Ares Capital Corp (ARCC) 2017 Q4 法說會逐字稿

Good afternoon. Welcome to Ares Capital Corporation's Fourth Quarter and Year-ended December 31, 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is be recorded on Tuesday, February 13, 2018.

I will now turn the call over to Mr. John Stilmar of Investor Relations.

Great. Thank you, and good afternoon to 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 the SEC Regulation G. Core EPS is a 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 losses; and any income taxes relating to such realized gains and losses. A reconciliation of this core EPS measure for net per share increase or decrease in stockholders' equity resulting from operations, the most directly comparable GAAP financial measure, can be found in the accompanying slide presentation for this call by going to the company's website. The company believes that core EPS provides a useful information to investors regarding the 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 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 fourth quarter and full year December 31, 2017 earnings presentation is available on our website at arescapitalcorp.com by clicking on the Q4 '17 Earnings Presentation link on the homepage of the Investor Resources section. Ares Capital Corporation's earnings release and 10-K are also available on the company's website.

Now, I'd like to turn the call over to Mr. Kipp DeVeer, Ares Capital Corporation's Chief Executive Officer.

Thanks, John. Good afternoon, and thanks for joining the call today. I'm here today with our management team, including: our Presidents, Mitch Goldstein and Michael Smith; our Chief Financial Officer, Penni Roll; and other members of the finance, investment and Investor Relations teams. You will hear from Penni and Mitch later in the call.

I'd like to start by reviewing the quarter and the year, and highlight some of the company's accomplishments. This morning, we reported strong fourth quarter core earnings of $0.38 per share. GAAP earnings were also strong, reaching $0.54 per share, which benefited from the improved core earnings and net appreciation of our portfolio. Our net asset value improved during the fourth quarter and over the course of the full year, ending 2017 at $16.65 per share.

Looking back over 2017, we're pleased that we've accomplished nearly all of the goals that we set out for ARCC at the beginning of the year, namely increasing our quarterly earnings through the rotation of the American Capital portfolio, resolving the wind-down of the SSLP, and investing prudently, with a focus on funding incumbent borrowers. We increased our portfolio yield by 40 basis points driven largely by our success to date, rotating the American Capital portfolio and through increases in LIBOR rates.

Our core earnings have now increased in each of the past three quarters, and ended the year back in line with our quarterly dividend. As we've stated in the past, is our goal to have our core earnings meet or exceed our regular dividend payout.

Finally, investment performance throughout the year has been good. Nonaccruals have been stable, and we've just completed our eighth consecutive year of net realized gains on the portfolio. As you've heard from us in the past, we emphasize full-cycle total returns from our diverse sources of revenue, and we're happy with how our overall business is performing.

Let me spend a few minutes reviewing a few of our most strategic portfolio initiatives from 2017 in greater detail, and provide an update on where we see things going forward.

The American Capital acquisition gave us a very unique opportunity to buy a large portfolio at a discount to NAV. And since closing, we've generated realized gains and improved the portfolio yield by rotating out of noncore, lower-yielding investments and increasing core earnings by redeploying this capital into higher yielding assets. We feel we've made great progress during our first year after closing. We've had no surprises, and in fact, we believe meet we may have found more to the upside than we expected.

During 2017, we exited more than $1 billion of assets, mostly in noncore investments from the $2.5 billion portfolio, and we realized $85 million of net gains on these exits. In addition, on the acquired investments that we still hold as of year-end, we've shown $184 million of net unrealized appreciation during the year. We currently have $735 million invested at cost or $910 million at fair value, of targeted lower yielding noncore assets remaining in the American Capital portfolio, with an aggregate yield of just 6.7%, all of which we are targeting for rotation. With this, we believe there is still more value to extract from the acquisition going forward.

Similar to the opportunity we see for expanding the yield on the American Capital portfolio, we believe there are future earnings opportunities to be had utilizing our 30% basket. As a reminder, we've freed up capacity in this 30% basket by purchasing $1.6 billion of the underlying loans remaining in the SSLP and effectively terminating the program. While the $1.6 billion of former SSLP loans yielding 7.5% at cost presents modest future yield enhancement opportunities for us over time, the new capacity under the 30% basket is arguably more important. This flexibility should allow us to expand with attractive investments such as the expansion of the SDLP that we announced this morning.

Today, ARCC and Varagon Capital announced that we have more than doubled the capacity of the SDLP with $2 billion of the available capital from a leading global insurance company and another $500 million from its current investor, AIG.

Alongside this increased support, ARCC has expanded its capital available to the program from $590 million to approximately $1.4 billion in the form of subordinated certificates. The increased size reflects the future opportunity we see for the SDLP and the attractive risk reward for our investment.

SDLP is performing very well for us and we believe represents a compelling investment for our shareholders. At year-end, our investment in the SDLP subordinated certificates was generating a 14.5% yield, and we also earned other fee income as the SDLP makes new investment commitments. During 2017, SDLP made $1.1 billion of new commitments, which increased the total SDLP portfolio commitments to $2.4 billion. We believe the additional capacity for the program should allow us to further grow our investment in this high-yielding asset which will contribute to future earnings.

Before I turn it over to Penni to take us through our financial results and activities, let me provide some high-level market commentary. 2017 was a year where we witnessed generally stable economic conditions, rising corporate earnings, accommodative monetary policy and historically low volatility, which led to a strong bid for credit assets throughout the year. In fact, many -- in fact, the 9 credit conditions and strong CLO formation drove the broadly-syndicated market to post-recession record levels for loan volume during 2017. And similarly, midmarket volumes benefited as private fund formation accelerated to meet the higher demand from middle-market companies and sponsors.

The abundance of capital and higher risk appetite, coming from existing players and many new entrants, led to tighter lending spreads and weaker structures. As a result, we believe that deep origination infrastructure, scale, experience and proactive portfolio management is more important than ever in our market.

So far into 2018, however, we've witnessed a bit of a change in course, with heightened volatility in the equity markets and a meaningful selloff in the U.S. Treasury markets, it seems investors are grappling with the prospects of higher rates, inflation and the potential unwind of an unprecedented amount of stimulus from central banks. Despite this volatility, the middle-market direct lending environment seems unchanged. With real outflows in the high-yield markets over the last few years, we believe we are prepared for volatility that could flow through the leverage credit markets. And most importantly, we feel we have a portfolio that's been built for capital preservation. And as Penni will discuss, we've been busy fortifying our balance sheet with long-dated, fixed-rate debt and other flexible financing that should allow us to withstand future capital markets volatility.

Now let me turn the call over to Penni to provide more details on the fourth quarter and full year results, as well as our financing activities.

Thank you, Kipp. Good morning. Our basic and diluted core earnings per share were $0.38 per share for the fourth quarter of 2017, as compared to $0.36 per share for the third quarter of 2017 and $0.42 per share for the fourth quarter of 2016. Fourth quarter core earnings benefited from fees -- from continued the strong generation activity and from the rise in LIBOR during the quarter which helped increase our interest income.

Our basic and diluted GAAP net income per share for the fourth quarter of 2017 was $0.54 compared to $0.33 for the third quarter of 2017 and $0.24 for the fourth quarter of 2016. Our higher GAAP earnings in the fourth quarter of 2017 as compared to the third quarter were primarily driven by the net unrealized gains in the portfolio.

Net unrealized gains on investments for the fourth quarter were $216 million or $0.50 per share, which included $140 million or $0.33 per share from the reversal of net unrealized depreciation related to net realized losses on investments. The net unrealized gains came largely from our controlled buyout investment in Alcami, an outsourced drug development service provider that we acquired in the American Capital acquisition, which had $85 million or $0.20 per share of unrealized appreciation in the fourth quarter.

We recognized net realized losses on investments for the fourth quarter of $123 million or $0.29 per share, largely due to a realized loss from the sale of substantially all of our investment in InfiLaw, which has previously been fully recognized through unrealized losses.

As of December 31, 2017, our portfolio totaled $11.8 billion of fair value and we had total assets of $12.3 billion. At December 31, 2017, the weighted average yield on our debt and other income-producing securities at amortized cost was at 9.7%, and the weighted average yield on total investments at amortized cost was 8.7%, up from the 9.6% and 8.5%, respectively that we reported at September 30, 2017. Our portfolio yields increased since the first -- or since the end of the third quarter, primarily from the increase in LIBOR.

Now looking at the full year. Basic and diluted core earnings per share were $1.39 for 2017 compared to $1.61 for 2016, and basic and diluted GAAP net income per share was $1.57 for 2017 compared to $1.51 for 2016. For the full year 2017, we had total net realized and unrealized gains of $156 million or $0.37 per share, including net realized gains on investments of $44 million or $0.10 per share. The total net gains were largely driven by the $167 million or $0.39 per share appreciation on our investment in Alcami for the full year of 2017.

Our consistent ability to generate net realized gains on our investments has allowed us to generate taxable income well in excess of our distributions to shareholders, and have added to our spillover income and provided additional cushion for our dividend stability.

Since our inception, we've recorded cumulative net realized gains of $613 million. We currently estimate that undistributed taxable income carryforward from 2017 into 2018 was approximately $346 million or $0.81 per share.

We announced this morning that we declared a regular first quarter dividend of $0.38 per share. This dividend is payable on March 30 to stockholders of record on March 15, 2018.

Turning to our capitalization. Our stockholders' equity at December 31 was $7.1 billion, resulting in net asset value per share of $16.65, up 1% compared to a quarter ago as well as up 1% from December 31, 2016. As of December 31, 2017, our debt-to-equity ratio was 0.7x, and our debt-to-equity ratio, net of available cash of approximately $260 million was 0.66x. At December 31, 2017, we had approximately $2.5 billion of undrawn availability, primarily under our revolving credit facilities subject to borrowing base and other restrictions.

From a debt capital perspective, we've been taking advantage of the low interest rate environment over the last year to opportunistically lock in our liability costs against what we expected would be a rising rate environment. During 2017, we issued 5-year fixed rate term debt in both the convertible debt and investment grade notes markets, with each issuance pricing at the tightest spread and lowest coupon for these markets in our history.

In addition to issuing fixed rate term liabilities, during the fourth quarter we also fixed the rate on the $395 million floating rate term loan portion of our revolving line of credit by entering into an interest rate swap to lock in a coupon of approximately 3.8% for close to the next 3 years.

Given how we've built an asset-sensitive balance sheet, we believe that we are well-positioned going into 2018 to further take advantage of a rising rate environment. As of year-end 2017, over 90% of our debt portfolio was floating rate. Our assets are capitalized with equity and a low level of leverage with such leverage predominately coming from fixed-rate borrowings. Assuming no change in our balance sheet composition from year-end 2017, an additional 100 basis-point rise in LIBOR would translate into incremental earnings of approximately $0.17 per share.

As we move into January, we continue to opportunistically access long-dated cost-effective forms of fixed rate term debt by issuing $600 million of 7-year high grade notes at a coupon of 4.25%. On the heels of that issuance, we repaid $270 million for our higher cost 4 3/4% convertible notes at their maturity. So as of today, we have only 1 remaining term debt issuance of $750 million maturing later this year, which is effectively resolved with the availability that we currently have under our revolving credit facilities.

Lastly, regarding our stock repurchase program. We extended the existing $300 million program through February 28, 2019.

And now, I would like to turn the call over to Mitch Goldstein, to review our recent investment activity in the portfolio.

Thanks, Penni. Let me spend a few minutes reviewing the fourth quarter and full year investment activity and portfolio performance. I will then provide an update on a few recent initiatives at ARCC. For 2017, we used our size, market coverage and extensive relationships to continue investing in our markets. For the year, we closed on $5.9 billion of investment commitments to high quality companies, with 63% of these commitments to incumbent borrowers. Our position of incumbency, we believe, is an important factor in being able to support the growth of our best credits, which in turn result in enhanced portfolio performance. Additionally, we continue to be selective, as our new volume represents a fraction of more than $200 billion in estimated deal volume we reviewed during the year 2017.

During the fourth quarter, we made 40 new commitments totaling $1.5 billion of gross fundings, and 70% of our commitments were made in the form of first lien loans. We saw a wide opportunity set this quarter with new investments being made in companies with EBITDA ranging from $20 million to approximately $250 million, and weighted average of $65 million for the quarter.

During 2017, we also nearly doubled our portfolio weighting towards first lien loans, now accounting for 44% of the total. Some of this came as a result of the unwind of the SSLP and our purchase of those assets from the joint venture. However, even with the increased weighting in first lien assets, we were able to increase our performance yield for the year.

Let me highlight a recent transaction to give some context on how we use our scale and incumbency advantages to source attractive new investments.

In the fourth quarter, we were the sole head arranger in book runner for our first lien loan to support Veritas Capital's acquisition of BeyondTrust Software. Veritas is a repeat sponsor client of ours. BeyondTrust offers account management software solutions to reduce IP risk and simplify reporting. Prior to this transaction, we held a $32 million senior loan commitment that we acquired through our acquisition of American Capital.

Given our ability to commit to the full transaction, we were able to present a compelling financing solution to support the company. We believe our knowledge of the credit and deep experience with the sponsor allowed us to capitalize our incumbent position acquired from American Capital and position ourselves to move into a more profitable lead financing role. Now let me shift to the portfolio performance.

As of December 31, our portfolio of companies continued to generate solid growth in their aggregate earnings. The weighted average EBITDA of our corporate portfolio of companies was $62 million and the leverage levels, interest coverage levels remained stable for both the quarter and the year at 5.4x and 2.3x, respectively. The weighted average EBITDA of our corporate portfolio of companies over the last 12 months increased approximately 6%. This is better than the growth we reported at the end of 2016 of 4%.

We also saw a net reduction in the number of companies on nonaccrual. During fourth quarter, we had 3 positions come off nonaccrual compared to 2 new nonaccrual investments. At the end of the fourth quarter, nonaccruals as a percent of the total portfolio at cost decreased to 3.1% as compared to the third quarter at 3.4%. When looking up nonaccruals at fair value, they increased slightly from 0.9% in Q3 2017 to 1.4% in Q4 2017. Despite this modest increase, we feel the portfolio was well positioned, and we have significant capabilities to manage any nonperforming investments.

Shifting to our investment activity since the year-end through February 8, we have made new investment commitments totaling $938 million, which includes an interesting transaction that just closed.

Recently, Ares was shown an opportunity to purchase $1 billion-plus portfolio of senior secured loans from Pacific Western Bank Corp, as the bank decided to exit middle-market lending. This is a real time example of the shift that has been occurring in the middle-market lending for the past 20-plus years, where non-bank lenders, such as Ares, are providing the capital for companies that banks used to provide. Because of our scale and leadership position in the sector, Ares was approached to evaluate this portfolio composed of senior loans to more than 60 companies backed by private equity sponsors. Given the breadth of our market coverage, we had seen many of these companies and had relationships with over 75% of the sponsors represented in the portfolio. Therefore, we were able to underwrite the portfolio efficiently using our informational advantages.

Due to the senior orientation and lower yield of this portfolio, Ivy Hill emerged as the more appropriate buyer of these term loan assets. The $1.2 billion of assets acquired by Ivy Hill, or funds managed by Ivy Hill will expand our incumbent position and increase Ivy Hill's assets under management from $4.1 billion at December 31, 2017 to over $5 billion. ARCC supported Ivy Hill's acquisition with an incremental investment that provided a portion of the capital they needed to close this transaction. We expect that Ivy Hill's earnings will grow as a result of this acquisition, which should translate into additional income to ARCC's from Ivy Hill. As this transaction has just closed, we will report in more detail on this in our Q1 earnings call.

In addition to this new investment activity at ARCC, we also exited $871 million, realizing approximately $3 million in net realized gains through February 8. As of this date, our total backlog and pipeline stood at roughly $505 million and $204 million, respectively. And as always, we are not certain that any of these transactions will close.

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

Thanks, Mitch. Before we take your questions, I'd like to provide just a few concluding remarks. We're very proud of the company's accomplishments in 2017. At the beginning of the year, we were just closing the American Capital transaction, and we'd laid out a formidable plan for the year that we felt would drive value for shareholders. We're happy to report that we've delivered on nearly all of our goals for the year.

Now with this transition year behind us, we feel that we've built a strong foundation for 2018 and beyond. During 2017, we are able to improve our overall portfolio yield and drive core earnings improvement based on multiple portfolio initiatives. We believe that this momentum at ARCC has real legs, and we see several opportunities to drive continued earnings growth at the company. But perhaps most importantly, the company has a highly diversified portfolio today that's performing well and a strong balance sheet that's well-capitalized, modestly leveraged, liquid and set up to benefit from rising interest rates. We're optimistic for 2018, and we think the company is very well-positioned.

I want to close by thanking our entire team for a great year. We also appreciate the support all of the many others who have helped us along the way in the last 12 months.

Operator, if you open the lines for questions?

(Operator Instructions) Our first question today comes from Ryan Lynch from KBW.

First one, just comes from -- as I was looking through the quarter-to-date investment activity for the first quarter 2018, I noticed some unusual activity as far as about 21% of the $1 billion, roughly, that you guys deployed in the first quarter, were in a non-yielding, other equity investments. And so, can you just provide some more color with that 1 large investment that you made, with that several smaller investments you made -- and just what was the driver of the above average exposure to the equity investments in the first quarter?

Sure. Hey thanks, Ryan. Yes, that relates exclusively to this investment that we're making in Ivy Hill -- related to the portfolio purchase that we discussed in the prepared remarks, so. It doesn't have a stated coupon and obviously, as we're kind of in the midst of closing and structuring the transaction and its financing, we'd expect, obviously, with that additional investment in Ivy Hill, will come additional dividend income. But it doesn't have stated yield, so to speak, if that makes sense.

Yes, yes, that makes sense. Okay, and then, when I look at your originations in the fourth quarter, American Academy Holdings, pretty sizeable investment, about $275 million. When I look at the description, it's a provider of education and trading to some healthcare professionals. In the past, you guys have done some other for-profit education investments. You guys mentioned InfiLaw this quarter having, a decent realized loss in the past. Could you just talk about what you guys are seeing in this kind of for-profit education investment versus some of the ones in the past and what you guys really like about this investment?

So AAPC is not a for-profit education deal, so if it was misleading, we apologize. It's a company that we've been invested in on and off now for about 10 years, primarily actually in the healthcare information technology and coding space, so. I think we disliked the for-profit education space as much as we have in prior quarters, to answer that directly. So we're staying away from for-profit education, and AAPC shouldn't fall into that category.

Okay, thanks for clearing that up. And then in your prepared remarks, you guys mentioned extending the stock repurchase program. Certainly, we feel your guys' stock is at a very discounted price at these levels. I know you guys have been in a black-out due to earnings. Can you guys just talk about your thoughts of a potential for repurchasing stock, given the current recent downturn in your guys' price?

Yes. So certainly, we think it's incredibly important to have an active buyback program in place at all times. And we just refreshed it, and it's kind of constantly being evaluated. I would tell you that with the stock in the high $15s and book value at $16.65, I can't make the math super, super compelling around major buybacks, but it's a tool -- it's meant to be there to be used. And to the extent we see opportunities, we'll use it.

Okay. And then just one last one, if I can. With the -- you guys had pretty good SDLP growth this quarter. Would any of that growth in the current quarter, funded by putting in legacy SSLP investments that you guys put on your balance sheet, or were those all brand-new originations that funded the SDLP growth this quarter?

No. We're actually out looking around. I think that -- I was asking Mike, there's just one new deal, actually this quarter. And I can't recall if it's a legacy SSLP position or not. I mean, the way that just is a reminder we had thought about it is that the existing, the old SSLP assets are kind of not SSLP assets anymore, right? We're the sole lender generally to these companies, and they're -- as likely are willing to refinance, we hope with us, as any other portfolio company that we're invested in today. So they're not any more ripe than anything else, is I guess -- as we think about it. But we're scratching our heads here to remember. I think the answer is no.

Our next question is from Jonathan Bock from Wells Fargo.

Kipp, first, just talking about the overall market environment. I'd like to dig into varsity brands. I understand that this was an attractive investment for you that you've grown with overtime. However, can you talk about the comfort you have in allowing a sponsor to take $300 million in a divi off the table, while you enter into a subordinated position in the credit, albeit at a second term -- second lien term loan for a longer tenure at a fairly tight spread?

Sure. We like the company. We can invest in the company for a long time. We've got a lot of confidence in the sponsor. To be clear, it's a second lien investment, not a subordinated debt investment. And I don't think we'd be the first person who've done a dividend recap in the last 2 or 3 years, so.

To the right question then, then that gets to just overall risk in the system, because there is no doubt based on your performance that folks can have a high degree of trust in the underwriting process. But how do you discern in an environment that -- by all intents and purposes is frothy, whether or not you want to deploy additional capital into name, as the sponsor takes off, money off the table. More importantly, how do you have additional comfort that in the event that the credit does run into problems, the sponsor will be there to support that investment if money is already off the table?

Look, we've got, I think, a pretty -- I hope well respected, but certainly experienced investment team here, that obviously gets paid to make those decisions 365 days a year. So again, this is just a -- this is a very large company that we like. I'm not quite sure how to answer that question, Jonathan, other than to say we think we know what we're doing, and we hope people will agree with us, so.

We would, as well. So the next part relates to the -- I think you closed a $3.4 billion second lien fund. And certainly it was very oversubscribed, a with significant amount of new investors that have come to the Ares management platform. And so the overall question is, I would imagine that a portion of that second lien went into that second lien fund as well as BDC, I think, or maybe it didn't. But can you talk about the ability to feed 2 rather sizable beasts with second lien paper, right, in order to actually make sure that, kind of you're quitting the pipeline to be relevant to your sponsors, but only feeding a rather large fund that probably requires that mid-year yields. The same that also shows we can fund themselves in the BDC.

That's why we have so many people. But in all seriousness, look, just be clear. right, I think that the fund you're referring to is obviously a private fund that has nothing to do with ARCC. But to your point, it can freely coinvestment with ARCC, so. I would make the argument that ARCC actually sees the benefit of co-investing with that fund because we have the ability to write larger checks and have more of an impact with companies with borrowers, with the sponsors. And I do think and there are some real-life examples, that certainly we'd talk about off-line, if some folks were interested, in transactions that we, I think, would not have competed as well for, had we not had the funds. So we're thrilled to have it. It's definitely focused on larger companies, it emphasize -- I'm thrilled that you're asking the question, Jonathan, because I remember a couple of years ago, when you said you guys are crazy to be making all of these large companies second lien loans. And so far, it's actually been a -- it's been a pretty good business for us, and we've kind of doubled down behind what we think is a market opportunity, so. In terms of feeding it, I mean, look, we've got an amazing origination engine here, right? We've been doing this for 20 years. We have been investing behind the team. We have north of 100 people focused just on this business, away from what else the Ares management platform allows us to bring to bear. As a reminder, big loan business, big high-yield business, et cetera, that helps us drive deal flow for all of this. So I can't tell you that it wasn't hard work last year for the team. I know it was, originating enough new deals to deploy capital, both in public and private funds, but we did it and I think we're confident we'll be able to continue to do it in the future.

Yes, I appreciate that, and particularly also about the second link comment. So the next question relates to utilization of the 30% bucket. And excellent momentum with expansion of the Varagon program, that's fantastic. And then I know over the past, we've discussed that Ares has a number of capabilities, whether it's asset-backed finance or distressed ABL. I mean, to take your pick, you're an extremely large credit operator, and one could design several funds to fit in that bad asset bucket that could be managed by your institution. And here's the broader question. If you were to take, let's say an asset-backed lending business that's earning great returns, you could clearly raise capital for that and generate more money for Ares leaving it outside of the BDC. So can you talk about the push-pull of managing something, or pull of capital outside of the BDC or effectively passing on 80% of those returns to shareholders, with the management co only taking 20%, if we were to build the business inside the BDC, utilizing the bad asset bucket?

Yes. I mean -- look, generally, what's good for ARCC is good for Ares. The counterpoint's also true -- I can't say that we go into business building discussions trying to figure out how we're going to enrich ourselves. We frankly go in trying to figure out how we're going to do right by our shareholders and by the public companies that we run and obviously have a fiduciary duty to run for their shareholders, so. That's a pretty complicated question and obviously, we'd to go through that offline -- name by name or business by business type of examples. But look, your point's taken, Jonathan. I think there are certain things that we've chosen not to do, I'll say at ARCC, for instance, investing in third-party CLO equity because, we do that here elsewhere at Ares, and we charge at lower fees, frankly, to do that. I know there's another BDC in the space who's taken the same position. We want to make sure that we're aligned with our shareholders and with our external investors. So it's a complicated question that doesn't really have a one-size-fits-all answer, but hopefully some of those thoughts are useful.

Yes, and then I noticed that there was actually a write up to Ivy Hill, I mean -- again, congrats on the transaction that Mitch mentioned, that's certainly more momentum and a game-changer for Kevin and his business. The question though is, was that $18 million write-up at the end of the fourth quarter based on the forthcoming deal that Mitch mentioned? Or was there something else in the works that was effectively leading to that write-up? So that's 1 separate question. And the last one is, how does risk retention change the prospects for Ivy Hill, given the recent ruling?

Sure, sure. So the write-up in Q4 at Ivy Hill actually had nothing to do with the PacWest transaction. It simply came from improved profitability at Ivy Hill, that was largely the benefit of their ability to reset liabilities in a whole host of their funds. There was also some additional pickup in carry around some of the kind of legacy activities in American Capital asset management, so nothing to do with prospective Q1 events.

Got it, got it. And then risk retention, and that was it?

Yes, I mean, look -- the good news about Ivy Hill is that we've -- risk retention hasn't really been an issue because ARCC has been such a significant investor and supporter of kind of their vehicles. So they haven't had issues raising capital. Risk retention on the CLO side, I think will obviously make it easier for the small CLO manager to continue to survive, obviously with not us much capital required to support the business. But I don't think we feel there's any meaningful impact on Ivy Hill today, Jonathan.

(Operator Instructions) Our next question today comes from Rick Shane from JP Morgan.

I just want to talk a little bit about the funding strategy. You have $1 billion of maturities, fixed rate liabilities of this year. You essentially replaced that in 2017 with the offerings you did. The interesting thing to me was the swap that you entered into in the fourth quarter. I'm curious going forward, if one of the ways to efficiently lock the balance sheet will be to start using swaps more aggressively.

Yes. Thanks, Rick. Really this, I think is more of an isolated incident in the context of -- if we think about our fixed term liabilities, we generally go out to the market and issue term debt. That's the best way to really manage against rising rates vis-à-vis borrowing on our line of credit. So if you look at our historical activities, we'll draw up on the line of credits, we use that for liquidity purposes, to funding the ins and outs in the portfolio, and when we have a reasonable size of outstanding borrowings, we look at that as an opportunity to go to the market at the best time to term those out. In the context of what we locked in, the $395 million of term debt, that is part and parcel of our revolving line of credit. So when we went out and upsized the JP Morgan credit facility back in January, in connection with the ACAS transaction, one of the ways we had the opportunity to upsize was to put a term debt component into that revolver. So given that we were borrowing at LIBOR plus 1.75% on a floating rate basis on that term financing. We felt like it was better to flip that into fixed. So that was something that's just a little different in the capital structure than what you've seen in the past. So I don't know that today, because of where we are on the revolver, that we need to do other interest rate swap activity on the liability management side, because it's probably more efficient and straightforward to kind of lock in rates by doing opportunistic bond issuances, just like we did in January for the 7-year notes. But it is something we'll continue to watch.

Yes. It is interesting, because when you adjust for term, it's not like the swaps looks really that much more efficient than some of the other instruments.

Right. Here it does -- if you look at it, we basically locked in a 3-year liability around 3.80% versus doing a 5-year issuance that we've just done around 3.5%. But rates have gone up a good bit since then. And so therefore, locking in at 3.80 seems fairly reasonable today against what we would issue to term that out. So it's something we'll continue to look at, but agree the better way in the way we've traditionally looked at that is more by just issuing term durations more in the 5-year to 7-year range.

Got it. And then, just 1 quick follow up. Kipp had mentioned a 6% yield on the noncore ACAS portfolio. Given the big discrepancy between cost and fair value on this portfolio, was that 6% on cost or fair value?

At fair value.

At fair value.

Our next motion comes from John Hecht from Jefferies.

First one, Penni, you attributed a lot of the increase in the effective yield in the portfolio over the last couple of quarters to benchmark rates. I'm wondering, can you attribute anything to -- of that rate move to optimization of the ACAS portfolio? And then maybe can you discuss new loan yields as well, and what trends you are seeing there?

Yes. We're just -- if you just look at Q4 in isolation, most of that was coming from a raise in LIBOR versus the ACAS optimization. But we do expect we could still have some continued upside in yield on the ACAS optimization, given we still have about $900 million of lower yielding assets that we could rotate out of, that we've targeted during 2018.

Yes. I think, John, in terms of -- thanks for the question -- in terms of overall yields again, just to reinforce a continuing theme, particularly with LIBOR going up, we really haven't seen the yields come in for quite a bunch of quarters. The battle now is spread plateauing and spread compression versus rises in LIBOR and I think how people think about absolute return on assets. But in terms of what we originated in Q4, again it's very much in line, kind of that 8% to 10%-ish type numbers that we've seen for -- we talked about this last quarter, 7 or 8 quarters now in a row, it's been pretty consistent in terms of what we originated and what we see in backlog and pipeline.

Okay, that's helpful. And then second question's related to taxes. First, so this is a broader question, with 2 sub-questions -- one is, is the tax sector accrual you have tied to just excise income and the spillovers or anything else, we should think about that, the small tax accrual you guys have had for the last few quarters? And second, could you just broadly speak about how -- your perspective on how tax reform affects your borrowers?

Yes. Maybe I'll take the -- just the tax accrual and then Kipp can take the borrower question. But generally speaking, most of our tax expense relates to excise taxes. So we do continue to accrue, based on what we think we're going to spill over, which at the end of the year was about $0.81 a share. We do have some smaller corporate income taxes for coming through from blocker corps that we own, but for the most part, our tax expense is excise tax-related.

Yes, and John, in terms of the borrowers and the overall conclusion is I'd say, it's very early in understanding some of the elements here -- and we continue to kind of be dug in on the portfolio management side, thinking through it. I think the earlier returns from that analysis say that it should have a modest positive impact on our portfolio as a whole. Despite less deductibility of interest, we think that there is a net positive offset from lower corporate tax rates. But again, that's just a pretty wide generalization in terms of early work. I think it's early, and we're still very much in the middle of doing the work on that.

Our next question comes from Doug Mewhirter from SunTrust.

A question on the, I guess the competitive environment. I guess there's this -- a lot of tension out there between the money coming into the, I guess the, for lack of a better term, from the credit oriented side of the market, and then as some people have said, many trillions of dry powder in private equity. And I was wondering, what -- do you think that, that dry powder, that huge pile of dry powder on the private equity side is beneficial to your business, because it drives more deal flow? Or will it be a net negative to your business because they'll be chasing the marginally, I guess, worse deal to get that money deployed?

I mean, I think, broadly -- look, we have a fantastic track record and long history of financing private equity transactions, have great relationships, I think, as good as anyone in that space. The simple answer that I'd have for you is that the -- on invested capital private capital, and its desire to do deals is a great tailwind for us, a great impetus for us to see lots of activity and see lots of deal flow. I guess, the potential negative that you're concerned on is, is does it compress returns. In private equity, I guess it may, but to be honest, it's not a huge concern for us. The activity levels and the amount of deal flow, the amount of companies that we continue to see owned by private equity in the U.S. increases. And just as a reminder, we're typically making loans that are 50% to 60% of a company's enterprise value in new deals, right? Where private equity is writing real, hard investor capital below us. And for us, it's just about picking the best companies and frankly, partnering with the best private equity firms. And then, we think we've got a long history of doing that.

Our next question comes from Derek Hewett from Bank of America Merrill Lynch.

Kipp, how long do you think it'll take to fully deploy the $1.4 billion of capital, which I think, if my math is correct, is just -- it's an incremental $900 million-or-so that was committed to the SDLP? And I'm assuming that there should be some acceleration versus Q4 levels, given the higher capacity at this point.

Yes, I mean, the bigger program gives us a little bit more diversity, right, in terms of check size. And I think the number is, in the last 12 months, we did $1.3 billion of new deals. And I think we'll stay in that trajectory, but there's probably some upside to that, with the additional capital and the ability to write larger checks.

Our next question comes from Robert Dodd from Raymond James.

Two real quick questions. First, what's the appetite for kind of keeping some of the lower-yield assets on balance sheet, like some of the SSLP assets you have on? Sure, the coupon's lower, but the structures were written by you guys, which are probably more robust than what's available kind of in the market at this point for a new origination. So what's the trade-off from sort of a risk-adjusted total return from rotating that portfolio, maybe given a high yield, but getting a weaker structure, versus keeping it, even if the coupon -- keeping those type of assets even if the coupons are a little lower today?

Yes, and thanks for your great question. Appreciate it. If you reread the earnings transcript, I hope you have other things to do. But if you chose to, we actually the inserted a word, modest, future yield enhancement --

I heard it.

That's around that portfolio. And that's there for a reason. I mean, we asked ourselves the same question as we were preparing that, which is, if you've got some seasoned credits that you really like, that are paying you 7.5%, that's not something that you're super, super upset about. So that's right on the balance, Robert. I mean, I would say, seasoned companies with large scale, that we've known a long time, paying at 7.5%, we're not all that unhappy with it. But obviously, when they choose to refinance based on the seasoning in this portfolio, most of them are long past (inaudible) protections. It's really their call, when they want to do something, and it's obviously our hope that when they do, our incumbency with those borrowers allows us to do it with them, right? So that's the key. But it's a good question.

And just one follow-up. Ivy Hill, obviously, the risk retention rules, well the rules per se didn't change on Friday, but a judgment came down. Should we expect them to be more -- not aggressive, but maybe more proactive, with more of these PacWest kind of deals, given the capital requirements have changed now?

You know what, I don't think so. As I mentioned, I think with Jonathan earlier, we've always been a very happy kind of supporter of an investor with Ivy Hill. We have a really great opportunity to think about increasing investments with Ivy Hill, which are higher ROE investments typically than we can achieve, making standalone loans or investments, right, because of the nature of that investment. But it's all conditioned, as I mentioned in the prepared remarks, on having that flexibility in the 30% basket, to make investments in that company. And for the first time in a long time, we have it, and when we see something opportunistic come along, like the PacWest transaction, we're actually able to execute on for the first time in a long time, which I think is pretty exciting, so. I do think there -- I hope there will be other opportunities to do things like that, and I bet there will be some opportunities to be things that are, a step away, or sort of look like that transaction, but perhaps are a touch different -- different assets or in different ways.

Our next question comes from Henry Coffey from Wedbush.

First, just a very technical item. How impactful are any LIBOR floors on the portfolio? And is there a trigger point where selling those floors are less relevant, and then you see a larger increase in yield as LIBOR goes higher?

Yes. So just as a recap, because it's a benefit for the company, obviously. The market LIBOR floor over the last, however many years, has been kind of at 1%. So 3 month LIBOR is well through that, so we are benefiting -- we did this quarter, we did this year. We expect to continue to be able to benefit into '18 with rises in short-term LIBOR, because again, more of our assets have floating rate LIBOR attached than our liabilities do, right? So we see an outsized benefit in earnings improvement from increases in LIBOR, and we're there now, Henry, so we're already in it.

And then, as you said, a look over your, look over the horizon, I know you'd made some comments about the market, certainly not worried about how you guys are positioned. We're seeing, while the stumbling seems to be going on in the small side. But when you look over the horizon, are there specific industries that represent a real problem or a challenge, and are there specific places where you'd like to put capital where you see richer opportunities?

For sure. We don't commit things with a top-down lensing. We want to go out and do 25% of our originations at year end, pick a sector, consumer. But what we do, do is, express industry views on frankly, an industry avoidance-type basis. So one of the great things about the direct lending business and about our BDC is that we don't have to run to a benchmark, right? We don't have to diversify by industry, so we can select ourselves out of industries that we think create more defaults than the median. Certainly, during 2016, you saw the oil and gas leverage finance base have a pretty tough go of it. We're underexposed to that sector. In 2017, the sectors -- and focus seems to be retail, where we're also meaningfully under-invested. So look, the key for us is picking good companies and avoiding the landmines, and I think we've done that, and we'll continue to emphasize focus on defensive industries -- companies that perform well in different market environments and withstand volatility or even a weaker economy.

(Operator Instructions) Our next question comes from Casey Alexander from Compass Point Research and Trading.

I'm curious, now that it seems as though dividend coverage is becoming less of an issue, although I understand that you're still doing the fee waiver for another 7 quarters or so, what's kind of the level of core earnings-per-share that you would feel comfortable starting to peel off and pay out some of the spillover? Because $0.81 a share in spillover income seems like a pretty large margin of safety.

Fair enough. We have that debate ourselves, as to what's the right number. What we've talked about, Casey, and thanks for the question, in the past is, we want to -- we're believers, and I said it explicitly, obviously in the prepared remarks -- we're believers that our core earnings should be at or above our dividend levels, right? And we haven't been there as many of you know, over the course of 2017. I think we've been pretty upfront about why that was, which was our need to resolve SSLP, because I think we would have been through the earnings issue you much, much earlier had we not chosen to go out and buy American Capital, which I don't think is something we would take back at this point, 12 months later. So to answer your question directly, we want to see the core earnings at or above the dividend level on a sustainable basis. And obviously, that's going to entail less forecasting things here for '18, that we probably aren't going quite to tell you until we decide to tell you. But our goal is obviously to have the core earnings at or above the dividend level. And when we have that, we can consider 1 of 2 things: we can consider special dividends, which can come from the spillover or from excess earnings; or continue -- or we can consider just raising the dividend based on the increased earnings power of the company. So, yes -- look, I mean, that -- the spillover to -- Mike's just making a point, which is a good one. The spillovers come because of the fact that we've meaningfully outearned our dividend for a long period of time, right? And that dividend's been outearned through core earnings and through net realized gains, as I mentioned in the prepared remarks, for 8 years, so. We're happy to be in that position, but we're also cautious because when we think about specials, and we think about dividend increases, they're not things you want to take back, so we want to make sure that we're well through it. But look, we have that conversation all the time, the $0.81 is a big number. We frankly continue to add to it virtually every quarter for the last 8 years. And our goal as we've mentioned is to provide more value in distributions to shareholders, not simply by building NAV, which is what we've been doing, so.

Real quick, the fixing of the term credit facility. I had a hard time hearing -- was that at $380 million or $318 million?

3-8-0.

Our next question comes from Chris York from JMP Securities.

Our next question comes from Christopher Testa from National Securities Corp.

I was just wondering if you could discuss kind of the difference between the average EBITDA and the leverage multiples that you're -- the loans you're putting in the SDLP, what's on -- compared to what's on the balance sheet, and how or if you project that changing any more now that you have a lot more investable capital at the SDLP.

No. I mean, there -- we don't differentiate SDLPs. I mean, SDLP is a product that we roll out obviously, with our partners at Varagon and AIG, and now a new partner. It's a product offering, so our customers, our clients tend to tell us what they'd like to do. So it certainly will offer folks 3-party deals, which is a senior, junior deal, or offer them a unitranche. Sometimes, it's SDLP, sometimes not, based on whether our partner wants to engage there, but the underwriting and the structuring is so different. I mean, it has probably the ability to do deals that range at the low end from a 4x "unitranche" all the way to maybe up to maybe 6x "unitranche". So that's probably the 2 edges of the fairway. But the underwriting and the structuring and the pricing is exactly what we would be doing on the ARCC direct basis.

Okay, got it. That's fair. And just, as you look at the pipeline, I know you guys had mentioned the 1 transaction where you were able to, basically, at the sourcing, it was an ACAS portfolio company. As you look at the pipeline, approximately, how much of that's coming from repeat business from existing ACAS portfolio companies?

Man, you're -- stump us on what might be the last question. I think we said for '17, Mitch said 50% of the portfolio, or sorry, 60% of the new investments we made this past year came the existing portfolio. We can poke around, I'm looking around the room -- I don't think we have that. Yes -- as Mitch has said, it's a handful, it's -- I don't know the actual number. But we can -- if it's important, follow-up with you for sure. But we view the acquired portfolio companies just as fondly as we view the companies that have been with us for 10 years, right, and we hope that the quality ones stick around, so.

And just curious, looking at the right-hand side of the balance sheet, I mean, obviously you guys put in the interest rate swaps. But as you go forward, are you looking to maybe, I guess, pare back on some of these unsecured fixed rate debt offerings, given you have over 90% of your debt portfolio at floating rates, or are you still going to be looking to continue to kind of just stagger the maturities as you've been doing?

I think it's really the latter. We'll look to stagger maturities. I mean, we are a $13 million balance sheet, and we need a lot of debt capital to build into the 0.7 to 1 leverage that we have today. Just -- you look at diversity of funding sources, we'll continue to access both the revolving markets as well as the term debt markets to build the amount of capital that we need to run the business.

(Operator Instructions) And once again, we have Chris York from JMP Securities.

It seems like fund raising and performance across the Ares platform continues to be robust. So Jonathan did ask the question on the benefits of coinvestment redemption to Ares on the junior capital fund and then the thought process and other specialty finance businesses. My question here is on the ABL. Do you expect some deals from the Ares commercial finance to find a home at Ares maybe potentially this year, because it continues or it appears that they are continuing to close some attractive deals?

Yes. Thanks, Chris. We hope so. It's one of the things that we're building at Ares and obviously, with the coinvestment, really you have the ability to freely invest with them. And it's a different business, right? I mean it's a different origination team than we're running. I mean, for the benefit of all of our cash flow-oriented lending vehicles, the ARCC included, it's the same team, same approach, it's same underwriting, same relationships that we're using to drive investment at the BDC or elsewhere. But for commercial finance here, it's obviously a very different capability set, and one that we'd would like to leverage, so. We actually had the team here yesterday, giving us a quick -- just rundown of their, to your point, great 2017 activity, and talking about ways that we could kind of work closely together and leverage their deal flow. So I guess I'd just say, I hope so.

And then my follow-up is on the Pac West portfolio. My understanding, it was heavy in healthcare and tech cash flow, which you have a strong specialization and then competitive advantages already in those sectors. But was there any reservation or hesitation in growing heavier there in the consolidated portfolio today?

Well, I think it was a good thing for us because to your point, we have a lot of capabilities. Underwriting those companies -- in fact, we knew a lot of them. When we saw the list of the portfolio being sold, it doesn't really skew the diversification of the company because it's such a diversified portfolio. And again, it's a diversified portfolio that's going to sit at Ivy Hill, right? So you kind of need to do the math a little bit differently, think to look through it, but, look safe to say, we paid a roughly par price for what we thought was a great portfolio that we could finance attractively at Ivy Hill, and that's obviously what we're working to do. But the industry concentration didn't give us any pause. It was actually, I think, an opportunity for us to get there quicker, maybe understand it better than others.

And ladies and gentlemen, this concludes our question-and-answer session. At this time, I'd like to turn the conference call back over to Mr. Kipp DeVeer for any closing remarks.

I don't think we have anything to add other than to say many thanks, and we'll catch you on next quarter's earnings call. Thanks.

Ladies and gentlemen, this concludes our conference call for today. If you missed any part of today's call, an archive replay of this conference call will be available approximately 1 hour after the end of the call, through February 27, 2018, at 5:00 p.m. Eastern Time. To domestic callers by dialing (877)344-7529. International callers by dialing 1 (412) 317-0088. For all replays, please reference conference number 10115525. An archive replay will also be available on the webcast link located on the homepage of the investor resources section of our website. Once again, we thank you for attending. You may now disconnect your lines.