Ares Capital 3Q16 Earnings Call Notes

Kipp DeVeer

I think there is caution here

So I think that there is caution here having spent a lot of time, getting ready for today with the team. I think, the way couple of us were describing it in a lot of different markets or the fundamental and this surrounding economic and political environment feel mediocre and uncertain. And up until maybe a week or two ago, the stock market seem to go up every day, and spreads in virtually every fixed income asset team to tighten leverage multiples in our market were going up, pricing was flat at best if not coming in a bit. And we’re seeing just weaker documents in a more heavily adjusted EBITDA numbers being leveraged and just things that you typically see when number one the market spend and number two is more competitive. I think, you’ve seen new capital come online in the space and I think that capital has to change the marginal deal, have to chase rather the marginal deal.

Don’t see any acceleration of decline

” I think, generally we see companies that are up year over year but maybe a bit behind budget, but it’s probably reasonably on either side of 50% of beating budget or missing budgets. When I think that’s in line with lot of the credit portfolios that we’re seeing across areas and also I think what the public equity markets are seeing. So we don’t view it as getting worse quicker. I don’t know if things slowdown again, just because folks are nervous around next week’s election. I continue to believe that they are. So we’ll see if any of those trends reverse after that’s resulted into a new year. But now, we don’t see any accelerating of the decline”

New entrants tend to be small and have adverse selection

“there is definitely been capital flowing into the space. The way that I think about new entrants is they tend to be small and they tend to be adversely selected on new deal flow. So they just don’t have the skill of platform in terms of origination breadth and reach. We have people on seven offices, we got almost a 100 people dedicated to the business, it’s a pretty different than what you would see from some of the new guys, and when you’re a new guy you have to justify your platform and explain who you are and explain your philosophy or no, even if you have relationships from past firms it’s never the same. You have no evidence to show your counterparties how you’re going to act in situations that don’t work out as expected. So the new entrants frankly tend to focus on the smaller companies and then we don’t see them much.”

I think consensus is that the consumer is slowing down

” I think some of the industries that we do participate in where I think folks would generally say there’s weakness, definitely retail. And retail is tough these days, brick and mortar retail, in particular with just changes in the way consumers and buying patterns are working in terms of online retail. Restaurants inevitably I think see the weak consumer, if the consumer is slowing down, which I think consensus is they are. You’re seeing a little bit of weakness there.”

We’re seeing valuation in venture come down

“We’re seeing valuations in venture come down. We’re seeing that the next round of equity capital, which is typically our take-out, take longer. So I think that business is a little bit choppier. We’ve added a non-accrual or two over the course of the year. And I think that’s representative. But again it’s a pretty small portfolio for us. It’s about $270 million. And even if you have a couple that it blips along the way it’s just not something that’s all that material for us. We like the business. It’s a nice part of the strategy. And I think venture is going through a time where you need to be more cautious and be paying attention to the fact that evaluations are coming down and capital isn’t flowing quite the way it was maybe 12 months ago. But nothing of great concern there to you.”

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.””