Ares Capital Corp (ARCC) 2017 Q1 法說會逐字稿

Good afternoon. Welcome to Ares Capital Corporation's First Quarter Ended May 31, 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded on Wednesday, May 3, 2017.

Comments made during the course of this conference call and webcast and the accompanying documents contain forward-looking statements and are subject to risks and uncertainties. Many of these forward-looking statements can be identified by the use of the words such as anticipates, believes, expects, intends, will, should, may and similar expressions. The company's actual results could differ materially from those expressed in such forward-looking statements for any reason, including those listed in its SEC filings. Ares Capital Corporation assumes no obligation to update any such forward-looking statements. Please also note that past performance or market information is not a guarantee of future results.

During this conference call, the company may discuss core earnings per share or core EPS, which is a non-GAAP financial measure as defined by SEC Regulation G. Core EPS is the net per share increase or decrease in stockholders equity resulting from operations, plus professional fees and other costs related to the 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 of stockholder's equity resulting from operations to the most directly comparable GAAP financial measure can be found in the accompanying slide presentation for this call by going to the company's website. The company believes that core EPS provides useful information to investors regarding financial performance because it is one method the company uses to measure its financial condition and results of operations. Certain information discussed in this presentation, including information related to portfolio of 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 first quarter ended March 31, 2017 earnings presentation is available on the company's website at www.arescapitalcorp.com by clicking on the Q1-'17 earnings presentation link on the homepage of the Investor Resources section. Ares Capital Corporation's earnings release and 10-Q are also available on the company's website.

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

Thanks, Allison. Good afternoon, and thanks to everyone for your interest today. I'm joined by members of our management team, including our President, Mitchell Goldstein and Michael Smith; and our Chief Financial Officer, Penni Roll, along with other members of the Finance, Investment and Investor Relations teams. You'll hear from both Penni and Mitch later on the call.

Let me begin by reviewing our first quarter's results and activities, and then I will update you on the American Capital transaction and highlight our strategy going forward. This morning, we reported first quarter core and GAAP earnings per share of $0.32 and $0.28, respectively, and this quarter is the first to include the impact of the American Capital acquisition, which closed on January 3. GAAP earnings included $0.08 per share of one-time and other costs related to the closing of the American Capital acquisition.

Core earnings were below our historical levels driven by several factors. Continued strength in the equity and credit markets, combined with significant inflows into the leverage finance arena created a more difficult investment environment, and we chose to close fewer deals than we'd expected. As a result, earnings were impacted by lower fee income and less interest income from new investments. In addition, as we highlighted during our call last quarter, we on-boarded a lower-yielding portfolio with the American Capital transaction, which included significant nonyielding private equity investments and other nonstrategic assets that we intend to exit. Finally, the wind-down of the SSLP has continued. And as previously discussed, this has been a headwind for the company.

We view the core earnings impact from the American Capital acquisition and the SSLP wind-down as short-term in nature. As we make progress in transitioning these assets, they provide significant opportunities for earnings upside as we exit these lower-yielding assets and reinvest in the higher-yielding assets.

Let me take a minute to more specifically discuss each of these areas. As many of you know, we typically generate seasonally higher fee income in the third and fourth quarters compared to the first quarter. This was again the case as our first quarter structuring fee income declined, reflecting lighter seasonal transaction volume and an increasingly competitive investment environment where we elected to finance fewer new borrower transactions, which often generate higher fees.

The new deal market has been frothy, supported by significant inflows into the asset class over the past year or so, and this has often led to aggressive behavior from other market participants.

In these types of markets, which we've experienced before, we focus on remaining selective and defensive in nature with the focus on backing our best borrowers, collecting call protection on refinancing, harvesting our equity gains and maintaining dry powder for improved opportunities down the road. We continue to use our scale advantages, deep market coverage and flexible approach to review the broadest set of investment opportunities with the goal of finding compelling risk-adjusted returns. But this is just much more challenging in the market today.

For the first quarter, we closed more than $850 million in new growth commitments, with the majority of these commitments made to existing borrowers. Post quarter end, from April 1 through April 26, 2017, we made new commitments of $533 million. In addition, we've taken advantage of the opportunity to harvest significant realized gains of $107 million this far in Q2 through only April 26. Mitch will talk more on this later in the call.

Turning to the American Capital acquisition. We remain excited about the long-term opportunities and accretion that we believe this transaction will bring to the company. We believe the transaction is likely to add numerous benefits, including increasing our scale and making us more effective in the market. In addition, we have the opportunity to continue to sell assets at attractive prices and to redeploy low-yielding and nonstrategic assets into core, higher-yielding investments that are more in line with what we've done historically at ARCC.

You may recall that we have a demonstrated track record of executing on this asset rotation strategy, which is very similar to the strategy that we executed with the Allied Capital acquisition in 2010. The good news is, at closing, the American Capital transaction was immediately accretive to our net asset value by approximately $0.11 per share, reflecting our attractive purchase price at a discount to their net asset value. Overall, the transaction contributed to an increase in our net asset value of $0.05 per share for the first quarter.

The first quarter core earnings impact from the transaction was modestly negative, but again, we feel it's important to take a longer-term view on our ability to reposition and grow earnings over time. To help during this transition period, beginning in the second quarter, Ares management will waive up to $10 million in income-based fees per quarter, representing roughly $0.02 per share of earnings benefit to ARCC.

This fee waiver will benefit our earnings during the periods when we expect we will be most active in rotating the American Capital portfolio.

American Capital was an active seller of assets between our May 2016 signing and our January 3, 2017 closing, and we've continued on this path. We believe that it is an excellent time to be a seller of assets. And during the first quarter, we divested about $240 million -- $284 million in American Capital acquired assets, and as of March 31, 2017, we have identified approximately $1.1 billion in debt and equity assets acquired from American Capital with a blended yield of 6.7% at fair value, most of which provide upside opportunity as we rotate out of these assets in exchange for higher-yielding assets. We feel that we are very much on track with the American Capital transaction and we're working hard to unlock value.

Another note, the American Capital transaction was a significant deleveraging event for ARCC, particularly when combined with our slower investment pace. This has also contributed to the lower earnings for the quarter but we feel fortunate to have significant financial flexibility going forward with the ability to increase leverage over time as market conditions improve.

Third, as we discussed last quarter, we continue to manage the wind-down of the SSLP portfolio and the associated decline in the SSLP yield. At the end of the first quarter, the SSLP yield declined from 7% to 6.5%, well below the 9.3% weighted average yield on the total portfolio. We currently estimate that the SSLP yield will decline to about 6% once all of GE's senior notes are paid. And therefore, we believe that we've experienced the most of the spread compression that we'll see on this investment. As of March 31, GE senior notes stood at around $1 billion. And based on current repayment activity, we estimate that we'll be in a position to see our SSLP sub certs start to repay as soon as the third quarter of this year. It's great news for us. As this capital is returned, we can finally deploy this capital into more attractive, higher-yielding opportunities, which should add to our earnings and increase our flexibility of the company by reducing the amount of assets dedicated to our 30% basket.

Finally, this morning, we announced our second quarter dividend of $0.38 per share. We're confident about the current dividend level based on our view of the earnings power of the company, the benefit from the income base waiver that begins in Q2 and our substantial spillover income. With that, I'll ask Penni to discuss our first quarter results in more detail and to provide some comments on recent financing activities.

Thank you, Kipp. Before we go into the earnings for the quarter, I'd like to start by taking you through the impact of the American Capital acquisition. As Kipp mentioned, the transaction was accretive to our net asset value at closing. There is more detail in the notes to the financials in our 10-Q filing, but to summarize, the fair value of the net assets we acquired totaled $3.4 billion, which exceeded the cash and stock consideration we paid by $54 million.

This translated into net asset value per share accretion at closing of approximately $0.11. The net assets we acquired included cash of $960 million and an investment portfolio of $2.5 billion at fair value that had an aggregate weighted average yield of 7.4%. The fair value of the investments at closing became our cost basis in these assets. The net assets acquired and their related earnings are reflected in our financial results for the first time this quarter, so I will note the impact of the acquisition as we go through the earnings discussion.

Our basic and diluted core earnings per share were $0.32 for the first quarter of 2017 as compared to $0.42 for the fourth quarter of 2016 and $0.37 for the first quarter of 2016.

Our basic and diluted GAAP earnings per share for the first quarter of 2017 were $0.28, including net gains for the quarter of $0.06 but after a reduction of American Capital acquisition-related expenses of $0.08. These expenses included certain one-time expenses related to the closing and also included higher administrative fees as we integrated the acquisition. This compared to GAAP net income per share of $0.24 for the fourth quarter of 2016 and $0.42 for the first quarter of 2016.

As Kipp mentioned, our lower core earnings in the first quarter of 2017 as compared to the fourth quarter were primarily driven by lower structuring fees, a reduced yield on our subordinated certificate in the SSLP, a modest initial impact from the American Capital portfolio and lower leverage.

As of March 31, 2017, our investment portfolio totaled $11.4 billion at fair value, and we had total assets of $12 billion. At March 31, 2017, the weighted average yield on our debt and other income-producing securities at amortized cost was 9.3%, and the weighted average yield on total investments at amortized cost was 8.1%. These compare to 9.3% and 8.3%, respectively, at December 31, 2016. Our total portfolio yield has declined since the end of the fourth quarter, primarily due to the higher amount of nonyielding securities from the American Capital portfolio and the continued decline in the yield on our SSLP subordinated certificates, as Kipp already mentioned.

Despite the fact that the yield on our total portfolio has declined over the last year as anticipated with the declining SSLP yield, we have maintained our net interest and dividend margin by focusing on lowering our cost of debt capital, which we improved by refinancing higher-cost term debt and through the higher usage of our lower-cost revolving credit facility.

We continue to generate net realized gains from the portfolio with $13 million in net realized gains booked during the quarter, representing the 11th straight quarter we have reported net realized gains on investments. We also reported net unrealized appreciation of $27 million for the first quarter as portfolio values improved modestly from last quarter.

We believe that our current dividend level remains well supported by our earnings, including net investment income and net realized gains as well as our spillover income. We estimate that undistributed taxable income carried forward from 2016 into 2017 was approximately $339 million or $0.80 per share. Our second quarter dividend of $0.38 per share is payable on June 30, 2017 to stockholders of record on June 15, 2017.

Moving to the right-hand side of the balance sheet. Following the $1.8 billion of equity issued in connection with the American Capital acquisition, our stockholders equity at March 31 was $7 billion, resulting in net asset value per share of $16.50, up 0.3% compared to a quarter ago.

As of March 31, 2017, our debt-to-equity ratio was 0.67x and our debt-to-equity ratio net of available cash of $185 million was 0.64x, down from 0.76x and 0.73x, respectively, at December 31, 2016.

The lower leverage ratio is a result of the significant amount of cash that we acquired in the American Capital transaction, which allowed us to deleverage.

In connection with the closing of the American Capital acquisition, we also upsized 2 of our revolving credit facilities by a total of $1.3 billion, providing for additional lower-cost capital to support the larger balance sheet.

At March 31, 2017, we had approximately $2.2 billion of undrawn availability under our revolving credit facilities subject to borrowing base, leverage and other restrictions, which we believe leaves us well positioned to deploy capital into new investments as we see attractive opportunities.

Since our last earnings call, we repaid $162 million of convertible notes at their maturity in March, and we believe we continue to be well positioned from a duration perspective with our next term maturity of $270 million not until January 2018.

Including the impact from the American Capital transaction, our balance sheet continues to be asset-sensitive and well positioned for an expected increase in short-term interest rates. For example, using our balance sheet at March 31, and assuming a 100 basis-point increase in LIBOR, our earnings would increase by approximately $0.14 per share.

Now I would like to turn the call over to Mitch Goldstein to review our recent investment activity and to discuss the portfolio.

Thanks, Penni. I'll spend a few minutes reviewing our first quarter investment activity, detailing portfolio performance and providing a quick update on our backlog and pipeline. As Kipp mentioned, we focus on originating a very broad set of middle-market opportunities with the goal of investing in the best credits where we find compelling risk-adjusted returns.

Historically, we have closed less than 5% of potential opportunities. However, that number today is meaningfully lower. During the first quarter, we made 28 new commitments totaling $864 million and had gross fundings of over $900 million, which includes existing unfunded commitments.

Given the environment we discussed earlier, we are focused on more conservative, first lien debt investments, which accounted for 74% of new commitment activity. Furthermore, we continue to emphasize using our capital to support the needs of our existing borrowers, and this represented nearly 55% of our first quarter investment activity.

During the first quarter, we exited $836 million of investment commitments, including $284 million of investments acquired in the American Capital acquisition. The first quarter exits from American Capital portfolio included $103 million from the sale of certain assets previously owned by American Capital Asset Management, or ACAM, which was merged into Ivy Hill Asset Management at closing. ACAM's net asset at fair value totaled $179 million at closing, consisting primarily of GP interest in managed funds, receivables and other management contracts.

Importantly, the most significant ACAM assets remaining at close were exited in the first quarter and we expect to realize the remaining assets over time.

As of March 31, our total portfolio company count rose to 316, which includes 87 new portfolio companies that we've acquired from American Capital. Our portfolio mix by asset class experienced a modest increase in the equity investments from approximately $980 million to $1.4 billion, primarily due to the ACAS deal, but in general, our portfolio did not meaningfully change in industry or asset mix.

From a portfolio credit quality standpoint, our statistics generally improved. Our portfolio weighted average leverage declined from 5.5x to 5.3x quarter-over-quarter, and interest coverage increased slightly from 2.4x to 2.5x. Combined last 12 months' weighted average EBITDA growth increased slightly from 4% last quarter to 5% this quarter, driven by comparable growth statistics from the acquired portfolio and stronger performance in the ARCC portfolio. Weighted average EBITDA declined slightly from $73 million to $69 million, reflecting the modestly smaller companies within the ACAS portfolio.

First quarter combined nonaccruals as a percent of total portfolio were unchanged compared to the fourth quarter at 2.9% at cost and modestly higher on a fair value basis increasing to 1.1% at the end of the first quarter from 0.8% at the end of the fourth quarter. These statistics continue to remain below average for the industry.

Looking forward, we are staying defensive with a continued focus on lending to franchise businesses with high free cash flows and strong margins. From an industry perspective, we continue to focus on investments in industries such as business services, healthcare, consumer and software services, and we continue to be underweight in sectors where we see volatility or weakening trends such as retail, restaurants and oil and gas and other cyclical and commodity-oriented sectors.

Our proactive industry selection and avoidance is a key differentiator in our investment approach and we believe is one of the key factors that allowed us to outperform other credit managers over a long period of time.

Before I turn the call back over to Kipp to conclude, let me provide some quick comments on our post quarter end investment activity. From April 1 to April 26, we made new investment commitments totaling $533 million and sold or exited $810 million of investment commitments, realizing significant net gains of approximately $107 million.

Investment commitments sold or exited during the period included $105 million from the American Capital portfolio on which we realized net gains of approximately $20 million.

In addition, as of April 26, our total backlog and pipeline stood at roughly $400 million and $580 million, respectively, and as always, these potential investments are subject to approvals and documentation and we may sell or syndicate post closing. In addition, we are not certain that any of these transactions will close.

And now I'll turn it over back to Kipp for some closing remarks.

Thanks, Mitch. While our first quarter earnings were below our expectations as we intentionally slowed our investment pace due to the market environment, we don't believe they reflect the longer-term earnings power of the company. We're focused on being long-term stewards of our investors' capital and have not lost sight of the investment and operating strategy that's driven our success over the past 13 years. We feel confident that a slower pace of investing is warranted today as it means positioning the company for less volatility long-term and the opportunity for stronger fundamental investment performance and higher earnings in future periods.

In addition, we continue to be confident about our plan on executing on the American Capital acquisition and we feel that we have multiple levers to pull to support earnings growth in the future.

That concludes our prepared remarks. Allison, would you please open the line for questions?

(Operator Instructions) Our first question will come from Jonathan Bock of Wells Fargo.

Just a few here. Kipp, you mentioned slower pace and that is a prudent measure in light of where spreads, and more importantly, junior debt spreads are today. Can you walk us through the net fee impact, right? Given the fact that you book fees upfront, to the extent that you take a more conservative posture on deployments, one could expect or one might expect the potential for net operating income to fall below the dividend, even including the fee waiver. How do you look at full dividend coverage? Is it something that you will strive to do and can likely expect? Or would you expect NOI to fall below the dividend, based on your conservative posture over time?

I don't expect it to be long-term, Jonathan, although thanks for the question. It certainly did this quarter. And I think the good news is we think that there's a lot of earnings power in the company that will get it back to or above the dividend level, and I tried to make that clear in the prepared remarks. But for us, it's really all about rotation out of a handful of assets. As I mentioned, we've been selling assets at American Capital. That's actually improved the yield on the portfolio between closing and today on American Capital overall. But I would tell you, we've got about $1.1 billion of assets that we acquired that yield roughly 6.7% that just aren't going to make the cut here (inaudible). And the ability to reposition that $1.1 billion into a higher-yielding portfolio creates earnings momentum. And that should get us back to the dividend level. I think the second key point that I made in the prepared remarks is we're finally fortunate to be getting toward the end of SSLP. Never having had any luck convincing our friends at GE to wind up more quickly. We've had to just run the natural course and based on repayments, it seems the natural course is we start to get some capital back based on our forecasts there in Q3. And we can take that money and we can redeploy that into something that earns a lot more than today's 6.5%. (inaudible) at $3 billion of assets, and you can choose whatever number you want to think about where we can drive yield. But driving it to the current yield on the portfolio of 9%, you pick up quite a lot of earnings. And I caveat that by saying it doesn't even consider the fact that with paydown in SSLP, we substantially free up our 30% basket to do things that can be even more interesting than you see in regular portfolio assets in terms of structures and other stuff.

No doubt, Kipp, that I believe that there's an opportunity to rotate the portfolio, but I guess, the question is what new issue spreads are. And two, whether or not there is enough attractive new issues out there to effectively deploy such a large amount. So if we look at -- and I know you're talking about 7%, where are you originating on a Unitranche asset today in the current market today? Firstly, in Senior Secured? Would it be as high -- would it be about 100 basis points higher than 7%? Or in line with 7%?

I think that's a reasonable estimate. Remember, we do more than just Unitranche lending. But I'm looking to our backlog and pipeline our guys were happy to hand over to me. But we talked about the size of the pipeline in the prepared remarks. But roughly $1 billion of cumulative value of backlog in pipeline I see ranging from kind of 9% to 10%, believe it or not. So the market is tough but I think we continue to differentiate with our platform and our scale and we're finding enough to do. But (inaudible) good one and we're not going to know until we get there. But right now, I think we're still finding enough to do. The good news, too, is we're able to add quite a lot of earnings, although they're not "core earnings" to the company, just monetizing a lot of our equity positions and a lot of assets that we bought at discounts, and it's a great market to be a seller. So in case you didn't hear the number, we generated $100-plus million of gains in the month of April. I think [that's] pretty good. So we'll continue to do that.

Got it. And then just one last question as it relates to structure products and to the extent that I think I noticed only about $20 million of CLOs effectively sold. And given the spread compression that's occurred, both in the middle market as well as the broadly syndicated market, what's your view of earnings contribution from what isn't a completely immaterial amount of CLO equity that likely gets pinched the hardest in light of the fact that leverage in those securities is the largest?

Yes, I mean, again, longer-term, we're sellers of assets. There's been a modest increase, or improvement in that market. So we've been selling some but not fire-saling this. They do come with income. So it's a way for us to continue to generate income in the near term on those assets in that they pay double-digit rates of return. But look, we're a pretty significant managers of CLOs and investments in other folks' CLOs. I think we understand the volatility of those cash flows, which will lead us out of that portfolio in time.

Got it. Also last question and I'll jump off. Kipp, Ares has certainly -- A.R.E. S. has stepped in to support this transaction and is also looking -- and folks would imagine that you've taken a very long-term perspective. To the extent that you and Mitch and Mike do not find what you'd consider to be attractive opportunities to deploy capital thus keeping earnings high, do you believe that there's the potential for a greater fee waiver to sustain the dividend at the current level beyond the $10 million to ensure that the dividend itself is fully covered from earnings?

I would bet that there is. Look, we've found $100 million fee waiver from our external manager to support the transaction. So I think -- I'll just say that running Ares Capital Corporation is a very important business for Ares management. That being said, we have an independent board that we discuss our fee arrangement with. So we'd be talking to them, we'd be talking to the manager. I'm, frankly, not worried that I'm going to have to have that conversation. I think when you look forward, we have enough levers to pull again such that we'll position the company and we won't have to have that conversation. And I'll just remind you that we don't have the highest fees by a wide margin in the industry. So we feel our investors, over a long period of time, have gotten a pretty nice return on owning stock and if you look past a couple of quarters here where we think we're repositioning things to deliver earnings growth.

Our next question will come from John Hecht of Jefferies.

I just, I guess, I'm trying to figure out the earnings capacity of the combined businesses now. And one thing that might be helpful is, can you tell us what the, I guess, if you have this handy, what's the differential in the yield of the Ares portfolio versus the ACAS portfolio at this point? Or maybe even another way you could say this, what would your yields have been or your margins have been in the absence of ACAS, the portfolio coming in?

What we've disclosed, John, and good morning to you, too, is our portfolio, total investments had a roughly 8.3% yield, 9.2% on the debt and income earnings securities. ACAS overall had a 7.8% yield. So the blend is modestly down to 8.2%. But again, I think that the earnings power story, just to try to be painfully clear, again, $1.1 billion that earned 6.7% that's for sale. $1.9 billion in SSLP that today earns 6.5%. And back to Jonathan Bock's question, take the $3 billion and reinvested it, whatever you think makes sense, right? But the overall company today, again, is earning about 9% on its debt investments, just from a pure yield perspective without fees and without gains. And it goes without saying, too, just remember, that $1.9 billion of SSLP, because it's a 30% basket asset actually used to earn 15%. At one point, it earned 20%. So if you take the 9% across the $3 billion and you adjust it, my basic math in going through it over the last couple of months has been that you can generate $78 million of incremental earnings on a company with 425 million shares. That's on a gross basis. So that's how we think about the repositioning and what we're aiming to achieve. One other thing too, John, we can decide whether we think rates are going up or not. But LIBOR's helped a little bit. And this is an asset-sensitive company. So even if the market remains tough with a modest increase in rates and its repositioning, I think we see real earnings accretion from where we were prior to the transaction.

Yes, of course. And then there's the -- our -- excuse me, the ability increased leverage as well. So that's the top line stuff, and that's -- you definitely helped us process that. The other question I have though is on the cost side. I know there was limitation to your ability to talk about synergies, or cost savings and the proxy and so forth. If you guys -- is there any more wood to chop there? Anything you can discuss on that front?

Penni will take that.

Yes, I mean, sure. As we've mentioned in the past, obviously, we're going to have synergies in the costs for the things just to run the company generally. So the cost of an audit, the cost of public filing, the cost of having -- so there are synergies. It doesn't decrease our baseline cost but we can bring in this $3 billion of assets without a lot of incremental cost to our expense base today. So we should see us running more efficiently from an expense ratio perspective on our core G&A costs.

Our next question will come from Terry Ma of Barclays.

Can you talk a little bit more about how you balance the desire or need to rotate the legacy investments with what you're actually seeing in the market environment today? It looks like you're pretty cautious. What if the environment doesn't change in the near term? Do you just hold on to $1.1 billion of assets?

Well, again, the $1.1 billion's earning's 6.7%, so if we could sell it all tomorrow, I think we could reinvest it at spreads significantly in excess of that. So I think that we think about the $1.1 billion of monetizations, which, again, is a combination of first lien, second lien, mez, preferred equity as being opportunistic sellers when it makes sense. Again, so we've got a whole handful of the control buyout portfolio that we're currently kind of in the market, exiting right now. Some of the other things will hang around longer. But I don't -- retaining that $1.1 billion because it creates earnings isn't something that we're considering again because the yields are so low on that portfolio.

Okay, got it. And what portion of the $1.1 billion are nonqualified assets?

I'm not sure I have the answer to that off hand. I think it's pretty small. I have the composition, first lien, second lien, mez, preferred equity, et cetera.

Probably around $300 million to $400 million.

Yes. $300 million. Penni's saying probably $300 million of the $1.1 billion. But freeing up the 30% basket story, again is the reduction of SSLP. (inaudible)

Okay, got it. So can you give us a sense of the pace of return of that SSLP capital?

What it's earning today?

No. Just the pace of return. So those start to pay back in 3Q. So I'm just trying to figure out how quickly you guys can actually free up more capacity in your 30% bucket.

Sure. Well, we have $1.9 billion of sub certs in the vehicle, and the senior notes are roughly $1 billion. And recall that GE does have 12.5% of the sub cert investment. So we're forecasting by the end of the third quarter, it's our guess that $1 billion will repay per quarter.

Our next question will come from Ryan Lynch of KBW.

I have a couple of questions on the dividend. So if you exclude Ivy Hill, the dividend income was about $14 million, which was up over prior quarters. Is that increase due to on-boarding the ACAS investments, which may have more equity investments, maybe higher dividend payers? And is that $14 million kind of a good run rate going forward?

I think that dividend income away from Ivy Hill is representative of the fact that we're seeing more dividends coming from our equity investments generally in a good market. It's really not a cash-driven [like we saw] last quarter.

Right. Those can be a little bit lumpy. But we have seen a higher just dividend singularly from companies both in Q4 and Q1.

Sure. And then one more on the dividend, though. So if you look at Ivy Hill, you guys have always paid a $10 million dividend on a quarterly basis, but you basically paid that. With Ivy Hill taking on a few more assets from ACAM, do you guys expect that dividend distribution from Ivy Hill to increase at all?

We don't because, unfortunately, what we have left there is kind of dribs and drabs of things that we're exiting. So again, what was -- the increase in value at Ivy Hill was kind of twofold. It was, number one, $70 million of assets contributed from ACAM. I think Mitch mentioned this on the call, but it's accrued carry-in funds, which we've sold but have held carry. We've got value in some contracts that we retained, some assets to be sold in other kind of just random here-and-there assets but frankly, don't have any income so that's not going to increase the dividend. I think in time, the second source of the valuation increase, which was a $50 million investment that we made into Ivy Hill to expand their assets under management, they're ramping a new vehicle there. That's something that will come with income and we'll just determine what the company's capital looks like over time, as to whether a dividend increase, because if that investment is warranted or not, but it's probably too early to guess on that one. So for the time being, I'd say I wouldn't expect anything different for us.

Okay. And then as far as the SDLP that, ever since you guys kind of initially funded that, that the assets in there have been pretty stagnant so no growth in that fund. What is your outlook for actually growing the SDLP? Because obviously that's -- that could be a big earnings driver, that could be a big offset. And it has been somewhat of an offset to the wind down of the SSLP. So are you guys expecting further earnings growth in the SDLP in the near term?

Yes, we are. I mean, it's very active in the market. And it's been successful ramping, continued to have backlog in pipeline they were excited about. We were a little disappointed we didn't close a new deal in SDLP in Q1. But you're right. It is a higher return in investment. It's obviously meant to come in on the heels of SSLP being terminated and then winding down. So yes, I mean, I think it's one of the numerous sort of bright lights that potentially exists there for us to drive earnings.

Our next question will come from Chris York of JMP Securities.

So Ryan just asked a question on Ivy Hill and the dividend run rate, but I'm curious whether you'll be filing separate financials for Ivy Hill going forward. Or has the company not met the conditions of a significant subsidiary?

Yes, I think we...

It hasn't met it, and so there's no requirement to file those. And keep in mind, too, Ivy Hill, on a relative basis today, aggregate portfolio stayed pretty constant. So it's kind of even smaller as a percentage of portfolio, relatively speaking, to before the transaction. So...

Got it. And then so we know that Ivy Hill was awarded the ACSF contract. Will the income there be offset by any operating -- marginal operating expenses? Or would all that income fall to the bottom line?

Yes, I mean, clearly, there are costs related to running a fund. So while there is a management fee that comes with managing ACSF, it comes to Ivy Hill but also there are expenses that have to be incurred to manage that portfolio. So there will be expenses deducted from that. So I wouldn't put a lot of value into the Ivy Hill ACSF contract in the context of how you're thinking about the value of Ivy Hill, at least currently.

Sure. And then maybe just returning to expectations for the dividend. So essentially, you invested $50 million this quarter. So that should be a non-income-earning asset essentially for, maybe what, 4 quarters before that could potentially be evaluated for any income to ARCC?

No, I mean, it's an equity investment to support them ramping in a CLO. So I mean, the way that works is once the structure itself starts paying cash flows, which is typically a quarter out, there can be some income associated with it but it maximizes income once the portfolio is fully built and leveraged. And we do have the ability to reduce that investment over time. We always have the ability to increase investments in Ivy Hill, but it shouldn't take too long for that to have some income associated with it.

Okay. And then maybe, Kipp and Mitch, so you did reference the solid amount of net realized gains post quarter end, maybe you could update us on how you were thinking about this form of income going forward, whether investors should expect these gains to be withheld, maybe on the balance sheet, for both value growth net the excess tax? Or more likely in the form of a special dividend?

Yes. I think many years ago, we paid some special dividends. And I'm not sure we view those as efficient. They tend to reward short-term shareholders. And particularly, where we sit today, I think our goal, at least for now, our expectation for now is that we retain it, and obviously, add the book value in. We hope people will never count as earnings. That's my thought today.

Okay. And then Penni, do you expect any of the $0.08 per share in expenses from the ACAS acquisition to linger in the second quarter, or maybe even third?

Yes, that's a good question. I think from a forward-looking perspective, we did, in the income statement, break out separately all of the costs related to the American Capital acquisition so you could see what we think is specific to finishing the acquisition at closing and also just on-boarding the transaction. It was obviously a lot higher in Q1 because we had certain costs related to closing the deal, specifically. But we also have additional overhead costs for on-boarding the transaction that we incurred, that the bulk of that's going to come in Q1 because that's when the integration activity was the most substantial. So that $26 million, if you take out the onetime costs, will come down. And I think we're probably looking more at, I would estimate, probably around $3 million for Q2, and then that would continue to decline. So...

We think it's less than -- yes, $0.01 or less a quarter on an ongoing.

Yes. And it will roll off over time, just like it did with the Allied acquisition. Anything that's core expenses, back to John's point, we show in our other G&A line. So those are the things that would be more recurring ongoing operating costs. Anything that's more specific, kind of one-time or not recurring over time, we have separated out for you so you have a view on how to run that off.

Great. That's very helpful. And then lastly, for me, so Kipp, of the $3 billion of investable capital that you identified, what is your expectation -- or maybe what is in the pipeline of mix for agented deals versus club deals given now your larger platform and scale?

I mean, one of the ways that we protect ourselves is we really tried to agent lead all of our deals, 90-plus percent -- 95% of what we do. I think there's a lot of pretty low-quality underwriting going on. We pass on deals because of that but we also pass because we don't like financing $35 million EBITDA companies with no covenants, which people are doing these days. We don't like the structural element of a lot of other people's documentation. So again, I mean, I think the good news is we've got a pretty robust pipeline. It was not only slow but I think reasonably unattractive in terms of new investing in Q1. And the flow part happened, but the frothy market is clearly there. I feel a little bit better about backlog and pipeline for Q2. And it's in line with our expectations of what we want to see on new deals. And a key element of that again is leading our own deals.

(Operator Instructions) Our next question will come from Robert Dodd of Raymond James.

Just going back to the SSLP and the repayment rate in that vehicle. If I remember right, last quarter, you indicated maybe the subsets good start getting paid back as early as late Q2. Now it's Q3. That's if I remember right. And it certainly looks like the repayments on that vehicle were below the run rate that we'd seen through '16. So is there anything changed in there in terms of repayment velocity? Given how frothy the market is, I would have expected maybe that velocity would have increased rather than slowing down. So is there anything that's going on with those -- the remaining assets in that vehicle?

I'm glad you asked. When Terry asked that question, I said $1 billion a quarter, that would repay the entire program. So I'm thinking about that, I think, that's not the right number, right. We're saying that actually all of the senior notes will be repaid by, call it, the end of Q2, which then allows for principal to be repaid to our sub certs. And we start seeing repayments on ours in Q3, just to be clear. So $1 billion a quarter is too high a number based on what I referenced earlier. To answer your question directly, Robert, there's no change in terms of what's going on in that portfolio other than what I've said in the past remains true, which is the longer a borrower is stuck in a program that can't actively help do out on acquisitions, do refinancings, et cetera, et cetera, the more frustrated that borrower gets being in a dormant program. So we've seen a more accelerated pace of repayments. We've been happy about that. I think Q1 was an anomaly with slower-than-we-expected repayments, but you're right, a refinancing environment that's attractive should lead to just continued accelerated repayment. The market allows for it. The borrowers want it. We want it. So it's sort of the everybody win scenario to ramp this thing down pretty quickly.

Perfect. I appreciate that. One follow-up, if I can. On the dividend income that you received. Obviously, is that -- the bulk of the non-Ivy Hill came from community education centers, which was an Ares asset, not an ACAS asset. But it, as far as I can recall, had not been paying dividends before. Is that an asset that you do expect to be able to pay some level of recurring dividend? Or was there a one-time payment in Q1?

Yes. When we elected to take dividend, we've actually -- we've announced that we -- to the company that we had to go in and restructure and own with a couple of other lenders. The good news is we actually sold it and it represents some of the realized gain that you see in the financials through the end of April.

Our next question will come from Doug Mewhirter of SunTrust.

I just had one last question or remaining question. In your pipeline, could you talk about the health of you, I guess, the senior large bank loan syndicated market, which you've been sort of in and out of, and definitely more active in the recent. Are there any, I guess, medium to large size deals, which could support fee income out there?

There's nothing that jumps out that's a [quicklike] deal, right, so to speak. We obviously saw that refinancing early this year. The deal that we did a year ago at LIBOR 800-plus get refinanced at LIBOR 350. So that says a lot of what the big bank market will allow for these days. And look, the CLO inflows and the loan fund inflows are making it much tougher for us to compete in those big underwrites. I don't have anything that I can point to or we can point to today. But again, they tend to be more complicated, less traditional deals that just don't work with the regulatory and credit frameworks of the banks. I think the longer-term point here is while we may not have one in the backlog in pipeline, we think that opportunity is just going to continue to exist into the foreseeable future for certain deals, but they're lumpy. But to answer the question directly, I think the answer is no.

Our next question will come from Christopher Testa with National Securities Corp.

Just curious, out of the remaining ACAS items to be sold, what do you think is on the block first? I mean, it seems like CLO equity prices are obviously very strong, and maybe there's some liquidity there to be able to sell. Just curious how you're looking at the book and kind of the order in which you're kind of selling those now.

Yes. I mean, it's a disparate portfolio that, I think, again, will be selling in time. It does have reasonable earnings even though, to Jonathan's point, we view them as long-term volatile earnings. We're an active manager of investments in other folks' CLOs here at Ares. We've got an outstanding team doing that day-to-day. So we're taking advice from them as to what to sell, when to sell. We've got some control positions. We've got some noncontrol positions in deals. So I think we're evaluating them on a single-name basis instead of a on a portfolio basis because we have to research and invest in capability here to do that. So I hope that answers your question.

Yes. So in other words, you probably prioritize selling things that are past the reinvestment period and not just looking at the broader market.

Exactly. I mean, there are whole hosts of considerations as to why a certain CLO investment can be more attractive than another one, and I think we're pretty good at identifying that here.

Got it. And I know last quarter, you guys were granted exempted relief from the SEC. Just wondering if you've begun to do co-investments with other Ares funds and the size of the funds that we should expect ARCC to be co-investing with?

Yes. The only accounts that we've really done any co-investing with at ARCC since the exemptive order have been some middle market-oriented bank loan accounts that we've raised from a handful of investors. And the target there was just to raise capital to make us a better platform and, frankly, help ARCC. The [co-investing's] been positive. But that's really about it. We haven't done and we don't intend to, for instance, co-invest with our private equity funds or co-invest with our distressed funds. I don't think the co-investment really we'll see -- I don't think you'll see any change in strategy from ARCC as a result of the co-investment release -- relief.

Our next question will come from Scott Sher of LMJ Capital.

Yes, 2 quick questions. In February, you increased the buyback by $200 million. I'm just curious what your mindset is on that today?

Remember -- Scott, how are you? Remember, we suspended the buyback as we were pursuing its closing. So some of it was just form in that we wanted to have a buyback in place because we think it's a great tool to use if we see value in the stock and we think we can buy back stock accretively. The larger buyback program really just represented the fact that we're a larger company today and we wanted to have more flexibility because the stocks in the space have been pretty volatile, really nothing. Those are the reasons.

Okay. And then one follow-up. The $0.14 of earnings accretion that would come from 100 basis-point increase in LIBOR, is that on the portfolio today? Is that on the portfolio as you see it repositioned within 2 or 3 quarters? So you have this $3 billion of assets that you've said you're going to reposition over the next 12 to 24 months, lower-yielding into higher-yielding. I'm curious, the $0.14 of earnings accretion, is that existing portfolio, pro forma portfolio? How are you thinking about that?

So that's 100 basis-point rise on the 3/31 portfolio and has nothing to do with any income that we can earn from repositioning lower-yielding assets at the company. So what we're trying to do, just to be clear to everybody on the plan for the year, it's repositioning the asset yields, and we think that, that adds meaningful incremental earnings, as I mentioned before, to the company. But the asset sensitivity point, I think, is key, too, Scott, whereas if we do see rises in rates from here, we see earnings lift as well.

Our next question is a follow-up from Jonathan Bock of Wells Fargo.

She let me in the queue one last time. Kipp, you outlined the potential for spread -- or excuse me, earnings expansion as it relates to the $1.1 billion or $3 billion, I guess, around 6.7% or 6.9%. That's part of the story. Outline to us your view of the potential spread compression that exists in your portfolio today and the potential net negative impact there, largely because, looking at your sales and repayments, and particularly where the markets are today, I'd imagine that we could see a heavy earnings headwind as it relates to spread compression in your existing book absent ACAS.

Yes. I mean, to be honest, over the last -- we've -- there's been a lot of refinancing in the portfolio in the last couple of years. It's not like we're sitting around with a whole host of wonderful 14% mez deals that we did in 2012, right. (inaudible) So I think that the existing portfolio is a reasonable mix, and it's not like getting called away now that everybody can issue at 7% instead of 9%. We're just not seeing that. So again, with the backlog and pipeline of $1 billion-plus, with average assets in the 9s, I feel pretty confident that if some of our higher-yielding investments come off that we can replace them. So for us, not a...

Got it. And that $1 billion of pipeline that you have, you mentioned your separately managed accounts, et cetera, are there -- does that $1 billion in pipeline origination that your team originates, is that effectively shared amongst all of available Ares private debt participants? Or is that ARCC specifically?

Yes, I mean, when our platform's originating it's originating for the benefit of all of our accounts so, remember though that, that kind of private account business generally is taking a different set of assets, right. It's money that we've raised to target the L450, L500 name. It just doesn't fit so well for us at ARCC because of the leverage restriction at 1:1, the company, as well as our investors' goals of achieving ROEs that require higher-yielding assets. But it does. That pipeline looks to all the available vehicles pursuant to our allocation policy.

Showing no further questions, this will conclude our question-and-answer session. I would like to turn the conference back over to Kipp DeVeer for any closing remarks.

We thank everybody for joining. We've heard some disappointment around earnings, but just so everybody hears from us we're pretty excited about where the company's positioned for the year, if we weren't clear in the prepared remarks and in the Q&A. I mean, I think we're on a path here that may take a little time but we feel great about. So just want to leave everybody with a couple of those thoughts, and I hope you have a great afternoon.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines.