Ares Capital Corporation (ARCC) Q2 2013 Earnings Report, Transcript and Summary

Good day and welcome to the Ares Capital Corporation Second Quarter 2013 Conference Call and Webcast. [Operator Instructions] Please note this event is being recorded. I will now like to turn the conference over to Mr. Michael Arougheti, CEO. Mr. Arougheti, the floor is yours, sir.

Great. Thank you, operator and good morning, everyone, and thanks for joining us. For today's call, I'll briefly highlight our second quarter results and touch on market conditions before turning the call over to Penni Roll, our CFO, to take us through the financial results in more detail. Our President, Kipp DeVeer, will then discuss our investment activity and portfolio performance and I'll conclude the call and open it up for Q&A. We reported strong results for the second quarter. Our core earnings per share of $0.38 continue to fully cover our dividend. Our GAAP earnings of $0.50 per share benefited from both net realized and unrealized gains, driven primarily by healthy market conditions and strong investment performance. Our net asset value increased 1.4% quarter-over-quarter and 4.5% year-over-year to $16.21. Our portfolio of companies continue to perform well. Nonaccrual ratio is further improved during the second quarter, reaching the lowest quarterly level since the end of the first quarter of 2008, measured on an amortized cost basis. Weighted average EBITDA growth for the underlying corporate portfolio companies remain strong at 9% when measured over the last 12 months for the most recently available period compared to the same prior 12 months. And while this was an active quarter of new investments for us, we ended the second quarter with modest leverage and approximately $1.2 billion in available debt capacity for new investments. Our balance sheet continued to be well-positioned at quarter-end, given our largely floating rate assets combined with a long-dated predominantly fixed rate and well laddered liability structure. From a market standpoint, beginning in late May, the credit markets began to experience volatility caused by Federal Reserve's communication around tapering. Credit spreads widened moderately and flex activity on syndications picked up in June. However, this volatility was fleeting and had no real lasting impact on the leverage loan market for the quarter. To that point, the S&P Leverage Loan Index was down only 0.8% during the second quarter while the Thomson Reuters middle-market loan index increased 0.7%. High-yield bonds, which carry fixed rate coupons and are more sensitive to interest rates, were more adversely impacted by the Fed discourse with [indiscernible] prices down 3.6% for the second quarter. Since quarter end, credit market volatility has declined as market participants have become more comfortable with the prospect of a gradual reduction in monetary stimulus. Weekly inflows are trending positive in both the leverage loan and high-yield markets and credit spreads are firming once again in both the broadly syndicated and middle markets for leverage loans. However, while the markets have recovered rather quickly, we are seeing a little more credit discipline in the markets than before this period of volatility. [indiscernible] syndicated loan market cooled off in the second quarter with loan volumes, overall middle-market loan volume was stronger, up about 19% quarter-over-quarter. Middle-market loan volume for private equity sponsored transactions was also more robust, up 31% quarter-over-quarter. This trend was clearly reflected in our quarterly investment activity. As Kipp will discuss later in the call, the strong sponsored finance market environment during the second quarter provided us with the opportunity to make several larger investments in new portfolio companies. In the aggregate, we made over $1.2 billion of gross commitments while repayments were comparatively slower, resulting in net new commitments for the quarter of $809 million. Lower capital markets volatility after quarter end allowed us to be opportunistic on the right-hand side of our balance sheet. And in July, we took advantage of improved market conditions and issued $300 million of 5.5 years senior unsecured convertible notes with a coupon of 4.375% and initial conversion price of $20.16. This issuance lowered our overall funding cost on our fixed rate debt and enabled us to term out some revolving debt for 5.5 years. And now Penni, if you'd lead us through the second quarter financial results in more detail.

Sure, thanks, Mike. For those of you viewing the earnings presentation posted on our website, you could start by turning to Slide 2, which highlights our financial and portfolio performance information. As Mike said, our basic and diluted core earnings were $0.38 per share for the second quarter of 2013, which was in line with the $0.38 per share for the first quarter of 2013, just slightly down from the $0.40 per share in the second quarter of 2012. The $0.02 decrease in our second quarter core earnings per share versus the second quarter of 2012 was primarily driven by the impact of higher leverage a year ago compared to the second quarter of 2013. GAAP net income for the second quarter of 2013 was $0.50 per share, an increase compared to $0.32 per share for the first quarter of 2013 and $0.41 per share for the second quarter of 2012. Total investment income for the second quarter of 2013 was $206.1 million, a 5.7% increase over total investment income of $195.1 million for the first quarter of 2013. As compared to the first quarter, the second quarter saw an increase in interest income due to the impact of the higher net origination activity and an increase in structuring fees. Dividend income for the second quarter of 2013 was lower than for the first quarter of 2013 as Q1 dividend income included an additional dividend of $17.4 million from our portfolio company, Ivy Hill Asset Management, which was paid out of accumulated earnings previously retained by IHAM. The regular quarterly dividend paid by IHAM for both the first and second quarters of 2013 was approximately $10 million. Our net investment income, which includes accruals for capital gains incentive fees, decreased to $0.35 per share for the second quarter compared to $0.40 per share in both the first quarter of 2013 and the second quarter of 2012. The lower second quarter 2013 net investment income per share was primarily due to the accrual of $0.03 per share of capital gains incentive fees attributable to net realized and unrealized gains as compared to a reduction in the capital gains incentive fee accrual of $0.02 per share in the first quarter of 2013 and a de minimis per share accrual in the second quarter of 2012. By comparison, net realized and unrealized gains for the second quarter of 2013 were $0.15 per share compared to net realized and unrealized losses of $0.08 per share in the first quarter of 2013 and net realized and unrealized gains of $0.01 per share for the second quarter of 2012. As Mike highlighted, our origination pace was strong, especially as compared to the seasonally slower first quarter as we made gross investment commitments totaling $1.2 billion compared to gross investment commitments of $410 million during the first quarter of 2013, and $728 million during the second quarter of 2012. We exited commitments of $395 million in the second quarter of 2013, resulting in net commitments for the quarter of $809 million. Net fundings for the second quarter of 2013 were $747 million as compared to $129 million and $248 million for the first quarter of 2013 and second quarter of 2012, respectively. As of June 30, 2013, we had total assets of $7.1 billion and total stockholders' equity was $4.3 billion. As you can see on Slide 4, as of June 30, our portfolio totaled $6.8 billion at fair value and consisted of 164 portfolio companies. At fair value, 62% of the portfolio was in senior secured debt investments, 21% was in subordinated certificates of the Senior Secured Loan Program, which as of June 30, had 41 separate borrowers, 4% was in senior subordinated debt, 4% was in preferred equity and 9% was in equity and other securities. We continue to emphasize floating rate loans and you'll see floating rate assets were 79.3% of our portfolio at fair value at the end of the second quarter of 2013, up from 75.3% as of the end of the first quarter of 2013. From a yield standpoint, the weighted average yield on our debt and other income-producing securities that amortized costs declined 30 basis points quarter-over-quarter and 90 basis points year-over-year to 10.8%. This decline reflects the continuous focus on investing in lower yielding senior secured debt, lower yields on new debt investments in general, and the repricing of some loans as a result of market condition and the exit or repayment of some higher-yielding investment. The weighted average yield on our total portfolio and amortized cost has shown a more moderate decline of 10 basis points quarter-over-quarter and 60 basis points year-over-year to 9.8% as we have reduced our portfolio weighting in non-yielding equity investment. Having said that, when income generated from our assets is measured against our interest cost, we have been able to maintain our net interest and dividend margin, which we look at as net interest and dividend income over our average portfolio at amortized cost over the last 12 months. This margin remains flat quarter-over-quarter at 8.7% and was slightly above the 8.5% margin for the second quarter of 2012. Let's turn to Slide 7 and I will highlight the components of our net realized and unrealized gains for the second quarter, which totaled $39.9 million or $0.15 per share. During the quarter, we realized $8.6 million in net realized gains in addition to $33.7 million of net unrealized gains and $2.4 million of reversals of prior net unrealized appreciation related to net realized gains. The $33.7 million of net unrealized gains were primarily related to the net appreciation of a number of our equity securities. Now let's turn to Slide 9 for a discussion of our debt capital. As of June 30, we had approximately $3.9 billion in committed debt facilities and approximately $2.7 billion aggregate principal amount of indebtedness outstanding. Over 50% of our total committed debt capital and approximately 75% of our outstanding debt at quarter end was in fixed-rate term debt with immediate to longer-term maturities. In our view, the long weighted average maturity of our debt of nearly 9 years provides us with significant stability and contributes to the overall strength of our balance sheet. In addition, we enjoy operating flexibility by not having any debt maturities until 2016. During the second quarter, we completed an amendment to our largest revolving credit facility, reducing the spread on the facility from 225 basis points to 200 basis points over LIBOR, extending the revolving period and the stated maturity by 2 years each to 2017 and 2018, respectively, which brings us to a 5-year tenor versus the previous 4-year tenor and increasing commitments to the facility by $30 million, bringing the total commitments to $930 million. Additionally, subsequent to quarter end, we further increased commitments to this facility by $25 million, bringing the total commitments to $955 million. The weighted average stated interest rate on our outstanding debt at quarter end decreased to 5% as compared to 5.5% at the end of the first quarter of 2013. This decline reflected an increase in borrowings on our lower-cost secured revolving facilities. The weighted average stated interest rate on our outstanding debt is calculated based on the mix of our actual borrowings at period end. On a fully funded basis, our weighted average stated interest rate declined from 4.3% for the second quarter of 2012 to 4.1% for the second quarter of 2013. In total, at the end of the second quarter, we had approximately $1.2 billion in available debt capacity subject to borrowing base and leverage restrictions and $80 million in available cash. As of June 30, our debt-to-equity ratio was 0.59x and our debt-to-equity ratio, net of available cash, was 0.57x. Since quarter end, we have continued to focus on our liquidity and cost of capital. As Mike mentioned in July, we completed a $300 million unsecured convertible notes offering. These notes mature in 2019 and have a stated interest rate of 4.375% and a conversion premium of 15%, resulting in an initial conversion price of $20.16 per share. We're excited to receive our lowest coupon and our highest conversion price compared to any of our prior convertible notes issued. The net proceeds of the offering were used to repay outstanding indebtedness under our revolving credit facilities, as well as for other general corporate purposes. Pro forma for this transaction, our available debt capacity subject to borrowing base and leverage restrictions as of June 30, was approximately $1.5 billion. Finally this morning, we declared our third quarter dividend of $0.38 per share, which is payable on September 30 to stockholders of record on September 16. And as a reminder, we still estimate a that we will carry over undistributed taxable income of approximately $0.97 per share in the tax year 2013. And with that, now, Kipp, I'll turn it back over to you.

Thanks, Penni. I'm happy to discuss our recent investment activity and portfolio performance in more detail. I'll also update you on post quarter end investment activity and discuss our backlog and pipeline. Please turn to Slide 12. In the second quarter, we made 22 new commitments, totaling $1.2 billion. Eight of these commitments were made to new portfolio companies, 8 were made to existing portfolio companies and 6 commitments were made through the Senior Secured Loan Program. We're pleased this quarter's activities was led more by new deal flow than the last, which was dominated by refinancings and recapitalizations. During the second quarter, 58% of our new commitments were in first lien senior debt, 25% were in second lien debt and 17% were in sub-certificates of the Senior Secured Loan Program. The weighting of new investments towards secured debt reflects our continued emphasis on conservative structuring and capital preservation in the current environment. We continue to feel that our ability to write large commitments to our borrowers is a meaningful, competitive advantage in sourcing. We utilize these large commitment and hold capabilities to our advantage this quarter, making 8 new commitments in excess of $75 million. Our largest new investments were in defensibly-positioned companies and in industries where we remain very comfortable. Turning to Slide 13. Notwithstanding the fact that the weighted average total net leverage for the corporate companies in our portfolio increased very modestly and that the weighted average interest coverage for these companies declined slightly, we believe the credit quality in the existing portfolio remains strong. This view is supported by the stability in the weighted average grade of our investments; our positive nonaccrual trends, which I'll get to on Slide 18; and the year-over-year EBITDA growth for our corporate portfolio companies, which Mike mentioned earlier. Slide 14 to 17 provide other notable summary highlights of the portfolio at quarter end. There are several points to make here. On Slide 14, you'll notice the new investments we completed this quarter in the corporate portfolio of companies had a weighted-average EBITDA of $98 million. This is larger than the norm compared to recent quarters, primarily as a result of investments that were made in 2 companies with significantly higher EBITDA than the current portfolio average EBITDA. We're pleased with the investments in these companies as they were deals that we view as somewhat opportunistic in nature. However, it's more likely that our investment focus going forward will continue to be on portfolio companies with EBITDA levels closer to our overall weighted average, which is about $49 million at the end of the quarter. On Slide 15 and 16, you'll see that our portfolio continues to be well-diversified. We typically like to manage a single name exposures to less than 5% of the portfolio from a risk management perspective. The only exception here of course, is the Senior Secured Loan Program, which at quarter end, represented approximately 21% of the portfolio at fair value. But as a reminder, the SSLP had 41 separate underlying borrowers as of quarter end and continues to grow its own diversification within the joint venture. Excluding SSLP, the next largest 14 investments in aggregate represent only 31% of the portfolio at fair value as of June 30. Slide 18 demonstrates the positive nonaccrual trends that I they mentioned earlier. As you can see, non-accruals as a percentage of our portfolio at amortized cost declined from 2.3% at the end of the first quarter to 1.9% at the end of the second quarter. And on a fair value basis, the nonaccrual ratio remained constant at 0.6%. We continue to be pleased by the performance of our portfolio companies as they emerge from a difficult economic period and performed well on a slow but steady growth environment. Now let's skip to Slide 19 and 20 for an update on our recent investment activities since quarter end, and I can provide some details on the current backlog and pipeline. Since July 1 and through August 2, we've made new investment commitments of $313 million, of which $301 million were funded. In terms of mix, 44% were in first lien senior secured loans, 31% were in subordinated certificates of the SSLP and 25% were in second lien senior loans. Of the $313 million of new investment commitments, 95% were floating rate. Only 5% were fixed rate, and the weighted average yield on the debt and other income-producing securities that we funded during this period had amortized cost at 10.2%. Also from July 1 through August 2, we exited $40 million of investment commitments. And of the $40 million of exits, 53% were floating rate, 46% were fixed rate and 1% were on nonaccrual status. The weighted average yield of debt and other income-producing securities exited or repaid during the period at amortized cost of 11.1%. On the $40 million that we exited, we recognized total net realized gains of approximately $36 million, driven by favorable realization on 2 of our successful equity investments. If you flip to Slide 20, I'll provide some more color on what we're working on today. And we're pleased to report new deal flow remained strong despite what is typically a slower time of year for us as the summer holidays factor in. As of August 2, our total investment backlog and pipeline stood at approximately $750 million and $230 million, respectively. With this roughly $1 billion in total potential investment opportunities at these stages, we feel that we're well positioned in the current market and we're also pleased that Ares Capital continues to be viewed as a go to provider for flexible financing solutions. Thanks for your time. I'll turn it back over to Mike for some closing thoughts.

Great. Thanks, Kipp. As you know, we will always look to be opportunistic on both sides of the balance sheet to take advantage of changes in market conditions. Consistent with that stated strategy, we will continue to remain thoughtful and highly selective on new investment activity while also standing ready to issue capital during periods of low volatility and high liquidity. We're pleased that our hard work in this regard over the past year has allowed us to maintain a strong net interest and dividend margin, realized net gains and to deliver attractive returns on equity despite tightening spreads. With an asset-sensitive balance sheet, modest leverage and a long-dated liability structure, we believe that we are well-positioned to continue to execute on our strategy. And in the long term, we continue to believe that the outlook is bright for scaled, non-bank capital providers like us, that can provide flexible capital with larger commitment and hold amounts to support the growth needs of the middle market. We have taken advantage of this growing non-bank opportunity by broadening our investment platform into project and venture finance, which we believe provides attractive investment diversification across markets. We do hope to continue to find other niche opportunities where we can take advantage of these secular trends. And that concludes our prepared remarks for today. And as always, we thank you for your time and continued support, and operator, I think we'd now like to open up the line for Q&A.

[Operator Instructions] The first question we have comes from John Hecht of Stephens.

First question is regarding the second quarter, the pace of investments, were they balanced throughout the quarter or were they front or back ended?

John, it's Kipp. In terms of when the closings, actually on new deals occurred?

Yes, I'm trying to just get a sense was it evenly balanced throughout the quarter or is there any particular concentration when you were closing the investment?

It was pretty balanced, John.

And second question is related to, Mike, you mentioned there was some volatility during the quarter in the credit markets, which will help spreads to widen but that was a fleeting moment. In your opinion, are we -- are you seeing stable spreads now or is there still pressure? And if there's pressure, where is it coming from?

No, as I mentioned, I think a couple of positive trends. Number one, we are seeing spread stability over the last couple of weeks despite continuing inflows. The pace of deal activity is absorbing the supply of capital, so we've seen spread and fee stability. And then the other positive trend, which Kipp highlighted, we are seeing a growing percentage of our closed deals as well as our backlog and pipeline in new M&A financings as opposed to recaps and refis, which I think bodes well for the supply-demand balance in the market. So we're not seeing further tightening and it feels pretty good out there right now.

As a little bit of a follow-up to that, you mentioned that you're seeing credit discipline kind of emerging in the market. How is that manifesting itself?

Why don't I take that. I think John, what we're trying to suggest is that, that period where the market came off a lot in particular, the high-yield market, I think it gave investors a chance to recalibrate a little bit. So for, call it a 3- or 4-week period, there's a real nice time to go out and commit capital, and that definitely helped us grow the portfolio this quarter. But I think what Mike was alluding to is, during those periods, sort of the recovery from those periods even if the market technical has come back, people sort of have learned the short-term lesson and least apply it in the near term. So without any steps to back it up necessarily, I'd say that we just felt that the investors had more strength pushing back in that market after a bit of tightening.

The next question we have comes from Doug Mewhirter of SunTrust.

I had one big picture question. Mike, you were talking about there is something -- obviously, a pickup in your pipeline, pickup in activity I mean -- and you also noted that positively, that there was a lot of these were new deals, new M&A deals, and generally increasing sponsor activity. Could you into maybe the reasons why, if you talked to a private equity sponsor they say, "Well, we're in the market now because of XYZ." What sort of that XYZ is it because the equity markets in general were good, are we still going to get financing, they have a more optimistic outlook of economy?

Yes, I think it's all of the above. Everything is somewhat circular and feeds on itself. On our prior quarterly calls, I think we expressed a little bit of surprise that we have not seen M&A pick up or sponsor activity pick up given the underlying strength in the economy and the strength in the capital markets. I think now that we've seen so many successive quarters of positive earnings momentum, we've seen significant momentum in the capital markets. I think it's a combination of solid fundamentals, a really healthy capital market backdrop and then you see a pickup in activity. And the way the market's psychology works is obviously, that activity feeds on itself and continues to fuel new activity. So we're seeing those trends continue now into the third quarter as well, heading into then what will be typically, our seasonally strongest quarter in the fourth quarter.

The next question we have comes from Robert Dodd of Raymond James. Robert J. Dodd - Raymond James & Associates, Inc., Research Division: Guys, you talked about again, some credit discipline return in the market if we look at the middle market and obviously we've seen that leverage pulling back a little bit. Can you give us any additional color on -- if you got anything in that on what's driving that -- I mean, is it just -- is that the source of discipline or can you -- is there anything you can add to that?

Let me try it. This is Kipp. Let me try to answer it a little bit differently. I think when you look at the markets stats, the obvious things that you pick up are what are the spreads, what are the leverage levels, but in underwriting, there are actually a lot of other things that go into it. It's number of covenants for instance, it's quality of loan documentation, these are pretty detailed credit agreements that we negotiate as a lead investor. So unfortunately, when the larger market tendencies kind of creep into the middle market, a lot of those things kind of fall by the wayside. So I think just again, around being more disciplined on underwriting, it's everything from insisting on better security provisions to collateral provision and loan documents, it's talking about covenants and setbacks to base cases, just being more realistic I think, in other underwriting metrics that may not show up just in kind of off-the-shelf numbers that you'll see from some of the publications. For us, that's helpful and... Robert J. Dodd - Raymond James & Associates, Inc., Research Division: Yes that is and if I can kind of follow-up on that, I mean, obviously, you pointed out your weighted average portfolio leverage picked up just a notch and the coverage down just a touch. I mean, but at the same time, so you're very, very comfortable with where that stands. I mean is that indicative that though they've moved, you're actually layering more covenants from the new deals or...

No, I wouldn't put it that way. I mean, look, we have 164 portfolio companies, they're obviously all slightly different underwritings. That moved in the weighted average leverage or in the weighted average interest coverage stuff that's frankly immaterial, and just kind of comes and goes quarter-to-quarter. I think while we're trying to reinforce -- I guess all that we're trying to reinforce was I think that there was a perception that the market meaningfully backed up over the course of maybe late May and June. All we're trying to make clear to folks is that by the end of the quarter, most of that had really come out. For us, the real key is driving our strengths, which we feel is a best-in-class underwriting culture, but also a very, very deep originations team that's across the country. And as always, we're just focused on credit selection, making sure that we're investing in the best companies with the best management teams.

I'll just add 2 quick things, Kipp. I think when you look at the leverage and cover statistics, one thing that we didn't report but I think is worth mentioning is that our first dollar of leverage actually declined in the quarter. So we're moving up the balance sheet to a higher attachment point as opposed to down only. The second thing I'd also highlight is that our loan-to-value within the portfolio and the corporate portfolio remained stable at around 57%, which was pretty consistent with most of the quarters within the year. And I think that's a reflection to some of Kipp's comments in the prepared remarks around the larger borrower concentration within our most recent closings. Those larger, higher-quality borrowers do come in slightly higher leverage. And then the only other phenomenon, which we've discussed in prior quarters, is also our intent focused on making sure that we're protecting the best borrowers within our existing portfolio. So some of that natural move quarter-to-quarter in the leverage is really a reflection of the fact that we are releveraging and recapitalizing a lot of our better performing borrowers as opposed to simply a reflection of the new market environment.

Next, we have Greg Mason of KBW. Greg M. Mason - Stifel, Nicolaus & Co., Inc., Research Division: You guys have talked quite a bit on the asset side and the opportunities there. What about additional changes to the liability side? A lot of BDCs have been issuing securitization debt. What do you think about that market? Do you have the assets to fit inside of a new securitization? Just your general thoughts on the opportunities there.

Sure. I mean, I think I'll let Penni answer some of this as well. But I'll take a first crack at it, Greg. We did a securitization, if you'll remember, back in '06. So we're pretty experienced relative to the public company doing that and also mentioned obviously, that Ares is a substantial issuer of CLO paper broadly across our institution, both in the U.S. and in Europe. So it's a market that we know well. I mean, I'd say that our current liabilities provide us quite a lot of undrawn debt capacity today at rates that we view as favorable, that have a substantially, more flexibility than what you'd see in a traditional CLO, which obviously, has work requirements and diversity score requirements in all sorts of other things that are frankly complicated in terms of managing those portfolios. But we do have the assets, obviously. We have lots of first lien assets. I'm sure it wouldn't be difficult for us to carve a pool off and sell a securitization against something that we've thought about and obviously, not done yet or you would've heard of it from us. But Penni, I don't know if you have any other thoughts on that.

I think it's definitely something we watch and as Kipp said, we have the right asset mix to do it. It's really a more relative trade off value to what we can get under our existing revolvers from flexibility and pricing, vis-à-vis what we could get there. If there's a point where the pricing becomes enough lower from where we borrow on our revolvers, so where it makes sense to give up some of that flexibility is something we would definitely explore further. Greg M. Mason - Stifel, Nicolaus & Co., Inc., Research Division: But could you talk just a little bit about your revolver utilization, then? I think in the past you've mentioned that you really want to utilize the revolver to do new deals but ultimately then term that out into longer dated liabilities like you've been doing with the convertibles and the baby bonds. Given that you view this, the revolving liabilities, as a more flexible source than a securitization, is there thoughts of utilizing more of the revolving facilities for a longer-term investment purpose?

Well, I think one thing that we have done is we've further increased the amount of revolving capacity available to us over the last few years and today, it's just under $2 billion of capacity. I think we haven't changed our view on how we use the revolvers in the context of using those to fill the portfolio to then ultimately, take out those revolvers with long-term debt and equity to keep the leverage ratios in line. So I think as long as we have continued capacity there, we will use them. If you look at where we're working in the quarter, we had drawn about $660 million. I would guess we're probably historically using those between 30% and 60%. Clearly, you don't want to use them to their full capacity, you want to make sure you're sure them out with term debt appropriately and also to give you timing opportunities to take down increments of term debt, so that you have properly and well laddered maturities as well. So the one thing about a securitization is it probably is little more permanent financing vis-à-vis the revolvers that we use, which is one thing that does make them attractive. But there's nothing to say that we wouldn't consider having more kind of floating rate lower cost debt available to us as it makes sense in the capital stack. Greg M. Mason - Stifel, Nicolaus & Co., Inc., Research Division: Great. And then one final question on the kind of net interest in dividend margin on the portfolio. As you talked about it, flat, actually slightly up over the last couple of quarters. As you think back to kind of where that was running a couple years ago or even prior to the crisis, I don't have those numbers available. How do you view your overall net interest and dividend margin today relative to where it stood a couple of years ago or even pre-crisis?

Yes, just -- we're comparing those here quickly but I mean, we have the numbers obviously, and we've laid them out here in this presentation back to June of 2012, the end of Q2 2012, Greg. So they've been pretty stable. We'd actually probably have to go back and look. I mean, I'd say a few things. We feel great about the credit quality in the portfolio. We feel that the ability to deliver an 8.7% net interest and dividend margin in a company that obviously, typically utilizes a leverage ratio in kind of 0.6:1 or less, is pretty extraordinary. We've obviously turned out our liabilities, both the secured revolvers. I was going to make the point on Penni's last point. And we all did this back 8, 9, 10 years ago. Most of what you saw on the liability side was a one-year warehouse to take out and a 2-ish year revolving credit facility. Our revolvers now have 3-year, 4-year maturities, and obviously, we've turned out all of our debt. So I think we feel great about the assets today. We feel like the net interest margin is very solid and that the balance sheet is in significantly better position than it was 7 or 8 years ago. So I'm not sure that they're directly comparable but we're pretty happy with where we are today.

I'll make a general comment, Kipp, then we can follow-up with people if they want the specifics on a historical basis. But just to put it in context, when you look at the ROA on the portfolio from prior cycles through the cycle up to today, you'll actually see a surprising amount of consistency. We've typically generated ROAs between 10% and 13% across the cycle. If you go back to Kipp's point and look at how we were funding ourselves economically going into the downturn, we had 1 year senior secured revolvers at roughly LIBOR 2.25% with LIBOR or probably averaging that period about 500 basis points. So you had a cost of funds that was probably approaching 7% plus against 12% assets. So using just that as a benchmark, going into the dislocation, we are probably running at a lower net interest margin than we are now. And as Kipp mentioned, we not only believe that the right-hand side of our balance sheet is much stronger and better positioned but I actually believe that the quality of the portfolio, despite our extraordinary performance through the downturn, is actually stronger now than it's ever been.

Next we have Jon Bock of Wells Fargo Securities.

Mike, maybe continuing with that topic just a little bit here in terms of NIMS. If we look at the new investments today, just kind of parsing through it, we see a rather low weighted average yield and largely, that's because of loans that some of which I'll take a $60 million ISS #2 LLC at 6.5%, you have a rather low, about 8% weigh on -- I think you've brought in about $800 million of assets that you put out just looking at it. So in light of that, right, if we're looking at lower weighted average yields, because you are focused on higher quality companies, walk us through how NOI can increase in light of the fact that your cost of debt is at 5%. You fixed it, that's great. Your cost of equity, your dividend rate yield, but then more importantly, the cost of actually running the business, fees and G&A as a percentage of total assets is about 330 basis points plus. So we understand your existing portfolio is providing you current NIMs that are attractive but a lot of those assets are being refinanced. American Broadband, for example. So maybe give us a few more kind of constructive terms on where we can see this going if you're going to continue to focus on higher quality, which right now, looking at 5% yields that were made in this quarter, high-quality is coming at a low yield or price.

There's a lot in there. I'll try to start at a high level and then give you some specifics. But as we've always said, this business is about risk-adjusted return and not absolute return. And when you're in benign credit environments, particularly benign credit environments with tightening spreads, it's not always obvious to the market what the quality of the underlying yield is. So we, as the management team in the company have always been focused on stability, predictability and quality of earnings first and earnings growth second. As it relates to earnings growth, I'll highlight a couple of things. Kipp mentioned in his prepared remarks that the weighted average yield on new investments that we've been making -- that we made through August 2 on $313 million of new commitments, was about 10.2%. If you look at our backlog and pipeline, those types of returns are continuing. And those yields exclude the impact of fee income, which I think people are aware, generally is 2% to 3%. So if you used the market convention of a 3-year discount margin and you amortize those fees over 3 years, we're booking assets at an ROA of 10% to 12% today in very high quality borrowers in defensive industries. When you look at that type of ROA relative to other credit products available in the corporate credit space or otherwise, I think you would see that relative to the risk we're taking, that it's significant excess return. Number two, as Penni mentioned, we are actually bringing down our weighted average cost of debt over time. It does not show up perfectly every quarter because of the timing of investments but if you look at the cost of our liabilities today on a fully funded basis, they've actually come down from 4.3% to 4.1% in the quarter as a result of the work that we're doing on the right-hand side of our balance sheet. So the continuation of high ROAs against the declining cost of liabilities will provide the stability and predictability in the earnings that we're looking for. The 2 biggest drivers of NOI growth, going forward, are going to be obviously, increased leverage. We have been operating at leverage levels in the 0.57 to 0.59 range. And as we've communicated before, we have significant comfort given the quality of our assets operating at higher leverage levels and that creates a pretty meaningful catalyst to earnings growth. And number two, what you'll continue to see is us rotating the portfolio and generating portfolio velocity as we've done through syndications to Ivy Hill and to the market, which drives earnings growth. So when you look at the picture today, obviously, given our size and given the complexion of the balance sheet, people should not expect significant earnings growth. I do think that the levers are in place through lower cost of funds and velocity as well as increased ROA. Then the only other thing I'll mention, we keep highlighting it but when you think about the construction of the portfolio, we are predominantly a floating rate asset portfolio against a predominantly fixed rate liability structure. And so as interest rates do go up and we're already beginning to see that, you should see earnings and that's yet another catalyst.

And you did mention, so from July 1 to August 2, the $313 million of new commitments were the 10 2 yield. I'm curious, what does that look like if we exclude the SSLP, which could be considered as well as maybe the second lien loans, which are likely considered I'd say, a little bit more leveraged, some would assume a little bit higher risk. I understand that the asset level, the SSLP is completely different. But just curious, what are you getting on that 44% of first lien senior secured that you're looking at quarter to date?

Yes, I don't want to give you a specific answer, Jon because again, as Kipp mentioned, how you price a loan is a function of so many companies, specific and structurally-specific issues. It's hard to just pin a number on the entire portfolio. Generally speaking, when you look at traditional first lien loans in this market, you're going to see us pricing them anywhere between 5% and 8% excluding fees, depending on the attachment point and the structural protections that we get from the loan.

Okay. Great. And jumping to one second lien investment made this quarter, I believe to Spinco, and I'm unsure if this is a loan that was part of the refi bucket. But I noticed there was about, in the press release, I think, $200 million committed. Yet on the balance sheet, I see roughly just $140 million show up. What's the delta $60 million between the $140 million and the $200 million, was that syndicated?

Yes, it was, Jon.

Okay. Great. So what is the market for that syndication in this environment? And is that increasing, should we say, over the next few months as banks are relatively hungry to put spread assets on the books?

Yes, sure. I mean, look, we originate a lot of paper, obviously. When you're doing $1 billion plus originations a quarter, it allows us to be the lead on deals and sometimes, we choose to optimize whole sized or take other considerations into account. But I'd say generally, do we find the loans that we underwrite easy to syndicate? The answer typically is yes because in most of the transactions, there's 3 or 4 other people that are trying to win that deal and they're losing to us. So our ability to turn around and syndicate a portion of those loans to the market is frankly not that difficult. There are a lot of buyers out there.

Okay. And then in terms of disclosure, will -- I mean, does this take on a similar type of syndication financing as some of the others that have been earmarked as I'd say back-end levered transactions? I think there's like 5 or 6 deals. I mean, will we end up seeing a footnote for that as it materializes or was it sold somehow differently than the previous ones that we've seen in your statement of investments?

Jonathan, it's Penni. Firstly, with respect to what everyone else is doing, it's just hard to know their details and specifics around how their transactions are structured and how they're accounting for it. But to the extent that we have information that needs to be disclosed around loans that are sold, we will disclose those. And with respect to just the accounting, you see how ours are accounted for and I really can't speak to how other people are accounting for their transactions.

Just other loans, Penni, not relative to other BDCs just -- will this loan at Spinco end up having a footnote just as the others that are on the balance sheet today?

It will not, Jonathan. We sold the security pari passu with the security that we're holding.

Okay. Great. And then one last question, Mike, related to Ivy Hill. Obviously, this is a meaningful contributor to dividend income moving past the substantial income you got dividend-ing up more just last quarter. A few questions about the entity. Does IHAM itself hold a position or hold a portion of the CLO equity that it -- did it perhaps sells their originates? Obviously, they sell a portion of the AAAs et cetera, down. Did they retain a portion of that equity at that asset manager level?

Sometimes.

Okay. So then the question is as you look at that dividend going forward, if they do hold a position in CLO equity and they were -- growth at that entity and new issuance in CLOs has been rather strong yet spreads have tightened, what's the likelihood of volatility in that dividend stream in the event that CLO returns decline as a result of limited spread on assets, yet a fixed liability structure?

It could theoretically have some impact. If you look at what the equity return requirement is generally speaking for a middle-market securitization today, it's probably in the 10% to 12% range, which is running slightly lower than the steady stream dividend yield coming off of the IHAM fee stream. That said, it typically isn't a requirement. So when Ivy Hill was looking at launching a new CLO vehicle, they're typically syndicating the bulk of the capital structure and then making an evaluation as to whether or not they want to hold the equity. When you look at the size of Ivy Hill's balance sheet and you look at the margins they're generating on the fees, I just don't think that the returns on new equity investments is going to be a meaningful downward driver on IHAM's earnings capability.

John, I mean, I'll make one other comment there too, which is obviously, we have an ongoing sort of dividend policy coming up from Ivy Hill. We saw a deviation from that last quarter where there was actually an excess dividend upstream out of the portfolio companies to Ares Capital, that you should take, is a reflection that we feel that the dividend level that we have in place that obviously, is recurring quarterly, is very conservative. And we're experienced looking at both the way operating profits coming off the management contract that they have work but also in terms certainly, of the securities that they own. So I don't think any market changes in those securities would have a meaningful impact on our ability to take dividend income from Ivy Hill.

And then last question for you, Kipp. Just as you are very active in the origination part of the franchise, give us a sense of where covenant cushions are today in terms of structure, as well as equity cures and how they compare to perhaps, the same covenant cushions and equity cures that you were doing 12 to 18 months ago.

Look, I mean, that's all over the map. It really depends on who's leading the deal, right? So it depends. If you're buying something from a bank, obviously, that they're underwriting and structuring to sell to accounts. I would tell you that the loan documentation, all the things that you mentioned are meaningfully worse than the things that we're writing in our own loan documentation as an arranger as the lead underwriter. It's too difficult to just say broadly that this is much better or this is much worse. But I would think convention in the market is that loan covenants are written at 20% to 25% discount to base cases laid out either by a sponsor, a company or a management team.

Okay. And then I guess just a last question on the weighted average EBITDA. You mentioned that it was up -- obviously, up significantly at $98 million as a result of 2 deals that you were involved with. Were you the sole underwriter and structurer of that transaction or both of those transactions that moved up that EBITDA number significantly?

I would say so in one of them, we were the lead but there were some other partners in the deal. And then the second one, we were not a lead, it was actually one of the companies that we underwrote back in '08, I think, that we originally got involved with. This is a company called Performance Food Group, that did a refinancing where we got involved with a significantly larger company in '08 because there was really no high-yield market and did a private notes deal on the company. They refinanced recently and we were part of the club, effectively, that refinanced but we weren't lead in that deal.

Kipp, would it be fair to say that those -- that the covenant packages on larger EBITDA type companies that are obviously hunted for by the banks, that it's possible -- that there's a little bit more latitude in terms of covenant and cures that might be perhaps a bit more aggressive in this market than maybe 12 to 18 months ago?

To be honest, Jonathan, I'm not sure. Obviously, I might have to go back and look at each of those -- one document in particular [indiscernible]

And our last question comes from Rick Shane of JPMorgan. Richard B. Shane - JP Morgan Chase & Co, Research Division: I just want to talk a little bit about the relationship between the backlog and the pipeline. Obviously, that's a leading indicator for future originations and this quarter, there was a little bit of an anomaly, which is the backlog itself is at sort of a peak level and the pipeline is at more of a trough level. We've never really seen that before. Does that suggest strong near-term originations but some need to rebuild that pipeline headed into the fourth quarter?

I think yes, probably, it does. I mean, Rick, it sort of comes and goes month-to-month, so it's just sort of unpredictable over the course of the quarter or over a year. I actually would highlight a lot of that backlog as being things that we have been working towards closing. I'd categorize the pipeline frankly, as being a little bit thinner because it's the beginning of August and a lot of people are at the beach. I can't really think of any other reasons, there's nothing else that's really indicative there other than probably coincidence and some summer factoring in. Richard B. Shane - JP Morgan Chase & Co, Research Division: Got it. Yes, it's interesting because ordinarily, I wouldn't read too much into this. The relationships sort of gravitates towards 1:1 and right now -- and it's never been over 2:1 backlog versus pipeline. Now, it's almost approaching 3.5:1, so that's why the issue comes up.

I think it's just seasonal, Rick. If you talk to people on the street, I think you'll hear a generally consistent theme that this has been a very busy summer, probably one of the busiest summers that people have seen. So I think the backlog is an indication of how busy the summer has been. The pipeline, I wouldn't read too much into that. You're not going to really get a good sense for how the pipelines develop until after Labor Day. Richard B. Shane - JP Morgan Chase & Co, Research Division: And Mike, do you think that's a function of issuers trying to get out before there's any movement in rate? Is that what's driving the behavior do you think?

No, I think it's some of the things we talked about earlier. Just you got a very good market environment, you've got good fundamentals, lots of liquidity in the market. I don't think that there's that much thought going into trying to rush because people think the market is going to fall apart in the fourth quarter. My expectation is that Q4 will be equally as busy and once people come back from the summer vacation, you'll start to see some meaningful activity pick up.

And Mike, let me add one thing. Rick, maybe for your benefit, I mean when we calculate that pipeline benefit for these purposes, we obviously probably-weight the things that are in our kind of deals under review is, to say what's the chance that this actually closes. And I guess the August issue is if you're not getting a lot of return phone calls pressing, pressing, pressing, it doesn't mean that you don't have a deal on review and that you're not working on a lot of things that are included in the pipeline. We probably just have lower probability weightings around some of those deals under review because we're just less sure on a month like August. But to my point, I think as everybody sort of gets back after it, perhaps a little bit more in September, we'll feel better about firming that pipeline up. I mean, there's a lot of -- we're pretty busy here and we have a ton of deals that we're working on right now. I think it's just probably how we calculate and probability-weight that backlog and pipeline that's skewing the number. Richard B. Shane - JP Morgan Chase & Co, Research Division: Got it. Because it's just interesting because the last 2 Augusts, the relationship's been more normal. It really is somewhat a function of August 2013 for whatever reason.

Yes.

That concludes our question-and-answer session. I would now like to turn the conference back over to management for any closing remarks, ladies and gentlemen.

Great. We have nothing further. Again, thanks for spending so much time with us today. We're thrilled with the quarterly performance and look forward to talking with you guys again next quarter. Thanks so much.

And we thank you, sir, and the rest of the management team, for your time. The conference call is now concluded. We thank you, all, for attending today's presentation. At this time, you may disconnect your lines. Thank you, have a great day.