Ares Capital Corporation Q1 2023 Earnings Call
[music].
Good morning, welcome to Ares Capital Corporation's first quarter March 31, 2023 earnings conference call.
At this time all participants are in a listen only mode.
As a reminder, this conference is being recorded on today Tuesday April 25 2023.
I will now turn the call over to Mr. John still more managing director of Arris Investor Relations.
One moment.
Yeah.
Okay.
One moment, ladies and gentlemen, I'm experiencing technical difficulties.
[music].
Thank you.
Let me start with some important reminders comments made during the course of this conference call and webcast as well as the accompanying documents contain forward looking statements and are subject to risks and uncertainties. The company's actual results could differ materially from those expressed in such forward looking statements for any reason, including those listed in its SEC filings Ares Capital Corporation assumes no.
Obligation to update any such forward looking statements.
Please also note 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's regulation G, which include core earnings per share or core EPS.
The company believes that core EPS provides useful information to investors regarding financial performance because it's one method. The company uses to measure its financial condition and results of operation.
A reconciliation of core EPS to basic and diluted net income per share. 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 press release filed with the STC. This morning on form 8-K.
Certain information discussed in 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 representation or warranty with respect to this information.
The company's first quarter March 31, 2023 earnings presentation can be found on the company's website at Www Dot Ares capital Corp, Dot com by clicking on the first quarter 2023 earnings presentation link on the home page of its Investor resources section areas.
Ares Capital Corporation's earnings release, and Form 10-K are also available on the company's website.
I'd like to now turn the call over to Mr. Kipp, Davir Ares capital Corporation's Chief Executive Officer.
Thanks, a lot John .
Hello, everyone and thanks for joining our earnings call today I'm here with our co President Mitch Goldstein and court Schnabel, our Chief Financial Officer, Penni Roll, our Chief operating Officer, Jana Markowitz and other members of the management team.
I'd like to start the call by highlighting our first quarter results and then provide some additional thoughts on the economic backdrop and the market.
This morning, we reported strong first quarter results, our core earnings per share of 57% increase.
<unk>, 36% year over year, primarily driven by the benefit of higher interest rates on new investments.
On a GAAP basis, our earnings per share of 52 cents per share for the first quarter was driven by our strong core earnings and the relative stability in the value of our investment this quarter.
Both our core and GAAP earnings were well in excess of our regular quarterly dividend of 48 cents per share, which led to modest growth in <unk> per share to $18.45.
We're pleased with the results this quarter, especially when considering the relatively slow transaction environment.
First quarter saw a fair amount of market volatility driven by the uncertain direction of the economy. It would certainly exacerbated by the recent turmoil in the banking system.
We believe that the banks remain constrained on new activity due to concerns regarding both capital and liquidity, which we believe makes our broad range of flexible capital solutions, even more valuable.
We feel that the current environment is similar to a number of prior periods of market dislocation at or improve the opportunity set for direct lenders.
The current illustration of these dynamics as highlighted by the fact that 95% of the first quarter LBO financing new issuance was completed by private capital providers are market traditionally weighted towards the broadly syndicated channel.
Prairie capital similar periods of disruption have historically led to increased market share profitability and N. A V growth for the company.
Our strong market position is in part driven by the breadth of our origination capabilities and the and the experience of our team.
Since <unk> IPO in 2000 and for Ares management has continued to invest in the quality and growth of our direct lending platform focused on both sponsored and non sponsored companies.
And besides having what we believe is the largest U S direct lending team in the market with 170 professionals across the U S. We've also built deep industry expertise in areas like software.
The health care.
Financial services.
Consumer.
Sports media and entertainment and power and project Finance.
We believe that the scale and experience of our team positions us to be even more meaningful the more than 440 sponsors that we've transacted web and.
And to further build upon the 250 non sponsored borrowers that we financed and are nearly 20 years as a public company.
To this end, we've already seen a 14% quarter over quarter increase in the number of deals we evaluated during Q1.
Deal flow represents a broad set of industries.
By seeing the largest set of investment opportunities, we are able to make what we believe are the best relative value decisions when committing capital.
Our selectivity rate remains consistently low through cycles and is even lower as we take market share through volatile periods.
In terms of the new deal flow, our selectivity rate on new transactions in the first quarter. It was one of the lowest in five years.
The merits of our investment of our origination strategy and our rigorous focus on credit quality allows us to continue to invest in high free cash flow and recession resilient businesses and this supports our strong overall credit performance.
Despite the more challenging market backdrop, the overall growth and profitability of our borrowers continues to be healthy with a euro per year weighted average EBITDA growth rate of 8%.
This is in line with our portfolio of company EBITDA growth rate experienced over the past decade.
Additionally, the percentage of our portfolio that we believe is highly impacted by inflation remains consistent quarter over quarter and at manageable levels today.
With respect to non accruals, despite increasing modestly this quarter, our non accrual rate is meaningfully below our 15 year historical average and is substantially below the historical K B W. BDC average for the same time through year end 2022.
Our portfolio quality is also reinforced by the substantial amount of equity invested in our company's most often by large and well established private equity firms at.
At the end of the first quarter, the weighted average loan to value in the portfolio.
Including that through our junior loan investments, whose only 43%, which we believe gives us strong downside protection on our loans.
And we do have an expectation that a slowing economy will create more stress in the portfolio along with the rest of the credit markets broadly.
There are nearly two decades of operating areas you see we have a time tested playbook for successfully navigating periods of volatility and market cycles.
In collaboration with our core investment teams or portfolio management professionals focused on identifying problems early and developing strategies to maximize our outcomes.
These capabilities are central to our ability to deliver our industry, leading track record for credit performance since inception, which includes generating a 1% annualized net realized gain rate in excess of losses on our investments since inception.
This means that along with generating gains on many of our investments. We have also successfully minimize losses in the portfolio in more difficult times.
Underpinning our ability to navigate these periods of volatility is the strength of our balance sheet, we deleverage during the fourth quarter and we ended the quarter with a net debt to equity ratio below one one times.
We also bolstered our level of liquidity post quarter end by increasing or proactively extending out the maturities and over $4 $5 billion of committed bank funding relative relatively attractive pricing and terms.
Which is a noteworthy accomplishment given the recent banking turmoil.
This highlights our broad relationships with our banking partners, which we believe will become even more valuable.
Banks become incrementally more selective.
And with that let me turn the call over to Penny who'll provide some more details on our financial results and some further thoughts on the balance sheet.
Thanks, Ken.
For the first quarter of 2023, we had core earnings per share of 57% compared to 63 cents in the prior quarter and 42 cents in the first quarter of 2022.
We continue to see the benefit of the higher base rates on our predominantly floating rate portfolio in the first quarter of 2023.
Other interest and dividend income increased from both the prior quarter and the first quarter of the prior year.
This higher interest and dividend income in the first quarter was partially offset by lower capital structuring fees, given the slower origination environment.
On a GAAP basis, we reported GAAP net income per share.
For the first quarter of 2023 compared to 34 cents in the prior quarter and 44 cents in the first quarter of 2022.
Our higher GAAP net income per share in the first quarter of 2023 benefited from relatively stable portfolio of value during the quarter.
Our stockholders' equity ended the quarter at over $10 billion or $18 on 45 cents per share compared to $9 6 million or $18 40 per share.
In the prior quarter.
Our total portfolio at fair value at the end of the quarter was $21 1 billion down from 21.8 billion at the end of the fourth quarter, reflecting net repayments in sales from the portfolio.
The weighted average yield on our debt and other income producing securities at amortized cost was 12% at March 31, 2023, which increased from 11, 6% at December 31st 2022.
Eight 9% at March 31st 2022.
The weighted average yield on total investments at amortized cost was 10, 8%, which increased from 10, 5% at December 31st 2022, and eight 1% at March 31 2022.
Yields on our portfolio reflect the continued increases in interest rates.
Shifting to our capitalization and liquidity we ended the fourth quarter with a debt to equity ratio net of available cash of 1.09 times as compared to 1.26 times a quarter ago, reflecting net repayments in sales from the portfolio as well as the incremental accretive equity raises totaling.
$477 million.
We did during the quarter.
Our liquidity position remains strong with approximately $4 $9 billion of total available liquidity.
<unk> available cash and also pro forma for our post quarter end that capital activities.
The beginning of this year through today, we have remained very active in ensuring we continue to maintain what we believe is the best in class capital structure by extending approximately $4.6 million of revolving debt commitments, which include increased commitments of over $200 million.
These extended maturities increased the weighted average duration of our secured revolving credit facilities from three six years at March 31, 2023 to four three years today.
We are very appreciative for the support we have received from all of our capital providers, whose continued long term commitment to ARCC or one of our key competitive advantages.
We believe our increased and significant amount of dry powder.
That's well you continue to support our existing portfolio of company commitments as well as investing in new opportunities in the current investing environment.
Okay.
With respect to our dividend we declared a second quarter 2023 dividend of 48 cents per share. This dividend is payable on June 30, 2023 to stockholders of record on June 15, 2023, and is consistent with our first quarter 2023 dividend.
We continue to consider our taxable income and the amount of spillover when setting our overall dividend.
Our current estimate of undistributed taxable income, sometimes referred to as our spillover at.
Year end 2022 is $650 million or approximately $1 19 per share.
This 2020 to spill over in lateral is nearly two and a half times greater than our current regular quarterly dividend rate.
We continue to believe that having a healthy level of spillover income is beneficial to the long term stability of our endeavor.
Yeah.
We will continue to monitor our undistributed earnings and balance these levels against prudent capital management considerations.
And with that I would like to turn the call over to Mitch to walk through our investment activities for the quarter.
Thanks Penni.
I'm going to spend a few minutes, providing more detail on our investment portfolio performance for the quarter.
And then provide an update on our post quarter end activity and our backlog and pipeline.
During the first quarter, we funded $1 1 billion of new investments across more than 30 transactions, primarily and resilient service industries as middle market sponsors and businesses continue to value Ares as a consistent and reliable source of capital.
Underscoring the breadth of our coverage of the EBITDA for the companies, we finance in the quarter ranged from approximately $20 million to over $400 million.
As a result of a constrained capital environment, the competitive dynamics and risk reward environment continues to be as attractive as we have seen in quite some time.
Market lending spreads continue to be approximately 100 basis points higher year over year with its historically strong lending documents alongside lower leverage levels.
Typically our new first lien loan investments in the quarter had a weighted average yield in excess of 11% and were levered less than four times debt to EBITDA.
Additionally, we were lead arranger on 85% of our originations in the first quarter the ability to be transaction is an important benefit of scale that we provide to our trusted relationships and borrowers. We believe being lead provides us greater control over capital structures pricing and documents and longer term better tools.
To drive successful credit outcomes.
Even though the new deal activity remains slow we believe the size and quality of our incumbent portfolio drives differentiated access to attractive investments as we have often said we benefit from originations, where we have incumbent relationships and this quarter was no different as over 80% of our transactions were to existing borrowers.
The breadth of our investment portfolio provides a compelling opportunity to invest in what we believe are our strongest companies.
We believe the portfolio continues to perform well and remains defensively positioned due to our long standing focus on market, leading companies with high free cash flows and what we believe are resilient industries.
We have also emphasized portfolio diversification, which reduces the single name risk in the portfolio or $21.1 billion portfolio at fair value is diversified across 466 companies in 25 different industries. This means that any single investment accounts for just 2% of the portfolio on average.
Our largest investment at any single company, excluding SDLP and Ivy Hill is just 2% of the portfolio.
Our portfolio also benefits from its weighting towards larger borrowers the weighted average EBITDA of our portfolio was 294 million at the end of the first quarter and that is up from 275 million last quarter and $173 million last year.
Quarterly increase was largely driven by the organic growth and M&A activity and our portfolio of companies and further underscores the momentum from our upper middle market companies.
While we maintain broad coverage of the entire market recently, we are focused on companies in excess of $50 million in EBITDA, and we believe that positioning pays off and its performance company.
Companies in our portfolio with EBITDA in excess of $50 million are growing faster and companies with less than $50 million of EBITDA.
The resulting health of the portfolio as demonstrated by our stable weighted average portfolio grades 3.1, and our collection of 99% of contractual interest from our portfolio during the first quarter.
While our portfolio companies are not immune to the inflationary environment.
As Kipp described the percentage of the portfolio. We estimate that is highly impacted by inflationary risk remains at manageable levels of between five and 10% of the portfolio.
It is important to note that we have minimal to no exposure to many sectors that are highly impacted by inflation that remained prominent in the broadly syndicated loan market industry.
Industry, such as packaging and paper capital goods gaming and chemicals were highlighted by a recent bofa credit research note is being heavily impacted by rising input cost, but we have consciously underway to these industries.
Our non accrual rates continue to be well below historical levels, our non accrual rate at costs ticked up modestly to.
2% to 3% from one 7% last quarter, but remains well below our 3% 15 year history average and the K B W. BDC average of three 8% at the same time through year end 2022.
Finally, I will provide a brief update on our post quarter end investment activity and pipeline.
From April 1st through April 19, 2023, we made new investment commitments totaling 369 million of which 311 million were funded.
We exited or repaid on $397 million of investment.
As of April 19th our backlog and pipeline stood at roughly $500 million.
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.
While it has been a pretty slow start to the year even for the typically seasonally slow first quarter. We do think that things should pick up in a regular course I will now turn the call back over to Kip for some closing remarks.
Thanks Mitch.
In conclusion, we are monitoring the potential for economic challenges that may lie ahead, but we believe that we are well positioned to navigate these conditions.
Our team has an approximately 20 year history together managing assets in a variety of economic situations as a public company.
Our confidence is supported by what we believe are our many long term competitive investing advantages the strength of our balance sheet and the defensive positioning of the current portfolio.
In addition to these advantages the tightening availability of corporate credit from the banks and the liquid capital markets as the only enhancing our competitive position.
We believe that our ability to deliver a flexible capital solution with scale and certainty leaves Ares capital well positioned to continue to grow share in a challenging yet expanding market opportunity.
As always we appreciate you all joining us today and we look forward to speaking with you next quarter and with that operator, we can open the line for questions.
Thank you.
Time will be conducting a question and answer session. If you'd like to ask a question you May press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue you.
You May press Star two if you would like to remove your question from the queue.
For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Please note a courtesy to those who may wish to ask a question. Please limit yourself to one question and a single follow up.
If you have any 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.
Our first question comes from the line of John Hecht with Jefferies. Please proceed with your question.
Morning, guys. Thanks, very much for taking my questions.
Just first one as you know John .
Hey, how are you are.
You know benefiting from a rising rate environment and the forward curve suggests that things may change in course of the next few quarters. Do you is there anything you guys can do whether it's kind of liability structuring or odd even if hedging of of some type where you could try to kind of protect yourself at a declining rate environment.
Yeah, I mean, I'm looking at Penni and I'll give you my opening answer which is we've tried to have a mix of obviously senior unsecured both floating rate and fixed rate liabilities, John so having sort of a balanced view of how we want to construct the liability side of it but on the hedging front, there's not a tremendous amount we can do that's particularly economic.
Today, the cost of hedging is pretty high.
And I take your point look we we do a lot of modeling forward.
The company and one of the things that we notice is the LIBOR curve tends to move around a lot.
And and often.
So.
It's something that we're keeping our eye on but I don't think there's a lot we can do about it today. Unfortunately.
Okay. That's that's helpful. And then just looking at I mean, obviously you talked about your EBITDA trends. You mentioned you noted a little bit of flows within your nonperforming asset buckets, I mean, but it seems I mean are you seeing anything.
That suggests there's a shift going on I mean, I know you guys have been generally defensive in your industries any ways, Barry even even like all else equal or are you seeing any shifts at this point or just sort of preparing for what might be coming generally speaking.
Yeah, I mean, I think we're I think we're cautious.
The question that I'm getting that we're all getting a lot as you know how does how does credit quality in the portfolio look today and the answer that I've given in and most of the meetings that we've done before this call today has been if you look at the overall credit metrics in the portfolio, they're actually quite strong today right, you're seeing year over year EBITDA growth.
Youre seeing good interest coverage youre seeing non accruals that are below historical averages again, when we look at the weighting of the portfolio and are ones and twos, which are the weaker names it's come down substantially since COVID-19. So all the credit metrics today are actually quite good does that mean that we think everything is rosy.
The remainder of the year is going to be you know not a little bit bumpy now I think we're preparing for a slower economy and the fact that companies have higher debt service costs, because the base rate environment. So.
But today as we sit here on the call that the credit metrics are holding up quite well.
Great guys, thanks very much.
Thanks, John .
Our next question comes from the line of Finian O'shea with Wells Fargo. Please proceed with your question.
Yeah.
Hi, everyone. Good morning.
On the opportunity for for upping lending terms two to market the add ons or amendments I think you touched on that what.
A portion of the portfolio would reflect that.
The economics of the more recent environment.
Hello.
I'm not sure I have that number.
Off the top of my head there I mean look the reality is we're doing incrementals and add ons to existing deals yeah, and I'm looking at credits tends to be small relative to what's outstanding right. So a bigger driver will be frankly, I think amendments on you know entire tranches of something that perhaps.
Isn't performing as expected so I don't I don't know offhand I'd have to guess it it's 10% to 20% of the portfolio, maybe but it's really just a guess I mean, Corey you can chime in with.
Might I might guess it could be a little bit higher because you have to remember even if we provide any incremental that is somewhat small we have MFN protections in a lot of our documents.
That allow us to reprice, our existing tranches to current market environment.
Despite the fact that we're only providing some small incremental capital so thats a nice effective tool.
To bring the portfolio up to market, so maybe it's a little bit higher.
If I could Scott Scott again, I said at the guests Yeah, it's definitely not 50% right I mean, most of what Youre seeing in the earnings really is the base rate right and as the portfolio cycles, and we're doing more new investing in new deals, which obviously have the base rate benefit and wider spreads that number will start to go up but again coordinate.
I think are both just guessing and then to give you to give you a guess that's our guests. We just don't have that number off hand, and I guess the other point to make is the base rate has accounted for the majority of the increase in overall yield.
More so than spreads so spreads are probably 20% or so the increase versus the base rates. So we're benefiting naturally.
Across most of the increase.
That's very helpful. Thank you.
Sort of a related follow up is.
The sort of activity can lead to more pik interest is is there a sort of upper bound you managed to work or can tolerate as a percentage of revenue or NOI.
In terms of pick income thank you.
Okay.
Yes, I mean, I think we were uncomfortable.
You know back during the Covid period.
All I would say around the Pic number we actually had pretty significant pick interest collected this quarter. So if you actually went through and you said what percentage of the total income today.
Is tickets, you know a little bit more than 15%.
We feel comfortable with that number.
I don't think going back a couple of years frankly.
Frankly, we felt as comfortable.
With a number into the Twenty's, which is where we were during COVID-19 and we had pretty explicit guidance to everybody that our goal was to manage that down.
We've done that successfully so I don't know if we're at the upper limits today, Theres, probably a little bit of room from here.
But most of the pick that we would I think take on on a go forward basis would be with perhaps an increase in amendment activity. If we have that and we'll just see where the rest of the year and maybe next year. It takes us.
Great. Thanks, so much.
Thanks for the question.
Our next question comes from the line of Melissa Wedel with Jpmorgan. Please proceed with your question.
Thanks, very much I appreciate you taking my questions today I'm curious.
On the thing, but particularly around borrower behavior.
For those folks who are.
Getting to a point of stress or challenge that maybe aren't quite at a nonaccrual stage yet.
Are you seeing them, having a flexibility to take cost out of there.
Their P&L at this point or do you feel like the actions have already been taken.
I mean, I'll, let Kirk give his opinion look I mean, I think one of the things that we reminded people about coming out of Covid was a lot of these middle market businesses right didn't didn't have room to not take a tremendous amount of cost out of their business and I think if you talk to a lot of the Ceos in our portfolio they would see.
Covid forced them to run a much tighter ship a much better business.
We haven't seen that we got asked a question last quarter about you see lots of layoffs in D. C slowing growth what do you make of large company lay offs and I would say the middle market companies have been experiencing that inflationary pressure for a while coming out of COVID-19 some of the issues around supply of.
People and frankly, the cost of your wages of people such that they've been pretty proactive taking cost out of the business for the last couple of years right.
I don't think there's a tremendous amount of margin there for them to recoup as my own opinion in court can provide his in terms of what are you seeing day to day I think a lot of it's already been done Melissa I think you know.
Yes, the economy really gets into a.
Tremendously difficult position, which is kind of not what we're forecasting and folks have to really take another cut at that.
Bank management teams today are trying to operate through the existing environment with an understanding that some of them have had some margin pressure in their business.
The bigger problem for them frankly is and a lot of situations companies that are actually performing fine.
And just to have a significant had significantly less cash flow because of the fact that they you know in our portfolio and many other leveraged finance portfolios have a fair amount of debt in base rates went from 1% to 5% and Theres just less cash around.
Yeah, I mean, you have to remember.
So far the overall portfolio is still performing quite well from a fundamental standpoint, I think we said it in the prepared remarks, LTM EBITDA is up 8%.
Year over year, so to <unk> point, its theres some constrained from interest rates.
Rising from a liquidity standpoint, but you're right. If your EBITDA is up 8% year over year. Your inclination probably isn't all I need to go costanza costs right. It's much more about that service and it is about cost cutting and a lot of these a lot of these companies in our portfolio have a nice buffer from a liquidity standpoint in terms of cash on the balance sheet or Andrew.
Undrawn revolvers and you have to remember 90% of our borrowers are supported by financial sponsors and we've seen a nice history of sponsors supporting their portfolio companies.
And we expect that to continue.
That's really helpful.
Follow on to to your point about.
Interest rate sensitivity.
There was a very brief period during March where we saw base rates.
A little bit lower and they're not promptly reverse but I'm curious about how responsive portfolio companies are able to be or have been in.
Choosing that moment to reset the base rate for the quarter ahead.
Notable that you saw during that very short period.
Yes.
Most of the companies in our portfolio have the ability to make one or three month elections. So some of them will hop between a one month election on a three month election, if they have a strong view as to what's going on with the short term rate, but it's not a it's not a real driver.
I think as.
As a consideration for most months.
Thank you.
Yes, Thanks a lot.
Our next question comes from the line of Casey Alexander with Compass point. Please proceed with your question.
Hi, good morning.
Thanks Brooks.
I really want to kind of drive into a little bit of what feels a little bit like a mixed message.
In your prepared remarks.
Scribed, a great environment for putting out new capital with excellent terms excellent conditions excellent yields.
And at the same point in time.
Acting you know defensively at the same time and so what I'm trying to figure out is do you anticipate.
Taking leverage down further before becoming more offensive.
And is it because you potentially see a period ahead with potentially material spread widening where you could really put money out at some incredible rates terms and conditions.
Okay. So if it makes you feel good I did look at the note that you've published this morning, while I was waiting for the train size I anticipated your question.
I would tell you that the the lesser activity.
Was more driven by the fact that there just was not a lot of deal flow in the quarter.
Activity levels were very light.
Your point on defensive positioning I would say two things I'd say number one we did have a stated objective to deleverage the balance sheet modestly, which we accomplished and that's one way to do it.
The second point was to your last comment I do think that we don't think the environment for investing in high quality companies at really attractive rates of return is going away anytime soon.
So we probably took a pretty patient approach to the quarter that being said you know we had a couple of transactions that we're excited about that there are obviously reporters reporting on that fell away.
So more than anything it was just a light activity quarter that drove that.
Okay great.
Secondly, and this is more technical my follow up.
I noticed that the excise tax.
Well you.
$16 million quarter over quarter did you guys defer some of the excise tax or are you or are we looking at a new kind of level of excise tax going forward, that's lower than it was in the past I'm just curious at that specific number.
No I'm actually this is the our tax expense has two component parts. One is corporate level taxes, where maybe we have some corporate level tax expectation around realized gains batter.
Batter in blockers, but we also have the excise tax. So if you break down the components, we actually had a reversal of some corporate level taxes that we had estimated in Q4 that we realized weren't going to be at the level, we expected none of them carry them out, but it's driving down the net number so the excise taxes still Eddie.
Level that we believe we will have a strong level of spillover going into next year, if you break down the pieces.
Okay alright, thank you.
Thank you. Our next question comes from the line of Kenneth Lee with RBC Capital markets. Please proceed with your question.
Hi, good morning, and thanks for taking my question.
Just one follow up on the the relatively subdued portfolio activity in the quarter end and the expectation that that you could see a pick up.
As the year progresses.
How much of that pick up.
It could be driven by either a pick up in M&A activity or other factors are realizing that a good portion of your origination volumes, our ARPA pin up more on an incumbent borrowers.
Yes, we're hoping it's a little bit more from a pickup in M&A activity.
And.
We're starting to see some initial signs.
Very early but some initial signs that that might occur now that there's a little bit more stability and less noise.
In the market.
<unk>.
We haven't seen a lot of volume obviously this year, but the volume that we have seen has been very high quality companies because those are the kinds of companies that.
Are able to transact in this market. So that's.
One piece of good news.
And but you certainly should expect us to continue to see backing our existing portfolio companies.
As if the environment stays light sponsors certainly you're going to be focused on tuck in M&A as they had been in the first quarter.
So it should be a mix of both but.
Again, we are starting to see some early signs of new M&A.
Got you very helpful, There and and one follow up if I may.
And in terms of the new investment commitments.
You highlighted in the release for for April .
I noticed there was a pickup in terms of fixed rate investments as part of the mix.
Wondering if that's due to the outlook for rates or whether there are any other factors at play there. Thanks.
I think it's just an anomaly of April I mean to be honest nothing strategic to take away.
I'd have to go back through what the April pipeline backlog actually.
Yeah.
It came through but no nothing nothing material or interesting going on there.
Got you. Thank you very much.
Our next question comes from the line of Mark Hughes with Truest. Please proceed with your question.
Yeah. Thanks, good morning.
Good morning.
The the activity in the first quarter and then in April a little heavier in the first lien.
Is that a more defensive as the.
More attractive relative to that.
Second lien.
Yeah, I would say that the court made the point about M&A picking up the predominance of new deal activity I would say that we're working on has been built around <unk>.
Hansen with direct lending providers right, we said about 95% of the deals done in Q1 got done away from syndicated markets, which.
Kind of inclines borrowers to not participate in first lien second lien deals. So the preponderance of what we've been working on and I think the market is seeing generally has been unit tranche floating rate senior secured unit tranche deals that's really what's leading the way.
So.
That's it.
And then.
Looking at interest coverage.
Take one seven times for Q1.
If you model that out is that.
About the bottom if we look at the.
Forward curve and depending on what happens with the economy.
Uh huh.
About as bad as it gets or lows again.
Yes, I mean, it's hard to it's hard to predict because it's so specific to where you what the direction of travel is do you think on rates.
Right.
We still as we mentioned, we see pretty good underlying company performance. So I think that number is going to be driven by rates. If your if youre playing off the forward LIBOR curve it should improve from here right everything else held equal.
Yes, running running the forward LIBOR curve through our model it does bottom out at one point Kevin.
Very good thank you.
Thank you. Our next question. Our next question comes from the line of Paul Johnson with K BW. Please proceed with your question.
Yes, good morning, guys.
Only one question, maybe two parts to this but.
Ivy Hill has grown to be a fairly large part of the portfolio I believe it's about 11% this quarter.
And a large part of this growth and the income from that investment come from the growth in investment income versus the management fees from Ivy Hill, but I was kind of hoping that maybe.
Sense of how you view the risk of that investment I guess versus your <unk>.
Current portfolio and how you would expect that to perform over a choppy or credit environment in the second part of that question as well just what the current environment for that business.
If thats potentially something that benefits from people looking to utilize more of their balance sheet or CLO issuance et cetera, any thoughts there would be.
Interesting here.
Yes.
Let me give you the short answer and then I'll give you a slightly longer answer but the short answer is.
We remain very optimistic about our investment in Ivy Hill, it's been a great performer for us for a 15 year period. It delivers what we think are unbelievably attractive returns.
Returns relative to the risk.
Again, we've talked about this in the past, but it literally generated a roughly 15% IRR to ARCC over a 15 year period with almost no.
Bliss.
We provided a little bit more financial disclosure on it so people could understand it but I will say one other thing theres a belief here that we're investing in a CLO business, which is really not the case anymore. Most of Ivy Hill's investments today are actually in bilateral loan funds and only about 25% of the AUM that they invest.
Today or in traditional CLO is that half.
Securitization that are.
Reminiscent of of Cielo is the other thing that's important is it's a middle market bank loan asset manager that tends to be materially less levered, both as a company as well as with its underlying funds than the competitors you might be thinking they compete with so.
It's a big investment for Us I don't expected frankly to grow from here because I have some of the same thoughts around.
Concentration both as a percentage of the outstanding assets as well as the outstanding income that comes from Ivy Hill I think it's reached its limit for the time being.
Until the company continues to grow but we feel again extraordinarily good about the.
The dividend at Ivy Hill, and the cash flows that come from that investment.
We run a lot of sensitivities.
We spent a lot of time with them thinking about what a.
More uncertain market could mean for them and I feel that we battle tested all of the assumptions such that I feel great about it.
That's great. That's a lot of very good detail on there. That's all from me. Thank you very much.
Thank you.
As a reminder, it is star one to ask a question. Our next question comes from the line of Robert Dodd with Raymond James. Please proceed with your question.
Uh huh.
On the kind of top one construction fees this quarter obviously.
Hello.
Oh gross fundings, but also a lower rate on that.
Is that can we just leave it there.
He is obviously about 25% of what you funded this quarter with Ivy Hill, probably doesn't get a fee on that 80% was followed ones. So so sometimes you don't necessarily see big structures. There I mean should we should we look at this quarter as kind of a one off because of the mix of deployments this quarter on those.
He's going to be structurally lower going forward at least at call it a bottom but yes.
I'm going to.
All I'd say, yes, Ravi I appreciate the question thing I mean, it's lower certainly because of Ivy Hill right. So if you back out the Ivy Hill investment, where we don't take origination fees. It's more in line with historical as you know it's around 2%.
But I'll, let <unk> comment on he's in the market, which I think have gone up a little bit.
Well versus last quarter, probably flat, but up versus a year ago.
But nothing's changed this quarter, you shouldn't read into that as meaning anything has changed in the market.
Probably the most important factor is the funding to existing portfolio companies being such a big percentage, but the other thing is also in the in prior quarters. We've done some very large transactions and large transactions often come with higher fees and if we're able to syndicate a piece of those larger transactions done.
The effective fee rate on our final hold is going to be even higher.
Versus this past quarter, where we didn't benefit from that so those are some of the other factors.
Got it thank you.
Thanks Robert.
Our next question is a follow up question from Casey Alexander.
From Compass point. Please proceed with your question.
Hi, Thanks, very much for taking an additional question I am just wondering.
If you could contour.
<unk>.
The larger usage of the ATM program during the quarter 13 million shares is way more than you guys have done in any particular quarter and usually things like that are associated with a high level of investment activity and yet your investment activity in the quarter was relatively muted. So I was just wondering if you could contour that for us.
Yeah.
Yeah, I think it's look I mean, it's there to obviously take advantage when.
When we think they are advantageous periods to issue in small amounts.
More than in the past, but I think relative to the company's overall market cap not particularly.
Substantial some of it was the point Casey that you made in your prior question about being defensive and yes. Some of it came early in the quarter. When we actually did have higher leverage and we're looking to deleverage a little bit but.
Probably more of that than the new investing I guess the only other thing I'd say is we did as I mentioned I have one or two larger transactions in the quarter fall away.
And my guess is we're capital planning for those and thinking about ATM issuance. We were planning on obviously participating in a couple of transactions that fell away I guess to your point also around defensive and offensive I mean, we were.
Really constrained in our ability to capitalize on the current market environment. When we were at one five times leverage at the top of our range. So in order to be offensive.
We sort of felt the need to delever a little bit.
So now we're in a nice spot, where we can be more opportunistic.
Alright, great. Thank you for taking my question I really appreciate it.
No problem.
Our next question comes from the line of Erik Zwick with Hovde Group. Please proceed with your question.
Hi, Good morning, everyone. Just a quick question.
The press release indicated about 88% of the new loans contained interest rate floors, and I think you've been pretty consistent over the past few quarters, having said that it's getting interest rate floors curious if that floor, if you'd been able to move that up as the interest rate environment has gone higher and curious if you could maybe give kind of give an average rate of what it.
It was in.
In the first quarter.
Yeah. Good question that we are.
Trying to move that floor right up to the best of our abilities and having some success, but not a huge amount of success just because obviously the market is the market in <unk>.
Not everyone is pushing maybe as hard as we're pushing but.
Back to the earlier question around how do you mitigate potential decreases in interest rates in the future certainly that's that's one effective way and we are we are trying our best but I'd say, it's any movement that we've been able to achieve across the overall portfolio is very small.
Got it understood and are you able to ballpark it all kind of what maybe the average floor was for our new originations in <unk>.
Yeah.
Yes, it's around 1%.
Okay, great. Thanks for taking my question.
There are no further questions in the queue I'd like to hand, the call back to Mr. Kip Davir for closing remarks.
As usual I don't have any.
But I'll thank everybody for their participation on the call and the good questions and we will look forward to.
Being in touch with you all.
And the call next quarter have a good day.
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