Q2 2022 Ares Capital Corp Earnings Call
Good afternoon, welcome to Ares Capital Corporation's second quarter ended June 30th 2022 earnings Conference call.
At this time all participants are in a listen only Mike.
As a reminder, this conference call is being recorded on Tuesday July 26 2022.
I'll now turn the call over to Mr jumped del Mar managing director of Investor Relations.
Thank you let me start with some important reminders comments made during the course of this conference call and webcast and the accompanying documents contain forward looking statements.
They're subject to risks and uncertainties.
Actual results could differ materially from those expressed in such forward looking statements for any reason, including notebooks and its SEC filings.
Ares Capital Corporation assumes no obligation to update any such forward looking statements. Please also note the 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, but just core earnings per share or core EPS. The.
The company believes that core EPS provides useful information to investors regarding financial performance because it is one method. The company uses to measure its financial condition and results of operation.
A reconciliation of core EPS to GAAP net income per share the most directly comparable GAAP financial measure can be found in the accompanying slide presentation for this call.
In addition records.
A 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 10-Q filed with the SEC this morning for more information.
Certain information discussed on this conference 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 such representation or warranty with respect to this information.
The Companys second quarter June 32022 earnings presentation can be found on the company's website at Www Dot Ares capital Corp, Dot com by clicking on the second quarter 2022 earnings presentation link on the homepage of the Investor section of the website.
Ares Capital Corporation's earnings release, and thank you are also available on the company's website.
I will now turn the call over to kept severe Ares capital Corporation's Chief Executive Officer.
Thanks, John Hello, everyone, I hope, you're all doing well and we appreciate you joining our call today I'm here with our co President Michael Smith, and Mitch Goldstein, Our Chief Financial Officer, Penni roll and several other members of the management team.
I'd like to start by highlighting our second quarter results and then provide some thoughts on the changing market condition and how we're seeing things.
This morning, we reported second quarter core earnings of 46 per share an increase of approximately 10% compared to the first quarter driven by the early benefit from rising interest rate, how your dividend income and <unk>.
<unk> credit stability within the portfolio.
Our LTV of $18 81 per share declined 1% quarter over quarter, largely due to unrealized losses, we took to reflect wider credit spreads in the market.
These unrealized marks are to be expected with more volatile market. However, I will say, it's a welcome trend it's more volatile markets tend to provide more deal flow for direct lending participant most likely more interesting investment opportunities for the longer term.
Great volatility within the leveraged finance and equity markets continued during the second quarter.
Banks around the world and more rapid than their fight with elevated inflation by rapidly rising interest rate.
With this tightening monetary policy, our concerns over an economic slowdown or recession or increase.
Leveraged finance markets are experiencing significant spread widening weak secondary liquidity and minimal primary issuance as the large banks are highly focused on working out their unsold inventory committed financing many of which we believe are being held at significant losses.
During these times, we rely on a playbook that we've developed over the past 17 years.
We try to be opportunistic on these situations with banks, we become incrementally more selective with our core deal flow focused on the highest quality investment.
Better pricing and terms we.
We aggressively manage our portfolio and we strive to build additional liquidity of the company.
Against this more volatile backdrop, its stability and scale of our capital is resulting in incremental demand from both our existing portfolio of companies and from new borrowers, including some much larger companies that otherwise would turn to the liquid markets and less on certain times.
We believe our long standing and disciplined approach to investing has resulted in an attractive highly diversified portfolio that is focused on upper middle market businesses that have significant long term franchise value and operate in resilient industries.
Demonstrating our focus on diversification our average investment represented just <unk>, 2% of the portfolio and this minimizes our exposure to any single portfolio company.
In addition, we focused on larger companies in recent years and the weighted average EBITDA of our portfolio has now reached $179 million.
This number has more than doubled over the past five years.
Our experience in previous cycles is demonstrated that larger companies tend to be more resilient during market dislocation.
All things being equal we believe these larger companies have more diverse revenue stream broader customer basis deeper management teams and more robust sources of capital.
These attributes should all serve to support the credit performance of our portfolio.
While we recognize the increasingly complex operating environment that many companies face in today's economy, our portfolio companies are performing well.
Our non accruals at cost remained well below our 10 year average and we reported another quarter of strong underlying portfolio company EBITDA growth.
Furthermore, the weighted average loan to value on the aggregate loan portfolio remains comfortably below our five year average at 51%, which reflects the significant structural support provided by the equity of our clients, but private equity backed companies and non sponsored borrowers.
As we discussed at our recent analyst day, we have a proactive and deeply embedded credit oriented culture.
We believe our portfolio management team provides an important and differentiated element to our overall approach to risk management.
During our quarterly portfolio review, our portfolio management team alongside our deal team.
But a heightened focus on the risks brought by today's high inflationary environment.
While our analysis of our industry sectors and underlying company fundamentals. This objective we take comfort that this quarter's review revealed only between 5% and 10% of our portfolio within the higher risk category, specifically regarding the potential impact from inflationary pressures such as rising energy prices.
The supply chain disruption and staffing shortage.
Looking forward, we believe the continued increase in market interest rates present, a potential opportunity.
Or is the growth of our core earnings given our largely floating rate loan portfolio is financed by mostly low cost fixed rate unsecured sources of financing.
Andy will discuss in more detail if the full impact of the market rate moves this quarter had flowed through our entire quarter, we calculate that our second quarter core earnings could have been about 11% higher on a run rate basis.
Additionally, you should market rates increase 100 basis points from the June 30th levels, Our quarterly core earnings could benefit by about eight cents per share or 17% increase.
Over our second quarter core earnings.
We believe the benefit of these market rate increases to earnings will be more impactful in the third quarter and beyond.
We also do not believe the currently projected increase in rates will result in deteriorating credit performance holding all else equal including leverage at the borrower level of 150 basis point increase in market rates.
<unk> and a weighted average interest coverage ratio in the portfolio of approximately two times.
Importantly, this analysis does not consider any EBITDA growth or deleveraging that has historically occurred in the portfolio.
We feel good about the ability of our portfolio companies to navigate a higher rate environment. We believe these dynamics will further differentiate Ares capital. Many other income oriented alternatives in the market today.
Before I turn the call over to Penny I wanted to highlight the dividend increase we announced this morning.
As a result of our run rate core earnings outlook and.
And the expected further benefit from higher interest rates, coupled with our strong portfolio performance. We increased our regular quarterly dividend grew 42 cents per share to <unk> 43 per share for the third quarter.
This amount is in addition to the <unk> <unk> per share additional dividend that we've already declared for each of the third and fourth quarters. This year.
Let me now turn the call over to Penni to provide more details on second quarter results and some other thoughts on the balance sheet position.
Thanks, Kip good afternoon, everyone.
Our core earnings per share of <unk> 46 for the second quarter of 2022, or four cents higher than a quarter ago and down seven from the same quarter a year ago. The.
The second quarter of 2022 earnings were driven by strong recurring interest and dividend income some higher one time nonrecurring dividend and a solid level of capital structuring service fees from new originations.
Our GAAP earnings per share for the second quarter of 2022, or 22 cents, which compares to 44 cents for the prior quarter and $1 nine for the second quarter of 2021.
Our GAAP earnings for the second quarter of 2022 included net realized and unrealized losses of <unk> 30 per share.
The net realized and unrealized losses on our investments this quarter were largely a result of the unrealized losses, we took.
For certain of our investments to reflect the current widening spread environment kept mentioned earlier.
Our total portfolio at fair value at the end of the second quarter was $21 $2 billion and we had total assets of $21 8 billion.
As of June 32022, the weighted average yield on our debt and other income producing securities at amortized cost was nine 5% and the weighted average yield on total investments at amortized cost was eight 7%.
Total investment yield at the end of the quarter increased approximately 60 basis points from last quarter supported by the rise in base rates.
As it relates to our future interest rate sensitivity, we remain well positioned to continue benefiting from a rising rate environment.
As of June 32022, 74% of our total portfolio at fair value was in floating rate investments.
Chip mentioned earlier, we expect continued increases in short term rates to have a positive impact on the net interest earnings performance of the company.
For starters, we have yet to see the full quarter benefit from higher market rates that have already occurred in the second quarter, given about 60% of the base rates for our floating rate loans currently reset every three months and the increase in base rates through these research generally occurred in the latter part of the quarter.
Our second quarter earnings did not fully benefit from the increase in market rates reflected in our yields at quarter end.
By holding all else equal for the second quarter and assuming that the June 30th base rates were in effect for the full quarter. We estimate our second quarter core earnings would have been about five cents per share higher resulting in core earnings of approximately 51 cents per share or about an 11% increase.
<unk> of our actual Q2 'twenty two core EPS results.
It is worth pointing out that this analysis does not forecast any other changes, including the incremental benefit from interest rate changes since June 32022.
If you look at this with a longer term lens as of quarter end, holding all else equal and after considering the impact of income based fees. We calculated that a further 100 basis point increase in market rates from June 30th could increase our annual earnings by approximately 31 cents per share a 17.
Per cent increase above this quarter's annualized core EPS.
We have provided details on our sensitivity to interest rate movements in this quarters Form 10-Q for those who want to further examine these impacts.
Shifting to our capitalization and liquidity during the quarter, we continued to enhance our liquidity by growing our committed debt capital more than $300 million by upsizing two of our revolving credit facilities.
Aside from the base rate transition from LIBOR to so far it terms of the two facilities remain the same including the existing pricing.
After considering our investment in capital activities during the quarter. We ended the second quarter with nearly $4 $6 billion of total available liquidity, including available cash of $200 million and a debt to equity ratio net of the available cash of 1.25 times up from one point.
Six times at the end of the first quarter.
Overall, with our significant dry powder, and only $750 million and debt obligations maturing in the next 18 months, we believe our capital and liquidity remain 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 $694 million or $1 41 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 that do not have this level of spillover.
This morning, we announced that we declared a regular third quarter dividend of 43 per share an increase to our regular dividend rate. The second such increase in the past year. The third such increase in the past six quarters, and our 50 <unk> consecutive quarter of unchanged or growing dividends.
This third quarter regular dividend is enhanced by the <unk> <unk> per share additional third quarter dividend that we previously declared in February .
Both are payable on September 32022 to stockholders of record on September 15th 2022.
And now I will turn the call over to Michael to walk through our investment activities for the quarter.
Thanks Penni.
I'm going to spend a few minutes, providing more detail on our investments and portfolio performance for the second quarter, and then provide an update on post quarter end activity and our backlog and pipeline.
During the second quarter, our team originated $3 1 billion of new investment commitments across 52 transactions and more than 20 distinct industries.
72% of the commitments issued were senior secured and approximately 60% of the transactions were to incumbent borrowers.
As we noted in our analyst day incumbent portfolio companies, which we have provided additional financings have historically had greater EBITDA growth and stronger interest coverage ratios on average in comparison to the rest of our portfolio.
We believe the opportunity to finance some of our best portfolio companies clearly provides informational and investing advantages. Additionally.
Additionally, we believe our track record and ability to finance our business as it grows continues to be a key differentiating advantage in today's dynamic market.
Further to Kipps point earlier about the upper middle market focus of our portfolio.
The weighted average EBITDA of companies to whom we issued commitments during the quarter was 183 million as compared to the average EBITDA of exited investments of $102 million.
While larger companies continue to be our focus we are reviewing transactions with EBITDA that ranges from approximately 10 million of EBITDA to more than $1 billion of EBITDA and we continue to be very selective and only finance approximately 5% of the new deals we review.
We believe that our selectivity and focus on high free cash flow businesses with market leadership positions ultimately results in a differentiated and attractively positioned portfolio.
Our portfolio company's performance during the quarter supports this view.
The weighted average EBITDA growth of our portfolio companies over the last reported 12 month period was very strong at approximately 16% importantly.
Importantly, this performance is broad based with all of our top 10 industry concentrations demonstrating a healthy level of positive EBITDA growth.
It is also worth noting that industries, where we have chosen to invest more heavily measured as industries that comprised 4% or more of the portfolio has experienced higher growth.
Then the portfolio weighted average in aggregate.
In terms of credit quality metrics, the weighted average portfolio grade at fair value for the quarter slightly improved to $3 two.
And continues to be above the 10 year average of 3.0.
Underscoring the overall stability of underlying portfolio companies only 5% of our portfolio companies had a change in their portfolio grade this quarter, which is consistent with our five year average.
We experienced more upgrades than downgrades for the quarter.
Which resulted in a decline in the number and percentage of our high risk grade one and grade two investments at fair value.
Our non accrual rate at cost of one 6% increased slightly from one 2% at Q1 'twenty two largely driven by the addition of one new nonaccrual, but continues to be meaningfully below our 10 year average of two 5%.
Now as mentioned I do on a quarterly basis, I would like to shift our post quarter end investment activity.
And pipeline.
From July one to July 20th 2022 we made new investment commitments totaling $245 million of which $142 million were funded.
We exited or were repaid on $379 million of investment commitments.
As of July 20th our backlog and pipeline stood at roughly $1 7.045 billion respectively.
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 will now turn the call back over to Kip.
Few closing remarks.
Thanks, a lot Michael.
Included simply by saying, we believe that Ares capital remains well positioned to navigate the economic and market uncertainty ahead.
The stability of our capital and our ability to be a strong and capable financial partner to our borrowers is likely to only be more valuable and continue the trend of increasing borrower demand for private capital and scale.
While we anticipate further market volatility and the potential for additional spread widening as the cycle progresses, we feel very good about our portfolio and the capabilities of our team.
The size and breadth of our team's experience through cycle positions us well to address any future challenges.
We also feel the investing environment going forward should begin to look more and more attractive.
This confidence in our position and the potential for meaningful earnings growth from rising interest rates as reflected in our election to raise our quarterly dividend.
I'd like to finish by quickly taking a moment to thank our team for their continued focus and dedication to the success of the company that concludes our prepared remarks, we'd be happy to open the line for questions.
At this time, if you'd like to ask a question. Please press star followed by one on your Touchtone fine.
If you'd like to withdraw your question. Please press star followed by Kate Please.
Please.
You 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.
Investor Relations team will be available to address any further questions at the conclusion of today's call.
Our first question today comes from Melissa Wedel of J P. Morgan. Please go ahead. Your line is open.
Yeah.
Thanks, So much first question I'm, hoping that we can go back to the comment you made about the earnings potential being driven by higher rates into three Q. I think you said it was an 8% increase potentially.
And I guess I wanted to make sure I'm understanding sort of what's driving that is not based off of a.
Sort of 630.
LIBOR rates or should we be thinking about that differently.
Yeah Melissa.
Hey, Paul Kenyon here, too where John for help on the numbers so what.
It's a little technical on that the borrowers obviously reset LIBOR typically every three months.
The point is is we got to the end of the quarter, we still had a bunch of companies that had not actually applied for their LIBOR resets, which when they do will imply a much higher.
Based borrowing rate so what we're trying to say is at the end of the quarter. If we pulled forward our expectation of what our interest income would look like with all of those LIBOR resets getting done where we're going to evidence all of that in Q3, we thought we had just eight cents.
Of additional earnings from where we kind of left off in June 30th does that makes sense, Yeah, and then I'll just maybe add a couple of clarifying.
Because I know we threw a lot of them that are you on this but you know the kind of four does this particular 100 basis points increase there is some you know hypothetically if you increase rates.
100 basis points from where we were at June 30, then we would have approximately 31 cents per year in additional core earnings which translates to about eight cents a quarter.
Because we did not see the full benefit of rates in Q2.
There you know, we're just saying you know further increases in base rates benefit the earnings. So the eight tenths as really more of a hypothetical side, where in addition to that we said if you would've taken a full quarter of higher rates, where they did reset two during the second quarter and had those rates in effect for the full quarter.
Ben <unk> pro forma to Q2, so you kind of have this five to eight and their training and things.
I'm not sure I'd say at work, but the second one is more just to say look we think we have further benefits from rising rates and if you added 100 beds. So it'd be about eight cents a quarter. Thank you.
Does that help.
Okay.
It does help I appreciate that I think one more thing.
I think going to be a lot easier once we get the refuse great [laughter] it'll be easier once we go now to Greg.
Yeah.
Okay. So on that potential eight cent increase per quarter that you know you hypothetically laid out here does that also include the impact of what we've seen on the dividend income line because we've seen a lot of growth. There I know, it's something you've talked about in prior quarters, but I'm also.
So wondering.
You know how much.
Gross and dividend income from I hand, and recurring income in particular are you sort of baking into that number. Thanks. So much.
Sure. So it doesn't include anything in regards to dividend income in this quarter, we actually had a not.
Not necessarily expected onetime dividend from an equity investment in a portfolio company.
Yeah.
The lion's share of the increases you can probably expect as our continued investment in Ivy Hill, that's larger it's going to just be paying us a larger dividend going forward.
Thank you.
Thank you.
Our next question comes from Finian O'shea of Wells Fargo. Your line is open.
Hi, everyone. Good afternoon.
Another question on Ivy Hill was the was the 379 million sold down this quarter was that the total allotted amount from Italy or are there. Other theories affiliated origination groups that may also syndicate down to to IV.
Phil.
Yes that number.
It is not part of the analyst numbers, So I just call that ordinary course spin.
The or was the 379, social dawn was not okay. That's helpful. That's all for me a couple of people asked the question.
Yeah, and with the <unk> portfolio, you know Ivy Hill bought you know north of $1 billion of that portfolio. So those are two separate numbers.
Okay. Thanks, so much.
Next in the queue today is Ryan <unk>.
M. P Securities. Please go ahead.
Hi, Thanks, This is Kevin faults on for Devon.
Chip you mentioned the increased market volatility has led to an improved improved competitive environment with more attractive terms on new transactions.
Just curious if you could talk a bit about the shift to a more lender friendly environment, how that's materializing both in terms of documentation and more specifically if you could.
Quantify how pricing has improved on any transactions.
Yeah, I mean, I think we're in a bit of a volatile period, we made reference obviously to the fact that you know banks.
Banks have underwritten some transactions that they are looking for liquidity on right.
It's probably going to continue through the remainder of the summer and even into the early part of the fall. So all it has done is simply widen.
What we're seeing in the public markets and and thankfully now.
I think we and most of our other.
Friends and competitors in the private lending space or our widening pricing out as well. So you know in early just preview is probably an additional 100 basis points of spread across most of the tranches as well as higher fees.
And we're also benefiting to your question from a much more lender friendly documentation you know reemergence of covenants and some of the smaller deals that perhaps tried to shed covenants during a frothy or period, so pretty much every aspect of the investing environment from pricing terms and documentation is all improved materially in the last 30 to 60.
Yes.
And then just looking at new commitment trends over the past two quarters, you significantly reduce commitments to second lien loans. Just curious is that mainly driven by less attractive spreads on second lien deals or is there an ongoing effort to reduce the mix of second liens in the portfolio given.
On a more uncertain economic outlook.
Yeah.
You know.
A little bit of that I mean, there's probably less opportunity on the junior side. You know there were more unitranche is getting done but I do think also we saw you know you've got a large public facing credit platform here. So when we think about where we were you know in March.
In April I think we took a pretty conservative tone around how we wanted to play.
Play a transitioning market, we might've been a little bit less busy than some others. During the second quarter, certainly less busy than we could have been but I think we're taking a bit of a pause as we expected a widening spread environment and we were trying to make sure that we had capital here going through the summer into the fall to take.
You kind of what we thought was an improving investment environment. So it's a little bit of everything to your point.
I'll leave it there and congratulations on a really nice quarter.
Thanks very much.
Our next question comes from John Hecht of Jefferies. Your line is open.
Good morning, guys. Thanks, very much for taking my question.
Quick quick question is and this is sort of maybe a segue from the last question a little bit as you of your gross depreciation Kip I think you cited that most of that was from credit spread widening can you kind of.
Kind of allocate some of the gross depreciation to base rate changes versus credit spread changes I'm trying to decipher how much of how much of the change in your book value is tied to call it generic credit risk versus rates.
Yeah, I mean I.
I think thanks for the question John We don't we didn't see really a must.
Material change in the overall credit in the portfolio most of what we observed was simply unrealized losses.
Pretty broadly across the portfolio.
Can reference just to the reference securities that we obviously look to the value of the portfolio of mostly the loan market and the high yield market.
Okay and then.
Just thinking about that I mean, you guys, obviously have a pretty.
Detailed view and perspective on credit spreads I mean, if you look at the past 15 years, including the great financial crisis.
Where are we right now with respect to how credit spreads are impacting the market relative to say more extreme times and in other words do you see a lot more potential for widening spreads or are we already at a point, where the market's pressing and some strip pricing in some distress.
I mean, it's it's a good question I think again, we're not seeing significant change in the overall credit metrics in the portfolio that being said.
From valuation, we're generally working off April and May numbers, right and were getting geared towards the end of the summer. So I think the question will be what are the what are the Q2 and Q3 numbers look like some of these companies.
That's going to impact I think more potential stress in the portfolio than anything look the other thing it's difficult to call right. Now John is everything is widening because there is this underwritten on syndicated backlog of some pretty large transactions that the banks were trying to clear out and depending on how aggressive they are in clearing those you know you could set some pretty low.
Levels on price, which would imply very very widens spreads.
What other than I expect that potentially come back right as deal flow is I think a little bit lesser and you don't have this unfortunate backlog of things to to get to the market look I mean I think.
<unk> had a very low base rate environment with base rates going up.
Spreads typically only widen when you see defaults go up and again, we're not seeing that really this is in our market in reference to two I think the phenomenon of this summer and inventory trying to get cleared out. So we keep taking kind of a patient wait and see approach I don't have a great crystal ball on that one I wish I I wish I did.
But I think we're just taking a little bit of a patient wait and see approach as to how we get through the summer and into the fall.
Great. Thanks, very much for the color.
Thanks, John .
Our next question comes from Ryan Lynch of <unk>. Please go ahead with your question.
Yes.
Hey, good morning, everybody.
My first question is IV, Hey, Ivy Hill has been just an incredible asset for you all.
But my question is we've seen that have pretty considerable growth over the last.
Four or five years and really in particular, the last last couple of years.
The U S as well as the dividend growth at Ivy Hill.
So could you talk about one what is driving kind of the really accelerated growth that you guys have been achieving.
And Ivy Hill on the assets that are going into what is what are the sort of change in that marketplace to kind of have that accelerated growth recently and then also.
So obviously, you've done really well generate very high income, but it's also becoming a very large portion of your portfolio now I know, it's a very diversified kind of asset managers not like individual loan credit risk with that large investment, but is there any sort of size limitation at eight 5% of your portfolio. Today is there any sort of size limitation, where you guys say okay.
This is not we're not going to grow this anymore.
Yeah, I mean, there's not obviously, it's a judgment call it's been going up because they've done a great job, obviously managing portfolios of bank loan assets and the cash on cash return. If you think about the dividend relative to the total investment. We've made has been very consistent and very attractive over a long period of time.
Look when I see something that they had in the 5% of the portfolio at obviously begs the question, you're asking which is how large could it get should it get yeah.
We just did a very large transaction, they're obviously buying this portfolio from Italy, you know they took on a 1 billion plus dollars of assets, we made a substantial investment in the company.
A little bit of a needle mover for this quarter relative to others.
But for me and I would certainly pull the management team too for me, it's getting to be at the upper end right eight or 9% positions us probably.
Feeling pretty chunky that being said the underlying there is very diversified.
And we don't really have any concentration in terms of the dividend income coming from one particular investment there. So it's not something that's keeping me up at night, but it is starting to test.
The limits a little bit mentioned is going to jump in here too.
One thing I want to make sure you Im sure. It is the devaluation of Ivy Hill through a number of different mechanisms right as the management fee as an asset manager and we also invest in the subsets of a lot of the CLO and leveraged loan funds that we manage because it's such a tremendous return for ARCC.
Over our history I remember Ivy Hill has been around since 2010, we've had many times, where other third party equity investors have invested in and Ivy Hill. So if it ever came to a point and I agree with Kip its getting up to the upper levels, there's probably still room to grow but it never came to a point, we've always had the ability to sell equity and continue to invest in the assets that drive.
More of our business. So we have many levers to pull to moderate the size of Ivy Hill that's.
That's great.
Hopefully that makes sense that makes sense.
That definitely makes sense and again, it's been a great asset. It's just yeah, you know kind of warehouses holidays, you guys feel comfortable with that.
The other question I had and I really do appreciate the color that you guys gave on kind of the run rate and in the quarter from from kind of if you've reset interest rates for the full quarter of Q2, and then also kind of the overall 100 basis points at the end of the quarter.
Statistics show, you know and and and.
Kind of a forward LIBOR silver curve shows earnings are going to go up pretty meaningfully over the next several quarters likely and so when I look at the core earnings today and the potential increases in the future and then I look at your dividend that you have today and the one you've declared for the third quarter, even with a <unk> increase and then the three kind of spec.
Dividends you guys had at the end of the year.
Earnings look like they're going to be well above those combined when you kind of look at 2023.
Earnings potential and so can you remind us what what are you guys thinking as far as dividend policy is going forward is your expectation there just kind of pay out all of your earnings in the form of a dividend and how do you guys plan on achieving that.
Core dividends versus special dividends.
Yes, So I think we all agree with your analysis as you look forward, we think that we've got great positive earnings trajectory here.
With a much much higher base rate, we'd obviously been fighting.
Persistently low base rates for a long time took advantage as an issuer, but yes, we do pick up some very easy earnings going forward and look I'll just say Ryan you know, we never talk about dividends beyond this quarter, but we felt highly confident.
Our ability to increase the dividend this quarter.
And a couple that by saying we've also built a pretty substantial amount of spillover income as youre aware the company and I don't feel the need frankly to add any more to that number.
I could argue that number might even be a little bit high which is why we've been using it to pay a special dividend throughout this year. So we feel good about the earnings trajectory and we feel good about the.
The dividend, where it is today and potentially growing from here.
Okay I appreciate the time today.
Thanks for the question.
Our next question today comes from Kenneth Lee of RBC capital markets. Your line is open.
Hi, good afternoon, and thanks for taking my question.
You mentioned in the prepared remarks in terms of the internal credit ratings, you saw more upgrades and downgrades within the portfolio just want to get a little bit more details behind perhaps some of the key drivers behind the more of those upgrades. Thanks.
It's what you'd expect from I would say just generally all around good credit performance as we mentioned.
We had one.
Name that we had added to nonaccrual, which was a pretty pretty small number and well below sort of our historical average if you look but no. There you know, it's a large diversified portfolio Kenneth and I, there's nothing in particular to pull out there I'd say it was good credit performance all around.
You know a couple of equity gains I think in certain.
Areas that probably moved that number up a little bit.
But there's it's a pretty broad and diversified portfolio I don't think there are any big takeaways that are worth sharing.
Got you.
And just one follow up question if I may.
Wondering if you could talk a little bit more about or share your thoughts on how leverage could trend over the near term.
Just given all the activity out there so we we.
Yeah, we had a busier quarter the annually situation and the upside that Ivy Hill kind of got us to a point where are less.
Leverage is now at the upper end of our target range at about 123, I think times on a net basis.
Yes, frankly in a in a more volatile market like the one we're experiencing I'd like to have that number come down I think we all would that being said the ability to upsize that Ivy Hill.
And the ability to make that portfolio acquisition that we did was just too attractive. So we pushed the leverage to the upper end, but I think the goal longer term would be to be managing that down here in the third and fourth quarters.
Got you very helpful. Thanks again.
Thank you.
Yeah.
Next we have a question from Robert Dodd of Raymond James.
Please proceed.
Yeah.
Hi, everyone and yeah, congrats congrats on the quarter and the outlook.
Kipp, a kind of a bigger picture question.
Your size of your.
Bara has gone up a lot.
You've made comments about how there's a more stable businesses et cetera et cetera.
A question for.
Generally speaking I would imagine you get to almost $200 million EBITDA businesses. These are global businesses. The economic outlook right now to me it looks a lot better.
There's headwinds in the U S, but compared to Europe for example.
The the.
Clouds up the less dark.
So can you give us any color on.
How much of the end customer demand for some of these larger businesses comes from those international markets, where the economic outlook might be more trouble than do you have any.
Concerns on that front, obviously it showed up in the numbers yet because it's still more looking looking backwards. Again, then the offset is FX can help on that side as well.
And any color on that.
Yeah, I mean, it's a it's a good question you know and with the 400 named portfolio I can't say I can actually give you an answer we'd have to go back and dig through a lot of data for the most part despite the size of these companies. They are U S companies right you know that that's the primary focus of what we what we do.
Here, we've got a very large business over in Europe to but we choose to do that away from the.
The BDC, so certainly with you now.
Some of these businesses being large and global I share your concern as we think about risk management Europe does look.
More difficult I think to your point and then it does over here in the U S.
But just trying to get to the risk in the heart of your question. We don't see any unusual risks in our portfolio, where we're heavily weighted to Europe , because we tend to be in some larger companies than other bdcs. So but again, it's it we'd have to go pull through a whole lot of data to get you a really good answer on that.
I mean, just to follow up how would you a little bit less people.
S&P I think the estimate is 40 to 50 in the U S. Domiciled companies, obviously, but 40% to 50% of revenues are international do you have a ballpark estimate.
No you ballpark it maybe Yankee Stadium site assessment.
I would've thought I would ballpark guess it is.
I would guess that it is much much lower than that.
Right. If you think about the industries and the sectors that we're in you think U S health care companies software businesses et cetera, I mean, a lot of this business is getting done in the states Robert right. So.
40% in the S&P that that's a very large number I think relative to where I would even guess at our portfolio I would guess where it like a 10 relative to a 40, okay for your index.
Okay perfect.
I appreciate it.
Thanks for the question.
Okay.
Our next question today comes from John Rowan of Janney Montgomery Scott.
Please go ahead.
Hi, this is reshaping, but sure on behalf of John Rowan.
Where the unrecognized losses on directly originated loans or broadly syndicated loans.
Both I would assume.
Is there any way to get a better breakdown on either or is that just.
Altogether you're reporting.
Sure.
And we could we could probably go offline and pull that for you guys I don't have it at my fingertips I mean, the reality is most of what we're doing is directly sourced loans. We don't have a lot of broadly syndicated loans on on Arcc's balance sheet.
But the larger the larger borrowers right larger EBITDA companies, probably have quotes and obviously, we know what ignore quotes.
We look at.
Even in a thin market something that's quoted and will typically use that but again.
Theres not a significant focus at ARCC on broadly syndicated loans.
Alright, Thank you very much.
As a reminder, if you'd like to ask a question today.
Followed by the number one on your telephone keypad.
Our next question comes from Casey Alexander from Compass point.
Please go ahead.
Hi, Good afternoon. This is Casey Alexander on behalf of Casey Alexander.
[laughter] Oh geez just.
Wondering the.
You know this period of economic uncertainty or a potential recession that we may or may not be going into or already in.
Seems it's obviously far more telegraphed than the Covid recession.
And it allows you to do an analysis that said, 5% to 10% of your companies are in higher risk categories from inflation and supply chain impacts does the telegraphed nature of this particular cycle as we go into it give you a better opportunity to work with your portfolio.
Folio of companies and and and just give them a better opportunity to prepare for it by bolstering balance sheets, managing expenses and would it be your expectation that there would be a better outcome through this cycle of companies that are at a higher risk category than perhaps in the past.
I think it's a great question I think the simple answer is yes.
And as we're all looking at our Crystal balls.
This is a situation we have a team here that's been doing this together prior to even getting to areas 20 plus years. This to me feels like a very traditional although being influenced by different reasons.
Cycle, right, where you're going to have companies that are having more trouble operating and I do take your point when you look back at Covid that was very unpredictable.
Something that we've never experienced before that impacted portfolio companies in a way that we probably couldnt have expected on underwriting and the credit cycle prior to that for me and the GMC was really much more of a banking crisis right and something that was influenced away from traditional corporate credit. So we're taking.
Satisfaction that we've got a playbook to.
To handle.
More traditional.
Credit situation right.
So our deal teams in our portfolio management teams are obviously in regular contact with borrowers with private equity firms, but I think to your point everybody sees what's happening now and it's not happening.
So quickly that you can take.
Measured to mitigate and help companies operate through this right. It feels like a much more traditional credit cycle and we've got a very experienced team that I think knows how to navigate through that.
Alright, great. Thanks for answering my question I appreciate it.
Thanks for representing yourself.
[laughter].
And finally, we have a follow up question from Ryan Lynch of <unk>.
Your line is open again.
Hey, I just had a couple more follow up question. So I appreciate the time.
You mentioned earlier in your prepared remarks.
Turning to kitchen, new larger borrowers that would normally trying to the broadly syndicated loan market and now that those are.
Under under more stress that that you have the ability to underwrite some of those deals I know in the past.
Some of the deals that could have wanted the broadly syndicated loan market that maybe once the direct route I know in order to meet the yield profile. Sometimes you are participating in our second lien for those positions and you felt comfortable as such just because they were larger safer borrowers I'm just curious with the kind of the stress and the uncertainty with the broadly syndicated loan market.
As well as the increase in base rates. We've seen recently are you able to participate in more of these in more traditional first lien or unit tranche positions than you have in the past.
I mean, I think what we're seeing Ryan because the traditional sort of bank led syndicate in a first lien second lien or first lien sort of high yield issuances is just kind of really not there, particularly on the junior side I mean, the market I don't want to say is close but is it.
Is generally not operating very well around right at <unk> getting sold by underwriters to new investors. So whats happening is there is a desire in particular on the parts of private equity firms and doing LBO is to find partners that they feel can offer certainty of closing and the preponderance of some.
These larger unit tranches has helped solve that Brian .
That being said, we're trying to find the right balance between.
Extracting better terms and extracting higher fees. There is sort of one of the few games in town that are available for those types of transactions and the good news is we're able to to push it there, but it doesn't happen overnight.
But no nothing is different.
We're as well positioned as we have been in past cycles, where volatility comes in and makes the capital market's less reliable we become again more reliable, but youre right probably the only difference maybe as the numbers are a little bit larger these days because we're bigger.
A lot of our competition is bigger.
Mhm Okay.
That's helpful and then the last one I had was.
You know obviously you guys had put up very strong results I would say this quarter.
You know there was obviously the volatility in the marketplace book, but overall book value.
<unk> held up well and in non accruals are still pretty strong and well below your guys' historical average. So so very good results, but I think everybody in the BDC space at least BDC investors are worried about kind of what is the next 12 months look like from a credit quality standpoint, you guys provided.
A statistic in your slide deck.
Mentioned on the call, 16% EBITDA growth in your portfolio of companies over the last 12 month period, but I think the question, but I think a lot of investors have and I'm not sure. If you get this data from your portfolio companies you guys work on this do you guys get any sort of forecast from portfolio companies of what they are expecting from.
And EBITDA growth over the next 12 months you guys have any any sort of forecast that you guys provide because I think that is kind of the real crux and thats, what really I think investors are worried about what happens over the next 12 months in these portfolio companies.
Well I mean, I think there's some math, yes, I mean, that's obviously, what we're talking about all the time here Ryan.
No.
I share some concern on my truly worried I actually think that with <unk>.
Slower growth, which.
Which we will likely see again, because we're comping off some some COVID-19 numbers right. So there's a little bit of a nuance there, but yeah I would expect slower growth in the portfolio I think I've said publicly to we would expect defaults broadly will go up that being said, we've always been able to manage those aspects of the company.
Better than most.
So we feel pretty confident but yeah, I mean I share your.
I share your forecast for probably not as rosy a back half of the year as we've seen for the first four to six months of this year and probably a little bit tougher sledding, but.
Again, a traditional credit cycle, where to Casey's question. We can be out early we can be proactive with company is expecting a weaker second half it really doesn't keep me up at night.
That's kind of what we do here during periods of <unk>.
West certainty and more volatility as we obviously manage credit we try to minimize non accruals and losses and we pushed forward. So.
But I share your concern.
Others Okay.
Okay.
Okay I appreciate the follow up questions.
Yeah. Thanks Ryan.
Yeah.
This concludes our question and answer session I would like to turn the conference back later, Mr. Davis for any closing remarks.
No just thanks for everybody attending.
We're happy with the quarter and <unk>.
If you enjoy.
Hope you enjoy the month of August and get some time with your friends and your families. Because I think it's going to be an interesting one as we do we get positioned here for September and beyond but thanks again for attending today.
Ladies and gentlemen, this concludes our conference call for today.
If you missed any part of today's call an archived replay up the call will be available approximately one hour. After the end difficult. So August nine 2022 Goodbye am eastern time to domestic callers by dialing 868139 floors that are nice to me.
International callers by dialing Trustful Tuesday rifle five five.
Slide eight.
For all replays. Please refer to conference I'd number 71531 came.
And I'll correct replay will also be available on a webcast link located on the homepage of the Investor resources section of Ares capital website. Thank you for joining.
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