Ares Capital Corp

NASDAQ:ARCC

Earnings Call Transcript 2020-Q4

[Operator]

Good afternoon. Welcome to the Ares Capital Corporation Fourth Quarter and Year Ended December 31, 2020 Earnings Conference Call. At this time, all participants will be in a listen only mode. As a reminder, this conference is being recorded on Wednesday February 10, 2021.

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

[John Stilmar, Managing Director of Investor Relations]

Thank you, Tom. Now, 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 reasons, 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 company uses to measure its financial condition and results of its operations. A reconciliation of core EPS to the net per share increase or decrease in stockholders' equity resulting from operations, the most directly comparable GAAP financial measure, can be found in the accompanying slide presentation for this call. In addition, the reconciliation of these measures may also be found in our earnings release filed this morning with the SEC on Form 8-K.

Certain information discussed in this call and the accompanying slide presentation including information relating to portfolio companies was derived from third-party sources and has not been independently verified and accordingly, the company makes no representation or warranties with respect to this information. The company's fourth quarter and year end December 31, 2020 earnings presentation can be found on the company's Web site at www.arescapitalcorp.com by clicking on the Fourth Quarter 2020 Earnings Presentation link on the homepage of the Investor Resources section of our Web site. Ares Capital Corporation's earnings release and 10-K are also available on the company's Web site.

I'd like to now turn the call over to Kipp DeVeer, Ares Capital Corporation's Chief Executive Officer.

[Kipp DeVeer, Chief Executive Officer]

Thanks a lot, John. Hello everyone, thank you for joining us. I'm here with our Co-Presidents, Michael Smith and Mitch Goldstein; our Chief Financial Officer, Penni Roll, and several other members of the management team. I will start by highlighting our strong fourth quarter and full year results and then provide some thoughts on our position in the current market conditions. This morning, we reported recorded fourth quarter core earnings of $0.54 per share, which concluded a strong year for Ares Capital despite the very challenging backdrop. We are proud of how our team managed through the difficult conditions created by the COVID-19 pandemic, and we believe our strong performance validates our ability to perform in challenging market conditions.

Our fourth quarter results were driven by the largest new commitment volumes we have made in any quarter of our 16 year history. This significant origination activity partially reflects the growing scale of our direct sourcing platform, which includes the expansion of origination and other credit-oriented strategies across the Ares platform. It also reflects the disruption our market experienced beginning in March, and continuing through the middle of last year due to the pandemic. Markets began to normalize towards the end of the summer, and the direct lending market saw a real resurgence of activity towards the end of the year as markets began to normalize.

Our GAAP earnings per share of $0.89 for the fourth quarter were driven by these healthy activity levels, as well as sizable net unrealized gains, a reflection of our strengthening investment portfolio. Overall, our core EPS was $1.74 per share for the year, well above our payout regular quarterly dividends totaling $1.60 per share. Our net asset value per share ended the year at $16.97, which is up approximately 9% since the March 31, 2020 draw down. Since the markdown in portfolio values that we experienced in March, we recovered a significant majority of the decline as of year end.

In conjunction with the economic and capital markets recovery during the back half of the year, our scale direct origination platform allowed us to see a large and varied set of opportunities in the financing market. During the second half of the year, we evaluated approximately 1,700 investment opportunities on a run rate annualized basis. This is a 5% increase when compared against the opportunities evaluated during the full year 2019. This large and expanding pipeline has enhanced our ability to be selective and allows us to invest in what we believe are the strongest companies. And not surprisingly, our 2020 new deal selectivity rate of approximately 3% was one of the lowest for us in over a decade and below our historical average of approximately 4%. In addition to this, we are finding many larger companies interesting and attractive. The average EBITDA for the companies we evaluated during the year increased 53% as compared to last year, underscoring the expansion of our opportunity set in terms of both number and size of borrowers. For the year, we estimate that we reviewed more than $500 billion of financing opportunities, which is a roughly 20% increase over our estimate for 2019.

As I alluded to earlier, the growth in the amount of transactions we are reviewing is partially driven by the continued scaling of our capabilities at Ares Management. We believe that the culture of collaboration across the Ares platform and the increased investment that Ares has made expanding into new verticals and capabilities meaningfully enhances the opportunity set for Ares Capital. With over 145 US direct lending investment professionals and relationships with approximately 550 private equity sponsors. We believe we have the largest US direct lending team in the industry.

Beyond this footprint, Ares has a strong European direct lending platform with more than 60 professionals that manage distinct and separate funds. This enables us to cover the private equity community globally, and positions Ares Capital to see incremental deal flow from European sponsors investing in the US, as well as select cross border investment opportunities. We also believe that the continued expansion of other credit teams at Ares Management has further augmented our market reach and brings additional opportunities to the company. Finally, the breadth of our platform has allowed Ares Capital to benefit from deeper industry specialization that continues to develop at the firm in areas like software, healthcare, infrastructure and sports media and entertainment.

We will provide more detail later in the call. But the quality of the portfolio has improved since the difficulties of this past spring, when we saw temporary business closures and general economic turmoil for many companies. During the fourth quarter, we collected 99% of contractual interest due and the LTM weighted average EBITDA growth of our portfolio companies accelerated, reaching a healthy 5% during the fourth quarter from about 2% a quarter ago. It's worth noting that we continue to see faster growth among our upper middle market companies in excess of $100 million in EBITDA compared to those below $50 million in EBITDA. The further strengthening of our portfolio is also reflected in other credit metrics that we report on a quarterly basis. Our nonaccruals were 5.1% at amortized cost and 3.2% at fair value at the end of the third quarter. These nonaccruals declined to 3.3% at amortized costs and 2% at fair value by the end of the fourth quarter. Our weighted average portfolio grade of 3.0 also improved versus last quarter's 2.9 and in line with our historical average.

Finally, I'd like to highlight the strong liquidity position and capitalization of the company. The strength of our balance sheet and the depth of our liquidity has proven to be a significant weapon that we continue to use support our existing borrowers during these periods of economic uncertainty and recovery. We had $2.6 billion of excess liquidity at the end of Q1 2020 and have now grown this uninvested capital to over $4 billion at year end. As Penni will expand upon shortly, we continue to access efficient forms of financing to further enhance the company's funding profile and we've continued to lower our cost of financing. We've been believe Ares Capital has a very strong balance sheet today that will provide us with all the tools we need to work through 2021 and beyond.

I'm now going to turn the call over to Penni to provide more details on our fourth quarter and full year 2020 financial results.

[Penni Roll, Chief Financial Officer]

Thanks, and good afternoon. Our core earnings per share of $0.54 for the fourth quarter of 2020 were higher than both the $0.39 for the third quarter of 2020 and the $0.45 for the fourth quarter of 2019. our GAAP earnings per share for the fourth quarter of 2020 were $0.89, which compares to $1.04 for the third quarter of 2020 and $0.48 for the fourth quarter of 2019. Our GAAP earnings per share for the fourth quarter of 2020 included $0.78 of net unrealized gains offset by $0.43 of net realized losses. As Kipp mentioned, we closed the year with a very strong fourth quarter that helped drive our full year core earnings per share of $1.74 and along with recovering valuations, our GAAP net income per share of $1.14. This compares to $1.89 and $1.86 respectively for 2019.

Our fourth quarter core earnings of $0.54 were driven by strong recurring interest in dividend income and a larger than usual level of capital structure and service fees of $93 million from new origination and capital markets activities. Our net unrealized gains on investments of $332 million for the fourth quarter of 2020 primarily reflect continued tightening of credit spreads relative to the end of the previous quarter and performance improvement in certain names. At December 31, 2020, our stockholders' equity was $7.2 billion, resulting in a net asset value per share of $16.97 as compared to $7 billion or $16.48 at September 30, 2020, and $7.5 billion or $17.32 at December 31, 2019. The increase in our net asset value during the fourth quarter of 2020 was primarily driven by the net unrealized gains. Despite the significant unprecedented market volatility, which impacted portfolio values in the first quarter, we saw a steady recovery of values during the remainder of the year, resulting in a more modest full year net realized and unrealized losses of $310 million.

We have recovered a significant amount of the NAV per share decline we recorded in the first quarter at the start of the COVID-19 pandemic. With this recovery, we had only a modest 2% decline in the company's NAV per share over the year. Our total portfolio at fair value at the end of the quarter was $15.5 billion and we had total assets of $16.2 billion. As of December 31, 2020, the weighted average yield on our debt and other income producing securities at amortized cost was 9.1%, and the weighted average yield on total investments and amortized cost was 8% as compared to 9.1% and 7.8% respectively at September 30, 2020 and 9.6% and 8.6% respectively at December 31, 2019. At December 31, 2020, 84% of our total portfolio at fair value was in floating rate investments. Additionally, excluding our investment in the SDLP certificates, 84% of the remaining floating rate investments had an average LIBOR floor of approximately 1.1%, which is well above today's current three month LIBOR rate.

Now let's shift to our capitalization and liquidity. As of December 31st, our debt to equity ratio net of available cash of $213 million was 1.17 times, up from 1.07 times at the end of the third quarter. As of the end of the year and pro forma for our recent bond offering, we had more than $4 billion of total available liquidity. To recap a busy capital activity year for us, during 2020 we closed on over $2.4 billion of new financing commitments, significantly increasing our liquidity across both unsecured and secured financing options. Once again, we demonstrated our ability to access diverse and cost effective sources of capital even in the most challenging of times. Post year end, we remained active in the capital markets, taking advantage of very favorable market conditions with an opportunistic unsecured debt issuance of $650 million at the lowest all in coupon in BDC history of 2.15%. As a reminder, our next term debt maturity is not until January of next year, and the earliest maturity of our bank credit facilities is September 2024. Overall, we are happy with our capital structure today and we believe it remains one of our most significant competitive advantages, positioning us well to remain active investors.

Before I conclude, I want to discuss our undistributed taxable income and our dividends. For 2020, despite the pandemic driven challenges for a significant portion of the year, we once again outearned the dividends we paid, resulting in an increase in our undistributed taxable income. We currently estimate that our spillover income reached $1.07 per share at the end of 2020, an increase of $0.11 per share from 2019's level. We believe having a strong and meaningful undistributed spillover supports our goal of maintaining a steady dividend through varying market conditions and sets us apart from many other BDCs that have no such spillover to speak of. To that end, this morning we announced that we declared a regular first quarter dividend of $0.40 per share, which is consistent with the regular quarterly dividend paid throughout 2020. This first quarter dividend is payable on March 31, 2021 to stockholders of record on March 15, 2021.

Now I will turn over the call to Michael to walk through our investment activities for the quarter and the year.

[Michael Smith, Co-President]

Thanks, Penni. I would like to spend a few minutes providing more detail on our investments and portfolio performance for both the year end and importantly, the fourth quarter of 2020. I will then provide an update on post quarter end activity and our backlog and pipeline. During 2020, our team originated $6.7 billion of new investment commitments across 142 transactions, including $3.9 billion of commitments to 59 companies in the fourth quarter. Our investments throughout the year came from a diverse set of high quality companies across more than 20 distinct industries. The EBITDA of the companies we financed this year ranged from $4 million to $731 million, which underscores the breadth of our opportunity set and capabilities. We finished the year with 350 portfolio companies, and we remain highly diversified with an average hold position at fair value of only 0.3%.

Focusing on our significant fourth quarter investment activity, approximately two thirds of the new fundings came from incumbent borrowers, which on average have been clients of ARCC for the past five years. Our position as an incumbent lender provides meaningful and differentiated sourcing advantages and enables the company to stay invested through ownership transfers and allows us to provide additional capital to companies that has exhibited strong performance over multiple years. This advantage was especially important in 2020 as follow on activity accounted for more than 70% of M&A activity during the year, a new record according to PitchBook. It is also worth mentioning that record origination volumes for us typically followed periods of volatility.

Prior to this quarter, our highest level of new investment activity was the fourth quarter of 2018 following the significant market dislocation at the end of 2018. During volatile periods, we believe our market share increases as companies increasingly seek the surety of capital and scaled financing solutions we provide. Much of the fourth quarter's robust investment activity involved transactions that were structured and committed to during the third quarter and the beginning of the fourth quarter when the market picked backed up and we identified opportunities that had attractive relative values. For example, the first lien commitments closed during the fourth quarter had an 11% higher spread per unit of leverage and 19% higher upfront fees as compared to the fourth quarter of 2019. Additionally, we benefited from seeing and financing higher quality companies as those businesses that came to market during the second half of the year generally had limited impact from COVID-19.

With respect to our portfolio composition, at fiscal year end 2020, 79% of our portfolio at fair value, inclusive of the SDLP investment, was in secured loans, which is consistent with our composition prior to COVID-19. What has changed more meaningfully is the weighted average EBITDA of our portfolio companies. At year end 2020, the weighted average EBITDA reached $156 million, up from $139 million at year end 2019 and just $99 million two years ago. This growing EBITDA underscores the expanding market opportunity for large direct lending transactions and our strong competitive position in this attractive segment of the market. As Kipp described earlier, the overall credit quality of the portfolio continues to improve with a rebounding economy and healthy capital market conditions. One measure of this is the weighted average loan to value of our last dollar of debt in our corporate borrowers, which ended the year below 50%. This is the most favorable assessment of LTV during the past five years and highlights the downside protection we feel is inherent in our portfolio.

Let me now provide a brief update on our post quarter end investment activity and pipeline. From January 1st through February 4, 2021, we made new investment commitments totaling $524 million, of which $411 million were funded. And we exited or were repaid on $1.1 billion of investment commitments, including $260 million of loans sold to IHAM or vehicles managed by IHAM, generating approximately $13 million of net realized gains on total exits. As of February 4th, our backlog and pipeline stood at roughly $685 million and $280 million respectively, which represents a similar level to early February 2020. It's worth pointing out this pipeline reflects a combination of the typical slower start to the year and the robust year end that pulled forward some demand. Looking forward, we remain optimistic that the continued firming economic conditions and healthy amounts of sponsor capital on the sidelines may provide a supportive backdrop for stronger deal activity throughout the year. Note that our backlog contains investments that are still subject to approvals and documentations, and may not close or we may sell a portion of these investments post closing.

With that, I will now turn the call back over to Kipp for some closing remarks.

[Kipp DeVeer, Chief Executive Officer]

Thanks, Michael. We continue to move the company successfully through what we hope is the near end of the COVID-19 health crisis around the world. Despite this difficult environment, our performance during 2020 was very strong and we closed the year on a high note with our best quarter in the company's history. We believe our disciplined investment approach, broad market reach, conservative balance sheet and deeply experienced team have differentiated the company during this difficult year.

I want to end my comments by sending deep appreciation and gratitude to all of our team members who have come together at such a difficult time to deliver value for the shareholders. This is not the first time we've seen this type of effort from our people and I don't expect it will be the last. We remain relatively unique as a company in the BDC space, a company that's shown cumulative growth in net asset value over 16 years and cumulative realized gains in excess of realized losses over the same period due to our consistent investment performance. We also continue to be focused on our earnings exceeding our dividends, which certainly was the case for 2020.

Fiscal year end 2020 once again proved that Ares Capital can navigate volatile and disruptive markets and deliver strong performance to investors, while maintaining a constructive presence with borrowers and clients as we did throughout the year. As the economy is now slowly emerging from this global health crisis, we are seeing growing evidence that these trends are yet again supporting Ares Capital's position in the market. Looking forward, we believe Ares Capital's leadership position and direct lending aligns the company to benefit from the continued expansion of the middle market and the secular growth trend of more companies seeking private capital solutions. Despite the many challenges that 2020 brought, we're pleased with the performance that we've delivered for you this year and we feel well positioned for 2021 and beyond.

That concludes our prepared remarks, and we'd be happy to open the line for questions. Thank you.

[Operator]

[Operator Instructions] The first question comes from John Hecht with Jefferies.

[JohnHecht]

Congratulations on navigating a strange year. First question, and I think Mike talked about the fee environment with respect to new deals in some of his remarks. But you had a high amount of capital markets activity event, good fee income. Is there anything changing on the fee margins or your ability to demand fees and deals, or is that simply just a metric of elevated activity?

[KippDeVeer]

I mean, it's mostly driven, obviously, by a really active origination quarter. If you looked at sort of the fee percentage to take fees and divide them by the amount of commitments, it's pretty in line with what we saw throughout the year in 2020, if you look on an annualized basis as well as in '19. There were one or two large deals towards the end of the quarter where we were able to achieve some better than expected sort of capital markets activity on some larger deals that maybe bumped it up a little bit, but it's largely a result of the significant new commitment number.

[JohnHecht]

And then nonrelated follow-up. We all see a pretty sizable decrease in NPAs. Was that all performance related or maybe just a indication of a recovering economy or was some of that related to some restructuring activities?

[KippDeVeer]

It's both. So we had two transactions that we did restructure in the quarter, that came off nonaccrual. So Production Resource Group as well as Vista were two companies that were removed basically of the five total that were restructurings. So it's a combination of both, John.

[Operator]

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

[FinianO'Shea]

Just a follow-up on John's question there on the origination level. I think that was in terms of your capital base and leverage profile, pretty meaningful, if you agree. Leverage is pretty solid at quarter end. There were presumably some sell-downs and Varagon picked it up. So can you talk about how above trend this was for a level of activity? I know the market opportunity was really big in the fourth quarter and it's growing for you. But how should we think about Ares approaching this or starting to sustainably produce this level of origination in the new environment?

[KippDeVeer]

No doubt it was unusual. I mean, I think as we've even talked about a little bit on the third quarter call, we expected this very busy fourth quarter. It really was a result of Q2 and Q3, for that matter, being significantly below what have been our historical kind of new commitments, just if you look back and track them, in the prior quarters, Q1 and before, we were ranging somewhere from $1.3 billion to as high as $2.4 billion. The fourth quarter is pretty unusual and that a lot of the deal flow that we closed were things that had kind of been brewing all year but didn't really have a firm market to close into. And with some additional recovery into Q4, a lot of that deal flow carried over. So I think it's certainly as a result of that. I think it's also a result of, there is concern around the election. There was concerns around taxes under potentially new administration that we now see, et cetera. So there is also, I think, a pull into Q4 potentially from 2021 with folks trying to get transactions done by year end. We saw both of those phenomenon occur. So I think it's an unusual quarter, no doubt. I mean, I don't expect, on a run rate basis, we'd be committing $4 billion a quarter, to answer the question simply.

[FinianO'Shea]

And then we’ve talked about last quarter, Capstone, where you were -- or at least as it started, you were engaged as a syndication provider. Has that proved to be sort of a onetime COVID market volatility thing, or is that something that you find yourself increasingly open to or potentially engaged in?

[KippDeVeer]

Yes, I think we have been historically open to and engaged in that typically, I think, as we talked about last quarter. We underwrite all of our transactions with comfort in holding the entirety of obviously what we commit to. But the market really firmed up going into year end. And in markets like that, sometimes pricing relative to where you underwrote titans and your desire to hold decreases maybe from where it was on an underwriting basis. So we've set a fully functioning capital markets and syndications team up to take advantage of tightening markets like that and reduce holds and names that we see as potentially less interesting by the time they close versus when we underwrote them. And that's sort of the story with Capstone, not to get into that deal in detail. But we've done that historically in the past, and in tightening markets we're absolutely opening to maximizing our advantages just to generate excess fee income in transactions where we see final holds being lower than we may have expected at underwriting.

[Operator]

The next question comes from Ryan Lynch with KBW.

[RyanLynch]

First one, I just want to talk about your liability structure. Obviously, first off, congratulations on that debt offering you guys did in January, that was a historically low rate. And so with doing something like that, you guys have always had very low unsecured debt cost, but I would say the one you did recently is kind of a game changer because that kind of falls right in line with the cost of your revolvers. And so assuming that the market for unsecured debt doesn't change, and obviously, that can fluctuate depending on market conditions, being able to issue debt close to unsecured debt at close to 2%. Does that change the way you all are thinking about utilizing your revolvers in the future?

[KippDeVeer]

I'll start and I'll let Penni chime in. We're obviously not in the same place but she will probably have some thoughts. I mean, look, we're thrilled with the debt issuance being able to issue in the unsecured markets at two and change percent is pretty attractive, to your point, relative to being able to draw down secured facilities at roughly the same cost, give or take. I don't think it changes our approach, to be honest. I mean, we still want a balance of floating rate debt and fixed rate debt, and that we're not looking to be particularly interest rate sensitive on the liability structure. And we value the duration and the laddered maturities that the unsecured market offers us. But more than anything, we've said this in the past, Ryan, I'll just say, look, we're thrilled about that cost of capital but we're trying to maintain a very flexible balance sheet that just allows us to run the company with, again, excess liquidity and the flexibility to stick to our investment approach, which has worked well over a long period of time.

[RyanLynch]

And then my follow-up would be, obviously, there is a ton of just market activity. You gave various reasons why fourth quarter had accelerated activity. Just as a market standpoint, obviously, Ares benefited from that by having an extremely robust quarter from an originations and commitment standpoint. My question was though, was there any -- do you think, any structural shifts that occurred during COVID that actually pushed more deals, sponsor backed deals to direct lenders? Obviously, those trends have already been in place for several years now. But was there anything that maybe structurally shifted during COVID that even accelerated those trends?

[KippDeVeer]

Yes, I mean, we'll see. I mean Mike, on this in his portion of the prepared remarks. But look, I think during uncertain times, private capital solutions tend to be more valuable. Syndicated deals can be tougher to get done. Market volatility, et cetera, is not something that folks want to take on. And 2020 was certainly a year where you could argue there's a whole lot of market volatility. So I do think just increased acceptance, increased preference for private capital deals has just been reinforced. And to Mike's prepared comments too, look, I think the consistency with which we approached both our existing borrowers and the new deal market throughout 2020 really resonates for people, because particularly -- well, for all of our clients, I was going to say, particularly private equity, you only do a couple of deals per year.

But I mean, with the folks that aren't private equity backed, you're talking about families or entrepreneurs, whoever owns these assets and companies, they're only going to do a transaction like one they do with Ares Capital once in a pretty long while. So not only do you want the certainty of a private solution but you obviously value a partner more who you know is going to be there for the long haul, who's shown consistency, who's shown stability, who hasn't closed their doors for new business, so to speak, for any period of time. And we're fortunate. We didn't do that. So I think we were, while playing defense on the existing portfolio, pretty front footed about wanting to do new deals throughout 2020. And that, again, to Mike's prepared comments, should help us continue to improve kind of our market share relative to the competition.

[Operator]

The next question comes from Devin Ryan with JMP Securities.

[DevinRyan]

Maybe just to follow up a little bit on the pipeline commentary. I appreciate some of the detail and kind of where we sit relative to last year. If you can maybe just give us a little flavor for pricing and terms today. Are we all the way back to pre COVID there as well or how things have evolved over the last few months? Obviously, quite a bit of tightening but curious if there's any other nuance within that.

[KippDeVeer]

There's not a lot beyond that. I mean, you kind of summarized it. Look, things have come back in to be more competitive and a bit tighter here, which is obviously why you see a backlog in pipeline that's more in line with what we've seen historically. Obviously, Mike called that out in his prepared remarks, comparing where we were kind of, at this point, 2021 versus 12 months ago as we kicked off 2020. I'd say that the quality of the underwriting and frankly, the quality of the businesses that we've seen are higher. And we made the comment too that most of them, now that we're out of the depths of March and April, are less COVID sensitive companies. It's more regular way. And of course, with that comes folks willing to be more aggressive on leverage or terms. I think that the quality of the underwriting, though, has reset a lot. Folks have used this in terms of leverage and negotiation with counterparties, companies, borrowers, et cetera, to try to structure really smart deals for lenders and that's continuing. But look, things have rallied back. And it is more competitive for sure now than it was. We were coming through the spring and summer, obviously, when we're taking on a lot of this backlog and pipeline that we closed into this fourth quarter. But nothing earth shattering beyond that, Devin.

[DevinRyan]

And then just on the unitranche side, originations were very strong there. Can you just remind us how you're defining unitranche and just more broadly the appetite there and just kind of what you're seeing around demand?

[KippDeVeer]

Yes, I mean unitranche is hard because people will look at it different ways. I mean, we've been doing that type of business a long time. I mean, typically, what we're doing in unitranche is we're taking what historically has been a three party deal, where there's senior and subordinated debt or senior and junior capital and combining it into one loan, that we can commit to typically without flex, underwriting that and holding that for the most part on our own account. So it just makes life easier for borrowers. It allows for a more even pay down of debt structure, typically less call protection, et cetera. But it's really meant to replicate what a borrower could get, in our mind, in a deal where they chose to raise senior and junior capital in two separate tranches to keep it simple.

[Operator]

[Operator Instructions] The next question comes from Melissa Wedel with JP Morgan.

[MelissaWedel]

Just wanted to touch on portfolio leverage and how you're thinking about that as you're sort of reaching the higher end of your target leverage range, especially when we think about some of the activity post quarter end, that could imply sort of flat, maybe even a little bit tick higher from where you ended the December quarter. So how are you managing that on a portfolio basis?

[KippDeVeer]

Yes. So I mean, it's actually right in line with the range that we've communicated in the past. We typically feel pretty comfortable running somewhere between 1 and 1.25 times. So while numerically, it looks like it's on the upper end and we talk about future backlog and pipeline, we also don't lay out what we expect for future repayments. So for us, nothing unusual, nothing out of the ordinary. We'll see how the activity levels go in terms of the things, to Mike's point, about some of the things in backlog and pipeline probably don't close. And we've got deal flow, obviously, that we're working on today, that will get into that backlog and pipeline through the back of the quarter. So really, I don't have any thoughts on it other than it's ordinary course.

[MelissaWedel]

And wanted to touch on something that you've referenced a few times where you talked about the sort of attractiveness of larger EBITDA companies. You put some interesting steps in your slide deck as well about extending sort of the size of your average commitment and the term of the average commitment, I think, has lengthened. So just want to make sure we're thinking about that the right way. Is that a function of the quality of the companies or broader macro outlook? How does that impact any sort of prepayment fees or terms that you write into those deals?

[KippDeVeer]

So I don't think we're extending -- feel free to -- I'm not sure where you picked up the longer commitment term. The term of the loans that we're writing, a small company, a large company, frankly, aren't any different. I think the trend that you're seeing in the larger companies actually speaks a little bit to the competitive set, which is sort of interesting. And most of the folks on the team have been doing this 20 plus years. Typically, when you're lending to smaller companies, $10 million to $30 million or $40 million EBITDA companies, you're able to extract better terms and better pricing and all of that. And I think with the amount of capital that's been raised in private credit and in direct lending over the last 5 years, when you really pore through it and you analyze it, what you'll see is a lot of folks that have what I would argue to be subscale pools of capital to really address any market other than that lower middle market, and it forces them into deals where they can compete. So we've actually seen it be more competitive in some of these smaller deals that we've had to just walk away from because we'll see the same terms.

Occasionally, we even see lower pricing in some of these lower middle market companies than we can achieve in the larger market or larger company deals that we're doing. And I think that, again, as a result of the fact that not very many folks have the capital, both in terms of scale and flexibility, to really approach $100 million or $150 million EBITDA company with a real solution. So we're seeing just this inefficiency occur in some of these larger businesses. The stats that we laid out about the performance of those larger companies, frankly, doesn't surprise us all that much because larger companies tend to be more sophisticated, better management teams, more scale, more geographic reach, et cetera. So I'm not surprised that they're performing a little bit better. So it's probably all those dynamics together impacting the fact that we really like that opportunity set in these larger company transactions we've done over the last year or two.

[Operator]

The next question comes from Robert Dodd with Raymond James.

[RobertDodd]

If I can, Kipp, on one of your comments, I think to Devin, about the kind of pipeline that's going through now, it's higher quality businesses and you said people are more willing to be a bit more aggressive on leverage. I mean, we talked about obviously pricing has contracted. I mean, would you say based on today’s comments that the spread in the fourth quarter was 11% higher per unit of leverage than a year ago. I mean, has that all evaporated or as leverage has gone up, has some of that held in, in terms of where those terms are with higher leverage?

[KippDeVeer]

Yes, I think some of it's held in. Thanks for the question, Robert. I mean, as you know, the middle market tends to follow the broadly syndicated markets in terms of its pricing. In terms of what is the broadly syndicated loan look like, obviously, middle market, for a handful of reasons, will always have spreads wide at the BSL market. And so as that markets come in, we probably come in a bit. I don't think we've given it all back. I think where we'll be reliant on for 2021 is what are the activity levels, what does M&A look like? And Q1 is a historically slow quarter and especially after such a busy fourth quarter, started slow and that doesn't help. But the good news is it's picked up a bunch. Our backlog and pipeline looks healthy. So I think we'll see that premium hang on. And I think 2021 is actually pretty good prospect for investing for the company.

[RobertDodd]

If I can ask you -- this one, I'll go with a hypothetical. If competition does continue to kind of drive away that spread, obviously, one of the tools you have is you're big, you can write a big check. You can potentially obviously sell down and take capital markets activity and maybe skim some syndication fees. So what should we expect that if the market gets more competitive, we might see more sell downs scheming maybe keeping the total economic synergy on the same, even if the coupon goes south because you can skim it to other vectors by having your capital markets team and having the ability to write initially a big check and then sell down and keep some of the other economics as well?

[KippDeVeer]

Yes, I mean, it benefited us as you saw in the fourth quarter. And obviously, we're positioned to do that. To the extent things come in, I think my own view is activity levels will pick up. I don't think competition is going to get any more heated, frankly, than it is today pitching new business and we can use that tool, to answer your question. But I don't see anything unusual changing for 2021.

[Operator]

This concludes 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]

Thanks. Well, I appreciate everyone getting on the call. I appreciate the time, and I hope you're staying well and look forward to actually seeing everybody in person one of these days. But otherwise, we'll catch you on the next earnings call. Thank you.

[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 the call through February 24, 2021, at 5:00 p.m. to domestic callers by dialing [phone] and to international callers by dialing 1 [phone]. Again, those phone numbers for domestic callers are [phone] and to international callers, 1 [phone]. For all replays, please reference the conference number 10150593. Again, that conference number is 10150593. An archived replay will also be available on a webcast link located on the homepage of the Investor Resources section of Ares Capital's Web site. Thank you for attending today's presentation. You may now disconnect.