Ares Capital Corp (ARCC) 2017 Q2 法說會逐字稿

Good afternoon. Welcome to Ares Capital Corporation's Second Quarter Ended June 30, 2017, Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded on Wednesday, August 2, 2017. I will now turn the call over to Mr. John Stilmar of Investor Relations.

Great. Thank you. And good afternoon, everyone. Let me start with some important reminders.

Comments made during the course of this conference call and webcast as well as 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 such expressions. The company's actual results could differ materially from those expressed in such forward-looking statements for any reason, including those listed in its SEC filings. Ares Capital Corporation assumes no obligation to update any such forward-looking statements. Please also note that past performance or market information is not a guarantee of future results.

During this conference call, the company may discuss core earnings per share or core EPS, which is a non-GAAP financial measure as defined by SEC Regulation G. Core EPS is the net per share increase or decrease in stockholders' equity resulting from operations less 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 in stockholders' equity resulting from operations to the most directly comparable GAAP financial measure can be found in the accompanying slide presentation for this call by going to the company's website. The company believes that core EPS provides useful information to investors regarding financial performance because it is one method the company uses to measure its financial condition and results of operation. 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 according to the company, makes no representation or warranty in respect to this information.

As a reminder, the company's second quarter ended June 30, 2017, earnings presentation is available on the company's website at www.arescapitalcorp.com by clicking on the Q2 '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'd like to now turn the call over to Mr. Kipp DeVeer, Ares Capital Corporation's Chief Executive Officer.

Thanks, John. Good afternoon, and thanks to everyone for being with us today. I'm joined by most of the members of our management team including our President, Mitch Goldstein; and our CFO, Penni Roll; as well as other members of the finance, investment and investor relations team. You will hear from both Penni and Mitch later in the call.

Let me start by reviewing our second quarter results and activity. After that, I will discuss in more detail the benefits of our exciting announcement this morning regarding the senior secured loan program as well as our progress on the American Capital acquisition.

This morning, we reported second quarter core earnings of $0.34 per share. In addition to these core earnings, we generated $0.25 per share of net realized gains from investments, which includes $0.02 per share of prepayment fees that many other BDCs include in their net investment income number. When taken together, these earnings are significantly in excess of our current quarterly dividend of $0.38 a share. We believe that this measurement, core earnings plus net realized gains, is the best proxy to use in reviewing what taxable income is available to our company to pay the dividend.

Throughout our history, we've invested primarily in middle-market loans that produce current income through recurring interest income, fees and other income. But we've also invested in equity and other securities with the expectation that these investments will produce net capital gains over time. We believe investing up and down the capital structure produces superior returns over time and is critical to a balanced model that's effective in difficult points in the cycle. Our track record would suggest that we've been successful investors in this regard. If you look at our performance over our roughly 13-year history through June 30, 2017, we've generated cumulative realized gains on investments in excess of realized losses of $702 million, resulting in annualized net realized gains of roughly 1.2%. During periods where market spreads are tighter, this element of our strategy should position the company to take advantage of strong market environment to optimize the portfolio and to monetize certain assets at attractive gains. The strong net realized gains of more than $150 million this year through July 26 is continued evidence of this success and provides earnings from which we can pay dividends. And before we move forward, we wanted to highlight that we think it's a particularly good time to be a seller in today's market.

As you'll hear from Mitch later on the call, we used our leading market position to deliver new originations totaling $2 billion. We're able to do this, in our opinion, while remaining selective and defensive as a significant majority of our second quarter commitments were again to repeat borrowers and sponsors. We believe the continued opportunity to provide additional capital to finance our best company provides distinct benefits to portfolio performance and the long-term credit quality.

Now let me update you on the progress we've made regarding our plans for the year, which I communicated on last quarter's earnings call. As a reminder, we identified 2 key earnings levers to execute upon. The first was finally resolving the SSLP and over time repositioning its capital. And the good news, as you saw in our press releases, is that we've wrapped up the SSLP ahead of schedule, which partially resolves the headwinds we've been experiencing with the gradual wind-down of this program. Given the smaller program size and our desire to accelerate the wind-down of the program in late July, we purchased the remaining loans outstanding in SSLP in a negotiated deal with GE. And as a result, the remaining $1.6 billion in loans, which are yielding approximately 7.1% in the aggregate, were brought onto our balance sheet, representing a net increase of approximately $150 million in assets.

But importantly, we eliminated specific program expenses. And as a result, ARCC will earn the full 7.1% weighted average yield on the $1.6 billion in loans that we acquired from the program instead of earning only 6% on the $1.5 billion in sub certificates that we earned for the second quarter. This obviously provides an immediate improvement in the run-rate of earnings. By bringing the SSLP loans on to our balance sheet directly, we also reduced the single largest asset in our 30% non-qualifying asset basket. With this dramatic reduction, we now have significant capacity in our 30% basket for interesting new investments that can potentially bring higher returns.

One of the main beneficiaries of this capacity should be the SDLP, which is our joint venture with Varagon and AIG, which can now take on more rapid growth. Needless to say, we're thrilled to have this flexibility going forward.

As we close the final chapter on the SSLP, it's important to remind ourselves of the success of this program and how valuable it was to our company. Over the life of ARCC's investment in the SSLP dating back to 2009, we generated an internal rate of return of 20% on a very significant amount of capital.

Finally, let me give a brief update on where we are with American Capital. The short summary is it's going very well. We continue to find the core debt positions to be healthy and a good fit for ARCC. Everything else is being evaluated for sale or is in process. And during the second quarter, we sold an additional $210 million in American Capital assets, generating net realized gains of approximately $21 million. The remaining portfolio acquired from American Capital at fair value at June 30, 2017, totaled $2.1 billion with an aggregate weighted average yield of 7.8%.

We currently have approximately $1.1 billion at fair value in low or nonyielding noncore assets that remain in the American Capital portfolio with an aggregate yield of 6.5% that we are targeting for rotation. We believe we're on track with our plans, and that by moving these lower-yielding assets into higher-yielding assets, we are positioning this company for future higher earnings. The full benefit from this repositioning may take multiple quarters as we've discussed in the past. And with this, I think it's worth pointing out that our external managers supported this effort by waiving up to $10 million in income-based fees per quarter starting with this quarter, the second quarter of 2017, and this fee waiver continues for the next 9 quarters.

Finally, this morning, we did announce our third quarter dividend of $0.38 per share. As I mentioned earlier, our earnings available to make distributions meaningfully exceeded this dividend declared. And as a result, we continue to feel very confident with the current dividend level. In addition to current year earnings and net realized gains, we continue to have significant level of excess undistributed earnings also available for distributions to shareholders.

Now let me turn the call over to Penni to provide some more detail on the financials and on the balance sheet.

Thank you, Kipp. Good morning. Our basic and diluted core earnings per share were $0.34 for the second quarter of 2017 as compared to $0.32 for the first quarter of 2017 and $0.39 for the second quarter of 2016. Our basic and diluted GAAP earnings per share for the second quarter of 2017 were $0.42, including net gains for the quarter of $0.13 per share, but after reduction for American Capital-related expenses of $0.03 per share. This compared to GAAP net income per share of $0.28 for the first quarter of 2017, which was reduced by American Capital-related expenses of $0.06 per share and $0.50 of GAAP net income for the second quarter of 2016. Looking forward, we expect the American Capital acquisition-related expenses to subside after the third quarter of this year. Our higher core earnings in the second quarter of 2017 as compared to the first quarter were primarily driven by higher structuring fees and the benefit of the $10 million income-based fee waiver for the quarter that Ares Capital management agreed to put in place in connection with the American Capital acquisition.

As of June 30, 2017, our investment portfolio totaled $11.5 billion at fair value, and we had total assets of $12.3 billion. At June 30, 2017, the weighted average yield on our debt and other income-producing securities at amortized cost increased to 9.4% and the weighted average yield on total investments on amortized cost increased to 8.2% as compared to 9.3% and 8.1%, respectively, at March 31, 2017. Our total portfolio yield increased since the end of the first quarter, primarily due to rising LIBOR rates.

In connection with the purchase of the loans from the SSLP that Kipp discussed earlier, we will see an immediate benefit to our total portfolio yield as the weighted average yield at amortized cost for the $1.6 billion in loans purchased from the SSLP is 7.1% compared to the 5 3/4% yield that we earned from our SSLP subordinated certificates in July just prior to the purchase of the underlying loan.

We continue to generate solid net realized gains from the portfolio with $112 million in net realized gains booked during the second quarter, representing the 12th straight quarter we have reported net realized gains on investment. In total, we had net gains on investments and foreign currency transactions for the second quarter of $58 million, driven by stronger portfolio company performance and better-than-expected valuations on realizations.

Our current dividend remains well supported by our current earnings, including core earnings and net realized gains and from 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 third quarter dividend of $0.38 per share is payable on September 29, 2017, to stockholders of record on September 15, 2017.

Now moving to the right-hand side of the balance sheet. Our stockholders' equity at June 30 was $7.1 billion, resulting in net asset value per share of $16.54, up 0.2% compared to a quarter ago.

During the quarter, we repaid $183 million of our higher cost retail notes yielding 5 7/8% ahead of their scheduled maturity in October 2022 and incurred a realized loss on the extinguishment of the debt of $4 million. As of June 30, 2017, our debt-to-equity ratio was 0.7x and our debt-to-equity ratio net of available cash of $440 million was 0.64x compared to 0.67x and 0.64x, respectively, at March 31, 2017. Our leverage remains below our target leverage range, leaving significant room for new investments.

Our total available liquidity at the second -- at the end of the second quarter was approximately $2.2 billion. The higher-than-normal cash balance we carried at the end of the second quarter was largely due to the timing of certain transactions that closed on June 30.

Our balance sheet continues to be asset-sensitive and a further rise in short-term rates benefits our company. For example, using our balance sheet at June 30 and assuming a 100 basis point increase in LIBOR, our annual earnings, net of income-based fees, are positioned to increase by approximately $0.13 per share. We have just started to see these benefits lately as 3-month LIBOR is finally in excess of 1%, where many of the floors on our assets are set.

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

Thanks, Penni. I'll spend a few minutes reviewing our second quarter investment activity and portfolio performance, and then conclude with a quick update on post quarter-end activity, market conditions and our backlog and pipeline.

During the second quarter, we used our scale and extensive relationships to generate a strong level of new investments, mostly in first lien senior secured loans. As Kipp highlighted, we made 47 new commitments totaling $2 billion and had gross fundings of $1.9 billion, with approximately 85% of our commitments to repeat sponsors or existing borrowers of ARCC and its affiliates.

Selectivity is a strong by-product of our market coverage and the breadth of our platform allows us to find compelling investment opportunities not available to others. Having a portfolio of $11.5 billion to over 300 borrowers provides distinct advantages in incumbency and information, and it allows us to selectively deploy incremental capital amongst our best borrowers. It also helps to sit within a large alternative asset manager that has over 1,300 portfolio investments and approximately $65 billion of AUM in credit as of March 31, 2017. This power of incumbency has been an important element that has supported our long-term track record of industry-leading performance.

Our second quarter investment in Global Health Care Exchange or GHX underscores this point. GHX is a leading provider of on-demand supply chain automation solutions to the health care industry. GHX has been an ARCC portfolio company since 2014 when we led a $225 million senior credit facility to support the acquisition of the company by Thoma Bravo. Since then, we have supported the company through a number of acquisitions. When the company was sold during the second quarter, our position of incumbency and scale allowed ARCC to agent $197 million of second lien debt and to make preferred and common equity investments in this attractive business.

Our financing of Veritas' buyout of Emergency Communications, known as OnSolve, is another good example of our focus on stable, noncyclical companies and ability to provide a differentiated product. In this case, our long-term relationship with the leading sponsor and our willingness to commit in whole the entire amount provided ARCC and its affiliates the opportunity to lend $390 million of senior financing. OnSolve is a leading provider of mission-critical emergency mass notification solutions to state and local governments and commercial customers.

During the second quarter, we also exited $1.8 billion of investment commitments with about 1/3 of such exits pertaining to sales of lower-yielding senior loans. As Kipp mentioned, we are also being proactive in our portfolio rotation and encouraging underperforming credits in certain situations to seek new capital.

In the second quarter, we reached an agreement to sell Hillarys Blinds, a legacy American Capital portfolio company, which closed in the third quarter of 2017 and generated a net realized gain of $58 million. This transaction is another example of the embedded value in the American Capital portfolio and our ability to execute on value-creation opportunities due to the strength of the Ares platform. This company is based in London where we enlisted the help of our London-based team in this sale.

Shifting to the portfolio as of June 30, our portfolio companies continue to have strong credit performance, and we continue to see growth in aggregate earnings. Our portfolio of companies' last 12 months' weighted average EBITDA increased approximately 5%, consistent with prior quarter levels. Weighted average EBITDA for the portfolio increased to approximately $70 million, reflecting some new commitments to larger companies.

Second quarter non-accruals as a percent of total -- of the total portfolio at cost improved to 2.7% compared to the first quarter at 2.9%. At fair value, non-accruals also declined on a quarter-over-quarter basis from 1.15% to 0.5%. In addition, the number of borrowers on non-accrual declined by 10% since the first quarter.

Looking forward into the current quarter, the market continues to be aggressive but we have seen stabilization in pricing trends. A recent slowing in fund flows into the loans has served to provide a more balanced supply-demand dynamic and is supporting pricing stability. We continue to be defensive and highly selective in our new investments, seeking to lend to franchise businesses with recurring revenues, high free cash flows and strong margins. From an industry perspective, we continue to focus on investments in the industry such as business services, health care services, consumer and software services. And we continue to be underweight in sectors where we see volatility or weakening trends such as retail, restaurants, oil and gas and other cyclical and commodity-oriented sectors.

Before I turn the call back over to Kipp to conclude, let me provide some quick comments on our post quarter-end investment activity. Excluding the SSLP transaction from July 1 to July 26, we made new investments -- new investment commitments totaling $128 million and exited or were repaid on $327 million of investment commitments, realizing significant net gains of approximately $61 million. It is important to note that 59% of the investment exits since quarter end were nonyielding equity securities, making the weighted average yield on total investments exited or repaid only 4.1%, representing a positive reinvestment opportunity on this invested capital. In addition, as of July 26, our total backlog and pipeline stood at roughly $530 million and $325 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 back over to Kipp for some closing remarks.

Thanks a lot, Mitch. So to conclude, we had a strong second quarter with improving core earnings, great GAAP earnings and increase in our portfolio yield, growth in net asset value and very strong net realized gains on our exits. We feel we're making excellent progress rotating the acquired American Capital portfolio, and we believe that current market conditions are only enhancing our opportunities to create and realize incremental value from this portfolio. The exit of Hillarys Blinds at a significant gain is a great recent example of our ability to create value in this market.

In addition, we brought the SSLP loans on to our balance sheet, providing earnings benefit and increased flexibility around our new investing activities. Going forward, we're confident in our ability to reinvest these lower-yielding assets into new investments that are higher yielding, including the optimizations and new capacity in our 30% basket. We feel the company is well positioned for the back half of the year, and we're acutely focused on delivering strong returns for the shareholders.

That concludes our prepared remarks. Operator, perhaps you can open the line for questions.

(Operator Instructions) Today's first question comes from John Hecht of Jefferies.

First, I guess, just a detailed -- a question on the details. I didn't realize your prepayment income was below the line. I think you guys mentioned it added -- it would have added $0.02 if you put it above the line last quarter. What's the average pace of prepayment income in a typical quarter there?

I'm sorry, what's the average (inaudible) what's the -- at the average pace?

Well, the average accrual in a typical quarter, prepayment income.

Yes, let me let Penni describe the accounting. Yes, go ahead.

Yes, I mean, we would record prepayment income when we actually get an actual repayment on the loan early while it's still in its prepayment period. And when that happens, we account for it as a net realized gain, again, while others in the industry will put it up as a part of interest income or other fees. And if you look at our run-rate history, it's probably about $0.01 a share a quarter.

Yes, I mean, it's accounting convention, John, back 13 years ago when we went public. I mean, that's just how we do it. Yes, we were earlier in making that decision than many others. Seems like others had followed along just to do it differently.

Yes, obviously, something has to prepay in its prepayment penalty period, which means it will go up and down in a given quarter. But I think on average it's about $0.01.

Great. And second, Kipp, just thinking about the margins. I mean, obviously, the ACAS portfolio, there's been a mix shift in the total margin. If you exclude the impact of the ACAS portfolio, where do you see -- how have margins fluctuated in the near term? And where do see that going given the AUM market right now?

Yes. I mean, just in terms of spreads on new loans, is that what your comment is...

Yes.

Yes. I mean, it's funny. There's this assumption, I think, that there's a race to the bottom where yields are going to continue to compress and compress. We really haven't seen that. And in fact, we've been talking about it here in advance of this call. We went back and we looked at the last 9 quarters that we announced publicly to talk about the market environment. And while we've been increasingly cautious, maybe even pessimistic at points, we looked back and realized that we had about $9.5 billion of backlog and pipeline over the last 9 quarters. And yields on that backlog and pipeline have ranged somewhere between 8.5% and 10.5%, depending on which quarter you're looking at. So I don't know if the market has slowed in its yield compression or just that we've been able to find things that we think were a good combination of reasonable yields, but also reasonable downside protection.

Okay. And then last is more of just a topical question. I mean, between rate increases, ACAS portfolio optimization, I guess, the ramp of the SDLP and then just, I guess, you're levering up a little bit, but you guys have a lot of opportunity to increase the NOI. Kipp, I'm just wondering, from your perspective, what do you think is the most -- you did the most -- likely the most opportunistic of those factors in the near term? And then what presents the biggest opportunity over the long term to increase NOI?

Yes, I mean, I think -- look, we finally have -- I'll just say it seems to be the tailwind of rates rising, the short rates rising, which obviously benefits the company. And there's clear disclosure on sort of what that does and people can make their own interest rate guesses and assumptions. But I don't know if I have something that is particularly near term. I think it's all happening together. The way that we've tried to think about the bridge is we've got SSLP, which was yielding at the end of Q2, 6% immediately kind of becoming 7.1%. We have reinvestment then of that 7.1% into higher yields over time as those assets come back, too. So that's pretty significant opportunity. But we also take, and we've tried to describe this to folks as well, a pretty large portfolio at ACAS today that's paying 6.4-ish percent rough numbers. And if we can get that up to the midpoint of where our historical backlog and pipeline is, you can start to create another pretty powerful bridge to higher earnings in time. And the third thing that we continue to focus on is the fact that we no longer have a constrained 30% basket. That's a place where we've often been able to drive higher return investments that we don't feel are any more risky. And I made the point in the prepared remarks SDLP is sort of candidate most obvious for that. So just accelerating that more quickly should help the earnings. But I think there are a handful of other initiatives that we can begin working on now that we have that flexibility that hopefully can enhance earnings as well in time. So I think there are 3 or 4 different drivers positioning us for higher earnings, John, and I don't view any of them as one's more near term or one's bigger than the other. I think they're all of equal or relative importance and are kind of happening together.

And our next question today comes from Jonathan Bock of Wells Fargo Securities.

Kipp, just a simple item because it's so important as it relates to fees below the line -- or prepayment fees rather. What percentage of the book currently actually has embedded call protection that does not expire within a year?

I don't think we have that one handy, but we can go get it for you and come back to you.

Okay. So we'll hold that just because it's helpful and it's a step that I imagine isn't entirely proprietary. It's just a good gauge. The second is now that you brought the SSLP assets on balance sheet, you now have the ability to reinvest it or I'd imagine put it in the SDLP, assuming Varagon agrees. Now that's of kind of -- it's a catch-22 because you either have a bigger asset earning a lower yield or a smaller asset earning a higher yield. And sometimes, that exchange can be dependent on the market environment that you're in. Any views on your willingness and/or ability to put some of those SSLP assets into the SDLP program to continue to spur its growth and/or your willingness to leave those assets on balance sheet?

Sure. We would be quite willing in that negotiation or discussion. We obviously have other partners, which include Varagon and their shareholders. And I think the consideration for them is you don't just -- we don't just move assets around, right? Obviously, we'd be talking about a refinancing in the portfolio company. We take our relationships with our portfolio companies and their sponsors to be of highest value. So there's a third party there that would actually have to sort of consent and be excited to do that. So I don't really have any concern about the, to answer your question directly, the smaller investment at the higher yield versus the bigger investment at the lower yield. If that's good for the company and that's good for our clients and it works for our partner, it works for us. But I think it's a more complicated discussion than simply just moving assets around. That's kind of not how it works that I think you appreciate, Jon.

Got it. So just to be clear, would that be something that -- well, I understand Varagon would have to clearly approve and they're your partner. And depending on the quality of the asset, it would make sense. But you're also saying that the PE sponsor itself gets involved in that consideration, even though perhaps the term is in the -- the rate on the debt doesn't change at all?

Yes, they will. Of course.

Okay, okay. Then the next is if we stand to look at your CLO exposure, which was the result of the ACAS purchase. As a result of spread compression that's been certainly apparent in the syndicate market, et cetera, cash distributions on CLOs are becoming lower and lower. And what's your view on retaining that equity, which obviously gives you fairly high cash distributions but at a set declining level, which at times we've seen some BDCs really end up getting sideways with ownership of CLO equity, and in particular, really no volatility kind of present to allow those distributions to grow? Can you talk about your view of repositioning the CLO bucket of the ACAS assets in light of the high yield and potential lower reinvestment rate that you get elsewhere?

Yes. Again, we're a stated seller of those assets. We view them as nonstrategic. That's not a business that we want to be in. And our BDC, we don't think that we're the low-cost provider of investing in those. In fact, we've got a pretty substantial business here at Ares organized away from our BDCs that does this for a living. So -- and we kind of prefer it that way. Just as a reminder, though, it's $200 million of investments against an $11-plus billion portfolio. And I'd say for now, while we've sold some, we haven't sold all. The long-term goal is to reduce that portfolio to 0. But obviously, we're a little bit underinvested today despite some declining yields there. It does still offer reasonable income. So we've not pursued an overnight sale of everything, so to speak, but I think we're taking a measured view to taking that $200 million portfolio to 0 over time. That's what you should expect. I'm not sure I've got a concrete -- or we have a concrete timetable on that, Jon.

Sure. I mean, a lot also would depend on the reinvestment rates when those things start to exit reinvestment, the cash flows go down pretty fast as the notes amortize. But I understand and appreciate the comment. Then one last question, it's more of a holistic view but we've outlined that in tight spread, high competitive environments, outsized opportunities come from, you outlined, one, gains, but also through fees, right, and particularly syndicate fees, et cetera. So I would imagine that direct balance sheet lenders, I'm going to refer to those as yourselves and you know a few others that would love to portfolio something versus the direct flash syndicate lenders, right, Antares or others that are out in the market. Right now, the syndicate markets are offering a more compelling higher spread option for sponsors at looser covenants. And I'd imagine that it's hard to compete with a unitranche offering, perhaps a big one or others, to where you might have the choice instead of providing a direct balance sheet option, you'd be able to syndicate or you'd have a capable team that can originate that loan and pass off to everybody else who doesn't have the ability to originate these assets on their own and many don't, but claim to. So can you talk about the ability to drive syndicate fees ala American Seafoods and others in today's environment, and whether you, Kipp, believe that, that strategic focus on kind of leveraging your origination platform to sell, for the time being until spreads widen, is a good way to supplement income and cover the -- well, continue to outearn your dividend?

Yes. I mean, we -- that's a long question, but I think I'll try to answer it. So we had $21 -- we had $29 million in fees in Q2. We had $12 million of fees in Q1. It was a busier quarter. I don't -- we take sort of a full, as you know, kind of one stop, provide a solution to our clients approach. I'm not sure if I know what the difference between a balance sheet direct lender is and an underwriting direct lender is in a bank. It's just too complicated for me. The reality is, is when we do bigger deals, we often compete with banks in markets where there are lots of loaning flows and you're finding folks that will buy into more mid-market-oriented deals from the banks. The banks feel more confident in their ability to syndicate paper. That is an environment that we're experiencing now. I think as a result, you've seen some smaller -- not as many big deals from us because the banks can easily underwrite and distribute paper. We're hopeful that it slows. So it's slowed down in the loan market over the last couple of months that, that shifts back a little bit our way. It typically does towards the end of the year as banks, I think, are more careful going into September than perhaps they are going into April. But look, the fees continue to be part of the business model. I don't feel like the earnings story or the dividend, frankly, their stability or we hope its future growth is particularly impacted by that. But look, underwriting and syndicating deals is part of the model. If that's what our clients look to us to do in a particular transaction, we're more than happy to do that. And if it's better to buy and hold something that's a great risk reward for us such that we want to sell down 0, we're happy to do that too.

Good. And maybe just the small follow-up would be -- you've answered it. Just a -- when you have a sponsor that's coming to you versus looking for a unitranche/full balance sheet you hold it option, clearly, at a higher spread versus a syndicate option, right now, which one are sponsors preferring one over the other?

I don't think we can generalize. I mean, every deal is different, right? So every sponsor, frankly, if you're just talking about private equity is different. Certain folks love distributed deals. Frankly, many of the larger private equity sponsors that we know prefer a balance. So in a market where there is no great syndicated deal they'll skewed towards doing bought deals and then when a syndicated deal gets to be alive again, they're happy to hire the banks to underwrite and syndicate. Remember, part of what they do is buy companies that generally investment banks are selling. So making sure that you pay them some fees along the way is probably smart. But in certain markets, just the attractiveness of that kind of fully syndicated deal just isn't there. So I don't think there's a general answer to that. Every situation's different.

And our next question today comes from Ryan Lynch of KBW.

First off, congratulations on accelerating the conclusion of the SSLP. I think that's great that you guys were able to effect that transaction. With that transaction, you mentioned that's going to free up some capital in your 30% bucket. Can you just talk about -- you mentioned one ability would be to deploy more capital or further ramp up the SDLP. But what are some of the other strategic options you guys are looking at? I know Ares Management currently has a big asset-based lending team on its platform. Is that an option you guys are looking at? Can you maybe talk about Ares' asset based lending team, number one? And is that something that you guys would -- to plan on doing maybe a JV with them, ARCC utilizing the asset-based lending team?

Sure. Look, I think the philosophy, to try to be general for a moment before I address anything that you've commented on, Ryan, specifically, and thanks for your question, is we've got a very large credit platform here. And we've tried to invest the 30% basket into things that we think are very clearly on the fairway or in things that we understand where we add real value. There's certainly abilities, just to contradict that, to go make equity investments in finance companies or in pools of assets or other things that we don't understand and that's something that we're not going to do. So the philosophy is this BDC benefits tremendously from the strength of the Ares credit platform. And I think that there are some things that we view as potentially appropriate that we can bring from the platform to benefit the BDC. I appreciate you bringing up the asset-based lending concept. Others have done that, whether it's a Crystal Financial or other types of arrangements like that. We do have a very interesting commercial finance business here at Ares. It's been funded privately. It's growing. It's attractive. Is it something that we can leverage and bring to the BDC? I think so, but it's very early in our evaluation. I would tell you there are probably 3 or 4 other things that are high on the list that we're considering. But onus is on us to figure that out here over the next, call it, 6 to 12 months.

Okay. And then as you discussed on this call and previous calls and others have, it's obviously a competitive environment with a little bit of an uptick in leverage and increase in EBITDA adjustments. So how do you get investors comfortable when they look at your second quarter results? Seeing that you guys did about $2 billion in commitments in the second quarter in a higher competitive environment, how do you get investors comfortable that you guys are being prudent underwriters and not taking on excess credit risk in order to deploy capital?

Well, we continue to remind people of just the fact that we've actually run this company through a couple of cycles and we have experience dealing with markets like this. I'd say it's kind of point number one. So I hate to say it, but you got to just trust us that we know what we're doing at some point along the way. Look, number two, $2 billion seems like an enormous number, but we're a very large company. We still have $12-plus billion of capital available to us. And we can write very large checks, right? So some of the new investments that we made are pretty substantial, and I think you'll see that on the SOI. And of course, the third point that we've tried to emphasize is the fact that we're backing a lot of existing names, right? We're incumbents in quite a bunch of great companies that continue to look to us for capital. And maybe just try to describe that differently, but in a way that I think about it and I know Mitch and Mike and others think about it is, most of the credit risk that you take on and then a deal -- and a new deal occurs in the first 12 to 18 months, in our experience. It is the risk of the unknown of bringing new due diligence and new management team and a hope that your underwriting was correct, right? It's just very, very different than dealing with a company that's been in your portfolio for 6 or 7 years where you actually have board observation rights, real relationship with management, excellent access to information, et cetera. So that, as we've tried to reinforce, we think is a huge mitigant and a huge protection to us and to this company in this type of a market.

Okay, that's good commentary. And then on the debt side, the liability side, I guess, you guys have about $1 billion of debt, if not a little bit of higher-cost debt, closer to 5%, with some unsecured notes coming due in 2018. What are your plans? Do you guys -- are you guys going to -- are you guys planning on letting those kind of run closer to maturity before either reissuing some notes or drawing down the credit facility? Or are you guys looking to do anything with those -- about $1 billion of 2018 notes coming due maybe this year? Because you guys, obviously, have some capacity on your credit facility, and you guys have also issued some unsecured debt recently at much cheaper rates than those 2018 notes.

We're obviously always watching the debt capital markets and looking at our maturity ladder. If you look at our history, we tend not to wait till the last minute to refinance things out. So it's something we're watching now. I think if we got a market opportunity to start to get ahead of those maturities, we would seriously look at that. And if you look at where we could issue today relative to the cost of capital we were issuing at 5 years, we've had a substantial tightening [up front] on our issuances. So we will look to refinance that out in the right markets. And if the right market presents itself, we may certainly do it sooner than waiting till the maturities. If you look at the ladder next year, we have $270 million maturing in January. So that's coming up relatively soon on a calendar basis. And then we have till November to really look at the remaining $750 million that matures in the back half of the year. But I think we've been prudent issuers of capital and have done a nice job in watching the markets and hitting them when we think it's favorable for issuing at a very good coupon for us.

Okay. And then Penni, one more for you maybe. I think you mentioned that the ACAS-related professional or onetime expenses, you expect those to subside after Q3 '17. So can you just provide what amount of ACAS-related expenses we expect to occur in the third quarter?

Yes. I think, obviously, as the first 2 quarters have been higher, $0.06 in Q1 down to $0.03 in Q2, because we had a fairly large transition team that we had on board to help us with transitioning, particularly back-office accounting, finance, et cetera, teams to work with us, most of those people have now rolled off. We still have some though. So I would guess we're probably still around $0.01 or so a share going into Q3. And then we'll see further roll-off of those, the staff that's remaining, as we move into Q4. But I think generally, we think these expenses will subside by the end of the year.

And our next question today comes from Terry Ma of Barclays.

So absent selling any former SSLP assets into the SDLP, can you just give us a sense of how quickly you can ramp the SDLP now, now that you have the flexibility in the 30% bucket? What's the actual governing factor there, the growth net program?

There really isn't one. I mean, we have enough capacity in the 30% basket at this point to kind of achieve the target that we've outlined with AIG. Doesn't mean that we can't grow the program. But as we've talked about in past calls, the ideas that we would get up to, call it, $3-ish billion of loans in the program, our commitment then is somewhere between 20% and 30% of that overall capital, depending on mix of borrowers, underlying leverage, other things. So we don't have any constraint to getting there. I think the opportunity beyond that maybe to upsize or at least consider upsizing there as we ramp. But for now, I think we're just hard at work continuing the growth there, Terry.

Okay, got it. And then I just wanted to touch on the accretion from the ACAS deal. If I were to assume that you rotate the $1.1 billion of 6.5% assets into, call it, 9% to 10% yielding assets, I think the additional earnings contribution there is about $0.05 to $0.07 annually. So if your quarterly earnings run-rate is about $0.32 a quarter before the fee waiver, that additional $0.05 to $0.07 doesn't actually get you back to where you were before the acquisition. But can you just maybe help us walk through how to think about the earnings contribution from ACAS, what I could be missing, whether that's from additional fee income or if there's anything else there?

I think your math is right. I'd have to go back and actually look at past earnings to think about that any other way. But no, I think that's right. I think it's -- our rough math is $1 billion. Make up your number, which is 3%, and divide it by the share count. So I think that's about $30 million on 400 million shares, rough numbers.

Got it. So should we expect any additional fee income just from a bigger portfolio size or whatever?

I mean, I think I answered the question earlier, but we think so. It's dependent on the markets. It's obviously driven by level of originations. We've built again a company here that I think has the ability to generate great fees when we're underwriting and syndicating big deals. And when we're not, it generates, in our opinion, good fees. Not sure how to answer that any other way.

And our next question today comes from Rick Shane of JPMorgan.

I just want to talk a little bit. So we understand the -- how to think about the SSLP portfolio. You essentially have a portfolio now that everything in the pool is at least 2 years seasoned. So I'm assuming that the repayment schedule here, through a combination of scheduled repayments, refinancing opportunities and then potentially some bullets of those loans reach expiration or reach term is going to be a little bit different. And given that you owned it at par, it's probably not a big deal, but I'd love to hear what you think that $1.6 billion is going to -- how that's going to repay over the next 3 years.

Yes. So again, hard to predict. I can give you a little bit of data. That's just what the portfolio looked like when we bought it, which might be a benefit to others. The weighted average leverage on the overall portfolio is around 4.9x, which is, in our opinion, sort of squarely, either in line or below current unitranche deals. And again, the portfolio has a growth yield, as I mentioned in the prepared remarks, of about 7.1%. So those loans are -- those will be difficult to originate in today's market. They offer good risk rewards. It's obviously why we paid par for the assets amongst other considerations. And I think, look, there is the ability, to your point, about the market. Certain companies may say, "Well, on a weighted average basis, I'm over 4.9x." I mean, some are at lower leverage and some at higher leverage. My guess is the ones that have lower leverage would pursue some sort of a refinancing and/or sale because they've created equity value [0] the other one. But again, it's 11 companies at June 30 and it's 11 different stories, so hard to predict. But your point is a good one, which is they're seasoned borrowers. They're typically 2-ish years in. The average life of our asset tends to be somewhere between 3 and, call it, 4.5 years, depending on the cycle. So if you're trying to build a model, Rick, I think it's reasonable to think about that stuff coming off somewhere in next 12 to 24 months.

And our next question today comes from Robert Dodd of Raymond James.

So to follow up sort of on Jon's question about the -- 2 questions about the SSLP, the SDLP and the mix. Of what's in that $1.6 billion, how much would you say is actually eligible and an appropriate asset to be moved to the SDLP? I mean, obviously, the SDLP seems slightly higher coupon, slightly smaller loan, maybe slightly smaller companies. And then, obviously, to your point in the SSLP, maybe you've made some commitments about hold to maturity to sponsors. So can you give us -- is it a ballpark? There's only like 20% of it even eligible or is it eligible and appropriate to be moved in there? Or is it some bigger number, if it's even on the table?

Yes. I mean, I think generally they're all eligible. I mean, one thing I didn't mention in Rick's comment was weighted average EBITDA in that portfolio is about $43 million, $43 million, $44 million, so about the same size to the average loan size. So we get $1.7 billion divided by 11 companies, about $155 million a name. That's a very comfortable loan size for SDLP. So I view them as all viable, potential refinancing candidates for SDLP.

Okay, great. If I can kind of flip almost 180 on that, from the liability side of your balance sheet, I would imagine your lender groups, the rating agencies, they would look at you putting $1.6 billion of really high-quality senior secured -- I mean, unitranche first lien significantly shifting your mix on balance sheet to very secure high-quality loans. So I wouldn't -- is there potential leverage in keeping those on balance sheet and using that on the liability side to gain better terms, maybe even doing a securitization or something like that for some really cheap debt to finance that piece of the portfolio and keep your mix looking even better?

Yes. So I appreciate the comment. If we go on a non-deal road show for any of our fixed income folks, we'll make sure to invite you, Robert.

Thanks.

That's great. But yes, I mean, certainly. We always -- back in 2006, we actually did a term-out [indiscernible] financing on bank loan assets. I think based on where, and Penni can comment, based on where we borrow today, which is pretty attractive, we're not going to see a huge improvement based on the work that we've done, packaging those loans and terming out some sort of CLO-oriented financing, but I do. I think it's -- in thinking about credit rating and all of that and folks to do all effective leverage calculations and off balance sheet this and all sorts of other stuff, those discussions obviously are substantially mitigated as it relates to our company today. And I think there's credit benefit.

And our next -- (Operator Instructions) Today's next question comes from Doug Mewhirter of SunTrust.

Most of my questions have been answered. I had 2 sort of unrelated questions. First, a numbers-type question. Of your non-accruals, either as a percentage on a loan count basis or as a percentage of cost, how many of those non-accruals are legacy ACAS assets, if any?

Yes, let me just take a look at the list here. Yes, 1, 2.

Actually, I have put in here...

Two.

Two out of how many? What's the total count of non-accruals in the portfolio?

2 out of 19.

2 out of 19, okay. And my second and final...

Hold on a minute on that one.

If you look at the 19 total borrowers on nonaccrual, 2 of them are from the old Allied portfolio and 3 of them are from the legacy ACAS portfolio. So 3 of 14 are from ARCC that we have originated.

(inaudible) there's a third one there.

Yes, okay. And my second and final question, bigger picture question. We've seen in the headlines where the larger cap-oriented private equity firms have had very successful fund-raising efforts. You look at Apollo, they raised or raising a $24 billion fund. Just tremendous amounts of resources going into the private equity on the equity side. Have you seen a similar fund-raising activity in the middle-market private equity world? And if there is indeed more dry powder, so to speak, moving into the middle market, what does that mean for your business? Are you actually encouraged that? Or does that actually give you some cause for concern?

Yes, it's an interesting question. I -- yes, it's pretty staggering when you see a $25 billion private equity fundraise so kudos to the folks at Apollo. The -- I think the lion's share of fundraising that we see these days is to larger firms, to answer your question simply. And we see it more difficult for the middle tier of what I think of as middle tier mid-market firms, call it, $750 million funds to $2 billion. They're definitely still specialists with under $1 billion funds that either focus on just consumer or focus on just this region, just health care, whatever it may be. But I do think the middle is getting squeezed a little bit. It doesn't give me a lot of concern about our business. Again, we continue to scale our capital base to play into that reality. We are having more success, I think, with our experience, with our product set, and frankly, with the scale of the capital-based dealing with these larger sponsors. So 5, 6, 7 years ago, we didn't have much to offer, pick your brand name, [indiscernible]deal from Blackstone, KKR or Apollo. I think that's changed, and we have quite a lot to offer them today. And I'm happy to report that I think they'd agree based on having closed some deals and some great conversations with folks like that these days. So I think your observation is the right one, Doug, and it doesn't give me a lot of concern.

And ladies and gentlemen, we have time for one more question, and today final question will be from Christopher Testa of National Securities Corp.

Just with sponsors obviously pushing the envelope on leverage and add-backs on EBITDA and what have you, I'm just curious if you have kind of an estimate as to how much of your deal flow on the first half of the year would have been good for the SDLP in terms of structure and pricing? And kind of on that same note, what you see from this point on in terms of how fast you could potentially grow that with originations for that?

I don't -- we'd have to go back and actually look at all of the 6 months of pipeline and backlog and all of that, Chris. I don't have it handy, but...

Sure. I mean, I don't -- I'm not going to hold you to like a specific number. I was just wondering if you kind of off the top of your head, just had some idea of that, just to give us an idea of what we could expect for the ramping of that going forward.

Sure. I mean, I think it's hard to get that. We've tried to build a very broad origination funnel here. So I think of 70-ish percent of our deal flow is being sponsor oriented and the SDLP is a sponsor-oriented program, right? It also (inaudible) with companies of specific size, probably at the bottom end, $20 million, $25 million of EBITDA to as much as $75 million with the midpoint being a good guidepost. So if you're a $50 million EBITDA company looking to borrow 5x or $250 million, you're a pretty good fit for SDLP. Again, I don't know the number, but I would guess that half of that 70%, so call it 35% of our pipeline, is suitable and that we'd pitch SDLP. But you're asking a good question that I don't know the answer to, which means that we'd would go back and figure out what the right answer is.

Okay, I appreciate it. And will there be any onetime fees in the third quarter associated with the wind-down on the SSLP?

Any onetime fees? I mean, nothing of any consequence. I mean, paying lawyers, doing other stuff, but nothing of any consequence that I think will translate into something we're thinking about for your model.

Okay. And just shifting gears more philosophical. If -- you have the management company waive $10 million of fees for the quarter. If your core NII is, let's say, with the full $10 million was to be above the dividend of $0.38, should we expect that Ares Management would still waive $10 million and possibly put you at $0.39 or $0.40? Or should we look at the waiver as being something that just kind of bridges the gap between core NII and the dividend?

Well, the fee waiver is meant to be quite explicit, right? So as I mentioned in the stated remarks, the board at Ares Management and, obviously, the team that I'm part of that's decided to waive $10 million of management fees this quarter has agreed to do it for 9 quarters following this on a hard and fast basis. And there's really nothing more to it than that.

And this concludes our question-and-answer session. I'd like to turn the conference back over to Kipp DeVeer for any closing remarks.

I don't have anything further, but I hope everybody gets some vacation and enjoys the end of their summer.

Thank you, sir. And 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 1 hour after the end of this call through August 15, 2017, to domestic callers by dialing (877) 344-7529 and to international callers by dialing +1 (412) 317-0088. For all replays, please reference conference number 10109646. An archived replay will also be available on a webcast link located on the homepage of the Investor Relations section of our website. Have a great day.