Ares Capital Corp 4Q15 Earnings Call Notes

Ares’ (ARCC) CEO Kipp deVeer on Q4 2015 Results

Leveraged finance markets have become more challenged since November

“it’s worth providing some color on the significant dislocation that the credit markets have experienced since we last gathered on our third quarter earnings call in November. September and October were both very difficult months in leveraged finance and the markets have become more challenged since then.”

Non-accruals at 2.6%

“Non-accruals remain low at 2.6% of the portfolio at cost and 1.7% of the portfolio at fair value at December 31 as compared to 2.3% at cost and 1.7% at fair value at September 30, 2015.”

We believe that many stocks in the BDC space are oversold

“I’d like to make a few comments on the BDC sector generally and ARCC, specifically. We have seen most BDC stocks trade meaningfully below book value and ARCC’s stock has followed suite. We believe many of the stocks in the BDC space today are oversold, and we feel that this is particularly true as it relates to ARCC. Unfortunately, certain companies that we’re often compared with have not met the expectations of investors, and we are sympathetic with the sentiment of disappointed investors.”

In terms of the economy we’d say we see a reasonably flat but sturdy economy

“It’s sort of an interesting environment that we’re in, and that I think if we gave a broad view on the economy, we would tell you that we see a reasonably flat, but reasonably sturdy economy across a lot of the industries that we’re in. So we, generally speaking, feel good about portfolio and about the credit quality.”

The markets are spooked though

“The markets based on kind of September to now are a lot more spooked. And then I’ll just say this, I think those markets continue to be spooked and led both in terms of trading levels being down, but also potential for default being up by oil and gas, by mining and metals, and increasingly by industries that are cyclical, whether it’s retail, restaurants, manufacturing, specialty chemicals, et cetera.”

Power markets are weaker in California as more solar comes online

“Specific to La Paloma, there has been some performance decline at that asset. It is a operating power asset in the California market. California power markets are a little bit weaker as more solars come online”

We have a pretty strong view that 2016 is a transition year for credit markets

“I, for one, but I think, we as a team, have a pretty strong view that 2016 is a transition year for the credit markets. We see a lot more stress and distress just as we look across credit business here at Ares that manages $60-plus billion of corporate and structured credit. We have 200 people around the globe looking at markets. And I think that the view is influenced simply by being late in the cycle by more and more technical defaults in portfolios, whether it’s large cap, mid-market, ours, competitors, the situations that we’re seeing in the market.”

The problems for the high yield market in particular are misunderstood

“But again, back to a comment I made earlier, I think that the problems that the oil and gas markets in particular are going to present, in particular, for the high yield market is misunderstood, but maybe not being currently kind of considered in the right way by many folks that aren’t invested in high yield and in some of larger cap credit markets the way that we are. We expect defaults will go up this year. They’re already going up.”

There’s also less capital in the market

“If you look back historically when defaults go up, spreads tend to widened and defaults were lagging indicator. So obviously when you see more of stress and distress in the market, it obviously has investor saying, I priced my capital today to higher returns that I did in prior years or prior quarters. And I think also there’s less capital in the market, right, so anytime there is less capital chasing the same opportunity, it doesn’t compete as aggressively for price. So capital flows in the loan market over the last, call it, six to eight months, $10-plus billion of outflows, that’s a big number.”

We see real lasting change with less capital in the market

“So I think with more distress in portfolios and less capital in the market, we just see a real lasting change here rather than a blip, where you kind of buy on the declines and wait for a rally, we’re really not expecting that. So that’s good news for us. Longer-term, it allows for us to invest money with much less risk being taken and with higher returns”

We don’t expect a recession in the US though

“So those changes in the market are happening. And again, not to play economist, but I’ll answer your question, we don’t see the prospect of a near-term recession in U.S., that’s not generally speaking something that we’re considering here at Ares. I’m not going to say that it’s not possible. Things gets worse, but our current view is that we don’t expect to see a recession in the U.S. We do see, as I mentioned, very flat growth.””