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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning. Welcome to Ares Capital Corporation's Third Quarter Ended September 30, 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded on Wednesday, October 30, 2019.
I will now turn the call over to Mr. John Stilmar of Investor Relations. Please go ahead, sir.
Thank you, Carl. And good morning, everyone. Welcome to Ares Capital Corporation's third Quarter ended September 30, 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded on Wednesday, October 30, 2019.
Let me start with some important reminders. Comments made during the course of this conference call and webcast and accompanying documents contain forward-looking statements and are subject to risks and uncertainties. Many of these forward-looking statements can be identified by the words such as anticipates, believes, expects, intends, will, should, may and similar such expressions. 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 the 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 a useful information for investors regarding financial performance because it is one method the company uses to measure its financial condition and results of operation.
A reconciliation of Core EPS to the net per share increase or decrease in stockholder’s equity resulting from operations. The most directly comparable GAAP financial measure can be found in the accompanying slide presentation for this call. In addition, 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 presentation, including information relating to portfolio of 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 third quarter ended September 30, 2019 earnings presentation can be found on the company's website at www.arescapitalcorp.com by clicking on the Q3, '19 Earnings Presentation link on the homepage of the Investor Resources section. Ares Capital Corporation's earnings release and 10-Q are also available on the company's website.
I will now turn the call over to Ares Capital Corporation's Chief Executive Officer.
Thanks a lot, John. Hello to everyone and thanks for joining the call today. I'm here with our Co-President, Michael Smith & Mitch Goldstein; our Chief Financial Officer, Penni Roll, and several other members of the management team. I’d like to take a few minutes to highlight our third quarter results and to provide some thoughts on the current market conditions. After that, I’ll turn the call over to Penni and to Michael, who will cover our detailed financial results, and discuss recent investment activity and some summary metrics for the portfolio.
This morning, we reported another strong quarter with Q3 core earnings of $0.48 per share, well above our regular and additional dividends declared for the quarter. We also continue to experience stable credit performance with no new non-accruals this quarter.
Finally, we believe we're in a strong liquidity position, ending the third quarter with approximately $3 billion of cash and committed debt capital available to us. Overall, we feel very good about our performance and our balance sheet positioning.
In terms of new investment activity, I would describe the market that we operate in as one that remains competitive but investable. Transaction volumes are running below levels from last year and this has increased pressure on some to put capital to work, leading some aggressive behavior and lower quality underwriting by certain market participants.
We believe that we continue to have the many competitive advantages we've developed at ARCC to differentiate us and that our experience in this market will serve us well.
As we look at the market today, we're beginning to see some changes in the broadly syndicated markets that might lead to more broad-based discipline in the middle market. Moderating CLO formation and continued outflows from retail loan funds are two factors that have led to a slowdown in activity in the broadly syndicated leveraged loan market.
In addition, there is a widening dispersion of credit performance in the broadly syndicated market that should begin to filter into the middle market. And this has made 2019 a more bifurcated credit pickers market, which we see as a positive for us. Since the middle market is typically influenced by the risk reward dynamics of these larger broadly syndicated transactions, we remain hopeful that more friendly terms and opportunities are on the way in the middle market.
Even with this, we continue to execute on our playbook focusing on high-quality companies and using our sourcing and competitive advantages to seek the best investments. Our market leadership position with a 100 plus investment professionals and national coverage footprint and long tenure in the market, generates opportunities for more than 500 active sponsor relationships, as well as with many non-sponsored borrowers.
Additionally, our significant capital base and ability to be a meaningful and stable source of capital, positions us uniquely to support our best borrowers. In the third quarter 47% of our new investment commitments were two existing borrowers, which we continue to view as a differentiated source of deal flow with attractive informational and structural advantages.
And when taken together, these sourcing advantages continue to enable us to be highly selective. Our selectivity ratio for new companies this quarter was 4%, in line with our historical average despite the unusually busy quarter of 2.4 billion in new commitments.
These sourcing advantages coupled with our consistent investment approach and our conservative balance sheet construction has enabled us to deliver strong returns to shareholders through a variety of market conditions. We feel we have a strong plan in place for the current market.
I’d like to turn the call over now to Penni, to provide more detail in terms of a financial review.
Thanks, Kipp. And good morning. As Kipp stated, our core earnings per share were $0.48 for the third quarter of 2019, as compared to $0.49 for the second quarter of 2019 and $0.45 for the third quarter of 2018.
Core earnings were stable versus Q2, 2019, the increase versus Q3, 2018, driven by higher interest and dividend income that primarily resulted from a larger portfolio as compared to Q3 of '18.
In addition to our core earnings for the third quarter of 2019, we reported modest net realized and unrealized losses on investments and other transactions totaling $37 million or approximately 0.3% of the average portfolio for the quarter. Our GAAP earnings per share for the third quarter of 2019 were $0.41, compared to $0.47 for the second quarter of 2019 and $0.49 for the third quarter of 2018.
As of September 30, 2019, our investment portfolio was $13.9 billion at fair value, an increase of 24% from a year ago and 7% from the prior quarter. Also at September 30, the weighted average yield on our debt and other income producing securities at amortized cost declined to 9.8% from 10.4% as of second quarter, and the weighted average yield on total investments at amortized cost was 8.8% compared to 9.2% at June 30. The yields at September 30 reflect decreases in LIBOR, as well as a higher concentration of first lien senior secured loans as compared to the prior quarter.
Moving to the right hand side of the balance sheet, our stockholders' equity at September 30 was $7.4 billion resulting in a net asset value per share of $17.26, which was basically flat with a quarter ago and up 0.6% from December 31, 2018.
As of September 30 2019, our debt to equity ratio, net of available cash was 0.89 times, which increased from our debt to equity ratio, net of available cash of 0.77 times at June 30. We ended the quarter just below the bottom end of our target leverage range of 0.9 to 1.25 times.
As Michael will discuss later, Q3 was unusually busy so we currently don't expect to see similar growth in the fourth quarter. We continue to execute on our strategy of extending and raising additional committed financing to our already diverse capital structure.
Taking advantage of favorable market conditions, we reopened our most recent five-year investment grade unsecured note issuance and raised an additional $250 million on top of the existing $650 million of notes already outstanding. The additional debt was issued at a premium, resulting in a 3.68% effective yield to maturity as compared to the 4.2% coupon on the original issuance in June 2019.
Building on our successes of upsizing and extending our committed bank facilities, in the third quarter we upsized our existing credit facility with SMBC by an incremental $100 million, bringing the aggregate facility size to $500 million. We also extended the facilities reinvestment period to September 2022.
As of September 30, 2019, our total available liquidity, including 142 million in available cash, was approximately $3 billion. With only 600 million of debt maturities between now and the end of 2021, we believe that our balance sheet is in a strong position with significant available capital to invest through a variety of market conditions in the years ahead.
Shifting to our dividends payable, we announced this morning that we declared a regular fourth quarter dividend of $0.40 per share. Also during the fourth quarter, we will pay the previously declared additional dividend of $0.02 per share. This is the last of our four previously declared additional quarterly dividends of $0.02 per share to be paid in 2019.
The fourth quarter, regular dividend will be paid on December 30 to stockholders of record on December 16, and the $0.02 per share additional dividend will be payable on the summer 2017 to stockholders of record on December 16.
Following the filing of our 2018 tax return, we determined that our final taxable income spillover from 2018 going into 2019 was $343 million or $0.80 per share, which provides us with a significant amount of undistributed earnings.
Given the amount of spillover coming into 2019 combined with our year-to-date 2019 core earnings in excess of our dividends paid, we believe we will continue to be in a strong undistributed taxable income position at the end of this year.
Before I turn the call over to Michael, I wanted to remind everyone that the third quarter was the last quarter of our 10-quarter fee waiver that was put into place in conjunction with the American Capital acquisition. As you may recall, our advisor voluntarily waived a total of $100 million of income-based fees over 10 quarters or $10 million per quarter, in order to aid the company's profitability as we transitioned out of the lower and non-yielding American Capital portfolio into higher yielding Ares directly originated investments.
Since we closed on the acquisition in January of 2017, we have exited almost $2 billion of these investments, realizing a meaningful IRR, generated a higher level of overall core earnings and expanded our quarterly dividend from $0.38 per share to $0.40 per share. While during the same time, increasing ARCC's net asset value over $0.80 per share.
In summary, we believe the fee waiver had the intended impact and the American Capital acquisition has been a success for shareholders, while also positioning the company for future success.
I will now turn the call over to Michael, to walk through our investment activities for the quarter.
Thanks, Penni. As Mitch Goldstein and I do each quarter, I'd like to spend a few minutes providing more detail on our third quarter investment and portfolio performance. I will then provide a quick update on post-quarter end activity and our backlog and pipeline.
During the third quarter, our team originated $2.4 billion of new commitments across 50 transactions, with 90% of the commitments in leading and controlling first lien loans. Additionally, nearly two-thirds of these commitments were in various service-related sectors that have performed well for us in past credit cycles.
As Kipp mentioned, although broader M&A volume has cooled, companies continue to seek additional capital for growth initiatives and strategic add-on acquisitions. Our significant portfolio and position of incumbency continues to be a meaningful competitive advantage in sourcing new investments and known high-quality borrowers.
This quarter, 32 of our 50 new commitments came from existing borrowers. Of note, the EBITDA of the companies we financed in the third quarter range from $12 million to $116 million, with a weighted average EBITDA of 50 million. In comparison, the weighted average EBITDA of borrowers in the portfolio was $137 million, which underscores our ability to be relevant to a wide spectrum of upper middle market borrowers. We are focused on finding new borrowers that can hopefully be in the portfolio for years to come, while also backing our best borrowers through additional financings.
In the quarter, we continued to broaden and diversify our portfolio, reaching 352 different borrowers with an average hold position at fair value of only 0.3%. Our largest single borrower, excluding our investments in SDLP and Ivy Hill, is just 2.6% of the portfolio at fair value, underscoring that no single name has a material impact on the future aggregate performance of our company.
We believe our large and diversified portfolio, which is focused on high free cash flow, non-cyclical industries is resilient and positioned to perform well through a wide variety of economic conditions.
As Kipp also mentioned, credit quality continues to be stable. Our portfolio generated weighted average EBITDA growth of 3% over the past 12 months, down slightly from the 4% level in the prior quarter. Our non-accrual rates at amortized cost of 1.5% and 0.2% at fair value remained very well and there were no new portfolio companies added to non-accrual in the quarter.
Before I turn the call back over to Kipp, let me provide a brief update on our post-quarter investment activity. From October 1 to October 24, 2019, we made new investment commitments totaling 316 million and exited or were repaid on $326 million of investment commitments, generating approximately $6 million of net realized gains.
As of October 24, our backlog and pipeline stood at roughly $665 million and $265 million respectively. While these levels are below average, we have seen a recent pickup in our activity and expect the typical year end push, we usually see. Furthermore, should the market experienced similar volatility as we saw in the fourth quarter of last year, we could have a more active quarter than today's backlog and pipeline imply.
Note, our backlog contains investments that are subject to approvals and documentations and may not close, or we may sell a portion of these investments post-closing.
With that, I'll turn it back to Kipp for some closing remarks.
Thanks, Michael. In closing, we had another good quarter, some strong profits and stable credit performance. We continue to execute on the same plan that we've had for 15 years; maintaining a defensively positioned portfolio investing in origination capabilities to see the broadest amount of deal flow from the best companies being highly selective in our approach and maintaining a strong and liquid balance sheet. We believe our continued execution against these goals positions our business for success in the future.
That concludes our prepared remarks. Carl, can you open the line for questions please.
[Operator Instructions] The first question comes from Rick Shane of JPMorgan. Please go ahead.
Hey, guys. Thanks for taking my question this morning. Look, last order WASH was on non-accrual and you guys made a significant additional commitment. I think it was about $107 million, off the top of my head. Just like to discuss what you saw last quarter and sort of what the developments are for the additional financing.
Yes, Rick. Go back and check some of the facts, but we did do an add-on to WASH. It's a long existing portfolio company, it was not on non-accrual last quarter.
Okay. My mistake then, okay. Can you just talk about that because it is one of the big commitments which you guys made this quarter?
Yeah, sure. It's a large leverage buyout. It's been in the portfolio for a while. The company literally installs laundry machines and residential apartment buildings where people do their laundry, so it's a pretty stable business. It's a large company. They have continued to make strategic acquisitions. I think that the private equity firm the owns it views it as a consolidation opportunity. So, it's one of those good companies that's been in our portfolio now for a while that we continue to keep growing.
Got it. Great, thanks and sorry about the confusion on that. I misread the footnote.
Hey, Rick. It's Penni. We actually realized after the fact that we had mislabeled that in the 10-Q last quarter, so we corrected it this quarter. So, I'll take that one.
It's our fault.
You caught me.
I was surprised to hear that one.
Sorry about that.
In those filings, you can't get everything right every quarter so shame on us...
Yeah. Unfortunately, when you have - companies, we try our best but we had a little hiccup. Our apologies for that.
Given what we do for a living, we understand. Thanks, guys.
It's a good company performing well.
Thanks for your question, Rick.
The next question comes from Arren Cyganovich of Citi. Please go ahead.
Thanks. Just kind of touching on your comments around the competitive environment and some actors not doing the best of investing choices, how does this compare, I guess, quarter-to-quarter? Is it worsening, staying about the same? And how does this compare to some of the more frothy times in -- over the past decade or so?
I don't think there is a huge change quarter-to-quarter. I mean, I think what you're seeing is a widening in loan spreads, a little bit of reticence on the part of loan buyers in particular is due to higher risk transactions whether it's single B triple C deals is much tougher to get done right now.
So, I would say that the caution probably in the broadly syndicated markets, where, as you know, Ares is an active player to just not through the BDC is probably a bit more cautious. And we might see from some of the middle market competition that's probably as a result of folks with a fair amount of dry powder wanting to stay busy.
I think one of the things, it's nice for us and we've got a very large credit platform here, and participate in a lot of markets that others may either not participate in or be more limited in. So that market has informed us to be a little bit careful.
I'd say that all the while, while having a big quarter, so I'll answer that question too even though you didn't ask it, Arren, because I'm sure we'll get it. Just that people remember that the pace of the year has been very funny and it continues to be a little bit funny today, right? I mean, the first quarter, as a result of last year's fourth quarter being so volatile, was incredibly slow. And I think we had a reasonably busy -- kind of traditionally busy second quarter.
The third quarter was busier than we usually experience because I think a lot of the things that maybe would have gotten done spilled over to the second quarter and, conversely, the second quarter spilled over into the third quarter.
And as you noticed from Mike's discussion of backlog and pipeline, when we report that number here today as part of our public earnings, it's actually pretty low relative to where we've been historically. That being said, the last couple of weeks have actually been very active.
So, it's just a little bit of a weird year in terms of pacing and we'll see how we finish out the year. We're hopeful that some of the modest dislocations and discipline in the larger markets, as I was trying to get through in some of the prepared remarks, spillover and create a good fourth quarter for us, but will see. It's just the end of October here.
Okay, thanks. Appreciate that. On the SEC [ph] rules, is there any movement or update for the industry, getting some relief from that?
Well, I mean, I think we've continued to tell a pretty positive story about that. We obviously sent, as folks are aware, an amended application to the SEC on September 3. There is no real update between September 3 and today. I think that it's under advisement but up until September 3, it's been great. We're being patient and waiting for a response.
All right, fair enough. Thanks.
Sure. Thanks.
Our next question comes from Ryan Lynch of KBW. Please go ahead.
Hey, good morning. First question is, you guys, this quarter, got into the bottom end of your target leverage range of 0.9 to 1.25. That's obviously a pretty wide range, so I'm just curious of what factors that you all consider that would cause you to operate at the lower end of that range versus the upper end of the range.
And then given those factors, and as we sit here today, do you guys foresee yourself operating more at the lower end or at the upper end or in the middle?
I mean, I think for now we made the point that actually, I think, based on the busier than we expected quarter, we're a little bit higher than we might have expected here at the end of Q3. I think our inclination for now is to operate at kind of the middle -- for below being a bit cautious.
The upper end of that range can drive more earnings but the earnings, that we think of the company, are quite good. So, I think we're balancing thinking about any potential declines and fair value down the line, preserving enough cushion for that.
So, I'd say, generally the middle to below the middle for now but things change. If the investing environment gets really, really exciting, we might change our view on that.
Okay. And then over the last two quarters, dividend income, excluding Ivy Hill, has run in kind of around the $21 million range versus when you look at 2018, that kind of ran at closer -- the $10 million range. I know, Penni, you've mentioned in your prepared remarks that that's just due to the larger portfolio. So, is kind of the lower 20 million a fair assumption for dividend income going forward excluding Ivy Hill?
Yeah. We have a lot of portfolio companies outside of Ivy Hill that pay dividends but a lot of them don't pay consistently, they'll declare them periodically and pay them. But I think it's still a decent run rate. We do have a few kind of preferred stocks that pay a dividend that we accrue in as well based on them declaring, so it's probably a good representative level.
It will ebb and flow and if you look at each quarter, you will see there are timing differences around when those kind of not scheduled dividends come in and get paid.
Okay. I appreciate the time today.
Thanks, Ryan.
The next question comes from John Hecht of Jefferies. Please go ahead.
Thanks, guys for taking my questions and good morning. I guess I'd focus a little bit on rates. Penni, you mentioned part of the yield drift this quarter was tied to higher composition of first lien and then some tied to just the effect of a LIBOR movements. Can you -- is there any way you can quantify how much was attributed to one versus the other?
Yeah. If you look at just overall, I would say roughly 20 BIPS or so was from LIBOR and about 30 BIPS was from just portfolio mix, rough split. And that's on the average -- at the end of the quarter.
And then given the rate environment, do you guys -- and I know you're revolvers are cheaper funding, but there's probably opportunities to fund elsewhere in the market with a lower cost of funding, but how do we think about your ability to optimize cost of funds in this type of rate environment over the next four quarters, say?
I mean, when we look at our balance sheet and how we capitalize it with debt and equity, clearly, we have a little more room to run with higher leverage now under the new leverage construct. But if you look at what we've been focusing on is we want to continue to be a consistent issuer into the investment grade market, which we've done. We have a large balance sheet that needs a lot of debt capital, so we want to keep the appropriate mix between secured and unsecured.
But we have had a strong focus on increasing the capacity on the floating side, which today is 5 billion committed in only about 2 billion funded, and I think that just gives us flexibility to think about how we fund the balance sheet in the context of rates.
Our LIBOR, we are -- the LIBOR floaters on the revolving secured facilities have no floor. So that's beneficial as well as we use more if -- in a declining rate environment. Even though right now, I'd say we wouldn't expect the LIBOR to go below the floor in the near term on the asset side.
So -- but it does give us a lot of flexibility on how we manage the balance sheet, gives us some potential benefit from using more floating rate options that we've been very focused on raising in the last six months.
John, I'll just -- I'll add one thing. This is Kipp. I think the question was right -- how do you optimize cost. I would just say, again and I say this to a lot of folks, we're not focused solely on optimizing cost, right? One thing that's particular to us is we're a very large company relative to others that finance themselves in the space. And we need to, to Penni's point, have a diversity of financing.
But the other thing that we've done that we think is a huge advantage to those companies, we've actually bought duration and that's cost something, right? So, we actually have a great balance sheet, which positions us with an almost [indiscernible] perfect but as close to perfect that we think we can achieve matching of assets and liabilities. And I put as much, particularly at this point in the cycle in that as I do optimizing cost, as being the first and foremost call.
Makes total sense. Thanks. And last question, obviously credits trended very well for you guys. I wonder if you could comment on the performance of the companies within the portfolio and maybe just a brief comment on what industries you might shy away from in the next few quarters, given what you're seeing out there?
Yeah. I mean, I think it continues to slow down a little bit. People probably saw the GDP numbers this morning, which look reasonably good. Our Q3 number, in terms of EBITDA growth, was 3% versus 4% in Q2 versus 6% a year ago, so we're absolutely with a broad portfolio and a whole host of different industries seeing, I think, the same slowing that others would say they're seeing in other companies in portfolios.
When we look at defaults, there have really been a couple of sectors that have driven and led -- even with lower defaults, the default picture that's been retail, it's been oil and gas and certain aspects healthcare.
So, those are places that we've been a little more cautious, I think particularly retail and oil and gas, in the last year or two, but I don't think that's anything new, right? We haven't really skewed the way that we're investing or chased things in one way or avoided things in another way than we have in the past.
Great. Appreciate that, guys. Thanks.
Yeah, thanks for the questions.
The next question comes from Casey Alexander of Compass Point. Please go ahead.
Hi. And I'm sorry if I missed this, but can you go through sort of the broader puts and takes of the realized gains and unrealized -- or the realized losses and the unrealized gains in the quarter?
The realized -- both of them, Casey, or just the realized…
I mean, the total number is a $37 million loss. I just -- trying to figure out how you got there without going through every name in the portfolio quarter-over-quarter...
You're talking about the unrealized...
I think he's saying both.
Well, let me give you the realized because it's in a couple of buckets and then we can go through the unrealized too, but I'm not sure we have everything here to go name by name. We've got a pretty large portfolio. But the realized loss position was basically writing off an unsuccessful investment that we had in a company called Trident Health Services, that was a roughly $96 million loss so pretty substantial.
It was offset by gains in selling it -- American Capital portfolio that we brought in called Soil Safe, which generated a $13 million gain. To the balance there, there's a whole host of puts and takes in portfolio companies. A couple here, a couple of there.
Yeah, and our 10-Q disclosure will list things out more specifically to you just for your reference later.
Okay. That's great. All right. I mean, when you discuss the 47% of your new loans were two existing borrowers. It almost feels like when I look at 2.4 billion in new originations and 1.4 billion in repayments, that I should almost be looking at it like 1.3 billion of new originations and $300 million of repayments because that's sort of what really happened that wasn't just you taking yourself out and replacing it with another piece of paper...
Now, because it's not necessarily -- so, there was the question about WASH earlier, right? The accounting on WASH is at 100 and whatever it is million, repay zero because we're just doing an add-on facility.
Right.
Right? So, if we have an outstanding $200 million loan and we make $100 million add-on, we don't account for it as a $200 million repayment and a $300 million origination. We just account for it as $100 million origination.
Okay, got it. All right, thank you. And I guess lastly, and maybe you don't want to discuss this because it's a portfolio company per se, but we saw another BDC just get waxed today based upon their CLO equity exposure. Can you give us a feel for how that might or might not be impacting Ivy Hill?
Yeah. So look, we -- I don't think we got waxed. We obviously took a modest write-down in Ivy Hill, a $19 million fair -- decrease in fair value. It's really driven by a combination of a couple of things, which would be my guess what was happening in whatever other BDC you're referring to, I haven't seen that, but it's a decrease in LIBOR.
It's a change in the LIBOR curve, it's a widening in market CLO spreads and it's also just some particular nuances at Ivy Hill where we happened to be a little bit under-invested in some of our CLOs, so a little bit heavy on cash, which creates lower rates of income that we'd taken.
So, I don't have the same concern there because we're running what we think are higher quality, materially lower leveraged vehicles. And you'll see in most other maybe BDC portfolios that own a bunch of broadly syndicated CLOs, I think it's pretty different. But look, that market is off. I mean, there is no doubt the CLO market is off and a portion of that is what drove some modest declines in our valuation and Ivy Hill.
Right. And then lastly, the write-off of Trident, is that what has created the decrease in your non-accrual percentage?
Yes.
On a cost basis, yes.
On a cost basis, right. Perfect. Okay, great. Thank you very much. I really appreciate you taking my questions.
Yes.
The next question comes from Finian O'Shea of Wells Fargo Securities. Please go ahead.
Hi, guys, good afternoon. Thanks for having me on. Just a first question higher level. Correct me if I'm wrong, it seems that you shifted a bit toward the more core middle market with an average EBITDA-mentioned of $50 million on, obviously, a great deal of commitments. And this seems to go against what you've done, saying pushing into the larger markets, the softness in those markets. So, I would have expected this quarter a good deal of origination but in the larger markets.
So, any comment on that. And if you've sort of changed view on where is the better area to invest?
No, not really. I mean, we've got a pretty broad fairway in terms of what we like to look at. As Mike laid out, I think it was 12, 200 and whatever that number was 15 million. And Mike, you can jump in too. And my quick thinking around it was more traditional middle market, call it 50 million of EBITDA unitranche [ph] investing this quarter, less of that large cap kind of privately placed second lien, which tends to skew to bigger sizes and larger EBITDA.
And again, it's really hard to -- it's very hard for us to change direction quarter to quarter, right? Sort of deal flows, deal flow and mix, and to dictate itself based on what you find that you like versus what you don't like. So, I wouldn't read too much into that, Fin.
Okay. Thank you. And then just a follow on the SDLP scaled down a little bit this quarter. Can you sort of remind us of the target area that that joint venture traffics in and is that becoming a more difficult origination front for you?
So look, it's one of the products that we offer clients. It's a menu of, obviously, different -- one of the things that is on the menu of different options that they can pursue. I don't think there's any -- I mean, [indiscernible] you can tell me if I'm right. I don't think there is any change in kind of how it's originating its competitive positioning, etc., etc. I don't think there is...
Yeah, we had one big repayment in the quarter and in general, it's kind of that middle market unitranche product that goes into that. And so again, to Kipp's point, it's really depends quarter to quarter what we're finding and liking and what the borrowers desire is to finance the company.
Okay, that's all from me. Thanks for taking my questions.
Thanks.
The next question comes from Chris York of JMP Securities. Please go ahead.
Good morning, guys and thanks for taking my questions. Kipp, or maybe even Michael or Mitch, it seems like lending to middle market software companies has been a source of Ares portfolio growth over the last year.
I'm curious, in these cases are you extending credit as a function of recurring revenue as opposed to free cash flow. And then if so, why do you think the returns in repayment characteristics of staff lending to these rapidly growing companies is attractive to them?
Yeah. Look, so when we look at the sector what we're predominantly doing is trying to lend against subscription-based cash flows. So that's the lion's share of the portfolio and software, it's around 6% of the portfolio cost. [Technical Issues] is telling he thinks it's five…
Four or five.
Four or five. In any case, the general rule is and you've seen a lot of growth both in software lending, I think as you're referencing. And in software, private equity, a lot of firms, ourselves included, have done a lot of work on this space because it's exhibited very high rates of growth and obviously, there has been tremendous amount of private equity coming into the space. But for the most part, we're lending to what we see as companies that have strong recurring revenue streams and subscription revenue over time.
There is another market that I think you're referring to, which is kind of the AAR lending market, which is looking at just recurring revenue and lending against revenue. And typically, those companies are such rapidly growing businesses that they don't have EBITDA because they're putting so much money back into sales and marketing and R&D.
We've done a couple of those deals, I think we've done five. We're one of the less active lenders in that space relative to the competition. But we do both, but primarily the first kind rather than the second kind you're asking about.
Got it. The distinction is clearly helpful and then you anticipated my follow-up question. In getting to the portfolio size, there are some private equity sponsors that are raising growth capital there and newer strategies. So, I'm curious is there -- and it's a bifurcated portfolio, but is there a portfolio max size that you would want to get that for tech lending? And then the other question would be what's the typical LTV of this portfolio?
Yes, sure. So max size on most industries tends to be 20%. Once you get to 20%, we start to think critically about whether there is too much allocation to a particular industry.
The LTVs, I'd say are comparable to low in this space because the purchase prices of these rapidly growing software companies are so high, but that's the debate, right? The leverage multiples are also high.
So, it's not unusual to see lenders lending six times or seven times EBITDA and a company that's getting acquired for 22 times EBITDA. And you can compare that to a regular way LBO where there's six turns of leverage against maybe 12 turns purchase price. So because of a handful of characteristics of these companies, i.e., high growth, very high free cash flow, no CapEx, no working capital, in fact, deferred revenue, right?
So, they often generate cash flow ahead of actual revenue recognition, they're just great, great growing cash flow businesses, which is why they're selling for such high prices. But it does keep loan to value pretty low based on that kind of quick snapshot of the math I gave you.
And I would also add that the software portfolio is well diversified in its end market, and we do a lot of diligence around the end market before we make an investment to make sure we understand the competitive dynamics on that end.
Awesome, the color is helpful. I guess just concluding there. So, if you 4% to 5% of the portfolio 20 is your max size, this could be theoretically, an area of growth. Is that an appropriate conclusion?
It has been an area of growth, yeah. I mean, it's a very active sector, and we've got some great relationships with some of the leading private equity firms out there and we've also been more active going direct to company in that space.
Got it. That's it for me. Thanks, guys.
Thanks.
The next question comes from Robert Dodd of Raymond James. Please go ahead.
Hi, guys. Just on the point in your opening remarks, you have the 47% of the commitments in the third quarter were to existing portfolio companies. I mean, can you give us any color on what the -- I mean, obviously, the basic underwriting is the same when it's a follow-on, but is there an additional dynamic of maybe other competitive lenders who've been raising capital trying to poach your deal, so to speak, and trying to force you out and driving the add-ons? Each additional add-on, obviously, increases your bite size in a particular portfolio company, which reduces diversification a little bit, right?
So, it changes the risk portfolio dynamics. I mean, can you give us any more color on how much appetite you've got for doing those follow-ons and what you'd like to see that be as kind of maybe a percent of the origination mix?
I mean, it's kind of we -- I'd say love financing our best high quality borrowers because we think they have less risk because we obviously know them, and have a relationship there and aren't conducting a new set of due diligence on a new company. We also think that because of we -- we have the existing relationship we're insulated on pricing.
We think that the maximum leverage ask, which is often the way private equity will go in a new transaction is typically not what comes through as leverage is getting added during buy and build strategies, so we think that there are a lot of attractive dynamics as it relates to continuing to finance our existing borrowers.
Hopefully that answers the question a little bit on, are we getting poached. The answer is usually not because it's more likely you bring a new lender into a deal or -- so if we're a sole lender, you bring a partner in if we're starting to get larger on exposure. And the reason for that is if you're a company that has $300 million of debt outstanding, and you've already paid a 3% fee on that $300 million of debt and you're two years into an investment, you're probably unlikely to want to go pay $10 million of new fees to refinance us.
So, you can say 50 basis points, right? Because the alternate proposal is a bit cheaper, plus you'd be working with somebody you didn't know. We also kind of like to think that we established good relationships with our borrowers and they want to stay with us because we're value-added and know the market and all of those things. So, I think it will stay in line with where it's been around 50% and that's some color on why we think it stays that way.
I appreciate that. And then there is no -- And another question sort of related, it's all about originations. There's been some -- obviously, some, to your point in the BSL market, some issues on getting some deals done on the syndication side. In the past, you have occasionally stepped in and done those kind of deals, which obviously can create nice fee income, plus a big bite size all one. So, what's your appetite to maybe approach that?
I mean, your color seems to indicate it's the weaker deals that are struggling, which I think it's always the case to get done. So, I presume that impacts your willingness to look at that area of the market at this point in the cycle.
Yeah. I think you may have answered your own question. I mean, most of the things that are tough that are difficult to get done now are things where borrowers are worried about ratings, right? Either single B or particularly triple C where there is a bit of a buyer strike these days for a whole handful of reasons. We obviously don't require ratings in our transaction.
So, to the extent we find a company that we think is not being evaluated well, potentially, in a rating agency process or a potential rating agency process that would lead to a not so great or poor syndication, it's a great opportunity for us to jump in and provide a private unrated solution.
We hope that improves, right? And we've been doing that at the company for a long period of time. So, in choppier markets those opportunities tend to be more plentiful. That's a little bit of what we're referencing on the -- in the prepared remarks. But obviously, to your point about adverse selection, it's time -- it's definitely time to be to be careful, as I said, be a credit picker and we think we have a lot of experience doing that.
Okay, I appreciate it. Thank you.
Sure, thanks for your question.
[Operator Instructions] The next question comes from Ryan Lynch of KBW. Please go ahead.
Hey, guys. My follow-up question has been asked and answered. Thanks.
Thanks, Ryan.
Okay. Thanks, Ryan.
[Operator Instructions] There are no more -- we have one other one on queue, Mr. David Rothschild - I'm sorry. This concludes our question-and-answer session. I'd like to turn the conference back over to Mr. Kipp DeVeer for any closing remarks.
I don't want to cut off questions, so if there is an additional question, we're happy to take it.
Absolutely, sir. We have a Mr. David Rothschild, a private Investor. Please go ahead, sir.
Thank you for taking my question. I'm not an analyst, I'm not as in-depth as the analysts are. My one concern I had was in your announcement of your more recent yields that they were coming down for the most recent quarter. Will that -- will your expense side on that debt go down so that the net investment income won't change going forward or is that a concern for the dividend?
You definitely have the relationship right, right? So, with decreasing yields will be a little bit of decrease in revenue, but we do, of course with floating rate debt, get the benefit of lower LIBOR on the portion of our debt that's floating rate so that should provide some comfort. And we don't have any concern whatsoever that the investment income is continuing well in excess of the dividend. So, thanks so much for your question...
Okay, thank you.
This concludes our question-and-answer session. I'd like to turn the conference back over to Mr. Kipp DeVeer for any closing remarks.
Nothing in particular. Just to thank everybody for your continued interest in the company and we'll catch-up with you next quarter.
Ladies and gentlemen, this concludes our conference call for today. If you missed any part of today's call, an archived replay of this conference call will be available approximately one hour after the end of the call through November 13, 2019 at 5:00 PM Eastern Time, to domestic callers by dialing 877-344-7529 and to international callers by dialing 1-412-317-0088. For all replays, please reference conference number 10134441. An archived replay will also be available on the webcast link located on the homepage of the Investor Resources section of Ares Capital's website.