Q1 2022 Ares Capital Corp Earnings Call
Good morning, welcome to the Ares Capital Corporation's first quarter ended March 31, 2022 earnings conference call. At this time all participants are in a listen only mode should you need assistance. Please signal like conference specialist by pressing Star then zero on your telephone keypad.
As a reminder, this conference is being recorded on Tuesday April 26, 2022, I will now turn the call over to Mr. Johnston Omar managing director of Investor Relations.
Great. Thank you, let me start with some important reminders comments made during the course of this conference call and webcast and accompanying documents contain forward looking statements and are subject to risks and uncertainties.
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 documents 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 certain non-GAAP measures as defined by SEC regulation G. Such as the core earnings per share or core EPS.
Company believes that core EPS provides useful information to investors regarding financial performance because it is one method. The company uses to measure its financial condition and results of operations.
A reconciliation of core EPS to GAAP net income the most directly comparable GAAP financial measure can be found in the accompanying slide presentation for this call. In addition reconciliation of these measures may also be found in our earnings release filed this morning with the SEC on form 8-K.
All per share information discussed during this call is basic per share information.
The company's Form 10-Q filed with the SEC This morning for more information.
Certain information discussed on this call.
And the accompanying slide presentation, including information relating 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 of this information.
The company's first quarter ended March 31, 2022 earnings presentation can be found on the company's website at Www Dot Ares capital Corp, Dot com by clicking on the first quarter 2022 earnings presentation link on the homepage of the Investor Resources section.
Ares Capital Corporation earnings release, and Thank you are also available on the company's website.
Now I'll turn the call over to Mr. Kip to Vir Ares Capital Corporation's Chief Executive Officer.
Thanks, John Hello, everyone, I hope, you're all doing well and we appreciate you joining the call I'm here in New York with our co President Mitch Goldstein and Michael Smith.
Chief Financial Officer, Penni roll and several other members of the management team.
I'd like to start by highlighting our first quarter results and then provide some thoughts on the market and our position today.
This morning, we reported first quarter core earnings of 42 cents per share.
We also generated net realized gains on our investments, adding 14 cents per share.
Our net realized gains on investments now total over $175 million since year end 2019, and approximately $1 $1 billion since our inception.
Our net asset value per share reached another record and its up 9% over the past 12 months.
Credit metrics in the portfolio are strong and overall the portfolio continues to perform well.
Our non accruals at cost or well below our 10 year long term average and we reported strong underlying portfolio company EBITDA growth.
Furthermore, the weighted average loan to value on the aggregate portfolio remains historically low at 44%, which reflects significant structural support for our loan portfolio.
After a very strong finish to 2021 market transaction activity was slower to start the year as we expected and as market volatility stemming from geopolitical events and a more aggressive calling from the federal reserve is creating uncertainty for us and many other investors.
2022 outlook for macroeconomic growth has been tempered by inflation.
Increase in short term rates and a more challenging outlook for global growth in part caused by the war in Ukraine.
As one would expect the liquid markets are bearing the brunt of the volatility with wider credit spreads and uneven trading.
However, as is often the case in the direct lending market volatility is not as apparent and changes in pricing and terms are slow to materialize.
This lagging a response in the private markets relative to liquid markets is not unusual we've seen many of these market transitions over our history and the private markets, often take a bit longer to reset to new economic and market conditions.
During these times, our playbook is to become incrementally more selective build additional liquidity and the opportunistic by leveraging our competitive advantages and vast sourcing capabilities.
The Aries platform as one of our most significant competitive advantages we have the largest direct lending team in the business with 150 investment professionals in the U S. Coupled with another 640 investment professionals in adjacent businesses at Ares.
We believe this provides distinct advantages to source investments in middle market companies.
Our ability to generate significant deal flow, which we estimate is running at roughly $550 billion annually continues to allow us to be highly selective and to pass on transactions when pricing or terms don't meet our standards, which is increasingly frequent in today's environment.
We also benefit from the large size of the long tenure of our existing portfolio of nearly 400 incumbent portfolio of companies, who may seek additional growth capital over time.
We believe that our ability to finance and grow with our winters enables us to reduce portfolio risk and often obtain better than market terms.
In line with this this past quarter over two thirds of our commitments were to incumbent borrowers.
Beyond these sourcing advantages we believe our large team in the Ares management platform provides a unique vantage point for doing research and conducting due diligence.
Ares has over 1600 investments in our private credit strategies and more than 900 corporate credit investments across 60 industries within our liquid credit strategies.
In our view the perspectives and insights we gain as a result provide a significant advantage in informing our credit and pricing decisions, especially in assessing relative value for illiquid credit.
Changing gears a bit these advantages have also allowed us to drive value through portfolio acquisitions consistent consistently throughout the Companys history.
As Mitch will discuss in more detail earlier this week Ares management announced the acquisition of an only capital U S middle market direct lending portfolio, which followed an OE strategic review.
Business.
We believe Aries is track record in making acquisitions continue to produce attractive and differentiated opportunities for our investors and we're excited about this transaction.
Looking forward, we feel very good about our positioning and the fundamental long term drivers of growth in our market.
North American private equity dry powder, which we believe is a key indicator of future M&A activity sits it.
Sits at near record levels and the larger companies are seeing the value in seeking private capital solutions.
In addition, we expect the continued volatility in the liquid capital markets will lead to increased demand from issuers for private credit solutions as we can deliver more certainty in these uncertain times.
These factors. These factors are widening the fairway for us, particularly as we as our scale and flexibility allow us to be meaningful partners to a wide variety of borrowers.
The last point I'll leave you with is that we don't believe a tightening monetary cycle will have negative effects on us.
Our largely floating rate loan portfolio is financed by mostly fixed rate unsecured sources of financing and our assets are largely floating rate investments.
We believe this positions us well to have.
Our net interest earnings benefit from rising rates.
As of quarter end, holding all else equal.
And after considering the impact of income based fees, we calculated that a 100 basis point increase in short term rates could increase our annual earnings by approximately <unk> 23 per share a 14% increase above it this quarter as core EPS run rate.
A 200 basis point increase in short term rates could increase our total annual earnings by approximately 44 per share a 26% increase above this quarter's core EPS run rate.
We also do not expect that a projected increase in rates will result in deteriorating credit performance, particularly given our strong starting point with portfolio weighted average interest coverage of nearly three times.
What this means is they're holding all else equal, including the leverage at the borrower level short term base rates would need to rise above 3% before aggregate interest coverage would dip below two times, which is similar to the five year pre pandemic weighted average of two three times.
Importantly, this analysis doesn't consider EBITDA growth or deleveraging that often occurs in our portfolio.
We feel good about the ability of our portfolio companies to navigate a higher rate environment and believe these dynamics will further differentiate ares capital versus many of the other income oriented alternatives in the market today.
So with that I will turn the call over to penni to provide some more details on first quarter results and other thoughts on our balance sheet positioning.
Thanks, Kip good morning, everyone.
Our core earnings per share of 42 cents for the first quarter of 2022 were in line with the 43 cents from the same period, a year ago, but lower than our record fourth quarter 2021 core earnings of 58 per share.
Our first quarter core earnings reflect the often typical slower first quarter of origination activity much like we saw in the first quarter of 2021.
The first quarter of 2022 earnings were driven by strong recurring interest and dividend income and a solid level of capital structuring service fees from new origination and capital markets activities.
Our GAAP earnings per share for the first quarter of 2022 were 44 cents, which compares to 87 for the first quarter of 2021 and 83 cents for the prior quarter.
Our GAAP earnings per share for the first quarter of 2022 included net realized and unrealized gains on investments of 13 cents offset by a realized loss of 10 cents related to the repayment of our 2022 convertible notes, which were in the money as a result of the significant stock price.
Depreciation and our dividend increases over the five years since the notes were issued.
The net realized and unrealized gains on our investments this quarter reflect the overall healthy performance of the underlying portfolio as a whole.
As of March 31, 2020 to our stockholders equity grew to $9 $4 billion, resulting in yet another record net asset value per share of $19.03 as compared to $18 96 at December 31 2021.
And $17 45 at March 31st 2021.
Our NAV per share for the first quarter represents 8.4% increase from a quarter ago, and a 9% increase from a year ago.
Our total portfolio at fair value at the end of the first quarter was $19 $5 billion and we had total assets of $20 5 billion.
As of March 31, 2022, the weighted average yield on our debt and other income producing securities at amortized cost was eight 9% and the weighted average yield on total investments at amortized cost was eight 1%.
Each increasing approximately 20 basis points from last quarter supported by market interest rate levels as base rates rise.
As it relates to our future interest rate sensitivity as Kipp mentioned, we remain well positioned to benefit from a rising rate environment and are now past the interest rate floors for certain of our investments.
As of March 31, 2022 .
74% of our total portfolio at fair value was in floating rate investments. Additionally, excluding our investment in the SDLP certificates, 93% of the remaining floating rate investments had an average interest rate floor of approximately 90 basis points.
As Kim mentioned earlier, we would expect increases in short term rates, especially as these rates exceed the floors you have a meaningful positive impact on the future net interest earnings performance of the company.
We have provided details on this in this quarters Form 10-Q for those who want to further examine our sensitivity to rate movements.
Shifting to our capitalization and liquidity, we remained very active during the quarter raising additional capital and extending debt maturities in order to maintain strong liquidity for our growing investment portfolio.
During the quarter, we grew our committed debt capital by more than $650 million. In January we took advantage of what may have been the interest rate low point for the unsecured notes market for bdcs by issuing $500 million of two and seven eighths percent unsecured notes maturing in July 2020.
Seven one.
While not our lowest coupon issuance in our history. It did represent the lowest spread at new issuance for us or any other BDC.
We are very pleased with the success that we've had since the beginning of 2021 to lock in low fixed borrowing rates, which we expect will benefit our aggregate cost of capital and our earnings as we move into a higher rate environment.
In addition, we extended our corporate revolving credit facility by approximately one year to bring it back to a full five years and upsized it by over $550 million, bringing the total facility size to $4 8 billion.
As part of the amendment to the credit facility consistent with other bank led deals closing in 2022 and going forward, we updated certain base currency reference rates, which included replacing the LIBOR rate with terms, so for plus an applicable credit spread adjustment.
Pricing in advance rates or otherwise unchanged on this facility.
Alongside raising additional debt, we also repaid our $388 million of convertible notes at their maturity in February resulting in a realized loss as stated before.
Following the repayment of these convertible notes, we only have one term debt maturity in the next two years, which occurs in 2023.
Providing us significant flexibility when it comes to our debt capital structure.
To support the continued long term growth of our investment portfolio. We also accretively raised incremental equity capital during the first quarter through a secondary issuance early in the quarter as well as through our ATM program.
After considering our investment in capital activities during the quarter. We ended the first quarter with nearly $5.9 billion of total available liquidity, including available cash of $690 million and a debt to equity ratio net of the available cash of one point O six times.
From one point to one times at the end of the fourth quarter.
While our leverage ratios will vary over time, depending on activity levels. We will continue to work to operate within our stated target leverage range appoint nine times to 1.25 times.
Overall with ample amounts of dry powder, we believe our capital and liquidity remains one of our most significant competitive advantages and positions us well to remain active yet patient investors.
Before I conclude I want to discuss our undistributed taxable income and our dividends.
We currently estimate that our spillover income from 2021 into 2022 .
Will be approximately $651 million or a dollar in 32 cents per share.
We believe having a strong and meaningful undistributed spillover supports our goal of maintaining a steady dividend throughout market cycles and sets us apart from many other bdcs, but do not have this level of spillover.
This morning, we announced that we declared a regular second quarter dividend of 42 cents per share the second straight quarter at our new regular dividend rate and our 52nd consecutive quarter of unchanged our growing dividends.
This second quarter regular dividend is enhanced by the three cents per share additional second quarter dividend that we previously declared in February .
Our payable on June 30, 2022 to stockholders of record on June 15th 2022.
I will now turn the call over to Mitch to walk through our investment activities for the quarter.
Thanks, Patrick.
I would like to spend a few minutes, providing more detail on our investments and portfolio performance for the first quarter of 2022.
I will then provide an update on post quarter end activity and.
And our backlog and pipeline.
During the first quarter, our team originated $2 billion of new investment commitments, a 14% increase from the first quarter of 2021.
Our commitments during the quarter were to a diverse set of high quality companies across more than 20 distinct industries.
The EBITDA of these companies' range from $13 million to over $1 billion underscoring the breath of our opportunity set and our ability to be a solutions provider to a wide array of companies.
We continue to be very selective in finding its less than 5% of the new deals where we view.
We believe that our selectivity and focus on high free cash flow businesses with market leadership positions. Ultimately result in a differentiated and attractively positioned portfolio.
It is important to note that arcc's portfolio does not have any direct exposure to companies domiciled in Russia or the Ukraine.
While we are keeping a watchful eye on inflation and supply chain issues. Our portfolio companies are continuing to experience strong overall fundamentals, which is reflected in the 20% weighted average EBITDA growth of our portfolio companies over the last reported 12 month period.
In our company's history.
Importantly, this performance was broad based all of our top 15 industry concentrations showed a healthy level of positive EBITDA growth.
This growth supported an increase in the weighted average EBITDA of our portfolio from 162 million last quarter to $173 million this quarter.
It is important to note that while our portfolio has a definitive upmarket focus based on dollars invested examining the portfolio by number of credits shows that most of our portfolio companies remain in our core middle market by.
By number of companies approximately two thirds of our portfolio companies have less than $100 million.
EBITDA.
We believe our track record and ability to finance the business as it grows continues to be a key differentiating advantage in today's competitive market.
This quarter, our weighted average portfolio great at fair value of $3, one remained unchanged from last quarter.
Our non accrual rate at cost of one 2% increased slightly from 8% at Q4 'twenty one.
As Kipp mentioned, our non accruals at cost continue to be meaningfully below our 10 year average of two 5%.
Before finishing up with some comments on our backlog and pipeline I want to discuss the exciting portfolio acquisition that Kipp mentioned earlier.
Last night, Ares management announced the acquisition of the direct lending portfolio of analytic capital management, which decided to exit its direct lending strategy.
The overall $2 4 billion dollar portfolio was comprised of U S senior secured loans to over 40 companies backed by numerous private equity sponsors.
Given the breadth of market coverage out areas. It wasn't familiarity with a significant percentage of the investments either through overlapping portfolio companies or three historical review of these companies.
These advantages and the scale of the Ares platform allowed for a diligent underwriting each loan in the portfolio to create what we believe is a highly informed and granular view of value.
In terms of specific impacts to ARCC approximately half of this $2 $4 billion portfolio will be funded by both ARCC and Ivy Hill with a significant portion of the loans being purchased by Ivy Hill, given the senior orientation of this portfolio.
We believe one benefit of this transaction is to further support the growth of Ivy Hill we.
We expect the revenue growth from these investments may ultimately support additional dividends from Ivy Hill to ARCC. After the transaction closes which is expected to be at the end of the second quarter.
As a reminder, Ivy Hill as a wholly owned portfolio company of ARCC that was started in 2007 to invest in and manage middle market senior secured loans restructured investment vehicles and separately managed accounts.
The business is highly diversified across more than 290 distinct borrowers.
And is enjoying continued success given its market position and track record.
We believe Ivy Hill success and profitability is also reflected in its $43 million first quarter dividend to ARCC.
$15 million increase from last quarter and up.
48th consecutive quarter of Ivy Hill, paying a stable or increasing quarterly dividend pay Ares capital.
Now, we'd like to shift to our post quarter end investment activity and pipeline.
From April 1st through April 22022, we made new investment commitments totaling $106 million of which $57 million were funded.
We exited or were repaid on $94 million of investment commitments, including $77 million in loans sold to vehicles managed by Ivy Hill generating approximately $1 billion of net realized losses on exits.
As of April 20th our backlog and pipeline stood at roughly $2 3 billion and $110 million, respectively, including investments expected to be made by ARCC as part of the portfolio acquisition that I mentioned.
Our backlog and pipeline contained investments that are subject to approvals and documentations and may not close or we may sell a portion of these investments post closing.
I'll now turn the call back over to Kip for some closing remarks.
Thanks Mitch.
In closing, while there seems to be a lot of uncertainty as to where we were headed for the remainder of this year and beyond we feel the company is well positioned to deliver for our shareholders.
We have a dividend that is well covered by earnings and a strong balance sheet that allows us to be patient as the market likely transitions amidst continuing volatility.
Our experience navigating changing times should continue to allow us to outperform and we can assure you. The team is focused on generating great results for 2022.
That concludes our prepared remarks, we'd be happy to open the line for questions.
Yeah.
Yeah.
We will now begin the question and answer session to ask a question you May Press Star then one on your telephone keypad.
If youre using a speakerphone please pick up your handset before pressing the keys.
If at any time. Your question has been addressed and you would like to withdraw your question. Please press Star then two.
Please note that as a courtesy to those who may wish to ask a question. Please limit yourself to one question and a single follow on.
If you have additional questions you may reenter the queue. The investor relations team will be available to address any further questions at the conclusion of today's call.
At this time, we will pause momentarily to assemble our roster.
The first question comes from Finian O'shea with Wells Fargo Securities. Please go ahead.
Hey, everyone. Good morning.
Kept your opening comments on an interest coverage I think you said about 3% at underwriting.
Can you talk about if it's that includes items like Capex EBITDA.
EBITDA adjustments and so forth.
And if not what the what the ballpark figure is like.
On a cash basis.
Yes, I mean, they calculate good morning by the way and thanks for the question. The morning is a simple interest coverage calculation. So it's operating cash flow divided by interests. So anything else. The company requires whether it's free cash flow amortization or sorry, capex amortization payments et cetera would be excluded from that calculation.
Yeah.
Awesome, Thank you and.
As a follow up what what's the picture like for a recurring revenue deal.
The two are understanding those generally start with a quick.
Cash infusion or runway.
How materially does that change.
Interest rates double or triple the base rates that is.
Let me try to answer that but if you want you can follow on so I mean, the idea with some of the recurring revenue lines that are getting done and the market is obviously youre looking at a company that's growing extraordinarily quickly, but that tends to have operating expenses.
Noting that growth right. So youre talking about R&D youre talking about sales and marketing where these companies.
I hope to be much much larger and most of them hope to be profitable on time.
For now, though what you're underwriting is stable recurring revenue, where you could simply change if you wanted to the way that the company was pursuing growth and generate free cash flow.
I am pretty quickly so that's sort of the construct.
We're we're sort of limited in that space, you know, where we're happy to play in that market I think we're one of the more conservative lenders and today, we've got roughly 3% of the portfolio at fair value and recurring revenue lines, just as a reminder.
Oh very well that's helpful. Thanks, so much.
Yeah, you're welcome thank you.
The next question comes from John Hecht with Jefferies. Please go ahead.
Good morning, guys. Thanks for taking my questions.
Kipp you your remark.
Good good. Thanks, Thanks, very much good to hear from you guys.
You didn't your entry remarks, you talked about you talked about.
Waiting for the private markets to just in a in a manner that the public markets have adjusted given all this disruption I mean I'm wondering can eat can you maybe quantify that is that like a function of credit spreads or is there. Other factors in terms of deal structures are something that we should be thinking about.
It just sort of in terms of when that might catch that catch up might occur.
Yeah, I mean, I think what we're trying to get back to the notion that we've left you with and many others within the past, which is the public markets as you've probably seen particularly anything fixed rate longer duration et cetera, whether it's high grade corporates the high yield market et cetera is off pretty substantially this year alone market a little bit less so.
Because the duration shorter, it's obviously, a LIBOR sofa, plus asset which benefits from rising rates.
But you know the public equity markets as well.
Don't seem very happy.
Past couple of months that being said a lot of what's getting closed or has been getting closed in our opinion in the first quarter in the private markets are often deals that get originated in a different environment right. They get signed up they have term sheets issued November December January and because a lot of what we're doing is longer duration holds with relation.
Ships that are important to US you don't go repriced our term sheets I guess is that you know generally speaking you go when you close over those deals with an understanding that you're in a fundamentally good credit, but what we're looking for John is with a widening in spreads broadly in the credit markets, which we've seen a bit of we're waiting for the private markets to kind of catch up.
Back up to recognizing the volatility that's been very obvious to all of us for maybe February to April and I think that's happening right now and that can get reflected in everything from pricing, which of course is spreads.
Tighter documentation you know whatever it may be so it can be it can come in a whole host of different forms, but first things first I think that there may be some price exploration.
On the part of a lot of investors frankly, whether their lenders their private equity firms. They are buyers of real estate et cetera that with less economic uncertainty.
Or more economic uncertainty less certainty about growth concerns about inflation concerns about the Ukraine tightening monetary cycle et cetera that there's a little bit of a wait and see approach for those who are maybe you've been doing this a bit longer than some.
Okay, that's very helpful color.
Second question you gave us very good information about you know the interest coverage and how that's impacted rising from a rising rate environment I'm wondering in addition to that.
Does the rising rate environment effect like appetite for borrowing from middle market companies is there anything for us to think about in that regard.
Somebody I think it is less sensitive than say the high grade market rent, which as you know.
Done loads and loads of refinancing over the last five to 10 years, taking advantage of historically low rates a lot of what we do as you know is driven by private equity.
And acquisitions and that's why we made the comment in the prepared remarks about the extraordinary amount of dry powder in the hands of U S. Private equity firms and the reality is our opinion is despite increased borrowing costs they will be looking to deploy.
And generate returns for their investors because that's what they were hired to do it right and most private equity funds up five year investment period. So you can take a wait and see approach, but you can't take a wait and see approach forever.
If I had to guess if I'm sitting in one of those tables would that tells me is you want to pay less for things because when rates go up assets tend to be worth less so a little bit of the feeling around I think is the part on all private markets investors trying to find what may be a new equilibrium new equilibrium again with some more uncertain market conditions.
And presumably materially higher rates.
Great that all makes sense, thanks very much.
The next question comes from Devin Ryan with JMP Securities. Please go ahead.
Hey, Thanks, Good morning, everyone. How are you.
Good morning, Doug.
Just maybe a follow up here on John's question questioning here just as the markets are adjusting you kept as you mentioned you just want to maybe think about kind of a stated leverage and liquidity.
Your leverage range is 9.1 0.1 0.25 times currently at 1.6 net of cash and just kind of based on the lagging dynamics in the private market is this impacting how you're thinking about managing maybe liquidity and leverage and just the very near term yeah, perhaps maybe deliberately slowing activity just to take.
Advantage on the other side is the market kind of get to that equilibrium point, just think about kind of the near term versus long term could you may get some more compelling risk reward on the other side.
Yeah, I mean, you know the Crystal ball is a little less clear perhaps than than at other times I mean, I would hope that the vintage for doing what we do from an investment standpoint is better towards the.
The back half of this year than it was maybe early days of this year and late last year in terms of terms and pricing. The only other thing I'd say Devin answered your question in in in more uncertain times that at least to us still volatile we would like to run less leveraged right. So I.
I think 0.9, frankly is too low when you look at the asset mix in the portfolio here, but somewhere in line with where we are today feels comfortable for us.
Yeah. Okay I appreciate it and then just a follow up here on prepayments just if you can give us any insight into kind of how youre thinking about the cadence from here and it feels like just the backdrop has shifted from last year. So any any thoughts on kind of the intermediate term.
So on that front as well would be helpful.
Yeah, I think playing off some of your first question as well its been and John when you see an environment of higher rates right, which offers fewer opportunistic refinancings and the volatile market. Our best guess is that we will see a slower pace of repayments going forward. We obviously.
The quarterly model here, where we're looking at our pipeline and our backlog and we're also looking at identified Paydowns that we know were coming because we're close to companies.
Probably imagine as we forecast quarters in the year, we look at it on.
And identified pipeline and we look at an identified repayments and I would tell you. We've made the conscious decision to try to take that down a little bit.
In terms of what we expect to come in from a liquidity perspective through repayments.
Okay, great. Thanks, very much I'll leave it there.
Youre welcome Thanks Devin.
Our next question comes from Ryan Lynch with K B W. Please go ahead.
Hey, good morning.
Good morning, Ryan.
First question I had.
I was pleasantly surprised to see that when you look at your unrealized and realized.
Net portfolio you guys actually had gains.
This quarter.
I was a little bit surprised just given that you had seen kind of widening credit spreads a little bit of decline in liquid leverage loan prices. This quarter. So what drove your net portfolio gains this quarter I'm not sure. If they were equity investments in there that that that drove it higher or what was it.
And kind of what's behind them.
Yeah, I mean basically quick answer is you have a debt raise.
Resolution sort of net net to zero, but the equity gains.
A couple of specific names allowed us to to show the net realized gains number Ryan.
Okay. So some equity gains in there.
And the other question kind of looking forward.
On how the market has moved and then kind of when with regarding kind of short term rates, but last time, we had a rate hike cycle and of course, you know every rate hike cycle is going to be different but what we saw was kind of a more gradual pace of rising rates by the fed in LIBOR.
And we saw what it was a lot of spread compression and so the net benefit to the bdcs was substantially less than what a lot of these disclosures showed as kind of a sudden shock in interest rates of 100, or 200 basis points rising because of that spread compression I'm. Just curious now that LIBOR has enough.
That could be gotten above the LIBOR floors in a lot of these loans are you seeing a meaningful spread compression in deals in the market and what do you think about going forward do you think a lot of those spreads.
Well, we will start to get eaten away or competed away by.
Bye bye.
Substantial amount of capital looking to be deployed in the direct lending market or do you think theres going to be Oh.
Meaningful.
Increase in benefit from from rising rates in your portfolio.
So I actually think you're your last question is the most interesting one the most heavily debated and the one that I'm, probably the leisure and answering meaning is there continued interest in everything that we and others do in our liquid credit just going to overwhelm a market that feels like it's going to widen out.
I don't know it never has before and we've been doing this a long time. So let me answer your first and second question sort of directly I think you are right and that it's very rare that we see a 100% of the pick up in the base rate right. So there was an acknowledgment that is the all in rate, whether it's what we're getting for our investors or what.
<unk> paying expands with the base rate, there's likely some credit spread compression, particularly in an environment, where defaults are very low which is certainly the environment. The environment. We're sitting in today with tends to really widened credit spreads is when you actually see a pickup in defaults. So for us it's all about.
Out what's your economic forecast for the year, how do you see companies handling a more difficult operating environment higher rates et cetera, and we've gotten asked this question a lot you know hows the portfolio well yeah. The answer is the.
Portfolio is an unbelievable shape here in April , but if he asked folks around our table if they're nervous about what will see towards the back ended the year and potentially into early next year I think youll certainly find plenty of folks who are right.
So I do expect as we come here through Q2, and even into Q3 to see.
The lion's share of the benefit of base rate increases because to your point. We're finally through the floors and there'll be a little bit of catch up time before anybody adjust new business to account for that.
So we should see some good tailwind with rising rates, but I think the back half of the year as is debatable right and I think the last question. You asked is most interesting.
Okay.
Alright, I appreciate the color on that and I'll hop back in queue.
Yeah.
Thanks, Brian the.
Our next question comes from Melissa Wedel with JP Morgan. Please go ahead.
Good morning, everyone.
My question today.
I was hoping to circle back to some of the EBITDA trends that youre seeing in the portfolio right now I think you cited.
I got it correctly it was about 20% EBITDA growth, but that was really at the last 12 months again, if I if I heard you correctly.
So I guess, that's the first question did I catch that right and if so could you pull that apart maybe and talk about what you saw specifically in the fourth quarter I'm, sorry in the first quarter and how that compared to for Q, which I think he asked for Q. You said that was sort of in the mid teens range.
How is that holding up on that with you.
Sure and we're looking to see every impulse numbers that that 20% mostly I. Appreciate your question is obviously, a very large number and frankly.
Larger than we'd expect.
We're playing off obviously easy comps against Covid periods, right coming out of them.
That period into something more normalized so we're poking around here and let me just see I'm not sure if we actually even pay a lot of attention to that on a quarterly basis. Mitch made the point I think in his prepared comments that we I think Mitch you said, we had growth across all 15 of the industry sectors that we measure so while it's a big number it's also pretty broad based and I'll just read.
<unk> size, we think the portfolio is healthy and doing quite well.
Okay.
The other thing that stood out to me in and just going through the results this quarter with the big jump up in dividend income and I think he talked about.
And you know with the anticipated growth in Ivy Hill, and potential upside or not dividend. There was also an uptick I think in some of the recurring dividend income and I believe that was attributed to sort of increased exposure to some preferred.
You could dig into that a bit.
Can you elaborate if we should sort of think of once you Mr revenue base level.
Dividend income.
The upside to it later in the year.
I'm going to let penni answer part of that too I mean look there there are a few items in a few line items that contribute into that line.
Largest one of course being Ivy Hill, and that's been moving up the last couple of quarters.
So there will be a new base level I think of recurring recurring dividend from Ivy Hill, the problem with that as you guys try to model them and I think thats, probably what youre trying to do is we do see dividends come through.
From our equity investments.
That are not necessarily recurring.
They'll come quarter to quarter, we obviously are 400 portfolio companies, they're pretty difficult to forecast.
Maybe we can take it offline and the IR team can can help give you a little bit more detail, but I'll kick. It depend if there was anything you wanted to add on top of that.
No I think you know we continue to grow the dividend in Ivy Hill and that's in line with the increased investments that we've made so I think you can look at that more as a baseline but the other nonrecurring dividends are such that they're episodic. So they come from individual companies periodically and arent necessarily recurring each quarter Bud.
Tend to still come in throughout the course of the year.
Right, Yes, and just as a baseline for Ivy Hill, the Ivy Hill dividend grew this quarter as a total of $43 million.
Okay.
Thank you. The next question comes from Casey Alexander with Compass point. Please go ahead.
Hi, good morning, and.
Maybe this is this this might be the same question that Ryan asked but I might ask it in a different way and if it causes some eye rolling.
I kind of apologize but.
It felt like you said a couple of things that just felt like they were in conflict with each other you're expression of your wariness of the current environment.
Both inflation rising interest rates geopolitical suggested that you've become more selective and might want to build liquidity with the rising interest rates. Obviously help your net investment income, but you don't expect any of that to relate to any deterioration in credit performance.
And it feels contradictory if you understand what I mean.
And I was wondering if you could throw me a little more color regarding that.
Yeah, I mean, I guess to try to I don't I don't think it's contradictory at all Casey, but I think what we're saying is in a period of Ryan So forget the economic backdrop, but purely in a period of rising rates right. We havent benefited at all from from the recent increases in short term rates in most of our borrowers are subject to LIBOR sofa floors, where until you get north of <unk>.
One the company doesn't.
<unk> need better earnings from rates going up and that's what's been happening the last couple of quarters right. So now we're finally at that inflection point.
Where we're able to generate those benefits.
And with that we don't think that we're in a base rate environment in the next nine to 12 months that even if you're on the.
You know more hawkish side of raising rates, if the base rate gets to two and a half or 3% by year end I think is the point we were trying to make we don't think our portfolio of companies that are particularly difficult situations. So theres, a little about a little bit of a goldilocks moment, where our company does well our portfolio of companies don't do any worse or.
Really worse in a way that we think will create defaults or credit problems and we hope we can sail through with that combination.
In a higher rate environment, where rates are 5%, obviously, if we're going to we're going to pick up those earnings benefits and we think we may start to stress the portfolio just to pick a number so thats what were trying to get at hopefully that clarifies it to a certain degree.
Yeah.
Okay was there a follow up Mr. Alexander.
Yeah. My follow up is is less a follow up in more of a request.
Which is given the size to which Ivy Hill has grown with your upcoming analyst day.
So it's almost a natural opaque to Ivy Hill.
I would I would kind of request that you did you give a deeper dive so that investors have a good understanding of what Ivy Hill is how it functions and what it means to the BDC that that's it.
Yeah, we're happy to do that I mean, it's it's not really that complicated I'm Ivy Hill as a bank loan manager.
They have third party investors, which obviously include Ares capital.
The income coming from Ivy Hill is basically management fees on assets under management.
As well as.
Revenue coming off some of the investments that we and others have made that accrue back to us when they're wholly owned all we're doing is looking at net of expenses. What the company is generating quarterly on a cash flow basis, and then we tend to take a conservative number call. It 80% of the cash flow getting generated at Ivy Hill on a quarterly basis.
Pay Ares capital the dividend.
So.
We're happy to we're happy to try to lay that out in some more details when we see all you guys in June .
Don't want it to be opaque don't think it is it's a fabulous.
Fabulous has been continues to be a fabulous investment for the company, which is why we've continued to invest more money in that company.
I appreciate it thank you.
Okay. Thanks, Jason.
Question comes from John Rowan with Janney. Please go ahead.
Good morning.
Just two questions. So what percent of your assets right now are past the the floor.
We're looking around.
Yes.
We think it's.
About two thirds of the portfolio is floating.
Where you have the floating rates are outside of SDLP I think about the weighted average floor is about 90 basis points. So depending on whether people are borrowing on a one month or three months, there's an iteration there of some of our past the floors and some are getting close to being passed the floors, but given they have the.
Option and resetting monthly or quarterly I always feel like it takes about a full quarter you see the impact of that resetting as you go through time, if there's a little bit of gaming a little bit of gaming of the system right by the borrowers because they do have the ability to elect one and three month LIBOR contracts, where it really depends when you are rolling over in what spot rate your play.
Whether you're going to re borrow one or three but dependent point everybody will be up for redoing those contracts again and even if they are choosing one month LIBOR in a month. My guess is there'll be through the floor. So we're we're largely there I think fundamentally is the answer John Yeah, I mean, just to give a little more insight about two thirds of the floating rate portfolio today is choosing three months lag.
Sure.
Okay, and then it takes a long time.
I'm just.
Just to kind of go back to the rate sensitivity questions as well you did change one of your funding liabilities I believe from LIBOR to chauffeur is there an impact in your rate sensitivity to having so far which I believe reprice is not quite as fast as LIBOR.
Yeah, where we've already migrated so far is reflected in the interest rate sensitivity table in the 10-Q.
A small piece of the portfolio is starting to migrate as well because as you may be familiar with the rules as things get amended or changed post the beginning of this year, there's a migration to sulfur, but that will take some time. So it's a small impact today, but we are factoring that into the interest rate sensitivity to the extent that the base rate.
Is already elected to you so far.
Yes, I mean, I would just say to John's or as a reminder, do you guys as analysts but also to the.
Folks that own the stock this is not a particularly rate sensitive company because its not very leveraged right. Most of the economic value. In this company is generated by excess net interest margin and frankly generating more gains than you realized losses in the portfolio. We've been doing that a long time, so while there's a shift obviously in where we are from a rates perspective.
Youre not going to see it at all by the end of the summer right. It's all going to play through.
And then we'll see where we are but just as a reminder.
Thank you.
Thank you. The next question comes from Robert Dodd with Raymond James. Please go ahead.
Hi, everyone. Good morning back back to the Sofa LIFO question, but right now the three month LIBOR index verses, Oh, but hopefully at least I mean, the spreads 100 bips.
Which so pleasant been around that long, but that seems pretty wide by any kind of historical I'm not sure I can I can come up with is that itself, causing any.
Disruption in the market either way you are lending into.
Uh huh.
Or refinancing or anything like that or is it causing.
Any fallback language in Buffalo, which.
Just three months and one month LIBOR can they go back to us.
Is there another alternative and I like that.
Fed funds like what were the spreads versus LIBOR is pretty wide right now.
70.
Yeah.
So okay. So theyre, telling me I yeah.
But.
The base rate is that how I spend a lot of my time, frankly thinking about managing the company, but I'll I'll answer the question. Nonetheless, I'd say, there's complexity in this transition the way that they've tried to allow the market to resolve it is obviously, creating something called the credit spread adjustments between so for them.
To get us through this interim period as we flip over.
To broadly answer your question Rod is it is it changing the way people are lending money youre doing deals or any of that it's not.
Now, we're just kind of getting through a transition period and it'll be behind us reasonably soon and we move on.
Okay got it thank you and one more thing very helpful color on all the interest rate coverage and how much rates have to go.
Before the aggregate interest coverage is below two but what about the margin like what proportion of your portfolio companies have interest coverage below two today.
What would that put caution b if rates went up say 200 basis points I mean, obviously at the margin, but I don't expect the aggregate portfolio to have a credit problem. Its always the weakest credit so any any color there.
We don't have that metric in front of US we can go try to dig it up for sure your.
Your comments are spot on I, just reemphasize, we do pretty rigorous portfolio reviews here on a quarterly basis as well as running our watch list every two weeks.
We've got probably the largest asset and risk management team of any BDC out there who has demonstrated a track record along with our investment team and being able to manage through so I'm sorry, Robert I don't have the number right here in front of me, but I would tell you the portfolio is in great shape and.
We don't think again.
Continued short term rises.
Continued rises in short term rates is going to be the issue from portfolio companies. The issues that we're seeing in the portfolio are much more specific.
Specific to inflation.
You know supply chain issues et cetera, where management teams are just having to operate in a much more complicated environment. We do not have management teams coming to us and saying, we're really really nervous about our interest coverage because rates seem to be going up.
Got it I appreciate it thank you.
Yes. Thank you.
Again, if you have a question. Please press Star then one.
The next question comes from Bryce Rowe of hub group. Please go ahead.
Thank you good morning wanted to maybe ask a little bit about Ivy Hill, and the injection of some of the annually assets.
Into both Aries and Ivy Hill, just curious are you do you anticipate any kind of return profile changing for Ivy Hill with that injection.
I'm curious what the incremental investment into Ivy Hill might might look like.
Based on that based on when that deal is expected to close.
Yeah, I mean, I think in terms of what it will look like by the end of Q2 I'd rather just let.
What you guys wait and see but it's probably not appropriate for us to comment on that what I would say is every time, we make incremental investments in Ivy Hill.
Obviously youre doing it with the mindset that we will be generating additional earnings and dividends coming from that company I would just say over the last couple of years.
We'd sort of insisted and frankly longer than the last couple of years, but the last couple of years. We've insisted on a 15 ish kind of percent rate of return coming from Ivy Hill in terms of the dividends at cost in the same underwriting standards and strategic view as to what we're doing here with the <unk> portfolio remain in place I wouldn't expect.
See any degradation of the return there.
We're excited about the transaction, we think it's great for US we think it's great for Ivy Hill.
Okay. That's that's helpful Curt.
And then maybe one more for me in terms of kind of portfolio mix we've seen.
We've seen this over the last few quarters in terms of maybe building preferred.
And common equity positions and obviously to the increased fruit from Ivy Hill do you see them.
Do you see this portfolio mix.
Transition.
Maybe coming to some level of it and know that market conditions are getting more volatile just trying to kind of get a feel for.
How how the portfolio might shape up over the coming quarters here.
Yeah. It's a good question and it's actually I don't have a direct answer to because it's actually one that we are talking about a fair amount around here as an investment management team right.
The impetus for them some.
Some of the more.
Active preferred investing that we've done has just been additional non equity capital so to speak in some of these extraordinarily high multiple L. B O is that we've been involved with where we felt like we had great loan to values are a preferred we could generate great returns often do that with a co invest look of that <unk>.
<unk> backtrack, a little bit in valuation multiples come down.
And that slice of preferred frankly isn't available it may not be part of as many transactions going forward.
Joking about this little bit last week, but we think we may look back on some of those investments and some of the best investments that we that we made right because they're very low loan to value they've got high total returns they've got tremendous amount of equity cushion below you.
So we will see price I, just I don't have a direct answer would snap to see where the market goes there will be you know an upper limitation as to how we see noncash pay securities in the portfolio right. We've always kept at it 10 to 15 ish percent rough numbers during normal times I don't think youre going to see a huge shift.
We're all of a sudden we're running a portfolio that has a 30% equity mix or something like that so I would expected that the higher end of where we would get but we're gonna have to see where the where the market in the world Texas.
Got it appreciate you appreciate the color.
Oh, great. Thanks for the question.
This concludes our question and answer session I would like to turn the conference back over to Mr. Kipp <unk> for any closing remarks.
I don't have any other than to say, thank you all for joining us and.
We look forward to seeing you for sure at our Investor Day.
And if not on the road.
After that thanks, so much.
Ladies and gentlemen, this concludes our conference call for today, if you missed any part of today's call an archived replay of the call will be available approximately one hour. After the end of the call through May 10th 2022 at five P M eastern time to domestic.
Callers by dialing 87734475 to nine and two international callers by dialing 141 to 3170088 for our replays. Please reference conference number 3957963.
An archived replay will also be available on a webcast link located on the homepage of the Investor resources section of Ares Capital's website.
Okay.
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