Ares Capital Corporation

Good morning. Welcome to the Aries Capital Corporation's fourth quarter and year-ended December 31st, 2023 earnings conference call. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded on Wednesday, February 7th, 2024. I'll now turn the call over to John Stillmar, partner of Aries Public Markets Investor Relations. Please go ahead, sir.

Thank you. Let me start with some important reminders. Comments made during the course of this conference call and webcast, as well as the accompanying documents, contain forward-looking statements that are subject to risks and uncertainties. The company's actual results could differ materially from those expressed in such forward-looking statements for any reason, including those listed in its SEC filing. 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 certain non-GAAP measures as defined by SEC Regulation G, such as core earnings per share or core EPS. The company believes that core EPS provides useful information to investors regarding financial performance because it's one method the company uses to measure its financial condition and results of operation. A reconciliation of 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, the reconciliation of these measures may also be found in our earnings presentation filed this morning with the SEC on Form 8K. Certain information discussed in this conference call and the accompanying slide presentation, including information relating to portfolio companies, was derived from third-party sources and has not been independently verified. And accordingly, the company makes no representation or warranties with respect to this information. The company's fourth quarter, December 31st, 2023 earnings presentation can be found on the company's website at www.ariescapitalcorp.com by clicking on the fourth quarter 2023 earnings presentation link on the homepage of the investor resources section. Aries Capital Corporation earnings release and Form 10-K are also available on this website. I'll now turn the call over to Mr. Kip DeBeer, Aries Capital Corporation's Chief Executive Officer. Kip?

Thanks, John. Hello, everyone, and thanks for joining our earnings call today. I'm here with our co-presidents, Court Schnabel and Mitch Goldstein, our chief operating officer, Jana Markowitz, our chief financial officer, Penny Roll, our chief accounting officer, Scott Lem, and other members of the management team. For those who may not have seen our announcement, Scott Lem has been appointed as our new chief financial officer, effective February 15th. Scott has been a key business leader within our finance and accounting team for more than two decades, and he has been instrumental in helping us drive growth and success at ARCC over our many years together. In hand with this announcement, the company wants to thank Penny Roll for the tremendous contribution she has brought to our company over the past 14 years. As many of you know, she joined us with the acquisition of Allied Capital back in 2010, and has been a great partner to me and everyone on the team. And thankfully, she's staying with ARIES in a senior leadership role, and it's noteworthy that Penny will also remain an officer of ARIES Capital. Scott and Penny's new appointments underscore the depth and quality of our team, and we look forward to both continuing to serve ARIES Capital in their new roles. Now to our strong results. This morning, we reported another quarter of increased core earnings of 63 cents per share, which culminated in a year of record core earnings of $2.37 per share. These results largely reflect the continued strong credit performance of our portfolio and the earnings benefits of higher market interest rates on our net interest income. The strength of our earnings and positive valuation momentum in our portfolio also led to growth in our book value per share, which increased 5% year over year and reached a new record of $19.24 per share. In addition, our regular dividend of $1.92 per share for 2023 increased 10% over the 2022 regular dividend. We're proud of our long-term track record of delivering stable and consistent dividends to our shareholders. We remain one of the few BDCs that's been able to build NAV while delivering an average dividend yield of roughly 10% on the NAV over our 20-year history. Our strong results in 2023 and over the past several years reflect the market share gains that direct lenders like ARCC have enjoyed due to the greater certainty of execution, larger final hold amounts, and enhanced flexibility provided to companies. As an example, in 2023, over 90% of new LBOs were completed by direct lenders rather than through banks or bank-led syndications. And while the markets were slower last year, we believe we saw substantial market share gains overall. Although many more traditional lenders are now returning to the market and the syndicated loan and high yield markets seem to be finding their footing, we believe more borrowers recognize our ability to partner with them in support of their long term growth objectives, even during volatile and dislocated markets. In 2023 and into 2024, we've witnessed large, high-quality companies that were traditionally financed by the broadly syndicated markets turn to us to refinance their capital structures, not because they were unable to access the public markets, but because they preferred the stability that we provide through market cycles. By leveraging the broader scale of ARIES' U.S. Direct Lending Platform, we believe we can unlock value for a wide range of businesses, whether they are large high quality companies seeking multi-billion dollar financings or strong performing core middle market companies seeking a lender with flexible capital and the ability to support growth over time. Borrower demand for dependable financing partners is not exclusive to the larger end of the middle market, as we're also seeing many core middle market companies seeking our financing solutions. As an example, the number of transactions we reviewed in 2023 for companies with EBITDA less than $100 million expanded 30% year over year. Our differentiated deal flow also stems from our ability to provide capital in situations where significant technical expertise is required or there's a high degree of complexity, particularly in industries such as software and technology, specialty healthcare, financial services, infrastructure and power, and sports media and entertainment, just to name a few. We believe that our capabilities have resulted in us transacting with a growing number of borrowers. Ultimately, we believe the breadth of our sourcing capabilities drives better selectivity, which in turn leads to better credit outcomes and ultimately differentiates our performance relative to other market participants. Reflecting this focus on our sourcing capabilities, we estimate that we reviewed more than $500 billion of transaction opportunities in 2023. And during the fourth quarter, we saw more transactions than were reported in the broadly syndicated loan and middle market combined. We believe our high selectivity and rigorous underwriting supports our historical track record of maintaining a relatively low level of non-accruals and generally healthy credit performance. And currently we're seeing strong organic EBITDA growth of our portfolio companies and a below average level of non-accruing loans. Through the fourth quarter, we continued to collect 99% of contractual interest and the weighted average interest coverage ratio of our portfolio companies remained stable quarter over quarter. Further augmenting the health of our portfolio is a significant value junior to our loans. We estimate that the weighted average LTV of our total loan portfolio, including our junior capital investments, is around 43%. Our junior capital investments have attractive returns with LTVs that are comparable to liquid first lien structures. We believe that our ability to selectively invest in junior capital for relative value, often in much larger companies, differentiates our platform from senior-only competitors. Our ability to invest for relative value across the capital structure and generate incremental risk adjusted returns in junior capital investments has been a hallmark of our company and a significant contributor to our results over the past two decades. Given our size and long-term financing relationships, we maintain a strong capital position with excess liquidity in order to navigate market cycles and to be opportunistic when we see growing borrower demand. Our current net debt to equity level is reasonably low relative to historical standards at around 1.02 times. This leaves us with additional earnings upside if we choose to operate with expanded leverage and plenty of capital to pursue what we feel are attractive new investments. Our available liquidity was further enhanced in January 2024 with the issuance of a five-year unsecured note at industry-leading pricing. With that, let me turn the call over to Penny to provide more details on our financial results and some further thoughts on our balance sheet.

Thanks, Kip. We reported gap net income per share of 72 cents for the fourth quarter of 2023 compared to 89 cents in the prior quarter and 34 cents in the fourth quarter of 2022. For the year, we reported gap net income per share of $2.75 compared to $1.21 for 2022. On a core basis, we matched our record level of core earnings per share of 63 cents for the fourth quarter of 2023, compared to 59 cents in the prior quarter and 63 cents in the fourth quarter of 2022. We continue to see the benefits of higher base rates on our predominantly floating rate portfolio in the fourth quarter of 2023 as our interest in dividend income increased from both the prior quarter and fourth quarter of the prior year. Additionally, we saw the benefits of an improving investing environment resulting in higher capital structuring service fees from our highest origination quarter of the year. Our stockholders' equity ended the quarter at $11.2 billion or $19.24 per share, which is over a 1% increase per share over the prior quarter and a 5% increase per share over the prior year end. Our annualized return on equity for 2023 using GAAP EPS and Core EPS was 14.6% and 12.6% respectively. This strong level of profitability further builds upon our long-term track record of a 12% total return on NAV since inception. Our portfolio at fair value ended the quarter at $22.9 billion, up from $21.9 billion at the end of the third quarter, reflecting a combination of net fundings and net unrealized gains from the portfolio for the quarter. The weighted average yield on our debt and other income-producing securities at amortized costs was 12.5% at December 31st, 2023, which increased from 12.4% at September 30, 2023, and 11.6% at December 31st, 2022. The weighted average yield on total investments at amortized costs was 11.3%, which increased from 11.2% at September 30, 2023, and 10.5% at December 31, 2022. Stipping to our capitalization and liquidity, we continue to benefit from the depth of our relationships we have built with our secured lenders over 20 years and with our investment-grade note holders over more than a decade. As the most tenured BDC issuer in the unsecured notes market, we capitalized on investor demand in the fourth quarter by reopening our three-year unsecured notes and ultimately executing the transaction at a better all-in yield than our original issuance. The initial issuance, which was done during the third quarter of 2023, was our first issuance in over 18 months, underscoring the merits of our approach to maintain deep levels of liquidity, which, amongst other benefits, allows us to be patient and tactical in how we access the capital market. As a continuation of this theme, we capitalized on the market demand for our notes at the start of the year and chose to enter the high-grade unsecured market once again. Given the constructive market and the deep support of our investors, we were able to issue $1 billion of long five-year notes at market-leading spreads. This issuance represented our single largest initial issuance in the high-grade unsecured market in our history and the largest BDC issuance done this year, underscoring our market-leading execution. This is our only term debt maturing in 2029 as we continue to extend out our maturities to maintain a well-laddered maturity profile and to further strengthen our solid balance sheet position. We have built what we believe is the best in class investment grade capital structure with a diversified base of over 275 bank lenders and debt investors, providing for meaningful access to the capital markets and significant unfunded revolving commitments. As always, we are grateful to their continued support of Aries Capital. We believe that our liquidity position remains strong with approximately $6.4 billion of total available liquidity including available cash pro forma for the recent $1 billion of notes issued a few weeks back. We ended the fourth quarter with a debt to equity ratio net of the available cash of 1.02 times as compared to 1.03 times a quarter ago. We believe our significant amount of dry powder positions as 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 this coming year's term debt maturity. We declared a first quarter dividend for 2024 of 48 cents per share. This dividend is payable on March 29th, 2024 to stockholders of record on March 15th, 2024. And it's consistent with our fourth quarter 2023 dividend. In terms of our taxable income spillover, we currently estimate that we ended 2023 with approximately $635 million or $1.09 per share from 2023 for distribution to stockholders in 2024. This estimated spillover level is more than two times our current regular quarterly dividend, which we believe is very beneficial to the stability of our dividend. Before I finish, I would like to say that it has been my distinct honor to have served as the Chief Financial Officer of Aries Capital and to have had the opportunity to work for the benefit of our investors and lenders. I have been fortunate to be a part of this incredible team that has collaboratively built this company over the years. Scott and I have been in this together for my full tenure here, and I am very pleased that he will be our next CFO. I would like to express my deepest gratitude to him and our talented and dedicated finance and accounting, investor relations, legal and compliance, and investing teams whose tireless efforts have contributed to our collective success. I am excited to continue as an officer of ARCC and to remain a part of ARIES. And with that, I will now turn the call over to Court to walk through our investment activities.

Thanks, Penny. I'm now going to spend a few minutes providing more details on our investment activity, our portfolio performance, and our positioning for the fourth quarter and the year. I will then conclude with an update on our post-quarter end activity, backlog, and pipeline. Over the course of 2023, our team originated nearly $6 billion of new investment commitments across 200 transactions. including $2.4 billion of commitments to 74 different borrowers in the fourth quarter alone. Further building on our leadership position in the market, after ARCC had the highest level of originations of any publicly traded BDC in Q3, our new commitments in the fourth quarter increased almost 50% quarter over quarter. This growth is in sharp contrast to the reported broadly syndicated market volume in the middle market per infinitive. both of which decreased quarter over quarter. One benefit of the ARIES platform that was particularly valuable for us in 2023 and which stems from the scale we have built over the past 20 years is the benefit of incumbency. Even during the less active market environment we saw in 2023, we continued to find attractive investment opportunities from our existing portfolio companies, which represented approximately two-thirds of our commitments during the year. By further investing in our incumbent companies that we have a relationship with and know well, we believe we can reduce underwriting risk and drive better credit performance. Our new investments during the year were in a diverse set of companies across more than 20 distinct industries and included opportunities in both senior and junior capital investments, reflecting the continued benefit of our flexible strategy to invest across the capital structure, as Kit mentioned. The EBITDA of the companies we financed this year ranged from less than $20 million to over $800 million, which further demonstrates the breadth of our sourcing capabilities. Our new investments were made into what we believe are high-quality companies that present opportunities for attractive risk-adjusted returns, especially compared to the broadly syndicated loan markets. For example, ARCC's newly originated first loan loans in 2023 had average spreads of 625 basis points and an average LTV of only 33%. These senior loans had spreads that were approximately 200 basis points wider and had equity cushions that were more than 30% higher than LBOs completed in the broadly syndicated loan market in 2023, based on data reported by LCD. Shifting to our portfolio, as of year-end 2023, our strong and growing portfolio remains well diversified across 505 different borrowers. The number of companies in our portfolio has increased 8% over the past year and 47% over the past five years. To dig a little deeper, our average hold size is only 0.2% at fair value. Excluding our investments in Ivy Hill and the SDLP, which we believe are diversified on their own, no single investment accounts for more than 2% of the portfolio at fair value. And our top 10 largest investments total just 12% of the portfolio at fair value. The significant diversification of our portfolio differentiates us from our competitors as it reduces the impact to the overall portfolio from any single negative credit event and individual company. As Kit mentioned, the fundamentals and overall credit performance of our portfolio remain healthy. The weighted average EBITDA of our underlying portfolio companies demonstrated increased growth in the fourth quarter, expanding 9% year over year, up from 6% in the prior quarter. This compares to an estimated flat earnings growth rate for the S&P 500 over the last 12 months. As a reminder, the EBITDA growth of our portfolio companies we report excludes the impact from acquisitions, as our goal has always been to provide investors with a view into the organic growth of our portfolio. We are seeing this healthy level of positive EBITDA growth across both our senior and junior capital investments, as well as our larger and smaller companies. In addition, the EBITDA of our top five largest industries in aggregate is growing at a faster rate than the overall portfolio. This underscores what we believe is one of the many merits of not being a benchmark-style investor, as we are able to be selective, not only in regard to the companies we are financing, but also to the industries we target more generally. With respect to our portfolio grades, the weighted average portfolio grade of our borrowers at cost was stable with last quarter's 3.1%. Non-accruals at cost ended the year at 1.3%, below the 1.7% at year-end 2022, and well below our 3% 15-year historical average, and the KBW BDC average of 3.9% for the most recent 15-year period available. Our non-accrual rate at fair value remained consistent with last quarter at 0.6%, which continues to be well below historical levels for our company as well. Finally, I will provide a brief update on our post-quarter-end investment activity and pipeline. From January 1st through February 1st, 2024, we made new investment commitments totaling $705 million, of which $478 million were funded. We exited or were repaid on $695 million of investment commitments, which resulted in us earning $19 million of net realized gains. As of February 1st, our backlog and pipeline stood at roughly $1.1 billion. Our backlog contains 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 Kip for some closing remarks.

Thanks a lot, Court. Building on the strength of our results in 2023, we believe that we are well-positioned for the year to come. We anticipate an uptick in deal activity in 2024 as a more stable capital markets backdrop is combined with growing pressure on private equity GPs and LPs to monetize positions and get returns of capital. In addition, the robust level of private equity dry powder that has largely gone unspent and is aging should support a more active M&A environment. We believe that ARCC is uniquely positioned to benefit from an increase in transaction activity, which we anticipate would support our ability to earn higher capital structuring fees. For context, in 2023, capital structuring fees as a percentage of our stockholders' equity was less than half of our five-year average. As a reminder, at ARCC, all capital structuring fee income is fully retained for the benefit of our shareholders, and none is paid to ARIES management. We believe the scale of our capital provides ARCC investors with these fee opportunities that some other market participants don't have or don't fully share with shareholders. Our many competitive advantages have resulted in differentiated performance in almost every relevant metric versus the competition. The company has delivered the highest regular dividend per share growth rate, the highest growth in NAV per share, and the best stock-based total return in each case when compared to every other externally managed BDC of size that's been publicly traded for the last 10 years. We believe the factors that have driven our outperformance remain firmly in place, and as a result, we remain optimistic about the year ahead. Let me just close by saying we're deeply grateful to our investors for the trust and confidence they've demonstrated in Aries Capital and to our team for their tireless work and dedication in 2023. And to conclude on a more personal note, I just want to once more sincerely thank Penny for her friendship and her partnership. We've developed a close relationship over the years, and I know I speak for the team as a whole. We will miss her day-to-day involvement with Aries Capital. And with that, operator, please open the line for questions.

Yes, sir. At this time, if you would like to ask a question, please press the star, then 1 on your touchstone phone. If you would like to withdraw your question, please press star, then 2. Please note, as a courtesy to those who may wish to ask a question, please limit yourself to one question and one single follow-up. If you have additional questions, you may re-enter the queue. The Investor Relations Team will be available to address any further questions at the conclusion of today's call. Our first question comes from John Heck with Jefferies.

John Heck, Jefferies, Jefferies Good morning, guys. Thanks very much for taking my question. Penny, congratulations. We'll miss you, and Scott, look forward to working with you. First question is, you know, when you think about kind of a mix of the forward curve, you know, and the implications for, you know, lower rates, and you think of spreads in the market and, you know, just overall competition, where do you guys see kind of new deal yields coming in relative to the runoff at this point?

Yeah. Hey, John. Good morning. It's Kip. Thanks for your comments, too. Look, I mean, I think – generalization, right? Spreads have tightened a little bit, I think, as folks have a little more confidence in the economy. So, you know, a regular way Unitronch these days is probably 550 over the base rate. You know, it's kind of the midpoint. Depends on company size, credit quality, and all of that. So relative to onboarding new investments vis-a-vis the existing yield in the portfolio, it's probably... right around the same. So I think we're able to take on new investing that's still pretty accretive to the earnings. In terms of rates and all that, I think we're in the camp of likely higher base rates for a bit longer. And I think so long as defaults remain reasonably muted, you'll see the spreads kind of sit around these levels for a little while. So I think we're in kind of a static, kind of comfortable place where things have plateaued a bit. We're hopeful that activity picks up, which we're seeing. So pretty good environment for new investing.

Okay. And at Second question is, I know your interest coverage ratio has actually been pretty steady given the rate environment, and obviously your credit performance has been good. There's been only a couple reports in the BDC sector thus far, but we have seen growth. Some, you know, have an increase in non-performing asset accumulation. Kip, I'm just throwing all that together. I'm wondering what your kind of industry outlook is for credit quality, understanding that you guys are differentiated in that regard.

Yeah, I mean, I think big picture, John, you know, it's been our expectation, and we've said this in the past, that we're likely to see defaults, you know, in the industry just increase this year. it does take a little bit of time for that to manifest itself, right? So, you know, in the bottom quartile of our portfolio and probably everybody else's, you have some companies that, you know, are making interest payments but continue to live off, you know, revolver availability, cash, et cetera, but the liquidity is getting, you know, tighter and tighter. So my expectation is that defaults will go up this year, probably more towards the historical norm, You know, we've had a little bit of, you know, amendment activity that's elevated. I think others probably have too, but nothing that's causing us a whole lot of concern. I think it's just a regular, you know, letting out as obviously rates are higher and companies have, you know, higher debt service costs and all that. But generally, I think we'll see that as will others.

Our next question comes from Finian O'Shea with Wells Fargo Securities.

Hey, everyone. Good morning. Would also like to first and foremost congratulate Penny and Scott. Kip's sticking with the market there. First question is, how would you describe the risk of a liquid market comeback, bringing a major refi wave, but without the corresponding pickup in new money volume?

Yeah, I mean, you know, I think we're actually starting to see that. And thanks for your comments, Stephen. I think we're starting to see that. You know, some of the existing issuers that probably took on some higher cost debt are pursuing repricings in the large cap market that's going to carry over a little bit into our market so it'll bring a little bit of pressure but frankly nothing that we can't handle from an earnings perspective and it's just how strategically do we think about you know staying in some of these credits versus potentially you know opting to to exit but um Yeah, that pressure is there real time, you know, right now here in February of 24. And we'll just keep evaluating it. I'm hopeful, you know, as CLO spreads, Titan and more, I think capital comes into that market. And there, again, to our prepared comments is a desire for growth. more New Deal activity on the GP side, on the private equity side, and on the company side. We're just hopeful that, you know, regular way new issuance will come with time and perhaps, you know, make that a little bit less of a pressure. But it's there right now for sure. We're experiencing it, but it's nothing that, you know, we can't handle.

Okay, sure. Thanks. And as a follow-up on deployment, you've obviously provided a lot on this thread in this call, but bringing it all together, fourth quarter commitments were, you know, a little lower roughly in line with last year. We would have thought last year fourth quarter would have been the very bottom. So if you could unpack, like, you know, a bit why things weren't at least somewhat better, the sort of main reasons there. And that's all from me. Thank you.

Thanks. I mean, so, yeah, so the fourth quarter, just to your comment, if you need to follow on, let me know. Just make sure I get the gist of it. But, yeah, I mean, the fourth quarter, I think, was a lot of picked up demand to get some transaction activity closed by year end. You know, we did, you know, looking back at last year, start the year, you know, very slow. And it obviously accelerated into year end. In terms of deployment, you know, we're expecting a more active 24. You know, I mean, 21 was a peak year. 22 was probably more normalized. Last year was a little bit slower. And I think this year, again, because, you know, a lot of GPs feel that, you know, their activity levels have been low and a lot of LPs are looking for capital back And I do think there's plenty of available financing to get deals done. We think 24 will be a pretty good deployment year and should be busier. I hope that answered the question.

This is Coach Schnabel. The only other thing to add is the fourth quarter last year in 2022 was not actually a particularly slow quarter. We had some large transactions that came our way as a result of all the dislocation going on in the broader capital markets. And so it actually was a fairly healthy quarter back then. So I think the comparison and looking at that as being a slower quarter probably isn't quite right.

Thank you. Our next question comes from Lisa Whittle with JPMorgan.

Good morning. Thanks for taking my questions. Once again, to Penny and Scott, congratulations to both of you. I wanted to follow up on your comments, Kip, about higher activity in 2024. Should we think about that as being sort of skewed towards the back half of the year? Of course, there's normal seasonality, but more skewed towards the back half of the year with potential rate declines, or do you just expect higher levels kind of throughout the year?

I mean, it's hard to predict, Melissa. Thanks for your question. I think I'd say two things. If rates do, in fact, start to decline middle into the back of the year, that should obviously compel some increased transaction activity. I think the counterbalance to that, speaking personally, is I actually think if the presidential election starts to creep into the equation, things will slow down a bit. But somebody else pointed out there's some Tax changes that are currently in the system that are meant to roll off. One of our friends and competitors had referenced that the roll off of those tax changes could actually compel people to pursue transactions this year versus next year. But look, I mean, you know, as we sit here today, we're pretty busy. Activity levels are good. They're definitely better than they were, you know, at this time last year. Hard to predict how it falls quarter to quarter, but I think it should just be a busier year and reasonably balanced. How about that? You know, I don't think there's going to be a particularly big quarter relative to another. We just see a more regular level of activity reoccurring, and we're happy about that. That's great for the business.

All right. Understood. Just as a follow-up, too, looking at – Slide 18, addressing the backlog and pipeline. Notice that there's a particular weighting towards insurance services in the backlog and pipeline. And just hoping you guys could provide a little context about the opportunity that you're seeing in that particular industry. Thanks.

Yeah, I mean, whenever we snap a quarter like that, it's hard. I mean, there's no, you know, that's one or two big, you know, particular deals, obviously, in that sector. It's an active area of new investing for a lot of private equity firms. You know, we have a significant portfolio in that market or in that industry rather. So I think it's just reflective probably of one or two big deals that happened to pull into the same quarter, but nothing other than that to take away.

Our next question comes from Ryan Lynch with KBW.

Hey, good morning. I'd like to also congratulate Eddie and Scott for the new roles and transitions. My first question has to do with, you mentioned the broadly syndicated low market and some of the liquid markets, maybe just gaining a little more footing here.