Ares Capital Corporation (ARCC)

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Ares Capital (ARCC)

Q1 2011 Earnings Call

May 03, 2011 11:00 am ET


Penni Roll - Chief Financial Officer and Principal Accounting Officer

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


Vernon Plack - BB&T Capital Markets

Faye Elliott - BofA Merrill Lynch

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

Richard Shane - JP Morgan Chase & Co

Arren Cyganovich - Evercore Partners Inc.

Joel Houck

Jasper Burch

John Stilmar - SunTrust Robinson Humphrey, Inc.

Greg Mason - Stifel, Nicolaus & Co., Inc.

John Hecht - JMP Securities LLC

David Miyazaki



Good morning. Welcome to Ares Capital Corporation's Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded on Tuesday, May 3, 2011.

Comments made during the course of this conference call and webcast and 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 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, any 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 or decrease in stockholders' equity resulting from the operations, the most directly comparable GAAP financial measure can be found on the company's website at 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 companies, was derived from third-party sources, 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 Q1 '11 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 call over to Mr. Michael Arougheti, Ares Capital Corporation's President. Mr. Arougheti, you may begin.

Michael Arougheti

Great. Thank you, operator. Good morning to everyone, and thanks for joining us. I'm joined today by the Senior Partners of Ares Management's Global Private Debt Group and members of our investment advisors and investment committee, Eric Beckman, Kipp deVeer, Mitchell Goldstein and Michael Smith. Our Chief Financial Officer, Penni Roll; and Carl Drake and Scott Lem, who Head our Investor Relations and Accounting teams, respectively.

I hope you've had a chance to review our first quarter earnings press release and our first quarter investor presentation posted on our website. We'll refer to the presentation later on our call. As in past calls, I'd like to start with a brief discussion of current market trends and how they influence our portfolio and financial management strategy. I'll then highlight a few items from our first quarter and review our investment strategy before turning the call over to Penni, who will take you through our quarterly results in greater detail. Finally, I'll cover our recent investment activity, the state of our current portfolio and update you on our backlog and pipeline before taking questions.

As we discussed in detail on our last call, strong liquidity continues to flow into the broadly syndicated leverage loan markets, influencing pricing and structure on new transactions. Through April, inflows into retail loan funds over $18 billion have set a new record, already surpassing full year 2010 levels. First quarter loan repayments were also exceptionally strong, nearly doubling from fourth quarter levels per S&P data. This cash from retail loan funds and loan repayments created additional demand for bank loan assets at a time when new issue loan supply was sharply lower than fourth quarter's levels. Consequently, spreads tightened and leverage increased, all against the backdrop of a greater appetite for risks. Although the market briefly became more rational in March brought by turmoil in Japan, Europe and the Middle East, strong fund inflows have resumed driving ever more liquidity into the market.

For a period of time, our core middle market, defined as companies with $20 million to $50 million in EBITDA, was more insulated from these pressures. However, this is no longer the case. Although current market data illustrates that the middle market for leverage loans still generally provides premium pricing and lower leverage compared to the broadly syndicated leveraged loan market, the middle market has too experience higher leverage and more aggressive pricing. Various data for middle-market leveraged loans corroborate pricing declines of 50 basis points on senior debt yields, as well as the expansion of total and senior leveraged multiples by about 1/2 of a turn of EBITDA.

It should be clear though that one cannot compare leveraged multiples across the middle-market in a vacuum. Leveraged multiples vary based upon the stability and the growth characteristics of the underlying borrower cash flows, as well as overall company size and industry. We do believe that if someone is looking for outsized returns in the current market environment, then they have to take outsized risk, expressed as either greater leverage, tighter pricing or weaker borrower fundamentals. And this is not something that we're prepared to do. Although overall broadly syndicated leveraged loan transaction volume was stronger year-over-year in the first quarter, over 70% of the total was comprised of refinancing and recapitalization activity, the highest level on record.

On the positive side, leverage buyout and merger and acquisition loan volumes have increased in April, and a forward calendar of M&A loans is at its highest level since S&P began recording this data in January of last year. This increase in M&A volume is a welcome sign after the significant slowdown in M&A related volume in the first quarter. At the current moment, we are definitely witnessing a higher level of activity with new companies, as opposed to opportunistic refinancings to existing portfolio companies. Naturally, a sustained increase in new money loans could help alleviate some of the pressure from continued inflows into the bank loan asset class.

As we search for the most attractive risk adjusted returns in the current market, we're focusing on high-quality franchise businesses that have demonstrated solid relative performance during the last economic downturn. We continue to focus on senior secured floating rate assets, including stretched senior and unitranche loans, funded both on our balance sheet and through the Senior Secured Loan Program. You'll notice that approximately 94% of our originations in the first quarter were in these asset classes. We believe senior secured loans continue to offer good relative value as spreads are still approximately 150 basis points wider than historical averages despite a lower-than-average default outlook. With short-term interest rates at about 0.3%, we like the risk reward of owning floating rate investments. Of course, we also like the lower leverage, greater covenant protection and higher attachment points provided by first lien and unitranche debt.

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