Ares Capital Corporation (ARCC)

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Ares Capital (ARCC)

Q3 2010 Earnings Call

November 04, 2010 11:00 am ET


Richard Davis - Chief Financial Officer

Michael Arougheti - Principal Executive Officer, President, Portfolio Manager, Director, Member of Investment Committee and Member of Underwriting Committee


Jasper Burch - Macquarie Research

Faye Elliott - BofA Merrill Lynch

Vernon Plack - BB&T Capital Markets

Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc.

Troy Ward - Stifel, Nicolaus & Co., Inc.

Jason Arnold - RBC Capital Markets Corporation

John Stilmar - SunTrust Robinson Humphrey Capital Markets

Arren Cyganovich - Ladenburg Thalmann & Co. Inc.

Donald Fandetti - Citigroup Inc

David Chiaverini - BMO Capital Markets U.S.

Christopher Harris - Wells Fargo Securities, LLC

James Ballan - Lazard Capital Markets LLC

John Hecht - JMP Securities LLC




Good morning. Welcome to Ares Capital Corporation's Earnings Conference Call. [Operator Instructions] Comments made during the course of this conference call and webcast and in the accompanying documents contain forward-looking statements, and are subject to risks and uncertainties. Many of these forward-looking statements can be identified by the use of the words such as anticipates, believes, expects, intends, will, should, may and similar expressions. The company's actual results could differ materially from those expressed in the forward-looking statements for any reason, including those listed in its SEC filings. Ares Capital Corporation assumes no obligation to update any such forward-looking statements. Please also note that past performance or market information is not a guarantee of future results.

During this conference call, the company may discuss core earnings per share or Core EPS, which is a non-GAAP financial measure as defined by the SEC Regulation G. Core EPS, excluding professional fees and other costs related to Ares Capital Corporation's acquisition of Allied Capital Corporation, is the net per share increase or decrease in stockholders' equity resulting from operations less professional fees and other costs related to the Allied acquisition, realized and unrealized gains and losses, any incentive management fees attributable to such realized gains and losses and the income taxes related to such realized gains and other adjustments as noted.

A reconciliation of Core EPS, excluding professional fees and other costs related to the Allied acquisition, to the net per share increase/decrease in stockholders' equity resulting from operations to the most directly comparable GAAP financial measure can be found in the company's earnings press release. 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 operations.

Certain information discussed in this presentation, including information relating to portfolio of companies, was derived from third-party sources and has not been independently verified and, accordingly, the company makes no representation or warranty in respect of this information. At this time, we would like to invite participants to access the accompanying slide presentation by going to the company's website at and clicking on the Q3-10 Investor Presentation link on the homepage of the Investor Resources section of the website. Ares Capital Corporation's earnings release and quarterly report are also available on the company's website.

I will now turn the conference over to Mr. Michael Arougheti, Ares Capital Corporation's President.

Michael Arougheti

Great. Thank you, operator, and good morning to everybody, and thanks for joining us. I hope you've had a chance to review our third quarter earnings press release including our fourth quarter dividend announcement this morning, as well as our third quarter investor presentation posted on our website. We'll refer to this presentation a little bit later in the conference call.

I'd like to start off by discussing current market and economic conditions, and then update you on some recent events at ARCC, including our strong third quarter results, before I turn the call over to Rick Davis. Once Rick takes you through the detail behind our third quarter results, I'll cover our recent investment activity, discuss our portfolio in greater detail and provide an update on our backlog and pipeline before closing and taking questions.

Following the volatility experienced during the second quarter, caused in part by sovereign debt concerns and mixed economic data, the broader leveraged finance markets bounced back during the third quarter with strong volumes, moderately tighter pricing and slightly higher asset prices. While overall leveraged loan market volumes were modestly below second quarter levels, specifically LBO and M&A-driven volume increased during the third quarter. Increased LBO activity is being driven by, among other things, improved earnings, uncertainty regarding tax rates and a significant overhang of uninvested private equity capital. Spreads in the more liquid, broadly syndicated leveraged loan market started higher on average at the beginning of the quarter, but narrowed toward the end of the quarter as fund flows increased and investor confidence improved.

From the high-yield bonds side, record third quarter new issue volume of $76 billion was driven by strong inflows, as investors chased yield in the sector. High-yield spreads tightened as volatility declined and the default rate outlook improved. Unlike the leveraged loan market where activity has been focused on M&A financing, high-yield issuance continued to be dominated by refi activity. Within the less liquid middle market where we operate, activity has also been very healthy.

Overall third quarter close volumes were slightly down from second quarter levels, but we too saw a meaningful increase in sponsor-driven activity. Middle market transactions in progress and under review increased, particularly post-Labor Day, and this is reflected in our Q3 investment pace and strong current backlog and pipeline levels. Unlike the spread tightening experienced in the broader syndicated and high-yield markets, third quarter middle market pricing was relatively stable on average compared to the second quarter.

That said, leverage levels did increase slightly during the third quarter. However, compared to the historical averages over the past decade, current market leverage levels are reasonable, while current market spreads and fees remain well above historical average levels.

Despite the strong level of refinancing activity in the leveraged loan and high-yield markets year-to-date, the medium-term opportunity in our asset classes remains strong. Fitch Ratings estimates that over $1 trillion of loans and bonds will mature by 2015 with a potential supply-demand gap of between $375 billion and $425 billion. Similarly, we've seen reports from Thomson Reuters estimating approximately $480 billion in middle market maturities between now and 2015.

Clearly, there's some overlap in this data. But it should give you an idea of the magnitude of the potential future capital opportunities and the importance of being in a strong position to capitalize on these opportunities in the future.

In terms of the macroeconomic environment and its impact on ARCC, the underlying companies on our portfolio continue to generate comparable weighted average revenue and EBITDA growth in the single- and double-digits, respectively, versus the prior year. We continue to believe that we are likely in a prolonged period of slow economic growth, and in our view, a slow growth environment can favor credit over equity, particularly if such slow growth is sufficient to allow companies to deleverage their balance sheets and maintain default rates at relatively benign levels.

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