Ares Capital Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
July 25, 2023

Key Takeaways

  • Ares Capital reported core EPS of $0.58 (up 26% y/y) and GAAP EPS of $0.61 in Q2, boosting NAV per share to $18.58.
  • Direct lenders like Ares captured 85% of new-issue U.S. LBO financing in Q2, and the number of deals reviewed by Ares rose 20% quarter over quarter.
  • New investments featured spreads well above historical averages, 4.5x leverage and a weighted average yield over 11.5%, with loan-to-value around 40%.
  • Portfolio credit quality remains strong with a stable average grade of 3.1, non-accruals at cost of 2.1% (below the 15-year average) and pro forma interest coverage of ~2.1x.
  • The balance sheet is conservatively positioned at 1.07x debt-to-equity with ~$4.7 billion of liquidity and a maintained $0.48 quarterly dividend, marking 56 consecutive steady or increased payouts.
AI Generated. May Contain Errors.
Earnings Conference Call
Ares Capital Q2 2023
00:00 / 00:00

There are 5 speakers on the call.

Operator

Good morning. Welcome to Ares Capital Corporation's 2nd Quarter June 30, 2023 Earnings Conference Call. At this time, all participants are in a listen only mode. As a reminder, this conference is being recorded on Tuesday, July 25, 2023. I will now turn the call over to Mr.

Operator

John Filmar, Managing Director of Ares Investor Relations.

Speaker 1

Thank you very much. Let me start with some important reminders. Comments made during the course of this conference call and webcast as well as the accompanying documents contain forward looking statements and are subject To risks and uncertainties, the company's actual results could differ materially from those expressed in such forward looking statements for any reason, including those listed in its 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.

Speaker 1

During this conference call, the company may discuss certain non GAAP measures as defined by SEC Regulation G, such as core earnings per share 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 A reconciliation of GAAP net income per share, the most directly comparable GAAP financial measure to core EPS, Can be found in the accompanying slide presentation for this call. In addition, a reconciliation of these measures may also be found in our earnings release filed this morning with the SEC on Form 8 ks. Certain information discussed in this conference call and the accompanying slide presentation, including information relating to portfolio companies, This is derived from third party sources and has not been independently verified. And accordingly, the company makes no such representations or warranties with respect to this information. The company's Q2 ended June 30, 2023 earnings presentation can be found on the company's website at www.arescapitalcorp.com by clicking on Q2 2023 earnings presentation link on the homepage of the Investor Resources section of our website.

Speaker 1

Ares Capital Corporation's earnings release and Form 10 Q are I'll now turn the call over to Mr. Kipp DeVeer, Ares Capital Corporation's Chief Executive Officer.

Speaker 2

Kipp? Thanks, John. Hello, everyone, and thanks for joining our earnings call today. I'm here with our Co Presidents, Mitch Goldstein and Cort Schnabel our Chief Financial Officer, Penny Roll Our Chief Operating Officer, Jana Markowitz and other members of the management team. I'd like to start by highlighting our 2nd quarter results, And I'll follow that with some thoughts on the economic environment and the current market.

Speaker 2

This morning, we reported strong second quarter results. Our core earnings per share of $0.58 increased 26% year over year, primarily driven by the benefit of higher interest rates Our GAAP earnings per share for the quarter were $0.61 driven by our strong core earnings And a modest increase in the overall value of our investment portfolio. These results led to another quarter of Sequential growth in our net asset value per share to $18.58 We are pleased with these results and we think it's important put them into context of what we're seeing in the broader credit markets, over the past 2 decades, direct lenders have demonstrated their ability to be a stable source of capital, According to growth of U. S. Companies, even when banks and syndicated capital markets are volatile and hard to access.

Speaker 2

More recently, this trend has accelerated and direct lenders such as Ares have stepped in to fill the void. Although 2nd quarter transaction activity remains slower than recent history, it picked up compared to the Q1 And the firming tone of the capital markets is an important step towards greater M and A deal activity. Importantly, We are seeing direct lenders gain significant share as 85% of new issue LBO financing in the U. S. Was completed by direct lenders.

Speaker 2

In less volatile markets, this percentage would typically be lower and transactions, particularly the large Deals would be more heavily weighted towards the broadly syndicated bank loan and high yield markets. Direct lending also continues to be increasingly active away from the LBL Market as direct lenders completed 1.5 times as many non buyout financings as the broadly syndicated market during the 2nd quarter, according to data by LCD. As it relates to our business, the number of deals we reviewed in the Q2 increased 20% over the Q1. This includes certain incumbent portfolio companies seeking incremental financing opportunities, which provides us with a steady source Differentiated originations. Overall, we're sourcing many compelling transactions and we're cautiously optimistic The recent pickup in activity will translate into a higher level of closed transactions.

Speaker 2

During the second quarter, Market pricing and terms continue to be highly attractive as it relates to our new deals. Spreads on our new loans are well above historical averages, Leverage levels are lower and equity contributions are higher. Similar to the existing portfolio, most of our new investments are floating rate deals to benefit from higher base rates. Market data provided by LCB underscores our view that the current vintage of buyout transactions has Highest level of equity support of any time in history. At the same time, the risk adjusted returns in our lending business are historically very attractive As spread per unit of leverage, which measures returns relative to risk, are 15% better than the 10 year average.

Speaker 2

We believe the current vintage ranked as one of the best for our lending business in the past 10 years. Within this attractive and growing market, we continue to enhance our leading market position. We believe our large and long Tenured U. S. Direct lending team of 170 investment professionals delivers a compelling brand in the market and this provides us with many intangible benefits, particularly in sourcing.

Speaker 2

Given the impact of our participation and the value we add in transactions, we believe we sometimes get more looks on new opportunities and have an ability to negotiate preferred terms with our counterparties. In recent periods, we've taken additional steps to further support our sourcing and credit advantages. Expanding on our extensive sponsor And non sponsor coverage over the past 5 to 10 years, we've continued to develop a significant amount of industry expertise, specifically in software and technology, specialty healthcare, financial services, infrastructure and power, And sports, media and entertainment to name a few. More recently, we formalized these industry specializations, creating 8 dedicated industry teams that enhance the significant sponsor and non sponsored coverage that we enjoy today. We believe that formalizing these teams has further contributed to the strength of our process and our risk management capabilities and made us an even more compelling partner for sponsors and for portfolio companies.

Speaker 2

Despite companies dealing with higher borrowing costs, we believe corporate fundamentals remain solid, perhaps stronger than we would have expected. Our portfolio companies continue to perform well, and we see no evidence of what many believe is an imminent recession. Credit quality has been stable and inflationary pressures have begun to show some easing. Our weighted average portfolio grade is flat quarter over quarter and slightly better than our 15 year average. Our non accruals at cost decreased slightly and remained well below our own and BDC averages over the past 15 years.

Speaker 2

Despite the constructive view that we maintain on the economy and the portfolio, we are paying particular attention to the cash flows at our portfolio of companies. EBITDA continues to grow nicely, as Court will describe, and our portfolio interest coverage ratio remained relatively stable quarter over quarter. While some market participants are calculating interest coverage ratio tests using actual interest expense over the past 12 months, If we don't necessarily think is particularly relevant, we calculate the ratio using pro form a annual interest expense using market rates at quarter end. If we instead did the calculation using the actual interest expense over the past 12 months, our portfolio interest coverage ratio would have been 30% higher For the Q2 approximately 2.1 times. The loan to value in our portfolio continues to be conservative At quarter end, we estimate it to be around 43%.

Speaker 2

There is significant invested capital and value beneath us in most capital structures, A lot of it is supplied by large and well established private equity firms with whom we have great relationships and do repeat business. We continue to believe that a lot of the focus should and will be on the behavior of our partners who own the equity in these businesses, And we would expect solutions for companies needing assistance to come from a partnership approach between lenders and these partners, if history is any indication. So as a result of these dynamics and the company's overall performance, feel confident about the results we were able to deliver for the 2nd quarter and our competitive positioning going forward. With that, let me turn the call over to Penny to provide more details on our results and our strong balance sheet position.

Speaker 3

Thanks, Kipp. For the Q2 of 2023, we had core earnings per share of $0.58 compared to $0.57 in the prior quarter and $0.46 in the Q2 of 2022. We continue to see the benefits of higher base rates on our predominantly floating rate portfolio in the second Our income was bolstered by higher capital structuring fees as compared to the prior quarter despite a generally continued slower origination environment in the quarter. On a GAAP basis, we reported GAAP net income per share of $0.61 for the Q2 of 2023 compared to $0.52 in the prior quarter and $0.22 in the Q2 of 2022. Our higher GAAP net income per share in the Q2 of 2023 benefited from modestly higher portfolio values during the quarter.

Speaker 3

Our stockholders' equity ended the quarter at nearly $10,400,000,000 or $18.58 per share, which is an approximate 1% increase in NAV per share over the prior quarter. Our annualized Return on equity this quarter was greater than 12.5%, whether one measures this on a core or a GAAP basis. This strong level of profitability further builds upon our long term track record of a 12% GAAP based annual return on NAV since inception. Our total portfolio at fair value at the end of the quarter was $21,500,000,000 up from $21,100,000,000 at the end of the first quarter, reflecting net fundings from the portfolio. The weighted average yield on our debt and other income producing securities at amortized cost was 12.2% at June 30, 2023, which increased from 12% at March 31, 2023 and 9.5 at June 30, 2022.

Speaker 3

The weighted average yield on total investments at amortized cost was 11%, which increased from 10.8% at March 31, 2023 and 8.7% at June 30, 2022. Yields on our portfolio reflect the continued increases in interest rates. Shifting to our capitalization and liquidity, We ended the 2nd quarter with a debt to equity ratio, net of available cash of 1.07 times as compared to 1.09 times a quarter ago. Our liquidity position remains strong with approximately $4,700,000,000 of We believe our significant amount of dry powder positions us well to continue to support our existing portfolio commitments to remain active in the current investing environment and to have no refinancing risk with respect to next year's term debt maturities. We declared a 3rd quarter 20 Dividend of $0.48 per share, which marks the 56th consecutive quarter of steady or increasing dividends.

Speaker 3

This dividend is payable on September 29, 2023 to stockholders of record on September 15, 2023 and is consistent with our Q2 2023 dividend. With that, I would like to turn the call over to Court to walk through our investment activities for the quarter.

Speaker 1

Thanks, Penny. I am now going to spend a few minutes providing more details on our investment activity And our portfolio performance and positioning for the Q2. I will then conclude with an update on our post quarter end activity, backlog and pipeline. In the Q2, we originated $1,200,000,000 of new investments across 46 different transactions As broader middle market sponsors and businesses continue to value Ares as a consistent and reliable source of capital. Underscoring the breadth of our market coverage, the EBITDA of the portfolio of companies we financed during the quarter ranged from below $20,000,000 to over $1,000,000,000 and we were the lead arranger on 77% of the transactions we closed in the 2nd quarter.

Speaker 1

We believe that our ability to lead transactions is an important benefit of our scale, providing us greater control over capital structures, Pricing and documentation and longer term better tools to drive successful credit outcomes. We continue to find compelling value in today's market. This is demonstrated by the 1st lien investments we originated in the quarter, which had a weighted average yield in excess of 11.5%, but leverage of only 4.5 times debt to EBITDA. Underscoring TIFF's earlier point about the historically attractive relative value we are able to achieve on our new investments, The weighted average LTV of our 2nd quarter commitments, including our junior capital investments, was below 40%. We also believe the breadth and quality of our incumbent portfolio provides differentiated access to attractive new investment opportunities.

Speaker 1

We continue to invest in what we believe are our strongest portfolio companies as over 70% Our transactions during the quarter were 2 existing borrowers, many of whom are executing tuck in acquisitions or seeking growth capital and have elected to grow with us as their financing provider of choice. Our portfolio continues to perform well and we are seeing a lot of stability within our credit metrics. We believe this is largely due to our defensively positioned portfolio in market leading companies with high free cash flow in resilient industries. In the 2nd quarter, the weighted average annual EBITDA growth rate of our portfolio companies With a healthy 7%, in line with historical levels and the weighted average portfolio grade of our borrowers at cost With stable with last quarter at 3.1. As we have discussed in the past, we are carefully monitoring the impacts of inflation.

Speaker 1

While our portfolio companies are not immune, the percentage of the portfolio that we estimate to be highly impacted by inflation risk has improved modestly and is now at the lower end of our 5% to 10% range as we are seeing some improvements from supply chain pressures. All of these factors resulted in our non accrual rates continuing to be well below historical levels. Our non accruals at fair value improved modestly from 1.3% last quarter to 1.1% this quarter, While our non accrual rate at cost also improved from 2.3% last quarter to 2.1% this quarter and remains well below our 3% 15 year historical average and the KBW BDC average of 3.8% for the most recent 15 year period available. Looking forward, we remain confident about the performance of our portfolio, in part due to our disciplined approach to risk management and portfolio diversification, which reduces the single name risk in the portfolio. Our $21,500,000,000 portfolio at fair value is diversified across 475 different companies in 25 different industries.

Speaker 1

This means that any single investment accounts for just 0.2% The portfolio on average and our largest investment in any single company excluding SDLP and Ivy Hill is just 2% of the portfolio. We believe we have the greatest level of portfolio diversification of any publicly traded BDC. In addition to the benefits of diversification in our portfolio, there is a meaningful amount of enterprise value beneath us. The weighted average LTV of our portfolio is 43%, inclusive of our 2nd lien and subordinated investments. On average, these junior capital investments are in meaningfully larger companies in defensive industries and with significant equity capital supporting our positions.

Speaker 1

At quarter end, our entire junior capital portfolio At a weighted average EBITDA in excess of $400,000,000 and a weighted average LTV of less than 50%. Our compelling junior capital track record, which includes annualized loss rates of less than 20 basis points over our nearly 20 year history, Supports our continued strategy of seeking attractive risk adjusted returns through selective deployment into this asset class. Finally, I will provide a brief update on our post quarter end investment activity and pipeline. From July 1 through July 19, 2023, We made new investment commitments totaling $211,000,000 of which $119,000,000 were funded. We exited or were repaid on $118,000,000 of investment commitments.

Speaker 1

As of July 19, Our backlog and pipeline stood at roughly $470,000,000 Our backlog and pipeline contain 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 Kipp for some closing remarks.

Speaker 2

Thanks a lot, Port. In closing, We believe that our portfolio continues to demonstrate strong overall performance and we are well positioned to navigate any potential future economic challenges. We believe our many long term competitive investing advantages, the strength of our balance sheet and the defensive positioning of our portfolio It should allow us to deliver differentiated performance and attractive risk adjusted returns for our shareholders. We are hopeful that activity will pick up As volatility subsides and as market participants have a more certain outlook in the direction of interest rates and the economy, and we stand ready to capitalize on this highly attractive new investing climate. For Ares Capital, we believe that this is a good time to focus on our diversified portfolio and are sourcing, underwriting, credit and portfolio management strengths with a view to delivering strong financial results and a significant level of core earnings from our diversified portfolio.

Speaker 2

As always, we appreciate you all joining us today. We're happy to open the line now for questions.

Operator

Please note as a courtesy to those who may wish to ask a question, at the conclusion of today's call. Our first question comes from the line of Melissa Weddell with JPMorgan, please proceed with your question.

Speaker 3

Good morning. Thanks for taking my questions today. Wanted to touch on actually some of the activity that you disclosed in the press release for this For 3Q to date, noted that I think it was 49% in preferred and fixed rate deals so far in Q, which was down, I think a decent amount from 2Q levels in terms of fixed rate allocation. I was hoping you could just Elaborate on that and what you're seeing?

Speaker 2

Thanks for the question, Melissa. Nothing That for me comes off the page, penny and 9 quarter looking at it. It's one frankly single fixed rate large preferred investment that skews the mix on a pretty small denominator. Yes. The other thing

Speaker 1

to add maybe to that would be on some of these preferred investments, we actually are able to get warrants and equity upside kickers as well. So The fixed rate component doesn't capture the totality of the return. Yes.

Speaker 3

Understood. And is just as a strategy going forward with the uncertainty of the rate environment, is your willingness to allocate more fixed Great deals sort of increasing and are you more amenable to requests from borrowers for that? Thank you.

Speaker 2

Not really. I think most of just a follow on. I think this is just literally a single circumstance of one negotiated deal with one particular company.

Operator

Our next question comes from the line of Finian O'Shea with Wells Fargo Securities, please proceed with your question.

Speaker 1

Hi, everyone. Good morning. Can you talk about the change at Baragon and What that might mean near or long term for the STLP?

Speaker 2

To be honest, not in a lot of detail And that news is pretty new. We're excited. And then I think our partners at Baragon are Feeling good about having a large institution to partner with. My guess is that Mann Group is going to want to Run Veragon the way it's been run and continue to grow, I'd expect that that relationship with them would be unchanged. But since the news is new, I don't really have any

Speaker 1

Great. Perfectly understandable. Thank you. Just a follow-up for does Ares BDC receive or is it interested in allocation from The Ares alternative credit line?

Speaker 2

From that business? For sure. I mean, as we say all the time, we think we're Real beneficiaries at the BDC of the rest of our credit platform here. So, what we've typically Excluded has been what we're doing in Europe for the most part. We really run that standalone.

Speaker 2

But everything else that we're doing in U. S. Credit benefits the BDC and alternative credit for sure can be part of that.

Speaker 1

Very good. Thanks so much.

Speaker 2

You're welcome.

Operator

Our next question comes from Arren Cyganovich with Citi. Please proceed with your question. Thanks. It sounds like structures and leverage levels are attractive here. Are you seeing any kind of opening up yet of sponsors willingness to invest in So what do you think the timeframe will be until you start to see deal activity start to increase?

Speaker 2

That's probably the hardest one, Aaron. And if you actually ask The senior folks here, I think you get a range of different responses in terms of optimism, pessimism, whatever it may be. I probably sit somewhere in the middle. I mean, look, we've seen the pipeline pick up a little bit. Specifically, we actually saw the number of deals that we review increase each During the Q2, if that's any indication, it's picking up a little bit.

Speaker 2

But as I said in the prepared remarks, I think different folks have a very different view At least there's not consensus perhaps around the direction of the economy or the trajectory for rates. Are they going to stay higher for longer? Are they going to be rate cuts This year, which I don't think we see on the table anymore early into next year as the economy weakens. So Look, I mean, anecdotally, we're starting to see things pick up, but it's the middle of the summer. It's a really difficult time to gauge that.

Operator

Fair answer. The other question I have is just in terms of funding. You've always had a nice balance between secured and unsecured funding. How are you thinking about funding going forward?

Speaker 2

You don't really have anything on the unsecured side, I guess, coming due until next year? I'll turn it to I'll turn it to Penny, but I mean, the answer is we don't really have a change in our view of how we're going to do things. So Penny, you should Pile on to that general comment, if you'd like to.

Speaker 3

Yes. I would just say, look, we I think it's more of the same. We have a view of having a very solid Balance sheet liability structure that shows ladder maturities and a nice mix of secured and unsecured. For the 24 maturities, they're effectively resolved at this point. We have $4,700,000,000 of liquidity available.

Speaker 3

We've done a lot to Grow the capacities that we have and therefore, I think there's no refinancing risk going into next year, but we're going to continue to look at the markets and As we've done in the past, be as opportunistic as we can about thinking about how to access those markets to continue to Filled out our ladder of maturities over

Speaker 2

time.

Operator

Our next question comes from the line of Ryan Lynch with KBW. Please proceed with your question.

Speaker 2

Hey, good morning. Following up on the previous question on kind of market activity. I was just curious, Obviously, there's been a big decline in kind of LBO sponsor activity recently. And I know you said that you're starting to see a little bit of pickup Activity, but those are obviously coming off very low levels, very low base. And so my question is, Do you think you can see a significant pickup in LBO sponsor activity if base rates Stabilize around these levels are a little bit higher.

Speaker 2

Is that enough to really get sponsors interested just to have that sort of clarity? Or do you think you actually have to Have the Fed cutting base rates, so that the cost of capital is actually cheaper

Speaker 1

for some of these deals?

Speaker 2

Yes. I mean, Ken, I'm not sure. That's a hard question. Appreciate the question, Orion. I mean, I think if Seller expectations for where they hope to sell companies to sponsors go down.

Speaker 2

The current level of rates is probably Fine. And then the counterpoint is decreases in rates in 2024 perhaps and beyond, I think should Loosen activity levels up and make it a bit busier. But we're seeing Folks try to put capital structures together with the current base rates, right? And again, activity is going up from here. But The cost of debt is much, much higher and you just have to factor that into the model in terms of how you think about buying something right now.

Speaker 2

And I think that's why everything is sort of Slow, right? You're in a period of just feeling things out?

Speaker 1

Yes. I don't think it's an unwillingness on the part of sponsors to invest. I think it's just the uncertainty creating a difficult environment to transact between buyers and sellers. So I do think that the more certainty there is, the higher the likelihood that we're going to see a pickup in transaction activity.

Speaker 2

Okay, understood. And then it feels like the economy has been Much more resilient than people were expecting certainly when their predictions 6 9 months ago of recession occurred in 2023. But while the overall economy seems to be pretty resilient, I would assume that there are certain sectors that are maybe you guys, whether it's your own portfolio Or broadly speaking, are seeing particular weakness. Are there any factors that you are more concerned of or maybe feeling more weakness And what would otherwise be considered more of a more resilient economy? Not really, Ryan.

Speaker 2

I mean, as you know and many others probably on the call know, we try to position the portfolio Defensively in terms of industry mix, so I think the places where you're likely to see real spikes in the fall are places where we try to have very little For no exposure, I too agree with your comment that the economy is actually performing better than I might have expected 12 months ago, if you would ask me in terms of where we'd be in the summer of 2023. I don't know if the soft landing is really in the cards. Obviously, the newspapers seem to imply that there's a chance of that now. But look for the back half of the year borrowers just I said this in the prepared remarks have less cash flow, right? They're deleveraging less quickly and we need to be focused on every company In every industry to make sure that we're doing what we need to do from a risk management perspective.

Speaker 2

But when we look across our industry mix, there's no one Particular place where we feel more concerned rather than in the aggregate.

Speaker 1

Okay. Thanks, Kit. Appreciate the time for that.

Speaker 2

Sure. Thanks.

Operator

Our next question comes from the line of Kenneth Lee with RBC Capital Markets. Please proceed with your question.

Speaker 1

Hi, good morning. Thanks for taking my question. Just in terms of Any potential future capital raising needs? Wondering if utilization of the ATM Equity Program is still method here or would you be open to any sort of block transaction? Thanks.

Speaker 2

I mean, I think the simple answer to that is we felt like we've been able to grow the company modestly through the ATM program in an accretive Effective ways. We'll probably stick to that as the primary source of where we go from here. The leverage level is in a very reasonable level at the end of this quarter, so we feel confident that we have dry powder enough to take advantage of what we think is a compelling environment. So For now, I think the ATM program is going to prove to be sufficient.

Speaker 1

Got you. Very helpful there. And that's all I had. Thanks again.

Speaker 2

Sure. Thanks for the question.

Operator

Our next question comes from the line of Casey Alexander with Compass Point. Please proceed with your question.

Speaker 2

Yes. Thank you. And sort of given your comments about the economy performing better than you would expect, can you give us some color On the pace of amendments and modifications in the portfolio, and are you actually doing less of that than you might have also might have expected at this point in time? Yes. I mean, it's less than certainly it was, although there's still some activity there Casey.

Speaker 2

I'd put it, I'd call it sort of middle of the road, right? It's not Very active, but certainly it's part of the discussion that we're having with owners of all these companies today that again may not be meeting plan, may not have as Cash flow is expected, but that's I call it just ordinary course. Okay. Thank you. And secondly, did Penny mention How much spillover there is in on a per share basis?

Speaker 3

I did not, but It was the same as last quarter. So if you look at what we estimate to be carrying forward from 2022 into 2023, It's stable at $650,000,000 or $1.19 a share.

Speaker 2

Terrific. Thank you very much. Appreciate it. Thanks for the questions. Our

Operator

next question comes from the line of Robert Dodd with Raymond James. Please proceed with your question.

Speaker 1

Hi, and thanks for taking the question. I've got so your comments obviously have reduced cash flow, etcetera, and that's Across the portfolio, but EBITDA is still growing, etcetera, and interest coverage, in aggregate, is pretty good. Can you give us color on How much of the portfolio will or does have interest coverage below 1 at PeakSOFA, call it $550,000,000 And then related to that, for those that are STRED, how what's The step up rate, so to speak, from the sponsors in terms of stepping up and providing incremental capital to that proportion Of the portfolio?

Speaker 2

Yes. I mean, where we always direct people on that, Robert, thinking about companies that have Probably insufficient or less than the implied cash flow. It really points you to the mix of 1s and 2s in the portfolios, which again is our Underperformers, material and underperformers are the ones and twos are kind of what I think of as the watch list. So that number adds up to well less 10% today. I'm sorry to follow-up.

Speaker 2

I was just stumbling through

Speaker 1

the details over here. On that, What proportion for those businesses, are the sponsors stepping up 100% incident rate or 90% already? I mean, How would the negotiations come? Are they coming through and supporting those businesses? Or are you having to do more of that?

Speaker 1

Yes.

Speaker 2

I mean, I think they have generally. And if you look at the pick percentage of our portfolio, it's kind of It's a 3 year low at this point. So the playbook during COVID where we actually provided the lease of paying cash interest is not really part of the playbook today. I would say that we've seen good sponsorship support in situations that have required it. But the way Progressing just to maybe try to give you all a little bit more color is, even if a company has a longer term problem with capital structure where Interest payments perhaps look too high with the base rate being this much higher.

Speaker 2

In most of those circumstances, they still have significant cash on the balance sheet. They have access This undrawn revolving credit facilities, which they can use. So there are a handful of interim tools before a sponsor probably needs to step up and support a company. I would say that is performing with more capital. And I think that's another reason why activity levels are low.

Speaker 2

I think you see a lot of private equity firms that are really focused What's going on in the existing portfolio and thinking about how to deal with that as much as they're struggling to do new deals. Hopefully, that

Speaker 1

gives you a little bit of color. I think, Tom, just to underscore the first point Kipp made though and to Your question is spot on. We're not seeing when it gets to the point where the company does need liquidity, we're seeing no change in sponsor behavior in terms of their willingness to those companies and we spent a lot of time in the prepared remarks talking about the loan to values. But Given the loan devalues in our portfolio on a go forward basis, we certainly would expect to see the same thing. Got it.

Speaker 1

Got it. Thank you. Then one sort of follow-up and stop learning. Ivyhill, it's been a tremendously successful business for you. It's now 10% of the Paul, yes, if we look at the equity, is there I think we've talked about this on par quarter, is there Still room to grow that or is 10% of the portfolio kind of the cap for the size of that business?

Speaker 2

Yes. I mean, we don't really have a cap, particularly on things that have been that successful. I Have acknowledged in a different setting, so I'll acknowledge it now that having a 10% exposure to a single name even though we don't really think about it as Single name because there are a host of underlying funds and cash flows that deliver the return is probably near the upper limit at least for me personally. So I wouldn't expect it to grow materially from here.

Speaker 1

Got it. Thank you.

Operator

Our next question comes from the line of Mark Hughes with

Speaker 4

Thank you. Good morning. None accruals improved this Quarter after stepping up for a bit for a quarter or 2, was there anything common to that improvement? Was it one off? You've talked about inflationary pressure easing.

Speaker 4

Was that a driver perhaps?

Speaker 2

I mean, really, Mark, when you go through with a little more detail, really what happened is we resolved one of the non accruals through restructuring of a specific portfolio company. So Removing that non accrual is what actually just from a math point of view took the number down. Obviously, with that, I'll say just to be clear, we didn't see other companies added in a material way, right? So But the decrease was really the result of one significant restructuring that we did at a portfolio company.

Speaker 4

Understood. And then With the potential for deal activity to pick up as interest rates improve, do you see maybe some pause as The expectation is for interest rates to decline further and then the question is when do you transact? How does it work at this point in the Interest rates, Michael?

Speaker 2

I think it's very hard to tell. Again, I think if you have stability in rates, it makes it easier back to one of the earlier questions for buyers To at least understand what their maximum cost of debt financing may be when you set up a model to Do a transaction. Obviously, more compelling for transaction activity would be a decline in rates, right, where you actually had the expectation for Cuts to start coming through, but your guess is as good as mine as to when that actually happens, if at all. So Like we kind of are where we are for the time being. Thank you.

Speaker 2

Thanks.

Operator

Our next question Coming from the line of Bryce Roe B. Riley. Please proceed with your question.

Speaker 1

Great. Thanks. Good morning. Thanks for taking the question here. Maybe first one is around balance sheet leverage.

Speaker 1

You all delevered a bit in the Q1 and Maybe even a little bit more here in the second quarter. Can you talk about kind of your view on Maybe relevering or maintaining at these levels, just kind of curious where your comfort level is at this point?

Speaker 2

Yes. Thanks for the question. I mean, it's the same answer, I think, as it's been in the past, maybe with a modest footnote. We tend to run kind of between 1 and 1.25 times. The leverage helps drive earnings a little bit.

Speaker 2

But again, just as a reminder, the BDCs are really not particularly leveraged companies, Right. So going from 1.05 to 1.17 times doesn't have a huge impact. We, I think, at this point in The cycle though would like to have a lot of liquidity both to pursue new investing and also to make sure that we can Invest in portfolio companies to the extent we want to or need to. So, I think it's really just driven quarter to quarter by how active we are and what the repayment Calendar looks like that's hard to predict, but we feel comfortable with where it is today. If it went up a little bit, that would be fine.

Speaker 2

If it went down a little bit, that would be fine. The earnings are more than supporting the dividend and we felt good about the trajectory here. So we don't feel any need to lever back up in And the way that you referred to it, we're happy with where we are today.

Speaker 1

Okay. That's helpful. And maybe a follow-up to those comments, Kipp. No view of imminent recession based on your prepared remarks. Obviously, dividend coverage is Extremely strong here, 20% plus.

Speaker 1

At what point do you kind of take it up another notch in terms of Dividend increases, I mean, obviously, you've seen some great dividend increases over the last year. But with that view of no imminent recession, just How are you thinking about dividend levels given that level of dividend coverage?

Speaker 2

I think the discussion that we had when we raised the dividend obviously Was the earnings are well in excess of even the raised dividend level, what's prudent, right? And the discussion that was much more about The direction of interest rates and it was about portfolio credit quality, right? So if we pulled A couple of the different levers that could allow us to have a higher dividend or a lower dividend, the one that's the most impactful would be a significant decrease in base rates. You'd have to model non accruals up a lot to have it have any real impact on how we thought about the dividend today.

Speaker 1

Okay. That's helpful. Appreciate the answers.

Speaker 2

Sure. Thanks for the question.

Operator

Our next question comes from the line of Eric Zwick with Hoagley Group. Please proceed with your question.

Speaker 1

Thank you. Good morning all. I wanted to start, I guess, just first with a follow-up to something I inquired about last quarter. So In terms of your new commitments, 92% had floors this quarter. I'm curious if the borrower is accepting of your maybe request to Move that floor up a little bit from kind of the 1% level that you've been operating for a while or is that still kind of bad to ask for?

Speaker 1

Yes.

Speaker 2

We've been trying and we haven't had a lot of luck.

Speaker 1

Okay. Fair enough. And then my second question is, maybe similar to some prior questions, but maybe So looking at new commitments in the quarter, up noticeably from 1Q, but still running well below the level that we've seen And prior years, so curious how much of that is just a reflection of the market, slower deal activity versus maybe caution on your part, just given Still uncertain economic environment at this point?

Speaker 2

No, I mean, we wish there was more activity. We're Not particularly cautious. I think we're thoughtful about the existing portfolio, but we would love a busier environment. The reality is there Not a lot of opportunistic recaps getting done because people have pretty good balance sheets in place. What's really going to drive a pickup Here is just going to be more M and A activity.

Speaker 2

And as we've mentioned, we've got the benefit of having a large diverse portfolio that contributes to a lot of follow on capital opportunities for us. But yes, to be materially busier, we just need the M and

Speaker 1

A environment to pick up. Of course, the counter the flip side of that is that the repayment activity is also Lower than historical levels. So we're getting more duration on our existing loans. So it's not

Speaker 2

all bad. It all sort of balances out. Yes. That's a good point.

Speaker 1

Makes sense. Thanks for taking my questions today. Yes, you're welcome.

Operator

And our next question comes from the line of John Rowan with Janney. Please proceed with your question.

Speaker 2

Good morning. Hey, John. So just to talk a little bit about the interest coverage and specifically kind of the ones and twos. And I appreciate the information you gave and How it's calculated? And particularly, the loan to value rates, which would seem to be compelling for sponsors to step up and help Struggling investors.

Speaker 2

I'm curious, is there a difference in kind of the LTVs across the portfolio relative to what would be in the 1s and 2s? I'm Trying to gauge if that same reason to step up and support a company is The same in the ones and twos as it

Speaker 1

is for the rest of the portfolio?

Speaker 2

Yes. No, I think, but it's not, right? The LTVs are going to be much higher in the under

Speaker 1

Yes. We're marking the equity value to market every quarter. And so as Underperformance, we're marking the equity value down. There still might be significant cash equity there, which would incentivize But obviously, sponsors are going to evaluate performance of the company and the loan performance might be harder for them to support.

Speaker 2

Okay. And then just one kind of housekeeping question. Obviously, non accruals came down, you did restructure 1 large loan. Is that what drove the realized loss in the quarter? Yes, primarily.

Speaker 2

Okay. All right. Thank you. Yes. You're welcome.

Speaker 2

Thanks for the question.

Operator

And this concludes our question and answer session. I'd like to turn the conference back over to Mr. Kit Devir for any closing remarks.

Speaker 2

I just thank everybody for participating and the good questions. And I hope everyone enjoys the rest of the summer. We'll be in touch soon. Thanks.

Operator

And ladies and gentlemen, this concludes our conference call for today. If you missed any part of today's call, an archived replay of the call will be available approximately 1 hour after the end of the call through August 22nd at 5 pm Eastern Time to domestic callers by dialing 877-660-6853 and to international calls by dialing 201-612 7415. For all replays, please reference conference number 1-three-seven-three-eight-eight 40. An archived replay will also be available on the webcast link located on the homepage of the Investor Resources section of Ares Capital's website.

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