Ares Capital - Q1 2024

Transcript

Operator (participant)

Good morning. Welcome to Ares Capital Corporation's first quarter, March 31st, 2024 earnings conference call. At this time, all participants are in listen-only mode. As a reminder, this conference is being recorded on Wednesday, May 1st, 2024. I'll now turn the call over to Mr. John Stilmar, Partner of Ares Public Markets Investor Relations.

John Stilmar (Partner)

Thank you. Let me start with some important reminders. Comments made during the course of this conference call and webcast, and the accompanying documents contain forward-looking statements and are subject to risks and uncertainties. The company's actual results could differ materially from those expressed in such forward-looking statements for any reason, including those listed in its SEC filing. 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. The company believes that core EPS provides useful information to investors regarding financial performance because it's one method the company uses to measure its financial condition and results of operations.

A reconciliation of 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, 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 on this conference call and the accompanying slide presentation, including information related to portfolio companies, was derived from third-party sources and has not been independently verified, and accordingly, the company makes no representation or warranty with respect to this information. The company's first quarter ended March 31st, 2024. Earnings presentation can be found on the company's website at www.arescapitalcorp.com by clicking on First Quarter 2024 Earnings Presentation link on the homepage of the Investor Resources section. Ares Capital Corporation's earnings release and Form 10-Q are also available on the company's website.

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

Kipp deVeer (CEO)

Thanks, John. Hello, everyone, and thanks for joining our earnings call today. I'm here with our Co-Presidents, Mitch Goldstein and Kort Schnabel, our Chief Operating Officer, Jana Markowicz, our Chief Financial Officer, Scott Lem, and other members of the management team. I'd like to start by welcoming Scott to his first earnings call with me in his new role as Chief Financial Officer. Scott's been with us for quite a while as a key business leader within our finance and accounting team. He's been at Ares for more than 20 years, so having him join us as our newly appointed CFO is great. We look forward to his continued contributions to Ares Capital. Scott and his promotion is just another example of our culture continuing to promote our strongest players and shows the depth of the talent that exists at Ares.

We still believe this differentiates us from other companies in the market. Now we'll move on to our results. This morning, we reported another quarter of strong core earnings of $0.59 per share. Our core earnings per share increased 3.5% from the prior year and were well above our $0.48 per share first quarter regular dividend. These results were driven by continued strong, attractive investment environment and the beneficial impact of higher base rates and attractive credit spreads. The strength of our earnings and the positive valuation momentum in our portfolio has also supported solid growth in our net asset value per share after paying a healthy level of regular dividends. Our NAV, which increased 6% year-over-year, reached another record of $19.53 per share.

In the first quarter of 2024, while merger and acquisition activity levels remain relatively low, our share in the business continues to remain very strong. The banks are more active again, and this is generally good for all market participants, as the increased availability of capital typically brings out more M&A and adds confidence to companies seeking financing for transactions. The firming of the credit markets, the aging of significant amounts of private equity dry powder, and the continued pressures from LPs to return capital are all factors that support higher levels of activity. We're seeing signs of a pickup in transaction activity, as evidenced by the $1.2 billion of commitments we've closed in the second quarter to date. While current market conditions are more competitive, this is not a new phenomenon for us. We've navigated many competitive markets over the past two decades.

2021 was the most recent that was similar. In these environments, we believe that our expansive direct origination capabilities that span the entirety of the middle market from the low, middle, and upper segments become even more valuable. Having a very large portfolio also helps to drive new investment activity. We continue to find attractive investments with compelling returns at historically lower levels of relative risk. Specifically for our originations in the first quarter, the weighted average LTV was below 40%. All-in yields were nearly 11%, and leverage is nearly a half a turn below our weighted average over the past two years. Furthermore, the originated yield per unit of leverage, which we view as one measure of the risk-adjusted return in the current rate environment, was 10% above the recent two-year average.

Our credit fundamentals across our portfolio are also indicating health and strength. Our portfolio companies showed organic EBITDA growth over the last 12 months of 10%, which is remarkable in today's economic environment. Interest coverage levels remained stable to slightly improved, and leverage levels ticked down. The annual EBITDA growth of our portfolio companies is more than double the annual growth of the companies in the S&P 500, which we sourced from data provided by S&P. On a final point, and as Scott will discuss further, the current market environment does enable us to raise capital more efficiently. So far this year, we've been active as an issuer in the unsecured notes market and the secured bank and CLO markets. We've issued in all these markets in what we believe are the tightest pricing levels amongst the BDCs.

With that, let me turn the call over to Scott to provide more details on our financial results and some further thoughts on our balance sheet.

Scott Lem (CFO)

Thanks, Kipp. I'm excited for the opportunity to serve as Ares Capital's CFO. This morning, we reported GAAP net income per share of $0.76 for the first quarter of 2024, compared to $0.72 in the prior quarter and $0.52 in the first quarter of 2023. As Kipp stated, we also reported core earnings per share of $0.59 for the first quarter of 2024, compared to $0.63 in the prior quarter and $0.57 in the first quarter of 2023. Our investment income in the quarter was primarily driven by the continued benefits of higher base rates and structuring fees due to an improving investing environment. Our structuring fees decreased from the fourth quarter of 2023, given the usual seasonality in our business. They increased meaningfully from the first quarter of last year.

Our stockholders' equity ended the quarter at $11.9 billion, or $19.52 per share, a new record high for us, which is a 1.5% increase per share over the prior quarter and nearly a 6% increase per share from a year ago. Our total portfolio at fair value at the end of the quarter was $23.1 billion, up from $22.9 billion at the end of the fourth quarter, largely driven by net unrealized gains in portfolio for the quarter. The weighted average yield on our debt and other income-producing securities at amortized costs was 12.4% at March 31st, 2024, which was down slightly from 12.5% at December 31, 2023, but higher than the 12% at March 31, 2023.

In terms of our capitalization and liquidity, we have had a fairly active start to the year, making sure we are able to continue supporting our investment opportunities. So far this year, we have amended, extended, or raised over $7 billion of financing for ARCC. More specifically, in the first quarter, we issued $1 billion of unsecured notes at market-leading spreads and successfully settled our maturing $400 million of convertible notes in almost all newly issued shares, allowing us to retain the capital and further bolster our permanent equity capital base. In March, we also extended each of the revolving period and maturity date for our SMBC funding facility by three years. Post-quarter end, we renewed our largest revolving credit facility for another year, pushing it to a full five-year maturity with the same pricing and terms.

We also lowered the pricing on our BNP funding facility to SOFR +250 basis points. Finally, just last week, we priced our first on-balance sheet CLO in nearly 18 years. The blended pricing through the AA tranche on the $476 million in notes was SOFR +186 basis points, which we believe is one of the tightest executions amongst issuers in this part of the market. Closing is expected in the next few weeks, subject to customary closing conditions. This transaction allows us to further diversify our sources of committed debt financing at pricing levels currently below other forms of secured funding available in the market. Our overall liquidity position remains strong, with approximately $6.3 billion of total available liquidity, including available cash and pro forma for all the post-quarter end transactions previously mentioned.

We also ended the first quarter with a debt-to-equity ratio net of available cash of 0.95x, as compared to 1.02x a quarter ago, and our lowest net leverage ratio since the end of 2019. We believe our significant amount of dry powder positions us well to continue supporting our portfolio company commitments, remain active in the current investing environment, and eliminate any refinancing risk with respect to this year's remaining term debt maturities. Moving on to the dividend. We declared a second quarter 2024 dividend of $0.48 per share. This dividend is payable on June 28th, 2024, to stockholders of record on June 14th, 2024, and is consistent with our first quarter of 2024 dividend.

In terms of our taxable income spillover, we currently estimate that we ended 2023 with approximately $635 million or $1.05 per share for distribution to stockholders in 2024. This estimated spillover level is more than 2x our current regular quarterly dividend, which we believe helps bring stability to our dividend. I will now turn the call over to Mitch to walk through our investment activities.

Mitchell Goldstein (Co-President)

Thanks, Scott. I'm going to spend a few minutes providing more details on our investment activity, our portfolio performance, and our positioning for the first quarter. I will then conclude with an update on our post-quarter end activity, backlog, and pipeline. In the first quarter, our team originated approximately $3.6 billion of new investment commitments across 61 transactions. We continue to find compelling investments with attractive risk-adjusted returns, despite some more competitive market conditions. We are generating double-digit yields with a weighted average LTV on our senior loan commitments at levels below 5x debt-to-EBITDA. Excluding the $1.6 billion of loans on transactions we originated and distributed as agent, our commitments nearly tripled from the first quarter of 2023.

The breadth of our sourcing capabilities allow us to find value in companies with EBITDA from less than $15 million to over $600 million. Our extensive market coverage of companies of all sizes across the market enables us to source transactions in segments where we are seeing less competition or where we believe that we have a strong competitive advantage. Shifting to the portfolio, we ended the first quarter with with a $23.1 billion portfolio at fair value, which grew 1% from the prior quarter and 9% from the prior year. The median EBITDA of our portfolio is $79 million, which reflects our presence in both the core middle market and the upper middle market. The weighted average LTM EBITDA growth of our portfolio of 10% that Kipp mentioned is also broad-based.

Importantly, in our portfolio, the size of a company has not been a driver of performance. Companies in our portfolio with $25 million-$50 million of EBITDA have similar to or even higher growth rates as compared to companies with over $100 million of EBITDA. We believe company and industry selection, as well as our underwriting process, drive these types of positive results. In fact, our view is based on a study done by the Ares Quantitative Research Group, that found that industry selection could account for approximately 500 basis points of difference in total for senior U.S. loan returns over more than a decade of investing. With respect to our credit performance, our weighted average portfolio grade of 3.1 remained unchanged from the prior quarter's level.

Our non-accruals at cost ended the quarter at 1.7%, up slightly from the prior quarter, but lower than the same quarter a year ago. Our current non-accrual levels remains well below our two point nine percent historical average since the Great Financial Crisis, and the KBW BDC average of 3.8% for the same period. Our non-accrual rate at fair value remained consistent with last quarter's at 0.6%, which continues to be well below historical levels for our company. Another indicator of stable credit performance is the fact that our portfolio companies with a risk grade of 1 or 2 declined quarter-over-quarter. And finally, our portfolio quality is also reinforced by the substantial amount of equity invested in our companies, primarily by large and well-established private equity firms.

At the end of the first quarter, the weighted average loan to value in the portfolio was 43%, which we believe gives us strong downside protection in our loans. As the market is starting to see more dispersion in results among managers, we believe our outperformance and credit position, including our significant diversification, differentiates us from our competition. Our strong and growing portfolio is well diversified across 510 different companies that span the market. The number of companies in our portfolio has increased 9% over the past year and 48% over the past five years, and the average hold size is only 0.2% at fair value.

Excluding our investments in Ivy Hill and the SDLP, which we believe are well diversified on their own, no single investment accounts for more than 2% of the portfolio at fair value, and our top 10 largest investments total just 11% of the portfolio at fair value. We believe this degree of diversification further adds to the credit strength of our portfolio as it reduces the impact to the overall portfolio from any single negative credit event at an individual company. And finally, we have had an active start to the second quarter. From April 1st through April 24th, 2024, we made new investment commitments totaling $1.2 billion, of which $1.1 billion were funded. We exited or were repaid on $249 million of investment commitments, which resulted in us earning $1 million of net realized gains.

As of April 24th, our backlog in pipeline stood at roughly $1.3 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.

Kipp deVeer (CEO)

Thanks a lot, Mitch. In conclusion, we believe that the company is well positioned to navigate the opportunities ahead of us.

At Ares Capital, we've navigated a variety of market environments, credit cycles, and interest rate cycles over our 20-year history, with a cumulative average return on equity in the double digits. In our opinion, this is a very good time to be invested in a high-quality company focused on private credit. Our portfolio is performing well, and we believe that the potential returns on our investment remain compelling by historical standards. While we remain mindful of the potential for increased credit risks delivered with a higher for longer rate environment, we are highly diversified in defensively positioned companies, and our companies are demonstrating healthy and differentiated levels of growth. Our balance sheet and liquidity position remain strong, which we believe allows us to take advantage of this compelling new investment environment.

Overall, we are confident that the factors that have driven our historical outperformance remain firmly in place, and as a result, we remain optimistic about our future prospects. As always, we appreciate you joining us today. We look forward to speaking with you next quarter. With that, operator, we can open the line for questions.

Operator (participant)

Thank you. At this time, if you'd like to ask a question, please press star, then one on your touch-tone phone. If you'd like to withdraw your question, please press star, then two. Please note, as a courtesy to those who may wish to ask a question, please limit yourself to one question and a single follow-on. If you have additional questions, you may reenter the queue. The investor relations team will be available to address any further questions at the conclusion of today's call. We'll take our first question today from John Hecht with Jefferies.

John Hecht (Managing Director)

Morning, guys. Thanks for taking my questions.

Kipp deVeer (CEO)

Hey, John.

John Hecht (Managing Director)

Good morning. Thinking about all, you know, a lot of activity in the quarter, both on the deployment and repayment side. I'm wondering, Kipp, can you give us kind of an update on the syndicated and illiquid loan markets and how they're influencing activity with you guys and elsewhere in the market?

Kipp deVeer (CEO)

Sure, John. I mean, I think, it's not a huge driver, frankly, of what we're doing. There's been a lot of press, I'd say, about, you know, the banks returning to the market and, and perhaps some more, you know, risk on way to try to arrange and underwrite and syndicate, you know, more traditional leveraged finance transactions. So that certainly picked up. I think if you look specifically at our activity, I think it was about 70% of our new deals were coming from the existing portfolio, a little bit slower on the kind of new platform side, which was a little bit surprising for us. But, you know, as I mentioned in the prepared remarks, we're pretty optimistic that, you know, a handful of factors remain in play that should compel pretty good transaction activity this year.

John Hecht (Managing Director)

Okay. Then you had, obviously, a lot of, again, deployment and repayment activity, and the capital structuring fees, you know, were as a percentage that were a little lower. Is there anything to read on that side, or is that just a function of the mix of originations?

Kipp deVeer (CEO)

It's more mixed than anything, although I will say we've noticed a little bit of pressure on upfront fees on new deals in the market, simply because there aren't as many of them. You know, so it's one of the levers that a borrower can pull to a certain degree to try to, you know, achieve a more attractive financing, but it's more mixed than anything else.

Kort Schnabel (Co-President)

Yeah, just also to add real quick, the numbers are probably a little bit inflated just because we also, as a role of agent, we did front some deals, so the true origination was probably closer to $2 billion.

Kipp deVeer (CEO)

You sort of have to back that number out.

Kort Schnabel (Co-President)

Yeah, exactly.

John Hecht (Managing Director)

What was that? The true origination was what?

Kort Schnabel (Co-President)

About $2 billion, because about $1.5 billion was us, as our role of agent fronting for some deals.

John Hecht (Managing Director)

Got you. Okay.

Kipp deVeer (CEO)

Which happens from time to time. Yeah, it happens from time to time, just depending on what a, you know, syndicate composition looks like, who can fund it closing and can. It's sort of a technical point, but when you evaluate it, just, you know, make sure you look at the math in that light.

John Hecht (Managing Director)

Okay, perfect. Thanks.

Kipp deVeer (CEO)

Thanks, John.

Operator (participant)

Our next question will come from Finian O'Shea with Wells Fargo.

Finian O'Shea (Director)

Hey, everyone. Good morning. Hi, Kipp. Can—

Kipp deVeer (CEO)

Hey.

Finian O'Shea (Director)

Can you talk about the environment for second lien, if the reduced exposure there is more market related or your portfolio positioning? And if that should continue or, if applicable, your ability to replace that with other forms of junior and structured equity. There's a lot of that in the portfolio, but wondering if there are sort of adequate volumes there, if second lien meaningfully recedes. Thanks.

Kipp deVeer (CEO)

Yeah. I'm going to have Kort follow on a couple of thoughts on my side. I would say, look, when last year came around and kind of, you know, the private credit players, us included, really were representing new deals in the market, almost everything that we were doing was getting done as a unitranche, you know, regardless of size. And that, you know, second lien, which has been a larger part of our investing effort, is just, frankly, not as prevalent in the market in terms of the mix of new deals. Does that come back, you know, if some large deals actually get done as first lien in the syndicated market where we can provide junior capital? You know, maybe. I guess, you know, we'll wait and see.

As you know, our second lien investing tends to emphasize much, much larger companies and is very often in line with the syndicated first lien. And that transaction just really hasn't been prevalent in the market, I'd say, for the last, call it, three, six, nine months, and we'll see where we go from here. The only other thing I'd add, and I'll take it to Kort if he wants to add on, is we are seeing a lot of really good companies, to your point about junior capital investing and structured equity and all of that, that are performing well but simply don't have the amount of cash flow that they expected.

So you see some senior lenders that are probably saying, "Well, with higher rates, I'm not really deleveraging the way I was hoping to." And frankly, on the other side, the equity is looking for an extension of duration to accomplish what they want to achieve from an IRR perspective. So there is, we think, a pretty interesting opportunistic credit pipeline and funnel to do some of these deleveraging, you know, junior capital deals. But hopefully that answers the question, Kort. If you have anything to add?

Kort Schnabel (Co-President)

No, I—

Kipp deVeer (CEO)

Yeah.

Kort Schnabel (Co-President)

Kipp, I think you covered it all. Obviously, the return opportunities in the first lien market are super attractive, so regardless of the fact that there aren't as many second lien opportunities right now, you know, we're not too bothered by that given the other opportunities that the market's showing us. But certainly, more a function of what the market is giving rather than a purposeful change on our part.

Finian O'Shea (Director)

Awesome. Thanks. I guess small follow-up, maybe sort of related. We noticed the Special Opportunities or ASOF group was moved over to credit, presumably under your domain, Kipp. Is that—is there any anticipated change there? Like, maybe if you can go over your historical collaboration or co-investment with that unit, and how might that change going forward? Thanks.

Kipp deVeer (CEO)

Yeah, I mean, it plays into the comment that I made about opportunistic credit, and I guess all I'd say is there's been a lot of collaboration over the years. And frankly, because that business was changing, I'd say, a little bit in this opportunity to look more credit-facing and less like it should be attached to our private equity efforts, it was just a pretty simple move for us that we made, kind of around year-end that became formal here at the end of the first quarter.

Finian O'Shea (Director)

Thanks so much.

Kipp deVeer (CEO)

Thanks, Fin.

Operator (participant)

Our next question will come from Melissa Wedel with JPMorgan.

Melissa Wedel (VP of U.S. Equities Research)

Good morning. Appreciate you taking my question. Noticed that dividend income was substantially higher quarter-over-quarter. As we think about the dividend income stream going forward, should we think about that as being, aligned with the direction and change in interest rates, and really consider that as much of a floating rate piece of the portfolio?

Kipp deVeer (CEO)

Yeah, I think, Melissa, thanks for your question. So it's two things, right? So Ivy Hill obviously represents, you know, the lion's share of that dividend income. But I'd say for this quarter, it's higher because we actually took on a kind of one-time dividend from one of our equity investments, so that's probably why you see it tick up. I don't think there's a big change there away from maybe that one-time event, but we obviously benefit from having a diversified equity portfolio that can deliver, you know, dividends from time to time.

Melissa Wedel (VP of U.S. Equities Research)

Okay. And then I was hoping to follow up on one of the things that Scott touched on. Scott, hi, and welcome. I look forward to working with you. The CLO issuance post-quarter end. I think you mentioned it's been a while since you've done something like that. I was hoping you could talk about CLO issuance as part of the funding strategy and next going forward. What role can that play? When will you collect that versus other secured or unsecured? Thank you.

Kort Schnabel (Co-President)

Yeah, sure. So I think, you know, it's like one of our main themes for capital raising is diversity, and I think that, you know, it was a pretty compelling opportunity for us. The spreads in that market are very attractive relative to other forms of secured financing. So, I think as we're seeing also just as assets have moved from the BSL side to the private credit, the flow of the debt capital in the CLO market is also moving that way. So, it made a lot of sense for us to tap that market to diversify funding sources at a pretty attractive spread. And, you know, going forward, I think it's definitely part of our playbook now.

Operator (participant)

Our next question will come from Casey Alexander with Compass Point.

Casey Alexander (Managing Director)

Yeah. Hi, good morning, and thank you for taking my question. Scott did not mention—traditionally, you guys mention what the spillover income is, but he didn't mention that. I was wondering what that number is, unless I missed it, which could be. But, you know, you continue to pile up the spillover income quarter-over-quarter. At what point in time do you sort of reach the limit, or do you just consider it to be a cheap form of financing with the excise tax? But when do you sort of reach the limit, at which point in time you'd kind of be forced to make some special distributions?

Kipp deVeer (CEO)

Yeah, I mean, you know, look, over the history of the company, Casey, I appreciate the question. We've obviously done specials in a whole host of different ways. And I said this in the past, we tend to really want to look at it on an annual basis because it's a tax calculation that we can really true up at the end of the year, and that's typically when we make determinations. But we're in a little bit of a tricky position, as you can probably appreciate, because while we have loads of earnings in excess of the regular dividend, the trajectory for rates going forward is reasonably uncertain. I think if you ask around the table, folks would have very different views.

So combining that with the fact that we really aren't in a position, in my opinion anyway, where we want to put the company in a place where it would have to reduce its regular dividend, we just feel better materially outearning it today and building the NAV. So hopefully that answers the question, but it, but it's a little bit tricky in a world where the rate environment changed quickly. We obviously wanted to recognize the much more substantial earnings power of the company when we increased the dividend to the $0.48. But, but yeah, it, it's something we talk about a lot. When's the right time? You know, do we get credit for specials? Do we not? All of that's very much in the dialogue with the management team and our board.

Casey Alexander (Managing Director)

Yep, that's my only question. Thank you.

Kipp deVeer (CEO)

Okay, thanks.

Operator (participant)

Our next question will come from Paul Johnson with KBW.

Paul Johnson (VP)

Hey, good afternoon or good morning. Thanks for taking my questions. You touched on my question in terms of just kind of, you know, pressure on fee income. But you know, is that something that you think you've experienced more on deals that you've refinanced in the market? Or are you also seeing, you know, a little bit of fee compression on new platform deals as well?

Kort Schnabel (Co-President)

Yeah, it's Kort Schnabel here. I would say, you know, it's primarily on existing transactions. New transactions are seeing some fee pressure, but as was mentioned before, the mix shift this quarter, I think we were 72% of our originations were to incumbent borrowers, and that was really, you know, the big driver of the numbers that you're seeing there. There is definitely some pressure across all fronts, but, you know, as is normally the case, existing portfolio companies don't deliver the same kind of fees as new borrowers do.

Paul Johnson (VP)

Appreciate that. And, one last question I had, just kind of higher level, but, I was wondering, you know, kind of get your thoughts on, a feature, a loan feature that, you know, we've heard more about, portability. If that's something that, you've offered in any of your loans, if that's something that you come across. But any kind of thoughts on that feature would be nice to hear. Thanks.

Kort Schnabel (Co-President)

Yeah, we've agreed to do it, you know, a couple of times. You put a lot of guardrails obviously around, you know, when that financing can go forward, i.e., you know, to what counterparty would we be continuing to be involved with? What would be the fees? You know, loan documentation, all sorts of other stuff. I actually think that's more of a feature, frankly, of last year, where the financing environment felt more complicated. So having the value of an incumbent group kind of move over with a new equity check in a sponsor-to-sponsor deal is highly valuable, right, when the financing markets feel uncertain. I wouldn't say that the financing markets feel particularly uncertain today, so my guess is the request for portability asks would go down. But we'll see where we go from here.

Paul Johnson (VP)

Appreciate it. That's helpful. Congrats on a good quarter. Thanks, guys.

Kort Schnabel (Co-President)

Thanks. Appreciate the questions.

Operator (participant)

Our next question will come from Mark Hughes with Truist.

Mark Hughes (Analyst)

Yeah, thank you. Good morning. You'd mentioned earlier in the call that your quantitative group determined that industry selection got you 500 basis points, or could account for 500 basis points of outperformance. How stable is that over time, those industry groups to migrate, or is it pretty, pretty steady?

Mitchell Goldstein (Co-President)

This is Mitch, by the way. Yeah, our group, if you look at how they did the analysis, it was over an extended period of time in our portfolio. And if you have been following us for as long as we've been doing this, our, you know, industry groups that where we tend to invest has been pretty stable. So they were able to get that analytics through our portfolio over a very extended period of time.

Mark Hughes (Analyst)

Is it that the industry groups that you focused on have been reasonably stable and that-

Mitchell Goldstein (Co-President)

Yeah, if you look at our business services, our healthcare services, the industries where we invest really haven't changed a lot. We don't invest in cyclical businesses. We don't invest in low-margin businesses. So they were able to, you know, have a significant amount of data with which to make that analysis out of.

Mark Hughes (Analyst)

Yeah. Okay. Appreciate that. And then the exits seemed low for April. Anything to that, or just happened to be lower?

Mitchell Goldstein (Co-President)

Yeah. I don't think there's anything to it. It's just a single month of data, so I wouldn't take too much away.

Mark Hughes (Analyst)

Very good. Thank you.

Mitchell Goldstein (Co-President)

Thank you.

Operator (participant)

Our next question will come from Erik Zwick with Hovde Group.

Erik Zwick (Director of Equity Research)

Good morning. Wanted to start just maybe a quick follow-up. I think you mentioned earlier, there's some, you know, uncertainty, I think, as we all know, with regard to the future direction of interest rates. And, you know, just looking at slide five, you know, percentage of fixed rate investments in the portfolio is up a little bit year-over-year. Not, not a huge change by any means, but curious if that's reflective at all of either your preference or borrower preference, you know, to maybe do floating versus fixed, given their belief in the direction of interest rates, or maybe that's more kind of natural migration, you know, from quarter-to-quarter?

Kipp deVeer (CEO)

Yeah, I don't think there's anything particularly targeted there. I will say when we do some of our junior capital investing, we try to strike the right balance between floating and fixed rate, and frankly, have a mix of both. But yeah, I think you're right that one borrower today may say, "I want fixed because I think we're higher for longer," and another borrower may say the exact opposite. So, there's nothing particularly intentional there, and different situations just lead to different outcomes. I wouldn't take too much away.

Mitchell Goldstein (Co-President)

Nothing, nothing intentional around the small change quarter-to-quarter, but definitely intentional in terms of having some fixed rate exposure in the portfolio, which I think is a differentiator for us versus others, you know, in the market, and just gives us more ballast to operate through all different kinds of environments. Some of that fixed rate, I know Kipp mentioned the junior capital, tying back to his comment about some of the opportunistic situations we're seeing for deleveraging, balance sheets right now, given the higher rates. A lot of those are also fixed-rate opportunities, so, you know, that's probably driving a little bit of that, that tick-up that you're seeing.

Erik Zwick (Director of Equity Research)

Thanks. I appreciate the color there. And just a bit of a follow-up as well on kind of your funding strategy today. You noticed or mentioned how active you've been during the first part of the year on the unsecured debt market. The you know, spreads have been very attractive and tight for you all. So you're up to about I guess 78% of unsecured debt to total debt at this point. And wonder if you could just kind of refresh me on your bigger picture view of you know, over time, what your preferred mix is. And it sounds like you know, as you've noted as well, CLOs have kind of reentered the picture as well. So just curious of your overall kind of bigger picture thoughts there.

Kipp deVeer (CEO)

Yeah, look, I think we're always. You know, our investment grade rating is very important to us and maintaining that, and definitely a big component of that is making sure we're majority unsecured. So, I mean, you know, we're probably a little heavier unsecured at the moment than we would normally, but I think we're happy at the levels we're at now. And, you know, I think, like, you know, doing the CLO and other forms of secured finance are also part of our, like I mentioned, part of our playbook, so we'll continue to probably do everything.

Erik Zwick (Director of Equity Research)

Great. Thanks for taking my question today.

Kipp deVeer (CEO)

Thank you.

Operator (participant)

As a reminder, press star one if you have a question. Our next question will come from Robert Dodd with Raymond James.

Robert Dodd (Director)

Good morning, everybody. Kipp, last quarter, you gave us an update on the tail side of the portfolio; there were some liquidity pressures. Obviously, I mean, non-accruals are still really low. There's only one new one this quarter. If I look at the revolver, the revolver utilization did go up a couple of hundred basis points this quarter, but, but not a lot. So can you give us any more color on what the liquidity pressures are in the tail end of the portfolio? And do you think, if rates do stay higher for longer, into 2025, is there a point at which those liquidity pressures really become problematic?

Kipp deVeer (CEO)

Yeah, thanks for the question, Robert. So I mean, yeah, we, we saw a modest, but I wouldn't say material, uptick in just revolver drawdown. That probably does obviously tell us that there's likely, you know, companies that obviously have less liquidity than they might like. And I mentioned this a bit earlier in the call. It's kind of a unique period, at least in my opinion, having done this a long time, because you have a lot of pretty strong company performance, and even with that strong company performance, you have capital structures that got set up that maybe can't live through, you know, 5% base rates for a long period of time.

That's why you're seeing more equity and more structured equity come in to deleverage a lot of these situations with potential for rates to remain, you know, higher for longer, which frankly, is kind of our baseline expectation around here. We're managing the portfolio and thinking about risk as if we have higher base rates for longer. But again, none of our metrics have really shifted materially, right? Our non-accruals are up a touch, but materially below historical averages. And again, when you look at what we consider to be our underperformers and watch list, the ones and the twos, it's pretty consistent in terms of the percentage of the portfolio.

So all in all, you know, as a big macro overlay to thinking about the portfolio as a whole, we definitely take that into consideration, and that's how we think about managing the assets today, but it's not of particular concern.

Robert Dodd (Director)

Got it. Thank you. And one more. I mean, obviously, PIK, and I don't necessarily have a huge problem with PIK, but PIK collections for the last couple of quarters have been quite low. Obviously, you know, I think cash PIK collection is voluntary by the borrower rather than, you know, at repayment. I mean, is there any trends there? I mean, it's volatile quarter-to-quarter anyway, but, you know, anything you're seeing from borrowers who elect who might have in the past, you know, two years or whatever, paid their PIK in cash and are electing to just hold the cash now instead?

Kipp deVeer (CEO)

I don't think there's any significant trend. I just looked at Scott, and he whispered me the word, it's episodic, which I think is just—

Robert Dodd (Director)

Yeah.

Kipp deVeer (CEO)

You know, comes quarter-to-quarter, and it's, it's not all that easy to predict. I wouldn't take, I wouldn't take any big picture trend away from some of that data.

Mitchell Goldstein (Co-President)

Yeah, Robert, it's Mitch. I, I think you have to look at when M&A picks up, a lot of our preferred, where we like to invest down the balance sheet, where we see real value, is based on exits, right? And it's, and when M&A picks up, you'll see a lot of that preferred come through. When M&A is slow, you'll see that just continue to stay out there, which we're happy to, because the companies are performing.

Robert Dodd (Director)

Got it. Understood. Thank you.

Kipp deVeer (CEO)

Thank you.

Operator (participant)

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

Kipp deVeer (CEO)

I'll just thank everybody for their participation today and, look forward to speaking to you all next quarter.

Operator (participant)

Thank you, ladies and gentlemen. This concludes our conference call for today. If you missed any part of today's call, an archived replay of the call will be available approximately one hour after the end of the call through May 30th at 5 P.M. Eastern Time to domestic callers by dialing 1-800-839-5635, and to international callers by dialing 1-402-220-2561. An archived replay will also be available on a webcast link located on the homepage of the Investor Resources section of Ares Capital's website.