Q2 2023 Ares Capital Corporation Earnings Call
Good morning, welcome to Ares Capital Corporation's second quarter June 32023 earnings Conference call. At this time all participants are in a listen only mode. As a reminder, this conference is being recorded on Tuesday July 25th 2023.
Now I'll turn the call over to Mr. John Zillmer, managing director of Investor Relations.
Yeah.
Thank you very much 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 efficacy.
Finally areas.
Ares Capital Corporation assumes no obligation to update any such forward looking statements.
Also note that past performance or market information is not a guarantee of future results. During this conference call. The company may discuss certain non-GAAP measures as defined by SEC regulation G. Such as core earnings per share of core EPS.
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 are.
A reconciliation of GAAP net income per share the most directly comparable GAAP financial measure to core EPS can be found in the accompanying slide presentation for this call. In addition, a reconciliation of these measures may also be found in our earnings release filed this morning with the SEC 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 such representations or warranties with respect to this information the company second quarter ended June 30th 2023 earnings presentation.
It can be found on the company's website at Www Ares Capital Corp, Dot com by clicking on the second quarter 2023 earnings presentation link on the homepage of the Investor resources section of our website.
Ares Capital Corporation's earnings release, and Form 10-Q are also available on the company's website I'll now turn the call over to Mr. Kipp severe Ares capital Corporation's Chief Executive Officer Kip.
Thanks, John .
Hello, everyone and thanks for joining our earnings call today.
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 by highlighting our second quarter results and I'll follow that with some thoughts on the economic environment and the current market.
This morning, we reported strong second quarter results, our core earnings per share of 58 cents.
Greece, 26% year over year, primarily driven by the benefit of higher interest rates on new and existing investments our GAAP earnings per share for the quarter were 61 cents driven by our strong core earnings and a modest increase in the overall value of our investment portfolio.
These results led to another quarter of sequential growth in our net asset value per share to $18.58.
We are pleased with these results and we think it's important to put them in the context of what we're seeing in the broader credit markets.
Over the past two decades direct lenders have demonstrated their ability to be a stable source of capital supporting the growth of U S companies, even when bank and syndicated capital markets are volatile and hard to access.
More recently this trend has accelerated and direct lenders such as areas of stepped in to fill the void.
Although second quarter transaction activity remained slower than recent history. It picked up compared to the first quarter and affirming tone of the capital markets is an important step towards greater M&A deal activity.
Importantly, we are seeing direct lenders gained significant share is 85% of new issue LBO financing in the U S was completed by direct lenders.
And less volatile market. This percentage would typically be lower and transactions, particularly the large deals would be more heavily weighted towards the broadly syndicated bank loans and high yield markets.
Direct lending also continues to be increasingly active away from the OBL market is direct lenders completed one and a half times as many non buyout financings as the broadly syndicated market during the second quarter. According to data by L. C D.
As it relates to our business the number of deals we were be it in the second quarter increased 20% over the first quarter. This includes certain incumbent portfolio of companies seeking incremental financing opportunities, which provides us with a steady source of differentiated originations.
Overall, we're sourcing many compelling transactions and we're cautiously optimistic that a recent pickup in activity will translate into a higher level of closed transactions.
During the second quarter market pricing and terms continue to be highly attractive as it relates to our new deals.
And our new loans are well above historical averages leverage levels are lower and equity contributions or higher.
Similar to the existing portfolio most of our new investments are floating rate deal did benefit from higher base rates.
Market data provided by LCD underscores our view that the current vintage of buyout transactions has the highest level of equity support of any time in history.
At the same time the risk adjusted returns in our lending business are historically very attractive spread per unit of leverage which measures returns relative to risk our 15% better than the 10 year average we.
We believe the current vintage ranks as one of the best for our lending business in the past 10 years.
Within this attractive and growing market, we continue to enhance our leading market position, we believe our large and long tenured U S. Direct lending team of 170 investment professionals delivers a compelling brand in the market and this provides us with many intangible benefits, particularly in sourcing.
Given the impact of our participation in the value we add in transactions. We believe we sometimes get more looks on new opportunities and have an ability to negotiate preferred terms with our counterparties.
In recent periods, we've taken additional steps to further support our sourcing and credit advantages.
Expanding on our extensive sponsor and non sponsor coverage over the past five to 10 years. We've continued to develop a significant amount of industry expertise specifically in software and technology specialty health care financial services infrastructure, and power and sports media and entertainment to name a few.
More recently, we've formalized these industry specialization screening eight dedicated industry teams and enhance the significant sponsor and non sponsored coverage that we enjoy today.
We believe that formalizing. These teams has further contributed to the strength of our process and our risk management capabilities and made us an even more compelling partner for sponsors and for portfolio companies.
Despite companies dealing with higher borrowing costs, we believe corporate fundamentals remain solid perhaps stronger than we would've expected our portfolio of companies continue to perform well and we see no evidence of what many believe is an imminent recession.
Credit quality has been stable and inflationary pressures have begun to show some easing.
Our weighted average portfolio grade is flat quarter over quarter and slightly better than our 15 year average.
Our non accruals at cost decreased slightly and remained well below our own and BDC averages over the past 15 years.
Despite the construct constructive view that we maintain on the economy and the portfolio. We are paying particular attention to the cash flows out of our portfolio companies EBITDA continues to grow nicely as Cort will describe in our portfolio interest coverage ratio remained relatively stable quarter over quarter.
While some market participants are calculating interest coverage ratio test using actual interest expense over the past 12 months.
Don't necessarily think is particularly relevant we calculate the ratio using pro forma annual interest expense using market rates at quarter end.
If we instead there'd be calculation using the actual interest expense over the past 12 months, our portfolio interest coverage ratio would've been 30% higher than the second quarter or approximately two one times.
The loan to value in our portfolio continues to be conservative and at quarter end, we estimate it to be around 43%.
Significant invested capital and value beneath us in most capital structures a lot of it supplied by large and well established private equity firms with whom we have great relationships and do repeat business with.
Continue to believe that a lot of the focus should and will be on the behavior of our partners who own the equity in these businesses and we would expect solutions for companies needing assistance to come from a partnership approach between lenders and these partners if history is any indication.
So as a result of these dynamics and the company's overall performance feel confident about the results we were able to deliver for the second quarter and our competitive positioning going forward with that let me turn the call over to penni to provide more details on our results and our strong balance sheet position.
Thanks, Ken for the second quarter of 2023, we had core earnings per share of 58 cents compared to 57 cents in the prior quarter and 46 cents in the second quarter of 2022.
We continue to see the benefits of higher base rates on our predominantly floating rate portfolio in the second quarter of 'twenty twenty-three as our interest and dividend income increase both from the prior quarter and the second quarter of the prior year.
Our income was bolstered by higher capital structuring fees as compared to the prior quarter. Despite a generally continued slower origination environment in the quarter.
On a GAAP basis, we reported GAAP net income per share of 61 cents for the second quarter of 2023 compared to 52 cents in the prior quarter and 22 cents in the second quarter of 2022.
Our higher GAAP net income per share in the second quarter of 2023 benefited from modestly higher portfolio values during the quarter.
Our stockholders' equity ended the quarter at nearly $10 $4 billion or $18 58 per share, which is an approximate 1% increase in NAV per share over the prior quarter.
Our annualized return on equity this quarter was greater than 12.5%, whether one measures that's on a court or a GAAP basis.
This strong level of profitability further builds upon our long term track record of a 12% GAAP based annual return on NAV since inception.
Our total portfolio at fair value at the end of the quarter was $21.5 billion up from 21.1 billion at the end of the first quarter, reflecting net fundings from the portfolio.
The weighted average yield on our debt and other income producing securities at amortized cost was 12, 2% at June 30, 2023 which increased from 12% at March 31st 2023, and nine 5% at June 30, 2022.
Weighted average yield on total investments at amortized cost was 11%, which increased from 10.8% at March 31, 2023, and 8.7% at June 32022.
Yields on our portfolio reflect the continued increases in interest rates.
Shifting to our capitalization and liquidity we ended the second quarter with a debt to equity ratio net of available cash of 1.07 times as compared to 1.09 times a quarter ago.
Our liquidity position remains strong with approximately $4 $7 billion of total available liquidity, including available cash.
We believe our significant amount of dry powder positions us well to continue to support our existing portfolio commitments to remain active in the current investing environment and to have no refinancing risk with respect to next year as term debt maturities.
We declared a third quarter 2023 dividend of 48 cents per share, which marks the 56th consecutive quarter of steady or increasing dividends.
This dividend is payable on September 29th 2023 to stockholders of record on September 15th 2023, and is consistent with our second quarter 2023 dividend.
With that I would like to turn the call over to court to walk through our investment activities for the quarter.
Thanks, Patty I'm now going to spend a few minutes, providing more details on our investment activity and our portfolio performance and positioning for the second quarter.
I will then conclude with an update on our post quarter end activity backlog and pipeline.
In the second quarter, we originated $1 2 billion of new investments across 46 different transactions as broader middle market sponsors and businesses continued to value Ares as a consistent and reliable source of capital.
Underscoring the breadth of our market coverage.
EBITDA of the portfolio companies, we finance during the quarter ranged from below $20 million to over $1 billion and we were the lead arranger on a 77% of the transactions we closed in the second quarter.
We believe that our ability to lead transactions is an important benefit of our scale, providing us greater control over capital structures pricing and documentation and longer term better tools to drive successful credit outcomes.
We continue to find compelling value in today's market.
This is demonstrated by the first lien investments we originated in the quarter, which had a weighted average yield in excess of 11, 5%, but leverage of only four and a half times debt to EBITDA.
Underscoring chips earlier point about the historically attractive relative value, we are able to achieve on our new investments the weighted average LTV of our second quarter commitments, including our junior capital investments was below 40%.
We also believe the breadth and quality of our incumbent portfolio provides differentiated access to attractive new investment opportunities.
We continued to invest in what we believe are our strongest portfolio companies is over 70% of our transactions during the quarter were to existing borrowers many of whom are executing tuck in acquisitions or seeking growth capital and have elected to grow with us as their financing provider of choice.
Our portfolio continues to perform well and we are seeing a lot of stability within our credit metrics.
We believe this is largely due to our defensively positioned portfolio and market leading companies with high free cash flow in resilient industries.
In the second quarter, the weighted average annual EBITDA growth rate of our portfolio companies with a healthy 7% inline with historical levels and the weighted average portfolio grade at our borrowers at cost was stable with last quarter at $3 one.
As we have discussed in the past we are carefully monitoring the impacts of inflation.
While our portfolio of companies are not immune the percentage of the portfolio that we estimate to be highly impacted by inflation risk has improved modestly and is now at the lower end of our 5% to 10% range as we are seeing some improvements from supply chain pressures.
All of these factors resulted in our nonaccrual rates continuing to be well below historical levels are.
Our non accruals at fair value improved modestly from one 3% last quarter to one 1% this quarter.
While our non accrual rate at cost also improved from two 3% last quarter to two 1% this quarter and remains well below our 3% 15 year historical average and the K B W. BDC average of three 8% for the most recent 15 year period available.
Looking forward, we remain confident about the performance of our portfolio in part due to our disciplined approach to risk management and portfolio diversification, which reduces the single name risk in the portfolio.
Our $21 5 billion portfolio at fair fair value is diversified across 475 different companies in 25 different industries.
This means that any single investment accounts for just <unk>, 2% of the portfolio on average and our largest investment in any single company. Excluding S. D. L. P and Ivy Hill is just 2% of the portfolio.
We believe we have the greatest level of portfolio diversification of any publicly traded BDC.
In addition to the benefits of diversification in our portfolio. There is a meaningful amount of enterprise value beneath us.
The weighted average LTV of our portfolio is 43% inclusive of our second lien and subordinated investments.
On average these junior capital investments are a meaningfully larger companies in defensive industries and with significant equity capital supporting our positions.
At quarter end, our entire junior capital portfolio had a weighted average EBITDA in excess of $400 million and a weighted average LTV of less than 50%.
Our compelling junior capital track record, which includes annualized loss rates of less than 20 basis points over our nearly 20 year history supports our continued strategy of seeking attractive risk adjusted returns through selective deployment into this asset class.
Finally, I'll provide a brief update on our post quarter end investment activity and pipeline.
From July one through July 19th 2023, we made new investment commitments totaling $211 million of which $119 million were funded.
We exited or were repaid at $118 million of investment commitments.
As of July 19, our backlog and pipeline stood at roughly $470 million.
Our backlog and pipeline contained investments that are subject to approvals and documentation and may not close or we may sell a portion of these investments post closing.
I will now turn the call back over to Kim for some closing remarks.
Thanks, a lot court.
In closing, we believe that our portfolio continues to demonstrate strong overall performance and we are well positioned to navigate any potential future economic challenges. We believe our many long term competitive investing advantages.
Strength of our balance sheet and the defensive positioning of our portfolio.
Allow us to deliver differentiated performance and attractive risk adjusted returns for our shareholders.
We are hopeful that activity will pick up as volatility subsides and as market participants have a more certain outlook.
The direction of interest rates and the economy, and we stand ready to capitalize on this highly attractive new investing climate.
Various capital we believe it that this is a good time to focus on our diversified portfolio and our sourcing underwriting credit and portfolio management strengths with a view to delivering strong financial results and a significant level of core earnings from our diversified portfolio.
We appreciate you all joining us today, we're happy to open the line now for questions.
At this time, if you would like to ask a question. Please press Star then one on your Touchtone phone. If you would like to withdraw your question. Please press Star then two please note as a courtesy to those who may wish to ask a question. Please limit yourself to one question and a single follow on.
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 comes from the line of Melissa Wedel with Jpmorgan. Please proceed with your question.
Yeah.
Good morning, Thanks for taking my questions today wanted to touch on and actually some of the activity that you disclosed in the press release or the corner for three kids a day.
Noted that I think it was 49% in preferred and fixed rate deals so far entry here, which are down.
Decent amount and crime.
QQ levels in terms of fixed rate allocation was hoping you could just elaborate on that and what you're saying.
Yeah.
Thanks for the question Melissa nothing nothing that for me jumped off the page nine quarter looking at it. It's it's one frankly single fixed rate large preferred investment that skews. The nexon are pretty small denominator yeah. The other thing to add maybe to that would be and some of these preferred investments, we actually are able to get warrants and equity.
Upside kickers as well so the fixed rate component doesn't capture the totality of the return.
Understood.
Just as a strategy going forward with the uncertainty of the rate environment or.
Is your willingness to allocate more fixed rate deals sort of increasing and more amenable to requests from borrowers for that thank you.
Not really I think mostly just to follow on I think this is just literally a single circumstance of one negotiated deal with one particular company.
No.
Yeah.
Our next question comes from the line of Finian O'shea with Wells Fargo Securities. Please proceed with your question.
Hi, everyone. Good morning. So can you talk about the changes there are gone and what that might mean near or long term for the SDLP.
To be honest, not and a lot of detail.
And that that news is pretty new.
You know we're excited and then I think our partners at Paragon or are feeling good about having a large institution you know to partner with.
My guess is that you know man group is going to want to run bare gone the way, it's been run and continue to grow it I would expect that that relationship with them would be unchanged, but since the news is new I don't really have any confirmation beyond that fan.
Oh great.
Perfectly understandable. Thank you just a follow up for does Ares BDC.
Receive or is it interested in allocation from.
The Aries alternative credit line.
From that business.
For sure I mean, as we say all the time, we think we are.
Real beneficiaries of the BDC of the breadth of our credit platform here. So what we've typically excluded has been what we're doing in Europe for the most part we really run that standalone, but everything else that we're doing you know in the U S credit benefits the BDC and alternative credit for sure can be can be part of that.
Yeah.
Very good thanks, so much.
Youre welcome.
Our next question comes from Erin.
You know rich with Citi. Please proceed with your question.
Thanks.
It sounds like structures and leverage levels are attractive here.
Are you seeing any kind of opening up yet of sponsors willing willingness to to invest and in you know.
What do you think the timeframe will be till until you start to see deal activity start to increase.
[laughter], that's probably the hardest one Erin and if you actually asked the senior folks.
Here I think you'd get a range of different responses, you know in terms of optimism or pessimism or whatever it may be I, probably sits somewhere in the middle I mean look we've seen the pipeline pick up a little bit you know specifically, we actually saw the number of deals. They review increased each month during the second quarter. If that's any indication is picking up a little bit.
But as I said in the prepared remarks, I think different folks have a very different view them or at least theres not consensus perhaps around the direction of the economy or the trajectory for rates. You know are they going to stay higher for longer they're gonna be rate cuts this year, which I don't think we see.
On the table anymore early into next year, if the economy weekend. So.
Look I mean, anecdotally, we're starting to see things pick up but it's the middle of the summer, it's a really difficult time to gauge that.
Fair variance or.
The other question I had was just in terms of funding.
You've always had a nice balance between secured and unsecured funding.
Are you thinking about.
Funding going forward, you don't really have anything on the unsecured side I guess coming due until next year.
Turning to Penny, but I mean, the answer is we don't really have a change in our view of how we're going to do things, but then you should pile onto that general comment if you'd like to yeah, and yeah. I would just say Luckily I think it's more of the same we have a view of having a very solid.
Balance sheet liability structure that shows ladder maturities and a nice mix of secured and unsecured.
For the 24 maturities there effectively resolved at this point, we have $4 $7 billion of liquidity available we've done a lot to go.
The capacity that we have and therefore I think you know there's no refinancing risk going into next year, but we're going to continue to look at the markets and as we've done in the past be as opportunistic as we can about thinking about how to access those markets to continue to fill it out our ladder maturities over time.
Yeah.
Our next question comes from the line of Ryan Lynch with K B W. Please proceed with your question.
Hey, good morning.
Following up on the previous question on kind of market activity.
I was just curious obviously theres been a big decline in kind of L. B O sponsor activity recently and I know you said that you're starting to see a little bit of a pickup in activity.
But those are obviously coming off very low levels are very low base and so my question is do.
Do you think you can see a significant pick up in an LBO sponsor activity base.
Base rates stabilize around these levels or a little bit higher is that enough. Just a really good sponsors interested just to have that sort of clarity or do you think do you actually have to have the fed cutting base rates.
So that the cost of capital is actually cheaper for some of these deals.
Yeah, I mean again I'm not sure that's a hard question I appreciate the question that Ryan.
I think if.
Seller expectations for where they hope to sell companies to sponsors go down.
The current level of of races, probably fine and then the counterpoint as decreases in rates in 2024, perhaps and beyond I think should you know loosen activity levels up and make it make it a bit busier, but we.
We're seeing folks tried to put capital structures together with the current base rates right and again activity is going up from here, but the cost of debt is much much higher and you just have to factor that into the model in terms of how you think about buying something right now.
I think that's why everything is sort of a slow right you're in a bureau period of just feeling things out.
Yeah, I don't think it's an unwillingness on the part of sponsors to invest I think it's just.
The uncertainty, creating a difficult environment to transact between buyers and sellers. So I I do think that the more certainty there is the higher the likelihood that we're going to see a pickup in transaction activity.
Okay understood.
And then it feels like the economy has been much more resilient than people were expecting certainly when their predictions you know six to nine months ago, a recession occurring in 2023.
But while the overall economy seems to be pretty resilient I would assume that there are certain sectors that are maybe you know you guys, whether it's your own portfolio or broadly speaking are seeing particular weakness are there any sectors that.
That that you are more concerned over may be feeling more weakness in what would otherwise be considered more of a a.
A more resilient.
Economy.
You know not not really Ryan I mean, as you know and many others probably on the call know we try to position the portfolio defensively in terms of industry mix. So I think the places where you're likely to see them real spikes in defaults are places, where we try to have very little or no exposure.
I do agree with your comment that the economy is actually.
Performing materially better than I might have expected 12 months ago, if you'd asked me in terms of where we'd be.
I'm in the summer of 'twenty three so.
You know I don't know if the soft landing you know it is is really in the cards. Obviously the newspapers seem to imply that there's a chance of that now but look for the back half of the year borrowers just I said this in the prepared remarks have less cash flow right, they're deleveraging less quickly and we need to be focused on every company in every industry to make sure.
We're doing what we need to do from a risk management perspective, but when we look across our industry mix. There's no one particular place where we feel more concern rather than.
In the aggregate.
Okay. Thanks, Kevin I appreciate the time.
Sure. Thanks.
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 I'm just in terms of any potential future capital raising needs are wondering if utilization of the ATM equity program is still the preferred method here or would you be open to any sort of block transaction. Thanks.
I mean, I think the simple answer to that is we felt like we'd been able to grow the company.
You know modestly modestly through the ATM program at an accretive cost effective way. So we'll probably stick to that is the primary source of where we go from here.
The leverage level is at a very reasonable level at the end of this quarter. So we feel confident that we have dry powder enough to take advantage of what we think the compelling environment. So for now I think the ATM program is going to prove to be sufficient.
Got you very helpful. There and that's all I have thanks again.
Sure. Thanks for the question.
Our next question comes from the line of Casey Alexander with Compass point. Please proceed with your question.
Yeah, Thank you and sort of given your comments about the economy performing better than you would expect can you give us some color on on the paces amendments and modifications in the portfolio and are you actually doing less of that than you might've. It also might have expected at this point in time.
Yeah, I mean, it's it's it's less and certainly it was although there's still some activity there Casey I would put it.
Call it sort of middle of the road right, it's not very active but certainly it's it's part of the <unk>.
Discussion that we're having with owners of all these companies say that again may not be meeting plan may not have as much cash flows they expected, but that's.
I call it just ordinary course.
Okay. Thank you and secondly did he mentioned how much spillover there is in on a per share basis.
I did not but it was the same as last quarter. So if you look at what we estimate to be carrying forward from 'twenty to 'twenty two into 'twenty, three it's stable at $650 million or $1 19, a share.
Terrific. Thank you very much I appreciate it.
Thanks for the question Stacy.
Our next question comes from the line of Robert Dodd with Raymond James. Please proceed with your question.
Hi, Thanks for taking the question I've got.
So to your comments, obviously, a reduced cash flow et cetera, and that's across the portfolio, but EBIT dollar still growing etcetera and interest coverage in aggregate is pretty good can you give us color on.
How much of the portfolio will oh, well or does have interest coverage below one.
Hum.
Peak, so call it 550, and then related to that.
Cause I wasn't at all.
Well what's the.
Yeah, right so to speak from the sponsors in terms of stepping up and providing incremental capital into that proportionate.
Portfolio.
Yeah, I mean, we're we always direct people on that Robert thinking about companies that have you know probably insufficient or less than we'd like cash flow really point, you to the mix of ones and twos in the portfolios, which again is our underperformers material underperformers of the ones and twos or you know kind of what I think of as the watch list.
So you know that number is up to well less than 10% today.
I'm sorry, as a follow up I was just.
They've done going through so you have any question you never hear but what was that.
What proportion booked for those businesses all of the sponsors stepping up but you know 100% incidents COVID-19 right.
The negotiations are they coming through and supporting those businesses or are you having to do.
I mean, I think I think they have generally and if you look at the pick.
Percentage of our portfolio, it's a kind of a.
You know, it's a three year low at this point so the playbook during Covid, where we actually provided relief from paying cash interest is not really part of the playbook today.
I would say that we've seen good sponsorship support in situations that are required it but the way it's progressing just to maybe try to give you all a little bit more color is even if a company has you know a longer term problem with the capital structure, where interest payments, perhaps look to high with the with the base rate.
It's much higher in most of those circumstances, they still have significant cash on the balance sheet. They have access to undrawn revolving credit facilities, which they can use and so there are a handful of interim tools before sponsor probably needs to step up and support the company I would say that is performing you know with more capital.
And I think that's another reason why activity levels are low I think you see a lot of private equity firms that are really focused on what's going on in the existing portfolio and.
Thinking about how to deal with that as much as they're struggling to do new deals. So hopefully that gives you a little bit of color I think to understand the under.
Yeah, and I underscore the first point Kip made though and to answer your question is spot on and what we're not saying when it gets to the point, where the company does need liquidity, we're seeing no change in sponsor behavior in terms of their willingness to support.
Those companies and we spent a lot of time in the prepared remarks talking about the loan to values, but given the given the loan to values in our portfolio on a go forward basis, we certainly would expect to see the same thing.
Got it got it. Thank you and then one sort of follow up.
Ivy Hill, it's been a tremendously successful business for years now 10% of the portfolio. If we look at the equity.
Yes is that I think we've talked about this some popcorn is there's still room to grow that at least 10% of the portfolio.
The cap or the size of that.
Yeah, I mean, we don't really have a cap, particularly on things that have been that successful.
I have acknowledged in a different setting so I'll acknowledge it now that you know, having a 10% exposure to a single name even though we don't really think about it as a single name because there are a host of underlying funds and cash flows to deliver the return is probably you know near the upper limit at least for me personally so I wouldn't expect it to grow materially.
From here.
Got it thank you.
Our next question comes from the line of Mark Hughes with <unk> Securities. Please proceed with your question.
Thank you good morning.
Non accruals are improved this quarter after stepping up for a bit for a quarter or two was there anything common two of that improvement was a one off that you've talked about inflationary pressure easing with that are they.
A driver perhaps.
I mean really Mark when you go through it with a little more detail really what happened is we resolved one of the non accruals or a restructuring of a specific portfolio company. So we're moving that non accruals what actually just from a math point of view took the number down obviously with that I'll say just to be clear we didn't see.
The other companies you know added in a material way right. So but the decrease was really the result of one significant restructuring that we did at a portfolio of company.
Understood and then.
With the potential for deal activity to pick up as interest rates improve do you.
Do you see maybe some pause that the the.
The.
Expectations for interest rates to decline further and then the question is when do you transact how does it work at this point in the interest rate cycle.
I mean, I think it's very hard to tell again I think if you have stability in rates. It makes it easier back to one of the earlier questions for buyers to at least understand what their maximum cost of debt financing may be when you set up a model to do a transaction, obviously more compelling for transaction activity would be.
The decline in rates right, where you actually had the expectation for <unk>.
Cuts to start coming through but your guess is as good as minus one that when that actually happens if at all so.
Like we kind of are where we are for the time being.
Thank you.
Thanks.
Our next question comes from the line of Bryce Rowe with B Riley. Please proceed with your question.
Great. Thanks, Good morning, Thanks for thanks for taking the question here.
First one is around balance sheet leverage.
You all de Levered a bit in the first quarter and maybe even a little bit more here in the second quarter.
Can you talk about you know.
Kind of your view on maybe.
Re levering or or maintaining at these levels just kind of curious you know where your comfort level is at this point.
Yes. Thanks for the question I mean, it's it's the same answer I think as it's been in the past maybe with a modest footnote we tend to run kind of between one and one in a quarter times.
The leverage helps drive earnings a little bit, but again, just as a reminder, that the bdcs are really not particularly leveraged companies right. So going from 1.15 to 1.17 times doesn't have a huge impact we I think at this point in the cycle, though we'd like to have a lot of liquidity both.
A person new investing and also to make sure that we can invest in portfolio companies to the extent, we want to or need to so.
I think it's really just driven quarter to quarter by how active we are and what the repayment you know Cal.
Olander it looks like.
That's hard to predict but we feel comfortable with where it is today. If it went up a little bit that would be fine. If it went down a little bit that would be fine. So the.
The earnings are more than supporting the dividend and we felt good about the trajectory here. So we don't feel any need to lever back up in the way that you've referred.
Referred to it we're happy with where we are today.
Okay. That's that's helpful and maybe a follow up.
There's two there's kind of a kit.
No no no view of imminent recession.
Based on your prepared remarks, obviously dividend coverage is extremely strong here at 20% plus.
What point do you kind of take it take it up another notch in terms of dividend increases I mean, obviously, you've seen some great dividend increases over the last year.
But with that view no imminent recession, just how are you thinking about dividend levels given that level of dividend coverage.
I think the discussion that we had when we raised the dividend. Obviously was you know the earnings are well in excess of even the raised dividend level, what's prudent right and the discussion there was much more about.
The direction of interest rates and it was about portfolio credit quality right. So.
If we pulled a couple of the different levers that could allow us to have a higher dividend or a lower dividend. The one that's the most impactful would be a significant decrease in base rates.
You'd have to model non accruals up a lot to have it to have any real impact.
Impact on how we thought about the dividend today.
Okay.
I appreciate the answers.
Sure. Thanks for the question.
Our next question comes from the line of Erik Zwick with Oh regroup to proceed with your question.
Thank you and good morning Al I wanted to start I guess, just first with a follow up to them.
The Guy inquired about that last quarter. So in terms of your new commitments are 92% are at floors. This quarter I'm curious if the borrowers accepting of your you know maybe a request to move up for up a little bit from kind of the 1% level that you've been operating for a while or is that still kind of absolutely. We've been we've been trying and we haven't had a lot of them.
Luck.
Right.
Okay fair enough.
And then my second question is you know maybe similar to some prior questions, but maybe just thinking about it in a slightly different way so looking at our new commitments in the quarter up noticeably from from <unk>, but still running well below the level that we've seen in prior years. So I'm curious you know how much of that is just a reflection of the market and slower deal activity versus maybe caught.
On your part just given that there's still an uncertain economic environment at this point.
I mean, we we wish there was more activity.
And we're not [noise], not particularly cautious you know I think we're thoughtful about the existing portfolio, but we would love a busier environment. The reality is there not a lot of opportunistic recaps getting done because people have a pretty good.
Good balance sheets in place, what's really going to drive a pick up from here is just going to be more M&A activity and as we've mentioned we've got the benefit of having a large diverse portfolio that contributes to a lot of follow on capital opportunities for us, but yeah that'd be materially busier, we just need the M&A environment pick up you know of course the key.
Countered the flip side of that is that the repayment activity is also lower than historical level. So we're getting more duration on our existing loans. So it's.
Yes, it's not all bad at all sort of balances out yeah. It's a good point.
That makes sense, thanks for taking my questions today.
Yep you're welcome.
And our next question comes from the line of John Rowan with Janney. Please proceed with your question.
Good morning.
Hi, John .
So just to talk a little bit about the interest coverage and specifically kind of the ones and twos and I. Appreciate you know the information you gave and how it's calculated.
And particularly the loan to value rates, and which you know would seem to be compelling for sponsors to step up and you know and help a struggling investment but I'm curious is there a difference in kind of the L. T v's across the portfolio relative to what would be in the ones and twos I'm just trying to gauge you know.
So if that's that same you know reason to step up and support our company is the same and the ones and twos as it is for the rest of the portfolio Yeah, No I think it.
It's not right. So the ltvs are going to be much higher than the underperformers.
Yeah, we were marking the equity value to market every quarter and so as there is underperformance were marketing the equity value down.
There still might be significant cash equity, there, which would incentivize support but obviously sponsors are going to evaluate performance of the company and.
Lower performance might be harder for them to support.
Okay, and then just what kind of housekeeping question, obviously non accruals came down you did restructure one large loan is that what drove the realized loss in the quarter.
Yes, primarily.
Okay alright, thank you.
Yep, you're welcome thanks for the question.
And this concludes our question and answer session I would like to turn the conference back over to Mr. <unk> for any closing remarks.
I just thank everybody for participating in the good questions and hope everyone enjoys the rest of the summer we'll be in touch soon.
And ladies and gentlemen, this concludes our conference call for today Goodbye. If you missed any part of today's call an archived replay of the call will be available approximately one hour. After the end of the call through August 22nd at five P. M. Eastern time to domestic callers by dialing 877660.
853 and to international callers by dialing 20161 to 7415 for all replays. Please reference conference number 13738840.
An archived replay will also be available on a webcast link located on the homepage of the Investor resources section of Ares Capital's website.
Okay.
Yes.
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Okay.
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