a name like this and that's what we're up to for now and that's what we're going to stick to doing. I don't have any expectation of near term exit from that name.

Okay. Got it. And just curious, are you seeing better opportunities, not just in terms of pricing, obviously, but in terms of structures, industry, whatnot, in second lien relative to first lien? Are we in an environment now where first lien has been bid up too much as people have this flight to quality with the volatility in markets?

I don't think necessarily. We always get the question of first lien versus second lien. We do both. We choose by Company. We choose based on risk adjusted return in each particular name and each particular deal. So I don't see any big changes in the relative value there.

We're still believers that both of them work. I think second lien -- pricing in second lien has come in a little bit. It's been under more pressure during this period as there's been limited new deal flow. So I think we're pretty happy with some of the second lien deals that we did over the last 12 months, and have been more cautious over the last quarter or two.

Got it. And just the backlog number that you cited earlier in the call, do those include the existing portfolio Company names or are those all new deals that you're potentially looking at?

Both.

Okay. And is it fair to say that's more heavily weighted towards your existing names, given the commentary, that's your preference?

I'm looking at it right now. Certainly, the backlog is, and the pipeline's always going to be a little bit more oriented towards new stuff because, again, that's still subject to a diligence filter which a company may not pass. It's subject to getting final pricing and terms and documentation and all of that done which is higher risk than something that's in backlog.

Got it. And last one -- sorry about that.

No, go ahead.

I was going to say, the last one from me, just a housekeeping item. Should we expect further professional fees related to ACAS in the fourth quarter?

Yes, we'll have some. We'll have a little bit ongoing through the closing and into next year, but like I said, last quarter nothing near what we had in Q2 as we move toward --

Right. Okay. That's all from me. Thank you for taking my questions.

You're welcome.

The next question is from Hugh Miller at Macquarie.

Hi. Thanks for taking my questions. I definitely you appreciate some of the color you provided on the energy and consumer oriented verticals that you gave. Was wondering if you could provide a little bit of insight on the trends you're seeing within the VC lending that you do?

There was industry data that just selected, or suggested some selective credit extension in the third quarter. Are you seeing the typical ramp in 4Q production that we tend to see in that industry? And are there any areas of concern that you're seeing within VC lending?

I think our venture lending business isn't necessarily like others. I think it has a lot of commonality with others in that you tend to provide non-dilutive shorter term loans to companies between equity rounds as they build value. Use of proceeds is obviously just a bridge to the next round.

We're seeing valuations in venture come down. We're seeing the next round of equity capital, which is typically our take-out, take longer. So I think that business is a little bit choppier. We've added a non-accrual or two over the course of the year. And I think that's representative. But again, it's a pretty small portfolio for us. It's about $270 million.

And even if you have a couple little blips along the way it's just not something that's all that material for us. We like the business. It's a nice part of the strategy. And I think venture is going through a time where you need to be more cautious and be paying attention to the fact that valuations are coming down and capital isn't flowing quite the way it was maybe 12 months ago. But nothing of great concern there.

Got it. That's very helpful. I appreciate that. And I guess just as a secondary follow-up, as you're moving a little bit further along working with ACAS, is there any additional insight you might be able to provide in terms of the expense synergies that you think can be realized as we head into next year?

I think, again, you'll see a lot of that come through and we're trying to get it out again as soon as we can on these pro forma financial results for 930. So if you wouldn't mind, why don't you let us distribute those. I'm sure everyone's going to take a good, hard look at them. We'll be more than happy to follow up after you see them.

We do expect we'll have some expense synergies just like anything. We only have one Board of Directors, one audit, those types of things. But most of those will actually be seen on the come as we go into 2017.

I find the historical pro forma financials, at least on the income statement side, aren't that instructive because of the way the rules are under GAAP to include those, and in fact, those don't allow you to include expense synergies when you look backwards oddly enough. So I think it's going to be something that as we put the two companies together and go into 2017 we'll start to be able to give you a little better lens. But, yes, as with any strategic acquisition you would expect to have some cost savings on the G&A.

Got it. Yes, absolutely. Got it. Thank you so much.

The final question is from Terry Ma at Barclays.

Hey, guys. So with more combined capacity to invest post ACAS, how do you guys actually balance your cautious view that you have right now with the need to use that increased capacity and grow looking out a few years, if presumably the economy is not going to improve dramatically from here?

It's a good question. Something we're thinking a lot about, certainly being selective on new deals. Look, I think it's going to be important for us to think about other things that we can do in the business. We have expanded over the years into different industry verticals. There are ways obviously to use, I think, the 30% basket more creatively with the pro forma balance sheet giving us capacity there, Terry.

So we've been focused obviously on making sure that we felt good about where we were six months in, having gotten the merger together and evaluating where we were vis-a-vis results against the due diligence framework, and we feel great about that. I think that the focus today is just really pushing as hard as we can towards closing and getting this done.

But, yes, in the back of my mind, in the back of all of our minds, that's something for 2017, but it's a good question. You raise a good point. We're hopeful that the market in time comes our way. I think rates going up will help.

I think more defaults, which are likely, again, we think more for others than ourselves based on the portfolio that we've built will widen spreads and we think that should hopefully improve the environment. Look, we've been saying that and hoping for that for quite a while. It's, frankly, about the same as it was four quarters ago.

So sometimes it just takes a little while for the reinvestment environment to improve meaningfully and I hope we'll get that right with the pro forma merger into 2017 and beyond. We're excited about the merger. We think there's real accretion out of the gate, but the long-term benefits I think may outweigh even the short-term accretion. It's continued upon us to continue to put people behind the business and find the best investment opportunities that we can. That's what we're thinking for next year.

Okay. Got it. That's helpful. That's it from me. Thanks.

All right. Thank you.

Would you like to make any closing comments? No. Ladies and gentlemen --

No, I don't think we had any other than we're happy to close out and you can close us out, operator.

Thank you. Ladies and gentlemen, this concludes our conference call for today. If you missed any part of today's call, an archived replay of this conference call will be available approximately one hour after the end of this call through November 15, 2016 to domestic callers by dialing 1-877-344-7529 and international callers by dialing +1-412-317-0088. For all replays please reference conference number 10093115. An archived replay will also be available on a webcast link located on the home page of the investor resources section of our website. Thank you. You may now disconnect.