Ares Capital Corp

NASDAQ:ARCC

Earnings Call Transcript 2022-Q3

[Operator]

Thank you all for joining, and welcome to the Ares Capital Corporation's Third Quarter ended September 30, 2022 Earnings Conference Call. My name is Brita, and I will be your operator. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded on Tuesday, October 25, 2022.

I will now turn the call over to Mr. John Stilmar, Managing Director of Investor Relations.

[John Stilmar, Managing Director-Investor Relations]

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. 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 operations. A reconciliation of core EPS to GAAP net income per share to the most commonly directly comparable GAAP financial measure 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-K. All per share information discussed during this call is basic per share information. See the company's Form 10-Q filed with the SEC this morning for such information. Certain information discussed on this call and the accompanying slide presentation, including information related to portfolio companies, was 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 third quarter ended September 30, 2022, earnings presentation can be found on the company's website at www.arescapitalcorp.com by clicking on the third quarter 2022 earnings presentation link on the Home Page of the Investor Resources section. Ares Capital Corporation's earnings release and 10-Q are also available on the company's website.

I'll now turn the call over to Mr. Kipp deVeer, Ares Capital Corporation's Chief Executive Officer.

[Kipp deVeer, Chief Executive Officer]

Thanks, John. Hello, everyone. I hope you're doing well, and thank you for joining our call today. I'm here with our Co-President, Mitch Goldstein; and our newly appointed Co-President, Kort Schnabel; our Chief Financial Officer, Penni Roll; and several other members of the management team.

I'd like to start by highlighting our third quarter results and then provide some additional thoughts on the economic backdrop and the market. This morning, we reported third quarter core earnings of $0.50 per share, an increase of 9% compared to the second quarter, driven by the benefits of rising interest rates and continued credit stability within our portfolio.

Importantly, if the prevailing market rates at September 30 had been in place for the full quarter, our third quarter core earnings would have been about 8% higher, or roughly $0.54 per share. The company is generating higher earnings with these higher prevailing base rates and we believe that we are well positioned to continue to benefit further from any future rate increases.

At the end of the third quarter, our NAV per share declined modestly by 1% as we took net unrealized losses, largely due to the declining prices in the credit and equity markets. Despite this, the fundamental performance of the portfolio remains solid, even as a more difficult economic backdrop appears inevitable. The Federal Reserve has continued its tightening monetary policy to combat inflation, and this has induced volatility in our surrounding markets. And while we did anticipate these markdowns, we take some comfort as these conditions are introducing a much more compelling environment for making new investments.

Mitch will discuss this in more detail later in the call. From a market standpoint, volatility in the leveraged finance and equity capital markets persisted during the third quarter as higher inflation and higher interest rates triggered increasing concern around slowing growth.

Economic data continues to present a mixed picture as corporate fundamentals remain solid, yet the consensus outlook seems to point to demand softening and an overall slowdown in the U.S. economy. The credit markets and the leveraged finance markets, in particular, are exhibiting weak secondary liquidity and slowing new issuance. These trends and the lack of competition from traditional sources has made it a much more lender-friendly market and we are taking this opportunity to improve the strength of the existing portfolio and to price new transactions more attractively.

As our shareholders know, we've operated the company well through periods of volatility over the past 18 years. We're taking the same approach today as we have in the past, focus on portfolio management and risk mitigation, while becoming incrementally more selective on new deals. We turn inward a bit to proactively manage our current portfolio to anticipate challenges and have early conversations about remedies. We believe we can use the current market conditions to improve situations in our portfolio and also to finance larger companies that would otherwise turn to the liquid markets in less uncertain times.

We believe our portfolio continues to deliver healthy overall performance and is well positioned to weather future market challenges. Two measures of portfolio credit quality, our nonaccrual rate at cost and the weighted average portfolio grade both remained static quarter-over-quarter and show stronger metrics than our historical averages. The stability in these credit metrics is supported by a healthy level of weighted average EBITDA growth of 13% year-over-year.

By historically focusing our efforts on upper middle market companies with high free cash flows that operate in more resilient, less cyclical industries, we believe we've been able to reduce some of the credit risks that come from operating in a more difficult environment with higher market interest rates. While we are closely monitoring these risks, we believe they are manageable.

Augmenting the strong credit profile of our portfolio companies is our approach to portfolio diversification. Our $21.3 billion portfolio at fair value is diversified across 458 portfolio companies. This means that any single investment accounts for just 0.2% of the portfolio on average. And our largest investment in any single company, excluding SDLP and Ivy Hill, is just 1.4% of the portfolio.

But before I turn the call over to Penni, let me discuss the significant dividend increase we announced this morning. We elected to raise the regular quarterly dividend from $0.43 to $0.48 per share because the company is now experiencing a higher level of core earnings, primarily due to the substantial increase in base rates. This increase, the largest quarterly increase in our company's history is our third increase this year and results in a regular dividend that is 17% higher than our regular quarterly dividend level at the end of 2021.

The higher base dividend that we are paying also reflects our positive outlook on our ability to generate this level of core earnings under a variety of interest rate and economic scenarios for the foreseeable future.

As a final reminder, we've already declared a $0.03 per share additional dividend for the fourth quarter. When adding this additional dividend, the total dividends for the fourth quarter comes to $0.51 per share. And on our fourth quarter call, we will provide additional details on our dividends going forward and our thoughts around the potential for further additional dividends due to expected increases in core earnings and the amount of our undistributed earnings spillover.

I'd like to turn the call over to Penni now to provide some more details on third quarter results and balance sheet positioning.

[Penni Roll, Chief Financial Officer]

Our core earnings per share of $0.50 for the third quarter of 2022 were $0.04 higher than a quarter ago and up $0.03 from the same quarter a year ago. Earnings for the third quarter of 2022, again benefited from the higher base interest rates on our floating rate investments. Our GAAP earnings per share for the third quarter of 2022 were $0.21, which compares to $0.22 for the prior quarter and $0.73 for the third quarter of 2021. Our GAAP earnings for the third quarter of 2022 included net realized and unrealized losses of $0.36 per share, which were largely a result of the unrealized losses we took for certain investments to reflect the decline in prices in the credit and equity markets that Kipp mentioned earlier.

Our total portfolio at fair value at the end of the third quarter was $21.3 billion, and we had total assets of $22 billion. As of September 30, 2022, the weighted average yield on our debt and other income-producing securities at amortized cost was 10.7% and the weighted average yield on total investments at amortized cost was 9.6%. The total investment yield at the end of the quarter increased approximately 90 basis points from last quarter, supported by the continued rise in base rates and the incremental spread on new investments.

As it relates to our future interest rate sensitivity, we remain well positioned to continue benefiting from a rising rate environment. Given 73% of our total portfolio at fair value was in floating rate investments as of September 30, 2022, we expect continued increases in short-term rates to have a positive impact on the net interest earnings performance of the company. A 100 basis point increase in market rates from September 30 could add about $0.07 per share quarterly or approximately $0.27 per share annually. We have provided details on our sensitivity to interest rate movements in this quarter’s Form 10-Q for those who want to further examine these potential impacts. Importantly, these earnings would be additive to the $0.04 per share benefit that Kipp mentioned from having a full quarter of the market rate moves that have already occurred in the third quarter, fully flowing through our core earnings.

Shifting to our capitalization and liquidity. After considering our investment in capital activities during the quarter, we ended the third quarter with nearly $4.5 billion of total available liquidity, including available cash of nearly $250 million in a debt to equity ratio net of the available cash of 1.24x down from 1.25x at the end of the second quarter. Overall with our significant dry powder and only $750 million in debt obligations maturing in the next 16 months, we believe our capital and liquidity remains one of our most significant competitive advantages and positions us well to remain active yet patient investors.

Before I conclude, I want to provide more detail on our undistributed taxable income and our dividends. Our taxable income spillover from 2021 into 2022 grew to $678 million or approximately $1.36 per share. We continue to believe that having a strong and meaningful undistributed spillover supports our goal of maintaining a steady dividend throughout market cycles and sets us apart from many other BDCs that do not have nearly this level of spillover.

Having said that, as a result of the increased core earnings power we are experiencing in this higher rate environment, we expect we’ll see an increasing amount of undistributed earnings spillover when we close out fiscal year 2022 as compared to 2021. So as Kipp mentioned, we will provide additional information on our year-end earnings call on how we may address that in 2023, while factoring in today’s announced increase to the regular quarterly dividend.

This morning, we announced that we declared a regular fourth quarter dividend of $0.48 per share, a $0.05 per share increase to the regular dividend rate and the largest single quarter per share increase in our company’s history. This increase is also the third increase in the past year, fourth in the past six quarters and our 54th consecutive quarter of unchanged or growing dividends. This fourth quarter regular dividend is enhanced by the $0.03 per share additional fourth quarter dividend that we previously declared back in February. Both are payable on December 29, 2022 to stockholders of record on December 15, 2022.

I will now turn the call over to Mitch to walk through our investment activities for the quarter.

[Mitch Goldstein, Co-President]

Thanks, Penni. I’m going to spend a few minutes providing more detail on our investments and portfolio performance for the third quarter and then provide an update on our post quarter end activity and our backlog and pipeline.

During the third quarter, our team originated $2.2 billion of new investment commitments across 40 transactions in more than 20 distinct industries as middle market sponsors and businesses continue to value Ares being a consistent and reliable source of capital in good market and volatile ones like the one we are in now.

As we have often said over the years, we tend to focus our originations on investments where we have relationship or information advantages and this quarter was no different as 68% of our transactions were to incumbent borrowers. Also, more than 70% of our commitments were seen secured. Importantly, the investment opportunities in today’s markets are highly attractive. Based on our view of the market, first lean spreads, as an example, are approximately 100 basis points higher than the five year average for similarly levered transactions.

In addition, on an absolute basis, first lean yields are the highest we have seen in more than a decade. In terms of the transactions we are executing, we are providing capital to larger companies. The EBITDA of our first lean originations this quarter was more than 3x higher than our historical three year average. The importance of this will be highlighted when I talk about the credit quality of the portfolio. We believe that the current market environment offers attractive opportunities, but it takes a disciplined, scaled and stable capital provider to be able to capitalize on that.

Now shifting to portfolio health. Our companies continue to perform well as Kipp mentioned. The weighted average EBITDA growth of our companies over the last reported 12 month period was 13%, our larger portfolio companies with EBITDA over $100 million performed particularly well and their EBITDA grew by 16% on average. This underscores the merits of our upmarket focus as the weighted average EBITDA of our portfolio reached $213 million in the third quarter. This compares to the weighted average EBITDA of $66 million five years ago and reflects the demand for our financing from larger companies.

In our view, all things being equal, larger companies have more diverse revenue streams, broader customer bases and deeper management, all of which serves to further support their credit performance. Overall, our portfolio companies are continuing to navigate the current higher inflationary environment. As Kipp mentioned during our quarterly portfolio review, our portfolio management team alongside our deal teams evaluated the impact of inflationary pressures, rising energy prices, supply chain disruptions and staffing shortages on our portfolio companies.

While our analysis of industry sectors and underlying company’s fundamentals is subjective, we take comfort that this quarter’s portfolio review revealed a consistent overall result with last quarters and less than 10% of our portfolio remained in the higher risk category. Further supporting this, the weighted average portfolio grade at fair value for the quarter was flat at 3.2 and continues to be above our 10 year average of 3.0. Our non-accrual rate at cost was 1.6%, was also flat compared to last quarter and continues to be meaningfully below our 10 year average of 2.5%. During the quarter, we added two companies to non-accrual and removed three from the list.

Now as we do on a quarterly basis, I would like to shift to our post quarter end investment activity and pipeline. From October 1 through October 20, 2022, we made new investment commitments total of $1.1 billion of which $1 billion were funded. We exited or were repaid on $418 million of investment commitments. The weighted average yield at costs on new first lean commitments was approximately 100 basis points higher than the weighted average yields on first lean securities we exited or were repaid during the fourth quarter. As of October 20, our backlog and pipelines stood at roughly $605 million. Our backlog and pipeline 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 Kipp for some closing remarks.

[Kipp deVeer, Chief Executive Officer]

Thanks, Mitch. Before concluding, I want to acknowledge the leadership change that we announced this morning in a separate press release. Kort Schnabel will now join Mitch Goldstein as the Co-President of ARCC. Kort has been a long time contributor to the success of both ARCC and Ares’ direct lending strategy. Kort joined Ares in 2001 and became a founding member of the U.S. Direct Lending team when our executive team joined Ares in 2004 to launch Ares Capital. Today Kort serves as a Co-Head of Ares U.S. direct lending strategy and as a member of our investment committee. We believe that Kort is a dynamic leader and we look forward to having him play a more prominent role in the company’s direction in the years ahead.

As part of this change, Michael Smith is stepping down as ARCC’s Co-President to take on other responsibilities at the firm and will continue to help lead Ares’ global credit group as a Co-Head. Given Michael’s insights and leadership at the company over the last 18 years, we’ve appointed him to the Board of Directors at Ares Capital. While relinquishing some of his day-to-day responsibilities to Kort, I can say we all take comfort in knowing that he’ll remain highly engaged with the company’s strategy as a Board member. Michael will also continue as a member of our investment committee.

We believe this transition further demonstrates the commitment, depth and tenure of the team and continues to support the ongoing performance at ARCC. We have confidence in our ability to continue to generate strong results for our shareholders. This confidence in our competitive and financial position and our earnings power is reflected in our decision to meaningfully raise our regular quarterly dividend as we highlighted earlier.

That concludes our prepared remarks and we’d be happy to open the line for questions.

[Operator]

[Operator Instructions] We have our first question on the phone lines from Finian O’Shea of Wells Fargo Securities. Your line is open.

[Finian O’Shea, Wells Fargo Securities]

Hi, everyone. Good morning. First question on the dividend here. Kipp, as you mentioned $0.48 was a significant increase and historically would’ve been a pretty good quarter for you. So I guess, appreciating your commentary on being able to earn it under a variety of economic scenarios. What if base rates and credit spreads revert back to where they were then where does the earnings power come from to continue to earn that $0.48?

[Kipp deVeer, Chief Executive Officer]

Yes. Thanks for the question, Fin and good morning. We obviously raise our dividend only when we feel that the core earnings can support it over the long haul, I guess is my brief comment and I tried to make that clear in our prepared remarks. As we thought about the dividend increase and how much we felt comfortable raising it, we obviously ran a lot of different sensitivities thinking about possibly future contraction and credit spreads or a reversal and rate policy and all of that.

And I think unless something really severe happened quickly, which is not what we would expect, we just – I’ll just reinforce that we feel good about this higher level of supporting the dividend. And look, we run a model into next year and beyond it guides our thinking there. So I’ll take your point. But we don’t take raising the dividend that substantially lightly and we obviously model a lot of sensitivities around where we go and how quickly. So you look to say the company’s just earning significantly more than that $0.48 dividend today. And we feel good about it being able to be supportable into the future for a while.

[Finian O’Shea, Wells Fargo Securities]

That’s helpful. Thank you. And just a follow on, on valuations. The portfolio has a lot of embedded subordinate equity, CLO equity, for example. So at this point today with private markets transactions seeming to go through at lower valuations, how does NAV at the BDC continue to hold up so well?

[Kipp deVeer, Chief Executive Officer]

Well, I mean we took – the portfolio was down a fair bit this quarter largely on the fact that we had declining prices in both the credit and the equity markets. So where does it go from here? I guess, we’ll see where the markets take us, but our markdowns were largely unrealized marks on the debt portfolio, although there were some as well on the equity portfolio. As you know, we’ve got exposure – fair amount of equity exposure at the company too.

I’m not quite sure on the CLO comments. Just as a reminder, we don’t invest in third party CLOs, so the only place that we’d see evaluation impact is potentially in the way we think about SDLP and Ivy Hill. But we look at the required yields on both SDLP and on Ivy Hill. And one of the key considerations there is what’s going on in the CLO market and obviously a pretty significant selloff there. So I think we’ve taken that all into consideration appropriately.

[Finian O’Shea, Wells Fargo Securities]

Thanks so much.

[Kipp deVeer, Chief Executive Officer]

Thank you.

[Operator]

Thank you. The next question comes from John Hecht of Jefferies. Please go ahead when you’re ready.

[John Hecht, Jefferies]

Morning, guys. Thanks for taking my questions and congratulations on solid operating results. The first one, you guys gave lots of pretty good constructive updates on credit quality in the portfolio. But I know you guys are – you follow very closely your portfolio. I’m just wondering what are you hearing from your counterparties in terms of how they’re reacting to changing rates and inflation? And just sort of thinking about that as it kind of colors your impression of what might happen from an economic perspective next year.

[Kipp deVeer, Chief Executive Officer]

Sure. Thanks for the question. Just so I’m clear, when you say counterparties, do you mean the portfolio companies?

[John Hecht, Jefferies]

Yes, the borrowers.

[Kipp deVeer, Chief Executive Officer]

Yes. I mean, I think look for the last 12 months most of the portfolio companies, I would say have been operating with just more challenging operating conditions, right? Whether it’s stuff that we’ve all read about in the newspapers, pressures from inflation, supply chain disruptions, labor shortages, energy price increases in certain parts of the world. So I think it’s been more difficult and now there’s more pressure on some of these companies because they have higher debt service costs.

So my expectation would be that defaults will increase. I’ve said this in other settings, defaults will increase broadly in the corporate credit markets through the back part of this year and into next year. But just as a reminder and I did say this in the prepared remarks, the credit quality today is better than our historical averages. When you look at both the non-accrual rates and the portfolio grades, would I expect that to get a little bit worse? If I had to guess, I’d say probably yes. But do we view it as something that is extraordinary and not manageable? The answer of that is we don’t.

[John Hecht, Jefferies]

Okay. And then I guess sort related question is, you over time talked about how you guys are positioned well for this environment, but you also tend to do better or at least take more advantage of disrupted environments. And I think most of us on the call know that certain parts of the credit markets are somewhat disrupted now. I mean, not – certainly not in crisis mode, but there’s some volatility and so forth. So the question I guess is, given that backdrop, is there any area in the credit markets where the disruption is sufficient enough where you are able to take advantage of it? Or is it, are we just sort of starting to look for opportunities in that regard?

[Kipp deVeer, Chief Executive Officer]

Yes. I mean, I think the broad answer to that is, the environment for new investing has improved substantially, right? And I think most substantially at the upper end of the range larger companies because the bank solution is a very difficult solution today based on just the fact that most of the banks are working on clearing out on syndicated backlog that they’d accumulated. But look, we’ve played some new investments here coming into the fourth quarter, both in new deals, although it’s admittedly slower. We’ve been active in the secondary markets, mostly in the existing portfolio names. So those are probably the two areas I’d highlight and I would expect that to continue. But the activity levels we didn’t comment on that had slowed down pretty substantially here, going into your end and we’ll see what next year brings.

[John Hecht, Jefferies]

Okay, great. Thanks.

[Kipp deVeer, Chief Executive Officer]

Thanks a lot, John.

[Operator]

Thank you. We now have a question from Ryan Lynch of KBW. Please go ahead when you’re ready.

[Ryan Lynch, KBW]

Hey, good morning and nice quarter guys. The first question I had was just related to your slide of 14, which looks at EBITDA and credit statistics. My question is, if I look at your weighted average interest coverage from the second quarter to the third quarter, it declined from about 2.4x to 2x. And I would assume that that’s primarily just driven by the increase in rates this quarter. The way we ended the quarter and the way that rates kind of flowed through and kind of that one quarter lag, I would assume that there’s probably another 200 basis points or so of rising rates, which again, are good for ARCC’s earnings.

But I think could have pretty significant pressure on this ratio. And the rough math looks like it could drop it down to the low 1s. So how should we be thinking about credit quality that’s really good today, but then look at something like this with the trajectory of this interest coverage going probably materially lower.

[Kipp deVeer, Chief Executive Officer]

Yes. I mean, I think that that directionally is true. I think if you look at the forward curve for the base rates, what it’s laying out is more of a likelihood of 100 basis point increase from here. And then it actually starts to come back down a little bit if you look even as far forward as 2024 and 2025. So look, with 100 basis point increase, in my opinion, likely to your question, we do see a deterioration in interest coverage to probably 1.8x.

And then we’ll see where rates go from there. I think that’s the question, Ryan that everyone’s asking whether you’re managing private credit portfolios or elsewhere, which is how far does the fed have to go to accomplish its objectives and what are the repercussions? I think something beyond 100 basis points is actually less likely. And I think the forward curve is saying the same thing. So we’re working with that expectation. But yes, we expect and to John Hecht’s question, we expect interest coverage ratios to go down a little bit and we expect credit quality to probably get a little bit worse in the fourth quarter and into next year. But again, we think it’s manageable.

[Ryan Lynch, KBW]

Yes. Okay. Yes, that makes sense. The other question is maybe more of a clarification or just an explanation on Ivy Hill. If I look at your guys’ disclosure of kind of the Ivy Hill generate income for the third quarter of this year, management incentive fees were like $13 million versus other investment related income was $42 million. If I look at that a year ago, management incentive fees were $8 million versus other investment related income was $22 million.

So the big growth in Ivy Hill income is really driven by that other investment related income at least year-over-year and the big dividends that then, of course ARCC is receiving. Can you just explain what that other investment related income is? Is that all basically subordinated tranches of CLOs or securitizations that that Ares holds from those Ivy Hill CLOs or is there anything else in that that bucket right there?

[Kipp deVeer, Chief Executive Officer]

That’s generally what it is.

[Ryan Lynch, KBW]

Okay.

[Kipp deVeer, Chief Executive Officer]

Yes. So obviously, Ivy Hill got larger – Ivy Hill got larger, the dollars go up, the return that we’re looking at, if you take the dividend, the way that I think about it is if you take the quarterly or the annual dividend divided by the fair value of that investment, we’re achieving the same rates of return there that we have historically, it’s just larger, so the dollars are bigger.

[Ryan Lynch, KBW]

Okay. Fair enough. I’ll hop back in the queue.

[Kipp deVeer, Chief Executive Officer]

Thanks.

[Operator]

We now have Casey Alexander of Compass Point. Your line is open, Casey.

[Casey Alexander, Compass Point]

Yes. Good morning.

[Kipp deVeer, Chief Executive Officer]

Good morning.

[Casey Alexander, Compass Point]

This is going to seem sort of like a – it’s going to seem like it’s kind of a distended question, but I’m struck by how attractive the operating environment is for you and yet at the same time how hyper focused the market seems to be on potential credit issues? And I look back at 2020 where it was a lousy operating environment and the market was hyper focused on credit issues. And then during that 2020 period, you guys were really overt about the extent to which you were willing to do modifications and amendments with portfolio companies. And again, looking at the weighted average interest coverage, if average is at 2.0x, you’ve certainly got companies below there, so you’ve got companies that must be internally that you’re watching. To what extent are you guys willing to and already starting to work on modifications and potential amendments to help make sure that your portfolio companies get through this cycle and come out better competitors on the other side?

[Kipp deVeer, Chief Executive Officer]

Yes, I mean, I would say, at the margin we are, Casey, it has – it bears no resemblance whatsoever, frankly, to the first and second quarters of 2020 where I think this company did something like 60 amendments over the course of two quarters. So look, as things – again to some of the earlier questions, as things weaken a little bit, I think that’s something that we’re going to have to look at and we’ll probably become increasing percentage of the time spent by the team.

But it’s not nearly as violent or frankly as difficult as it was during COVID when it all came at once. And it’s a natural part of the business, right? I mean, if you’ve been doing these deals a long time, like I have and our team has, it’s ordinary course that you have amendment activity and you have to go into companies that aren’t performing the plan and make accommodations. But I keep trying to use the same word, which is, we think it’s pretty manageable and ordinary course for now.

[Casey Alexander, Compass Point]

Okay, great. Thank you. My other question is, looking at your debt to equity ratio of 1.27x, you’re fairly in the pocket of where you want to be. But would you expect origination volumes to do what they traditionally do in the fourth quarter, which is have at least some acceleration towards the end of the fourth quarter? And how would you manage that origination volume relative to the leverage ratio?

[Kipp deVeer, Chief Executive Officer]

Sure. So I think we've communicated in the past, and I'll say it again, the leverage ratio is at the top end of our target range, and we have a focus actually on trying to bring it down. To your second question, I think this will be a much, much slower fourth quarter for our company and for most of the industry participants as a result of the way that the volatility is crept into the market. Deal flow is much slower. I wouldn't expect to see that big fourth quarter out of us or many others that you've seen in previous years as it seasonally the busiest of quarters. So...

[Casey Alexander, Compass Point]

All right, great. Thank you very much. Appreciate you taking my questions.

[Kipp deVeer, Chief Executive Officer]

Yeah, sure. Thanks.

[Operator]

The next question comes from the line of Devin Ryan of JMP Securities. Please go ahead when you’re ready, Devin.

[Kevin Fultz, JMP Securities]

Hi, good morning. This is Kevin Fultz on for Devin. Most of my questions have been asked and answered, but I did have one question on amendment request. Kipp, you mentioned that during like peak COVID environment that you were seeing about 60 amendments come in, in one quarter. Just curious where that stands on a normal basis, like where it was last quarter?

[Kipp deVeer, Chief Executive Officer]

I’m not sure. Actually, I'm looking around at some of the team. Yes, I mean, it's less than 10 a quarter, probably even less than five a quarter that are material.

[Kevin Fultz, JMP Securities]

Okay. That's helpful. And then just one follow-up, if I can. In regards to portfolio positioning, just curious if there are any pockets or industries that you find particularly attractive given the current macro backdrop?

[Kipp deVeer, Chief Executive Officer]

I mean, I think you'll see us stick with our focus on sort of less cyclical service-oriented industries for cash flow, companies that can pay down debt even in a slower environment. But sort of come at it a little bit differently, which is we go out of the wide funnel to look at everything. We get asked the question sometimes of now that cyclical earnings are kind of down, are you more prone to play into those industries? And the answer is, we're probably more willing to look at those type of transactions than we are in a in a frothier market, but we're not really changing our approach in terms of how we think about new originations and new deals.

[Kevin Fultz, JMP Securities]

Okay. That makes sense. Thank you for taking my questions and congratulations on the quarter.

[Kipp deVeer, Chief Executive Officer]

Thanks so much.

[Operator]

Thank you. We now have Melissa Wedel of JPMorgan. Your line is open, Melissa.

[Melissa Wedel, JPMorgan]

Thank you. Appreciate you taking my questions this morning. Actually, most of them have already been asked, but I do have one follow-up to Casey's question regarding amendment activity. When we think about how that tends to occur, a lot of times that involves some additional capital contribution or support from sponsors for portfolio companies and I'm curious what you're seeing in terms of what – how you perceive sponsors willingness to support those portfolio companies in this environment as we've seen some change in private market valuations generally?

[Kipp deVeer, Chief Executive Officer]

Yes. I mean I think it continues to be pretty good. And thanks for the question. To be honest, most of our amendment activity now, unlike during COVID, where we saw big liquidity shortfalls in the company that required equity to come in, is more technical in nature where covenant gets tripped or company needs a little more access to capital through a revolver or something, the typical amendment is the group charges a fee, they reset some of the loan documentation and covenants in exchange for the fee and potentially some higher pricing. And I think the positioning of private equity is – and frankly, our capital as the duration of their investments are all extended here, right. We're going to see fewer repayments. I think we're likely to see fewer deals get done because it's a difficult time to buy or sell a company. So the relationship benefit of being with a private credit provider like Ares is actually a benefit, right. So you can pay a small fee. You can pay slightly incremental pricing, and then you get a three or four-year look at the equity investment that you've made.

And most of our portfolio comes in substantially below 50% LTV. And just as a reminder, there's lots and lots of equity supporting the loans that we make. So the positioning and the response from private equity has continued to be quite good, at least in that portion of the portfolio.

[Melissa Wedel, JPMorgan]

Okay. Just to clarify, Kipp, am I hearing that because of the difference in the environment now and the more technical nature of any amendment activity that might be needed, there would be less required support from sponsors?

[Kipp deVeer, Chief Executive Officer]

I think that's right. Yes. Maybe I didn't say that clearly, but yes, I think that's right.

[Melissa Wedel, JPMorgan]

Got it. Thank you so much.

[Kipp deVeer, Chief Executive Officer]

You’re welcome.

[Operator]

We now have Kenneth Lee of RBC Capital Markets. Your line is open, Kenneth.

[Kenneth Lee, RBC Capital Markets]

Hi, good morning. Thanks for taking my question. Just one on, I wonder if you could expand upon your comments. You talked about an opportunity to improve your portfolio in the current environment. And it sounds like you're shifting a little bit more towards the larger-sized companies. Wondering if there's any other aspects that you're looking to improve in terms of the portfolio in this environment? Thanks.

[Kipp deVeer, Chief Executive Officer]

I mean, it's pretty consistent with our past philosophy. I mean the reality is, if a company gets off side a little bit today, it's easier for us to have a discussion with the sponsor or with the company about how their financing from three years ago, perhaps is not resembling the current market conditions if they had to refinance today. And that just gives us a little bit more strength in our argument as we say, I think we deserve a higher fee or we deserve some more pricing here to compensate for the increased risk that we weren't expecting. So in the market conditions widen, it just improves our ability as risk managers to kind of rerate the portfolio a little bit if something is not performing to plan.

[Kenneth Lee, RBC Capital Markets]

Got you, very helpful. Thanks again.

[Kipp deVeer, Chief Executive Officer]

Thanks Ken.

[Operator]

Thank you. [Operator Instructions] The next question comes from the line of Robert Dodd of Raymond James. Your line is open.

[Robert Dodd, Raymond James]

Morning, Kipp and beating on a dead horse, can we talk about amendment some more. One of the things I think Mitch said in his prepared remarks was less than – and I think you mentioned that it was a lot less than 10% of the portfolio is what you classify as the higher risk exposures to inflation, et cetera, et cetera, with all the various macro dynamics that are going on. Can you give us any color on how aggressive, it's not quite the right word for it. But how aggressively are you in going to those companies and potentially encouraging or pushing or recommending amendments to the high risk category ahead of a potential problem? Or is that just something you don't do? You wait for the problem, puts you in a stronger position? Or are you more proactive on kind of resolve those problems in advance of anything coming up?

[Kipp deVeer, Chief Executive Officer]

Look, I mean I think the relationship for the lender to the equity since a lot of the deals that we do or repeat with sponsors is one where we're pretty balanced. I think most of the – let's talk about private equity transactions. Most of the private equity transactions, or private equity firms we do business with, I'd like to think the U.S. is value-added. We tend to have larger portfolios than they do, and we tend to have more insight into industries and, frankly, credit markets than they do. So if we see something because, as you know, we've got close contact with them, we'll certainly start to talk to them about it early and say, we have investments in eight other companies that are pretty tangential to this company and this is what we're seeing. And these are some of the pressures that we see mounting for other companies. And just start to ask the questions, are you seeing the same pressures? What's your level of concern?

So it's really about just increasing the dialogue, which we think is value-added for a lot of our partners. But the reality is, you don't get into discussions about amendments unless something trips your loan documentation. For a company really is going to need capital in advance of that happening which is unusual. So hopefully, that's helpful. Mitch?

[Robert Dodd, Raymond James]

That is helpful. Thank you.

[Mitch Goldstein, Co-President]

Hey Robert, I just want to add. Remember, this is a fluid type of process. So we are constantly getting information on our portfolio companies weekly and monthly. And the minute we see some weakness, and we have a very large portfolio management team, as I think, we're beginning dialogue with the company and the sponsors as to what is happening? What needs to be fixed, if anything? And getting way ahead of any really serious weakness well before the company needs an amendment, it's a constant dialogue with our companies because of our access to information and our relationship with the companies and the sponsors.

[Robert Dodd, Raymond James]

I appreciate it. Thank you.

[Kipp deVeer, Chief Executive Officer]

Thank you.

[Operator]

Thank you. We now have a question from Erik Zwick of Hovde Group. Please go ahead when you’re ready, Erik.

[Erik Zwick, Hovde Group]

Good morning. Just to follow on the line of questioning about the expectations for increasing corporate defaults. Curious if you can provide some color into what quantitative metrics you may be monitoring that are starting to maybe show some signs of weakness at this point? And do you have a view of which industries or verticals may experience more stress first? Or do you think the stress could be more idiosyncratic and borrower specific?

[Kipp deVeer, Chief Executive Officer]

Yes. I mean, typically, it's more – and thanks for the question, Erik. It's more idiosyncratic. But obviously, the metric that we're looking at is we're monitoring interest coverage across the portfolio in each company as well as fixed charge coverage, which takes into account sort of other debt service costs that companies have. We don't see any particular industries today that represent a broad risk. One of the things that I think we've mentioned to you and you're picking up coverage was that we've tended to shy away from certain industries that do create, in our opinion, and if you look historically, the most defaults, right. And we're under weighted towards a lot of these industries.

So I think our portfolio is performing better than the indices. It usually does as a result of that philosophy and positioning. But for now, it's probably more of a name-by-name assessment. And to Mitch's comments, being close to our borrowers and understanding where there's the potential for stress and trouble on the horizon.

[Erik Zwick, Hovde Group]

Great. Thanks for taking my questions.

[Kipp deVeer, Chief Executive Officer]

You’re welcome.

[Operator]

This does conclude our question-and-answer session. I'd like to turn the conference back over to Mr. Kipp deVeer for any closing remarks.

[Kipp deVeer, Chief Executive Officer]

I'll just thank everyone for joining us. We – frankly, I thought this was a great quarter, and we think the company is really well positioned going forward. But again, thanks for your participation and your questions, and we will catch you in the next quarter.

[Operator]

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 one hour after the end of call through November 8, 2022, at 5:00 p.m. Eastern Time to domestic callers by dialing [phone] and to international callers by dialing [phone]. For all replays, please reference conference number 265938. An archived replay will also be available on a webcast link located on the home page of Investor Resources section of Ares Capital website.