Ares Capital Corp

NASDAQ:ARCC

Earnings Call Analysis

Company Signifies Growth and Strong Liquidity

In a thriving quarter, stockholders' equity rose to $11.2 billion, marking per-share increases of over 1% since the previous quarter and 5% year-over-year. The annualized return on equity hit 14.6% with a GAAP EPS; a solid improvement over the long-term 12% total return on NAV. The portfolio appreciated to $22.9 billion, fueled by $6 billion of new commitments in 200 transactions. Notably, the fourth quarter saw accelerated growth, with commitments soaring by almost 50%. Liquidity remains robust with $6.4 billion available, including $1 billion from recent long 5-year note issues. This financial vigor allowed a quarter's dividend declaration of $0.48 per share and an estimated $635 million for 2024's stockholder distributions.

Company Overview and Leadership Changes

Ares Capital Corporation, led by Kipp DeVeer and experienced executives, has announced leadership transitions, with long-time finance and accounting team leader Scott Lem stepping into the Chief Financial Officer role. As ARCC navigates a changing financial landscape, these internal shifts highlight the firm's strength and continuity.

Financial Highlights and Portfolio Performance

Ares Capital Corporation showcased robust financial achievements in its fourth-quarter and full-year reports, marking a period of increased core earnings per share to $0.63 and annual core earnings of $2.37. Recording a 5% year-over-year growth, book value per share ascended to $19.24. Alongside this, ARCC announced a boosted regular dividend of $1.92 per share for 2023, reflecting a 10% rise from the previous year. These successes are attributed to healthy portfolio credit performance and the advantageous impact of higher market interest rates on net interest income.

Strategic Market Position and Growth Strategy

The firm's strategic direction has capitalized on the opportunities presented by direct lending market share gains. As banks retreated, ARCC clinched deals with over 90% of new LBOs in 2023 and extended its reach by accommodating large and middle market companies seeking stable, flexible capital sources. These shifts have led ARCC to scrutinize an expansive deal flow, with more than $500 billion scanned in 2023, promoting stringent selectivity and a robust underwriting procedure that safeguards credit integrity and enhances long-term performance.

Capital Structure and Liquidity

Maintaining a strong capital stature, ARCC operates with a calculated net debt-to-equity ratio of around 1.02x, which not only offers potential earnings expansion through prudent leverage but also equips the firm to pursue attractive investment opportunities. Strategic capitalization continued in early 2024 with the issuance of a new 5-year unsecured note at competitive pricing, reinforcing ARCC's liquidity profile and its preparedness to meet borrower demand amid fluctuating markets.

Earnings Call Transcript 2023-Q4

[Operator]

Good morning. Welcome to the Ares Capital Corporation's Fourth Quarter and Year ended December 31, 2023, Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded on Wednesday, February 7, 2024. I will now turn the call over to John Stilmar, partner of Ares Public Markets Investor Relations. Please go ahead, sir.

[John Stilmar, executive]

Thank you. 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 that 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 operation.

A reconciliation of GAAP net income per share, the most directly comparable GAAP financial measure to core EPS can be found in the accompanying slide presentation for this call. In addition, the reconciliation of these measures may also be found in our Earnings Presentation filed this morning with the SEC on Form 8-K. Certain information discussed in this conference 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, December 31, 2023, Earnings Presentation can be found on the company's website at www.arescapitalcorp.com by clicking on the Fourth Quarter 2023 Earnings Presentation link on the homepage of the Investor Resources section. Ares Capital Corporation earnings release and Form 10-K are also available on this website. I will now turn the call over to Mr. Kipp DeVeer, Ares Capital Corporation's Chief Executive Officer. Kip?

[Robert DeVeer, executive]

Thanks, John. Hello, everyone, and thanks for joining our earnings call today. I'm here with our Co-Presidents, Kort Schnabel and Mitch Goldstein; our Chief Operating Officer, Jana Markowicz, our Chief Financial Officer, Penni Roll; our Chief Accounting Officer, Scott Lem, and other members of the management team.

For those who may not have seen our announcement, Scott Lem has been appointed as our new Chief Financial Officer effective February 15. Scott has been a key business leader within our finance and accounting team for more than 2 decades, and he has been instrumental in helping us drive growth and success at ARCC over many years together.

In hand with this announcement, the company wants to thank Penny Roll for the tremendous contributions, she has brought to our company over the past 14 years. As many of you know, she joined us with the acquisition of the Allied Capital back in 2010, and has been a great partner to me and everyone on the team. And thankfully, she's staying with Ares in a senior leadership role and it's noteworthy that Penny will also remain an officer of Ares Capital. Scott and Penny's new appointments underscore the depth and quality of our team, and we look forward to both continuing to serve Ares Capital in their new roles.

Now to our strong results. This morning, we reported another quarter of increased core earnings of $0.63 per share, which culminated in a year of record core earnings of $2.37 per share. These results largely reflect the continued strong credit performance of our portfolio and the earnings benefits of higher market interest rates on our net interest income. The strength of our earnings and positive valuation momentum in our portfolio also led to growth in our book value per share, which increased 5% year-over-year and reached a new record of $19.24 per share.

In addition, our regular dividend of $1.92 per share for 2023, increased 10% and over the 2022 regular dividend. We're proud of our long-term track record of delivering stable and consistent dividends to our shareholders. We remain one of the few BDCs that's been able to build NAV, while delivering an average dividend yield of roughly 10% on the NAV over our 20-year history.

Our strong results in 2023 and over the past several years, reflect the market share gains that direct lenders like ARCC have enjoyed due to the greater certainty of execution, larger final hold amounts and enhanced flexibility provided to companies. As an example, in 2023, over 90% of new LBOs were completed by direct lenders rather than through banks or bank-led syndications. And while the markets were slower last year, we believe we saw substantial market share gains overall.

Although many more traditional lenders are now returning to the market and the syndicated loan and high-yield markets seem to be finding their footing, we believe more borrowers recognize our ability to partner with them in support of their long-term growth objectives, even during volatile and dislocated markets. In 2023 and into 2024, we've witnessed large, high-quality companies that were traditionally financed by the broadly syndicated markets, turned to us to refinance their capital structures, not because they were unable to access the public markets, but because they prefer the stability that we provide through market cycles.

By leveraging the broader scale of Ares' U.S. direct lending platform, we believe we can unlock value for a wide range of businesses, whether they are large, high-quality companies, seeking multibillion-dollar financing or strong performing core middle market companies seeking a lender with flexible capital and the ability to support growth over time.

Borrower demand for dependable financing partners is not exclusive to the larger end of the middle market, as we're also seeing many core middle market companies seeking our financing solutions. As an example, the number of transactions we reviewed in 2023 for companies with EBITDA less than $100 million expanded 30% year-over-year.

Our differentiated deal flow also stems from our ability to provide capital on situations, where significant technical expertise is required or there's a high degree of complexity. Particularly in industries such as Software and Technology, Specialty Health Care, Financial Services, Infrastructure and Power and Sports, Media and Entertainment, just to name a few. We believe that our capabilities have resulted in us transacting with a growing number of borrowers.

Ultimately, we believe the breadth of our sourcing capabilities drives better selectivity, which in turn leads to better credit outcomes and ultimately differentiates our performance relative to other market participants. Reflecting this focus on our sourcing capabilities, we estimate that we reviewed more than $500 billion of transaction opportunities in 2023. And during the fourth quarter, we saw more transactions than were reported in the broadly syndicated loan and middle market combined.

We believe our high selectivity and rigorous underwriting supports our historical track record of maintaining a relatively low level of nonaccruals and generally healthy credit performance. And currently, we're seeing strong organic EBITDA growth of our portfolio companies and a below average level of nonaccruing loans. Through the fourth quarter, we continued to collect 99% of contractual interest and the weighted average interest coverage ratio of our portfolio companies remained stable quarter-over-quarter.

Further augmenting the health of our portfolios is significant value junior to our loans. We estimate that the weighted average LTV of our total loan portfolio, including our Junior Capital Investments is around 43%. Our Junior Capital Investments have attractive returns with LTVs that are comparable to liquid first lien structures. We believe that our ability to selectively invest in Junior Capital for relative value, often in much larger companies differentiates our platform from senior-only competitors.

Our ability to invest for relative value across the capital structure and generate incremental risk-adjusted returns in Junior Capital Investments has been a hallmark of our company and a significant contributor to our results over the past 2 decades. Looking at size and long-term financing relationships, we maintain a strong capital position with excess liquidity, in order to navigate market cycles and to be opportunistic, when we see growing borrower demand.

Our current net debt to equity level is reasonably low relative to historical standards at around 1.02x. This leaves us with additional earnings upside, if we choose to operate with expanded leverage and plenty of capital to pursue what we feel are attractive new investments. Our available liquidity was further enhanced in January 2024, with the issuance of a 5-year unsecured note at industry-leading pricing. With that, let me turn the call over to Penni to provide more details on our financial results and some further thoughts on our balance sheet.

[Penni Roll, executive]

Thanks, Kip. We reported GAAP net income per share of $0.72 for the fourth quarter of 2023, compared to $0.89 in the prior quarter and $0.34 in the fourth quarter of 2022. For the year, we reported GAAP net income per share of $2.75, compared to $1.21 for 2022.

On a core basis, we matched our record level of core earnings per share of $0.63 for the fourth quarter of 2023, compared to $0.59 in the prior quarter and $0.63 in the fourth quarter of 2022. We continue to see the benefits of higher base rates on our predominantly floating rate portfolio in the fourth quarter of 2023, as our interest and dividend income increased from both the prior quarter and fourth quarter of the prior year.

Additionally, we saw the benefits of an improving investing environment, resulting in higher capital structuring service fees from our highest origination quarter of the year. Our stockholders' equity ended the quarter at $11.2 billion or $19.24 per share, which is over a 1% increase per share, over the prior quarter and a 5% increase per share, over the prior year-end. Our annualized return on equity for 2023 using GAAP EPS and core EPS was 14.6% and 12.6%, respectively. This strong level of profitability further builds upon our long-term track record of a 12% total return on NAV, since inception.

Our portfolio at fair value ended the quarter at $22.9 billion, up from $21.9 billion at the end of the third quarter, reflecting a combination of net funding and net unrealized gains from the portfolio for the quarter. The weighted average yield on our debt and other income-producing securities at amortized cost was 12.5% at December 31, 2023, which increased from 12.4% at September 30, 2023, and 11.6% at December 31, 2022.

The weighted average yield on total investments at amortized cost was 11.3%, which increased from 11.2% at September 30, 2023, and 10.5% at December 31, 2022. Shifting to our capitalization and liquidity, we continue to benefit from the depth of our relationships we have built with our secured lenders over 20 years and with our investment-grade noteholders over more than a decade. As the most tenured EDC issuer in the unsecured notes market, we capitalized on investor demand in the fourth quarter, by reopening our 3-year unsecured notes and ultimately executing the transaction at a better all-in yield than our original issuance.

The initial issuance, which was done during the third quarter of 2023 was our first issuance in over 18 months, underscoring the merits of our approach to maintain deep levels of liquidity, which, amongst other benefits, allows us to be patient and tactical in how we access the capital markets. As a continuation of this theme, we capitalized on the market demand for our notes at the start of the year and chose to enter the high-grade unsecured market once again.

Given the constructive market and the deep support of our investors, we were able to issue $1 billion of long 5-year notes at market-leading spreads. This issuance represented our single largest initial issuance in the high-grade unsecured market in our history and the largest BDC issuance done this year, underscoring our market-leading execution. This is our only term debt maturing in 2029, as we continue to extend out our maturities to maintain a well-laddered maturity profile and to further strengthen our solid balance sheet position.

We have built what we believe is a best-in-class investment-grade capital structure, with a diversified base of over 275 bank lenders and debt investors, providing for meaningful access to the capital markets and significant unfunded revolving commitments. As always, we are grateful to their continued support of Ares Capital. We believe that our liquidity position remains strong with approximately $6.4 billion of total available liquidity, including available cash, pro forma for the recent $1 billion of notes issued a few weeks back.

We ended the fourth quarter with a debt-to-equity ratio, net of the available cash of 1.02x, as compared to 1.03x a quarter ago. We believe our significant amount of dry powder positions us well to continue to support our existing portfolio commitments to remain active in the current investing environment and to have no refinancing risk with respect to this coming year's term at maturities.

We declared a first quarter dividend for 2024 of $0.48 per share. This dividend is payable on March 29, 2024, to stockholders of record on March 15, 2024, and is consistent with our fourth quarter 2023 dividend. In terms of our taxable income spillover, we currently estimate that we ended 2023 with approximately $635 million or $1.09 per share from 2023 for distribution to stockholders in 2024.

This estimated slower level is more than 2x our current regular quarterly dividend, which we believe is very beneficial to the stability of our dividend. Before I finish, I would like to say that it has been my distinct honor to have served as the Chief Financial Officer of Ares Capital and to have had the opportunity to work for the benefit of our investors and lenders. I have been fortunate to be a part of this incredible team that has collaboratively built this company over the years. Scott and I have been in this together for my full tenure here, and I am very pleased that he will be our next CFO.

I would like to express my deepest gratitude to him and our talented and dedicated Finance and Accounting, Investor Relations, Legal and Compliance and Investing teams, whose tireless efforts have contributed to our collective success. I am excited to continue as an officer of ARCC and to remain a part of Ares. And with that, I will now turn the call over to Kort to walk through our Investment activities.

[Kort Schnabel, executive]

Thanks, Penny. I'm now going to spend a few minutes providing more details on our Investment activity, our portfolio performance and our positioning for the fourth quarter and the year. I will then conclude with an update on our post-quarter-end activity, backlog and pipeline.

Over the course of 2023, our team originated nearly $6 billion of new investment commitments, across 200 transactions, including $2.4 billion of commitments to 74 different borrowers in the fourth quarter alone. Further building on our leadership position in the market after ARCC had the highest level of originations of any publicly traded BDC in Q3, our new commitments in the fourth quarter increased almost 50% quarter-over-quarter. This growth is in sharp contrast to the reported broadly syndicated market volume in the middle market pro-ifinitive, both of which decreased quarter-over-quarter.

One benefit of the Ares platform that was particularly valuable for us in 2023 and which stems from the scale we have built over the past 20 years is the benefit of incumbency. Even during the less active market environment we saw in 2023, we continue to find attractive investment opportunities from our existing portfolio companies, which represented approximately 2/3 of our commitments during the year.

By further investing in our incumbent companies that we have a relationship with and know well, we believe we can reduce underwriting risk and drive better credit performance. Our new investments during the year were in a diverse set of companies across more than 20 distinct industries and included opportunities in both senior and junior capital investments reflecting the continued benefit of our flexible strategy to invest across the capital structure, as Kip mentioned.

The EBITDA of the companies we financed this year range from less than $20 million to over $800 million, which further demonstrates the breadth of our sourcing capabilities. Our new investments were made into what we believe are high-quality companies that present opportunities for attractive risk-adjusted returns, especially compared to the broadly syndicated loan market. For example, ARCC's newly originated first lien loans in 2023 had average spreads of 625 basis points at an average LTV of only 33%. These senior loans had spreads that were approximately 200 basis points wider and had equity cushions that were more than 30% higher than LBOs completed in the broadly syndicated loan market in 2023, based on data reported by LCD.

Shifting to our portfolio. As of year-end 2023, our strong and growing portfolio remains well diversified across 505 different borrowers. The number of companies in our portfolio has increased 8% over the past year and 47% over the past 5 years. To dig a little deeper, our average hold size is only 0.2% at fair value. Excluding our investments in Ivy Hill and the SDLP, which we believe are diversified on their own, no single investment accounts for more than 2% of the portfolio at fair value and our top 10 largest investments totaled just 12% of the portfolio at fair value.

The significant diversification of our portfolio differentiates us from our competitors, as it reduces the impact to the overall portfolio from any single negative credit event and individual company. As Kipp mentioned, the fundamentals and overall credit performance of our portfolio remain healthy. The weighted average EBITDA of our underlying portfolio companies demonstrated increased growth in the fourth quarter, expanding 9% year-over-year, up from 6% in the prior quarter. This compares to an estimated flat earnings growth rate for the S&P 500 over the last 12 months.

As a reminder, the EBITDA growth of our portfolio companies we report, excludes the impact from acquisitions as our goal has always been to provide investors with a view into the organic growth of our portfolio. We are seeing this healthy level of positive EBITDA growth across both our senior and junior capital investments, as well as our larger and smaller companies. In addition, the EBITDA of our top 5 largest industries in aggregate, is growing at a faster rate than the overall portfolio. This underscores what we believe is one of the many merits of not being a benchmark style investor, as we are able to be selective, not only in regard to the companies we are financing, but also to the industries we target more generally.

With respect to our portfolio grades, the weighted average portfolio grade of our borrowers at cost was stable with last quarter's 3.1. Nonaccruals at cost ended the year at 1.3%, below the 1.7% at year-end 2022 and well below our 3% 15-year historical average and the KBW BDC average of 3.9%, for the most recent 15-year period available. Our nonaccrual rate at fair value remained consistent with last quarter at 0.6%, which continues to be well below historical levels for our company as well.

Finally, I will provide a brief update on our post quarter end investment activity and pipeline. From January 1 through February 1, 2024, we made new investment commitments totaling $705 million, of which $478 million were funded. We exited or were repaid on $695 million of investment commitments, which resulted in us earning $19 million of net realized gains. As of February 1, our backlog and pipeline stood at roughly $1.1 billion. Our backlog 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.

[Robert DeVeer, executive]

Thanks a lot, Kort. Building on the strength of our results in 2023, we believe that we are well positioned for the year to come. We anticipate an uptick in deal activity in 2024, as a more stable capital markets backdrop, as combined with growing pressure on private equity GPs and LPs to monetize positions and get returns of capital.

In addition, the robust level of private equity dry powder that has largely gone on spend and is aging, should support a more active M&A environment. We believe that ARCC is uniquely positioned to benefit from an increase in transaction activity, which we anticipate would support our ability to earn higher capital structuring fees. For context, in 2023, capital structuring fees as a percentage of our stockholders' equity was less than half of our 5-year average.

As a reminder, at ARCC, all capital structuring fee income is fully retained for the benefit of our shareholders and none is paid to Ares Management. We believe the scale of our capital provides ARCC investors with these fee opportunities that some other market participants don't have or don't fully share with shareholders. Our many competitive advantages have resulted in differentiated performance in almost every relevant metric versus the competition. The company has delivered the highest regular dividend per share growth rate, the highest growth in NAV per share and the best stock-based total return in each case, when compared to every other externally managed BDC of size, that's been publicly traded for the last 10 years.

We believe the factors that have driven our outperformance remain firmly in place. And as a result, we remain optimistic about the year ahead. Let me just close by saying that we're deeply grateful to our investors for the trust and confidence they've demonstrated in Ares Capital and our team for their tireless work and dedication in 2023. And to conclude on a more personal note, I just want to, once more sincerely thank Penny for friendship and our partnership. We've developed a close relationship over the years, and I know I speak for the team as a whole. We will miss her day-to-day involvement with Ares Capital. And with that, operator, please open the line for questions.

[Operator]

[Operator Instructions] The Investor Relations team will be available to address any further questions at the conclusion of today's call. Our first question comes from John Hetch with Jefferies.

[John Hecht, analyst]

Penny, congratulations. We'll miss you and Scott look forward to working with you. First question is, when you think about kind of the mix of the forward curve and the implications for lower rates? And do you think of spreads in the market and just overall competition, where do you guys see kind of new deal yields coming in relative to the runoff at this point?

[Robert DeVeer, executive]

Yes. John, it's Kip. Thanks for your comments, too. Look, I mean I think a generalization, right? Spreads have tightened a little bit. I think as folks have a little more confidence in the economy. So a regular way, unitranche these days is probably 550 over the base rate. It's kind of the midpoint. It depends on company size, credit quality and all of that.

So relative to onboarding new investments vis-a-vis the existing yield in the portfolio, it's probably right around the same. So I think we're able to take on new investing that's still pretty accretive to the earnings. In terms of rates and all of that, I think we're in the camp of likely higher base rates for a bit longer. And I think so long as defaults remain reasonably muted, you'll see the spreads kind of sit around these levels for a little while. So I think we're in kind of a static kind of comfortable place, where things have plateaued a bit. We're hopeful that activity picks up, which we're seeing. So a pretty good environment for new investing.

[John Hecht, analyst]

Okay. And then second question is, I know your interest covered ratio has actually been pretty steady given the rate environment. And obviously, your credit performance has been good. There's been only a couple of reports in the BDC sector thus far, but we have seen some have an increase in the nonperforming asset accumulation. Just throwing all that together, I'm wondering what your kind of industry outlook is for credit quality, understanding that you guys are differentiated in that regard.

[Robert DeVeer, executive]

Yes. I mean I think big picture, John, it's been our expectation, we've said this in the past that we're likely to see defaults in the industry just increased this year. It does take a little bit of time for that to manifest itself, right? So in the bottom quartile of our portfolio and probably everybody else is, you have some companies that are making interest payments but continue to live off revolver availability, cash, et cetera, but the liquidity is getting tighter and tighter.

So my expectation is that the fall will go up this year, probably more towards the historical norm. We've had a little bit of amendment activity that's elevated, I think others probably have 2, but nothing that's causing us a whole lot of concern. I think it's just a regular letting out as, obviously, rates are higher and companies have higher debt service costs and all that. But generally, I think we'll see that as well others.

[Operator]

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

[Finian O'Shea, analyst]

Would also like to, first and foremost, congratulate Penny and Scott. Kipps sticking with the market there, first question is, how would you describe the risk of a liquid market come back, bringing a major refi wave but without the corresponding pickup in new money volume?

[Robert DeVeer, executive]

Yes. I mean I think we're actually starting to see that, and thanks for your comments, Finian, I think we're starting to see that some of the existing issuers that probably took on some higher cost debt are pursuing repricings in the large-cap market that's going to carry over a little bit into our market. So it will bring a little bit of pressure. But frankly, nothing that we can't handle from an earnings perspective and it's just how strategically do we think about staying in some of these credits versus potentially opting to exit.

But, yes, that pressure is there real time right now here in February of '24, and we'll just keep evaluating. And I'm hopeful as CLO spreads tighten and more I think capital comes into that market and there -- again, to our prepared comments is a desire for more new deal activity on the GP side, on the private equity side and on the company side, we're just hopeful that regular way new issuance will come with time and perhaps make that a little bit less of a pressure. But it's there right now for sure. We're experiencing it, but it's nothing that we can't handle so.

[Finian O'Shea, analyst]

Okay, sure. And as a follow-up on deployment. You've obviously provided a lot on this threat in this call, but bringing it all together, fourth quarter commitments were a little lower, roughly in line with last year. We would have thought last year, fourth quarter would have been the very bottom. So if you could unpack like a bit why things were at least somewhat better, the sort of main reasons there? And that's all for me.

[Robert DeVeer, executive]

Do you mean -- so yes, so the fourth quarter, just to your comment, if you need to follow on, let me know -- just make sure I get the gist of it. But yes, I mean, the fourth quarter, I think, was a lot of pent-up demand to get some transaction activity closed by year-end. We did -- looking back at last year, start the year very slow and then obviously accelerated into year-end.

In terms of deployment, we're expecting a more active '24. I mean '21 was a peak year. '22 was probably more normalized. Last year was a little bit slower. And I think this year, again, because a lot of GPs feel that their activity levels have been low and a lot of LPs are looking for capital back. And I do think there's plenty of available financing to get deals done, we think '24 will be a pretty good deployment year and should be busier. I hope that answered the question.

[Kort Schnabel, executive]

This is Kort Schnabel. The only other thing to add is the fourth quarter last year in 2022 was not actually a particularly slow quarter. We had some large transactions that came our way, as a result of all the dislocation going on in the broader capital markets. And so it actually was a fairly healthy quarter back then. So I think the comparison and looking at that as being a slower quarter probably isn't quite right.

[Operator]

Our next question comes from Melissa Wedel with JPMorgan.

[Melissa Wedel, analyst]

Once again, to Penn Scott, congratulations to both of you. Wanted to follow up on your comments, Kipp about higher activity in 2024, should we think about that as being sort of skewed towards the back half of the year? Of course, there's normal seasonality, but more skewed towards the back half of the year with potential rate declines? Or do you just expect higher level kind of throughout the year?

[Robert DeVeer, executive]

I mean it's hard to predict, Melissa. Thanks for your question. I think I'd say 2 things. If rates do, in fact, start to decline middle into the back of the year, that should obviously compel some increased transaction activity. I think the counterbalance to that, speaking personally is I actually think is the presidential election starts to creep into the equation, things will slow down a bit. But somebody else pointed out, there's some tax changes that are currently in the system that are meant to roll off.

One of our friends and competitors had referenced that the roll-off of those tax changes could actually compel people to pursue transactions this year versus next year. But look, I mean, as we sit here today, we're pretty busy. Activity levels are good. They're definitely better than they were at this time last year. Hard to predict how it falls quarter-to-quarter, but I think it should just be a busier year and reasonably balanced about that. I don't think there's going to be a particularly big quarter relative to another. We just see a more regular level of activity reoccurring, and we're happy about that. That's great for the business.

[Melissa Wedel, analyst]

All right. Understood. Just as a follow-up to you. Looking at Slide 18, addressing the backlog and pipeline. I noticed that there's a particular weighting towards Insurance Services in the backlog and pipeline. And I was just hoping you guys could provide a little context about the opportunity that you're seeing in that particular industry?

[Robert DeVeer, executive]

Yes. I mean, whenever we snap a quarter like that, it's hard. I mean, there's no -- that's 1 or 2 big particular deals, obviously, in that sector. It's an active area of new investing for a lot of private equity firms. We have a significant portfolio in that market or in that industry rather. So I think it's just reflective probably of 1 or 2 big deals that happen to pull into the same quarter, but nothing other than that to take away.

[Operator]

Our next question comes from Ryan Lynch with KBW.

[Ryan Lynch, analyst]

I'd like to also congratulate Penny and Scott for the new roles and transition. My first question has to do with -- you mentioned the broadly syndicated loan market and some of the liquid markets, maybe just getting a little more footing here recently. I know you've talked about in the past, building up a lot of relationship with a lot of -- lower the reason they're choosing your products and your relationship with the Ares versus those liquid markets. And I'm just curious, do you have any sense of -- just maybe a ballpark of what percentage of your portfolio borrowers are of the size where they could access the broadly syndicated all market or liquid markets, but choose to cargo with Ares because if the broadly syndicated loan market comes back very strongly, I would just assume that, that could potentially be a potential higher risk of refinancing.

[Robert DeVeer, executive]

Yes. I mean I was just hit mute as Scott, nothing off the top of my head, Ryan. It's a good question. I mean, look, I think when as you know, the markets are a little bit more volatile. Direct lending will capture a larger share of those big transactions that just feel difficult again, in a volatile market. I think the syndicated market, if you look just at the segmentation of the portfolio is probably focused on $300 million, $400 million of EBITDA and above, right? And that number has grown over time. And as I made the point in the prepared remarks, we do feel that if you look over a 10-year period, direct lending has continued to kind of show its value proposition to the larger companies.

So I'll see if we can dig around in the numbers a little bit and come up with an estimation. But I guess probably 10% -- just guessing, 10% or 20% of our deal flow is probably stuff that came to us as a result of the syndicated markets just sort of not working for a while. But let me -- let me go front a few numbers with Scott and the team, and we'll see if we can come up with something a little bit better than that.

[Ryan Lynch, analyst]

Sure. I appreciate that. I understand. I mean that'd be at your fingertips. The other question I had was you just kind of talked about from a high level, probably some credit deterioration across the space, maybe in your portfolio, but maybe just to cross the space broadly. I think we were all a little bit surprised about how strong the economy was in 2023. Is your prediction or estimation that credit is going to probably get to your rate in 2024, is that based on more of a slowing of the economy? Is that based on base rates just being elevated at the levels where they are now and that sort of finally having an impact on borrowers? Or is that based on some sort of just maybe credit normalization or a combination of all that, I'd just love to just impact what gives you kind of the thought behind kind of saying that you expect credit...

[Robert DeVeer, executive]

It's probably the second one. I mean I share your comment that I actually think that the economy is proving to be more resilient than perhaps higher, a lot of other people expected. We all remarked a little bit that we're -- we report this EBITDA growth number on a quarterly basis, and we actually saw the first increase, right, on an LTM metric in a bunch of quarters, right, with EBITDA growth around 9% versus 6% the prior quarter. So the company performance is good. But I think to your question, it's probably #2, which is just -- it takes a little bit of time.

And when you look at the underperformers, dealing with higher debt service costs because rates, as I said earlier, we think are likely to remain higher for longer. It just continues to deplete cash flow and create issues for companies that probably hope they'd be delevering, but aren't. So you really just look to the watch list and the nonaccruals in our company and probably others. And say they're hanging on for now, but it's probably just a matter of time before there needs to be a fix there, and that's likely to create some more issues in defaults just as time moves along, right? And as things kind of mature a little bit. in response to higher rates for a bit longer.

But again, I don't think it's anything that we can't handle, right? I don't think it's particularly severe. We have a very significant, as you guys know, portfolio management and risk management team and infrastructure to handle some of the underperformance. So look, we go through a more traditional credit cycle where defaults inch up, and we have to resolve some more situations and then you start over and you continue to grow from a new base. I actually think that's a pretty constructive backdrop for credit and for this company.

[Kort Schnabel, executive]

Maybe just one other comment on the liquid syndicated market point because it's certainly getting a lot of attention is we obviously knew the liquid syndicated market was going to come back, and we've been providing alternative solutions against that market for 20 years. And the value proposition of private credit only become stronger anytime we go through these periods of dislocation. So we kind of -- we actually almost welcome back the syndicated market a little bit because it will increased transaction volume, heal the markets. And as Kip mentioned in the prepared remarks, boost our structuring fees. So I think it's just a continuation of what we've seen throughout our history, but with further proof of our value proposition.

[Operator]

Our next question comes from Robert Dodd with Raymond James.

[Robert Dodd, analyst]

I want to pile on and say congratulations to Scott also say thank you to Penny for all the work she's done over the years, helping building Ares but also the space as a whole. On coming back to kind of the liquidity question because when I look at the numbers, I mean, PIK collections were the lowest we've seen in many quarters, interest receivable was high. You've mentioned that some of the borrowers across the industry are living more on the revolver. I mean, is that -- certainly seems to be an inclination for borrowers to hang on to as much cash as they can for as long as they can. Is -- do you think that could really accelerate, if rates remain high for longer? I mean, is this the beginning of a problem if rates don't -- a big problem? I mean, obviously, there's deterioration. But how does that tie in with how bad could it be if, say, rates are still 4.5% by the end of the year?

[Robert DeVeer, executive]

Yes. Thanks, Robert. I mean I'll try to maybe reinforce some of the comments that I made, but we're not seeing an increase lately, last couple of quarters in revolver draws, right? So again, it would coach me to say, look at the underperformers, where we're expecting to have to work things a little bit. But all in all, we think that the interest coverage levels have sort of bottomed 1.6%, 1.7%. We don't think rates are obviously going up from here. And we think most of the companies in the portfolio, when you think about nonaccruals and percentage of the portfolio, marked 1 and 2, which are kind of the underperformers, really hasn't gone up the last couple of quarters, and we're well below 10%.

So I think we know where the potential credit issues are in the portfolio and 90-plus percent of the portfolio is performing quite well and having no real issue with higher rates for longer, right? The PIK interest is actually lower on a year-over-year basis. And again, we're into these companies with very, very low loan to values. So it's just thinking again about the 1s and 2s, the underperformers and how we achieve resolutions there. But all in all, the portfolio is performing quite well. And I think the economy, I think it was Ryan's question is better than we might have expected at this point after a pretty dramatic tightening cycle. So we're feeling...

[Robert Dodd, analyst]

Understood. I mean, to your point, I mean, the draws on your delayed draw in your revolver comment has actually declined this quarter versus last quarter. So I mean, that raises a hypothetical, if you will. If a semi-strugging portfolio company would come to you and ask for a liquidity revolver. What scale of concessions would you be looking for, at this point from the company or the sponsor? I mean, would it just be a no or would it be something you would consider given the environment with appropriate levels of maybe Godzilla like concessions?

[Robert DeVeer, executive]

Yes. I mean it's hard to generalize in that every name is obviously different. In most of the situations where companies are perhaps not achieving the performance they were hoping for and have liquidity concerns. We're looking to the owners of companies to provide liquidity. And as I mentioned in the past, we're happy to be part of the solution, where we can take a portion of our cash interest and perhaps convert to PIK for a short period of time. But more often than not, it really is on the owners of these companies to deliver solutions for us as the lender. So I hope that answers the question, but the same as it's always been.

[Operator]

Our next question comes from Mark Hughes with Truist.

[Mark Hughes, analyst]

Congratulations, Scott and Penny. Look like you have to -- there's more first lien activity in the fourth quarter and in January so far. Is that just what the better opportunities were? Or is there some intentionality there?

[Robert DeVeer, executive]

I think as the market is recovering to do new transactions markets, just -- it's keep it simple, right? So probably the down the middle of the Fairway transaction has been particularly in private equity, regardless of size, let's just structure a single unitranche with partners that we know I think capital structures have been less levered and less complicated perhaps than in the past. Purchase prices are coming down, which is great and simple unitranche loans have probably just carried the day, over the last couple of quarters.

[Mark Hughes, analyst]

Understood. Then the exits were pretty low in the fourth quarter, a little more balanced, I guess, in January. But anything there and noteworthy?

[Robert DeVeer, executive]

No, not really. I mean, I think again, with lower activity on the new deal side, you'd expect lower repayments and lower exits. So my guess is as transaction activity picks up in '24, you'll see a more normalized rate of exits as well, but nothing particularly remarkable there.

[Operator]

Our next question comes from Eric Zwick with Hovde Group.

[Erik Zwick, analyst]

Good morning. First, I just want to echo everyone else's congratulations to Penny and Scott. And then in terms of kind of my questions, I wanted to follow up on a commentary Kip, I believe you gave to one of the earlier questions about your expectation for the portfolio yield to remain relatively stable. Just looking at the activity through the first month of the year in the Press Release, it looks like the weighted average yield on debt and income for new fundings was 11.3%. And then for exits during that same period, 12.6%. So a little bit of compression there. And I know 1 quarter -- or sorry, 1 month certainly doesn't make a trend, but just curious if you could talk to -- kind of the any factors in that first month that contrite that compression there? And kind of what gives you kind of confidence again that the portfolio you can stay relatively stable at this point?

[Robert DeVeer, executive]

Yes. I mean, look, I think the natural trend is likely to be lower and less defaults pick up substantially, right? So I think the the expectation is that base rates are likely to go down this year. So we'll see a little bit of pressure there. And if the economy remains resilient and defaults, even if they creep up modestly, don't spike, which is my expectation. I think you'll see sort of a stable spread environment, with perhaps a little bit of pressure as transaction activity picks up.

So I do think that the general trend is likely to see the all-in yield on new investments come down, from the prior year or 2, where they've been elevated, very attractive. We've obviously taken advantage of that. But I'll just remind everybody, I mean, it doesn't -- it doesn't have a particular impact, I think, on us having earned $0.60-plus of core earnings against a $0.48 dividend this quarter. We've sort of built in as it relates to the dividend an assumption that over time, yields are likely to come down, and we've got plenty of earnings capacity to continue to support the current dividend, in fact, support the dividend plus at NAV over the next couple of quarters?

[Erik Zwick, analyst]

I appreciate the commentary there. And I think the last part of your answer there is the most important that dividend coverage still remains very strong. You've been with -- if we come down from historically high rates. And just secondly...

[Robert DeVeer, executive]

We have a lot of room. And obviously, we're using the current environment to obviously pay the dividend but continue to build NAV too, which is a luxury at this point in the cycle?

[Erik Zwick, analyst]

Right, true. And just my second question in terms of the floors, I think the majority of new floating rate commitments and fundings have floors. I'm just curious if you've had any -- given the fact that we're kind of in this higher for longer, rate environment. How many success having those floors move up relative to, say, maybe a year or so ago?

[Robert DeVeer, executive]

Yes, we've tried it hasn't really worked, sort of annoying to be honest, but now the market convention kind of remains that 1% LIBOR floor, which doesn't make a lot of sense to me, but it is what it is.

[Operator]

Our next question comes from Casey Alexander with Compass Point.

[Casey Alexander, analyst]

I was going to ask if you -- it was your expectation that first quarter originations might be seasonally slow, but you already answered that you expect it to be somewhat balanced to the higher rate across the year. So let me shift to, while we were in this period of slower originations, you were able to just in time fill your capital needs through the ATM program. If you see a higher level of activity being generated across the year this year? Would it be shareholders' reasonable expectation that you would pepper in some syndicated offerings to go along with the ATM program?

[Robert DeVeer, executive]

I assume you mean on the equity side. I mean not necessarily. I mean, the ATM program has been, I think, efficient source for us to continue to kind of grow the equity base and with that grow on the asset side. And the leverage levels at the end of Q4 were probably, in my mind, on the lower side of where we might like them. So we've got a lot of debt capacity to continue to support new investing.

So I don't see any particular reason sitting here today to think about an issuance outside of the ATM program. I'm also a little surprised, frankly, that the stock hasn't performed a little bit better than it has relative to the growth in book value over the course of '23. So doing an issuance at this price to me isn't something that's particularly attractive. So nothing in the hopper there, I think.

[Casey Alexander, analyst]

All right. Well, certainly agreed on your second point there. My follow-up, I'm going to tip one over here to Penny, and thank you for your years of work with Ares. If your thought process is that we're in the higher for longer camp. I mean is your most recent unsecured offering was $1 billion that you then chose to swap out and float out at a couple of points higher than the stated coupon on that deal or in that range anyway. If you're in the hire for longer camp, why swap it out, I mean the spread is still pretty attractive and rates would have to move pretty materially for it to balance out to the coupon on that over the course of the next 5 years.

[Penni Roll, executive]

Yes. Thanks for the question. This is something that -- this is our second issuance that we've swapped recently. We are still in a higher rate environment for fixed rate debt issuances. If you think about our portfolio, we have about 70% of our portfolio being in floating rate. So there is a benefit to kind of match funding the interest rate and looking at that opportunity to have that more aligned with the rate on the portfolio being floating.

So over a longer period -- this 5-year window, if you look at where we swapped it to, which is roughly S200. That's well in line or below what we could get new secured financing at today. So we think that it is a good cost of capital. Yes, it does kind of make it a little more expensive on the front end, but if you believe the curve and you look at that on a relative basis to where we can get secured debt, it's a good variable rate floating pricing for us and gives us that matching as we go through the 5-year window. We look at this on a case-by-case basis. We may not always swap out. But in this case, we felt like given the benefits of where the swap price at the time that we did it, it made sense.

[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.

[Robert DeVeer, executive]

Thanks for everybody joining the call, really happy with the quarter. Again, just to finish off another congratulations to Scott, on his new appointment. And again, many thanks to Penny for all the contributions for partnership, her friendship over the years, and we're thrilled that she'll still be obviously with us day-to-day at Ares. But thanks for everybody attending and we'll catch you 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 1 hour after the end of the call through March 6 at 5:00 p.m. Eastern Time to domestic callers by dialing 1-800-753- 6121 and to international callers by 1-402-220-2676. An archived replay will be available on the webcast located on the homepage of the Investor Resources section of Ares Capital website. Thank you, and have a great day.