ARCC - NASDAQ

Thank you. Let me start with some important reminders. Comments during the course of this conference call and webcast and accompanying documents contain forward-looking statements and are subject to risks and uncertainties. The company's actual results could differ materially from those expressed in such forward-looking statements for any reason, including those listed in its SEC filings. Ares Capital Corporation assumes no obligation to update any such forward-looking statements. Please also note that past performance or market information is not a guarantee of future results. During this conference call, the company may discuss certain non-GAAP measures as defined by SEC Regulation G, such as core earnings per share or core EPS. The company believes that core EPS provides useful information to investors regarding financial performance because it's one method the company uses to measure its financial condition and results of operation. A reconciliation of GAAP net income per share of the most directly comparable GAAP financial measure to core EPS can be found in the accompanying slide presentation for this call. In addition, a reconciliation of these measures may also be found in our earnings release filed this morning with the SEC on Form 8-K. Certain information discussed in this conference call and the accompanying slide presentation, including information related to portfolio companies, which derive 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, 2024, earnings presentation can also be found on the company's website at www.arescapitalcorp.com by clicking on the third quarter 2024 earnings presentation link on the homepage of the Investor Resources section of the website. 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 Mr. Kipp DeVeer, Ares Capital Corporation's Chief Executive Officer. Kipp?

Thanks a lot, John. Hello, everyone, and thanks for joining our earnings call today. I'm here with our Co-President, Kort Schnabel, and our newly appointed Co-President, Jim Miller; Jana Markowitz, our Chief Operating Officer; Scott Lem, our Chief Financial Officer; and other members of the management team will also be available during our Q&A session. Before discussing our third quarter results, I want to recognize the leadership changes that we announced this morning. As I mentioned, Jim Miller will now join Kort Schnabel as a Co-President of ARCC. And by way of background, Jim joined Ares in 2006 and currently serves as a co-head of our U.S. direct lending strategy and as a member of our Investment Advisors Investment Committee. Jim has been one of the key contributors to the success of ARCC and the Ares Direct Lending platform and we look forward to having him play an even more prominent role in this company's direction in the years ahead. As part of this change, Mitch Goldstein is stepping down as Ares Capital's Co-President, but he is joining Ares Capital's Board where he and Michael Smith will serve as Co-Chairman, which will also continue to lead Ares' Global Credit Group as a co-head. And as part of this transition, Michael Arougheti will relinquish his role as Chairman but remain a Director of the company. This transition demonstrates the depth and tenure of our team and the continued evolution of our company and its success over a long period of time. With that, let me now turn to the third quarter results. This morning, we reported another quarter of strong core earnings of $0.58 per share and another quarter of record NAV per share of $19.77. As we've discussed in the past, we believe we are well positioned to what we expect will be a more active deal environment in the future, driven by expanding M&A and sponsor activity as private equity managers are benefiting from lower rates while at the same time, feeling growing pressure to return capital to their investors. In the third quarter, we saw a further increase in overall M&A volume with an acceleration in sponsor-backed transactions in particular. Against this backdrop, direct lenders have continued to finance a high percentage of new leverage buyouts, specifically representing about half of the loan volume supporting buyouts in the third quarter. We believe that Ares is well positioned to take advantage of this environment given our deep and long-standing sponsor relationships and our focus on strategic transactions in defensive industries with strong secular trends. Due to our strong competitive position and a more active investing environment, we saw meaningful year-over-year growth in both transactions reviewed and new commitments during the third quarter. Specifically, we reviewed nearly 30% more transactions compared to the same period last year, resulting in an estimated $155 billion in quarterly deal volume reviewed. For context, this amount exceeded the completed transaction volume reported for the entire broadly syndicated leveraged loan market for the quarter. Our long-held approach of sourcing as many transactions as possible is a key factor in remaining highly selective, which we believe ultimately results in strong long-term portfolio performance. Our ability to grow with our existing portfolio of companies that we know well is another key factor in our high level of selectivity, further reducing underwriting risk and driving stronger credit performance. This advantage supported our loan growth in the third quarter as over 75% of our new commitments were to incumbent borrowers. We believe the growing trend of existing portfolio companies consolidating their financing relationships with us is an encouraging trend. We also added 23 new companies to the portfolio, bringing our highly diverse portfolio to over 530 companies. Ares Capital's strong credit profile can be seen in the health and performance of our portfolio companies. Our nonaccrual rates declined quarter-over-quarter and remain at levels well below industry averages and the fair value of our risk-rated 1 and 2 loans also declined from the second quarter. Further underscoring the consistent health of our borrowers, the LTM EBITDA growth of our portfolio companies remained in the low double digits for the third consecutive quarter. And finally, as Scott will discuss in more detail, the right-hand side of our balance sheet continues to support our investing activities and remains a competitive advantage. You've seen that we were recently upgraded by Moody's to a higher investment-grade notch which we believe further solidifies Ares Capital as the highest rated company in our sector by all 3 major rating agencies. With moderate leverage just over 1x debt to equity and well over $5 billion in available liquidity, incorporating post-quarter end financing activities, we believe we have significant financial flexibility and leading access to efficient forms of capital. With that, let me turn the call over to Scott to provide more details on our financial results and some further thoughts on the balance sheet.

Thanks, Kipp. Let me walk through our income statement before discussing our balance sheet and the actions we took during the quarter to enhance our capital position. This morning, we reported GAAP net income per share of $0.52 for the third quarter of 2024 compared to $0.52 in the prior quarter and $0.89 in the third quarter of 2023. We also reported core earnings per share of $0.58 for the third quarter of 2024 compared to $0.61 in the prior quarter and $0.59 in the third quarter of 2023. Overall, our total investment income increased compared to the prior quarter, largely due to higher interest and dividend income from net portfolio growth, offset by lower restructuring fees as the majority of the new commitments during the quarter were with existing portfolio companies. In terms of our expenses, the increase in our interest and credit facility fees was consistent with our higher leverage during the quarter to fund a portion of our portfolio growth. Our total portfolio at fair value at the end of the quarter was $25.9 billion, up from $25 billion at the end of the second quarter. The weighted average yield on our debt and other income-producing securities at amortized costs was 11.7% at September 30, which was down from 12.2% at June 30 and 12.4% for the same period a year ago. Our total weighted average yield on total investments at amortized cost was 10.7% which compares to 11.1% a quarter ago and 11.2% from a year ago. The declines in our yields were largely due to reduced base rates and, to a lesser extent, spread on new investments. Our stockholders' equity ended the quarter at $12.8 billion or $19.77 per share, another record high for us, as Kipp noted earlier in the call. Before discussing our capitalization and liquidity, let me start by highlighting the notable accomplishment Kipp mentioned related to our credit ratings. At the end of September, Moody's upgraded the long-term issuer and senior unsecured rating for Ares Capital to Baa2 from Baa3. In addition to being rated investment grade by all 3 of the major rating agencies, we now have 2 of our 3 ratings firmly mid-BBB. We believe this should lead to even more efficient funding costs and potentially increase debt capacity over time. These ratings further distinguish Ares Capital, not only within the BDC sector but also among a select universe of firmly BBB or higher-rated public companies in the U.S. Within the BDC sector, we are the only BDC that has both the highest credit ratings from all 3 major agencies and positive outlooks from S&P and Fitch. In terms of our recent debt capital activity, we amended our revolving funding facility, which included extending the end of the reinvestment period and the maturity to a full 3 and 5 years, respectively, and upside in the facility from $1.78 billion to $2.15 billion. We also announced that we priced our second on-balance sheet CLO for ARCC, which we expect will close next month subject to customary closing conditions. This closing will bring an additional $544 million of low-cost secured debt capital priced at SOFR plus 158 basis points. We're happy to continue both diversifying and lowering the weighted average cost of our debt capital and believe CLO financing can continue to be a nice addition to our debt capital going forward. Lastly, as we discussed on our last earnings call, earlier in the third quarter, we amended our SB funding facility, where we extended the reinvestment period and maturity each by more than 1 year. upsized the facility from $865 million to $1.3 billion and reduced the drawn spread by 40 basis points. In total, pro forma of all these transactions since June 30, we have added over $1.3 billion of new debt capacity and reduced the weighted average spread of our committed floating rate debt capital. Our overall liquidity position remains strong with nearly $5.8 billion of total available liquidity, including available cash on a pro forma basis for the post quarter end activity that I just highlighted. We also ended the quarter with a debt-to-equity ratio net of available cash of 1.03x. We believe our significant amount of dry powder positions us well to continue supporting our portfolio company commitments and new investing activities. Moving on to the dividend. We declared a fourth quarter of 2024 dividend of $0.48 per share. ARCC has been paying stable or increasing regular quarterly dividends for over 61 consecutive quarters. This dividend is payable on December 30, 2024, to stockholders of record on December 13, and is consistent with our third quarter 2024 dividend. In terms of our taxable income spillover, we finalized our 2023 tax returns and are happy to report that we ended 2023 with approximately $631 million or $1.04 per share available for distribution to stockholders in 2024. In addition to our third quarter core earnings being well in excess of our current dividend, the spillover level is more than 2x our current regular quarterly dividend, which we believe is a significant differentiator for us in the BDC sector and helps provide further visibility and stability to our dividend in a potentially declining rate environment. I will now turn the call over to Kort to walk through our investment activities.

Thanks, Scott. I'm now going to spend a few minutes providing more details on our investment activity, our portfolio performance and our positioning for the third quarter. I will then conclude with an update on our post-quarter-end activity and backlog. In the third quarter, our team originated approximately $3.9 billion of new investment commitments across 74 different transactions. Excluding the $670 million of loans we originated and distributed as agents, our new investment commitments more than doubled year-over-year, reflecting the strength of our platform and a more active overall M&A market. Our level of originations also reflects our growing market share with our existing borrowers, as Kipp discussed previously. Evidencing this trend, our share of the overall financings for our top 10 largest incumbent commitments in the quarter more than doubled. Shifting to our portfolio. We ended the third quarter with a $25.9 billion portfolio at fair value, which grew 4% from the prior quarter and 18% from the prior year. In addition to our expanding market share with incumbent borrowers, our growth is supported by our ability to provide flexible capital solutions to a wide variety of new companies seeking a direct lending solution. This can be seen in the total number of companies in our portfolio, which reached 535 in the third quarter and increased 9% year-over-year. Further underscoring our focus on covering the broader middle market, the median EBITDA of the borrowers in our portfolio was $82 million in the third quarter, with approximately 1/3 having less than $50 million of EBITDA. As Kipp mentioned, our portfolio companies remain healthy, and credit performance remains strong. Our weighted average portfolio grade of 3.1 remained unchanged from the prior quarter's level. Our nonaccruals at cost ended the quarter at 1.3%, representing another 20 basis points decline from the prior quarter and is within 50 basis points at our lowest level in the last decade. Our current nonaccrual level remains well below our 2.8% historical average since the great financial crisis and the BDC historical average of 3.8% over the same time period. Our nonaccrual rate at fair value also decreased to 0.6% from 0.7% last quarter, which continues to be well below historical levels for us as well. Further underpinning the strength of our portfolio, at the end of the third quarter, the weighted average loan-to-value in the portfolio was 43%, which we believe provides us with strong downside protection for our loans. This loan-to-value is also significantly below our 10-year average. When looking at performance by company size, it is noteworthy that company size continues to not be a driver of performance as companies in all size bands in our portfolio had similar EBITDA growth rates over the last 12 months. In our view, our underwriting and portfolio management processes and our ability to select what we believe are the best companies in attractive industries drives these results. It is also noteworthy that to further our advantages and to support our broad middle market coverage, Ares Management acquired Riverside Credit Solutions during the third quarter. Riverside is a well-established, lower middle market-focused firm managed by a team that we have known for a long time with a very strong investing track record. We believe this team is additive to Ares' direct lending platform's coverage in this important part of the market. As we discussed in detail at our Investor Day in June, we believe Ares is the only direct lending platform at scale that actively focuses across the lower, middle and upper middle markets. This differentiated coverage approach supports our ability to focus on market segments that offer better risk-adjusted returns while remaining highly selective. Across our markets, we have seen credit dispersion start to emerge with certain other managers experiencing growing and elevated levels of nonaccruals. We continue to believe the merits of our many competitive advantages are driving differentiated results as diversification and industry selection have contributed to ARCC's strong credit performance in comparison with other BDCs. Through our time-tested underwriting processes and collaborative culture, our highly selective approach to investing and focus on incumbent borrowers as a differentiated opportunity for growth, we have been able to avoid many of the problems that have driven recent nonaccruals in the BDC space. Another point of differentiation for ARCC versus other BDCs is our high level of portfolio diversification. By maintaining small individual company position sizes of less than 0.2% of the portfolio on average, ARCC has been able to mitigate the impact of negative credit events in any one company or industry. Finally, let me highlight our active start to the fourth quarter. From October 1 to October 24, 2024, we made new investment commitments totaling $408 million of which $320 million were funded. We exited or were repaid on nearly $1.2 billion of investment commitments, which resulted in us earning $4 million of net realized gains. As of October 24, our backlog stood at roughly $2.8 billion, more than triple the level 1 year ago. 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.

Thanks so much, Kort. So let me just take an opportunity to share a few thoughts on our past and our future. As many of you know, we're celebrating the company's 20th anniversary this month. Over the course of our 20-year history, my partners and I have seen the growth of direct lending evolve from a small handful of BDCs competing with banks for their lower middle market loans to a proven industry with real institutional backing and recognition. During this time, we've continued to refine our processes, grow our team and leverage some new thinking. However, we've remained consistent in our approach, our investment philosophy and our focus on the team and our culture, which underpin everything that we do. Our third quarter earnings and credit results build upon our 20-year track record of successfully managing the company throughout a wide variety of economic and market cycles. Over the past 2 decades, Ares Capital has made nearly 4,000 investments with a cumulative net realized loss rate of 0% and at an asset level realized gross IRR of approximately 13%. And over the same time period, our shareholders have been rewarded having enjoyed an average annual total return of roughly 13%, which represents outperformance of over 225 basis points per year for the S&P 500 Index. Needless to say, we're very proud of this performance. Looking forward, we believe Ares Capital and its competitive advantages remain strong. With the declaration of the fourth quarter dividend, ARCC's regular quarterly dividend has been stable, we're growing now for more than 15 years, and we remain confident in our ability to maintain this dividend level in the foreseeable future even in the face of lower expected interest rates. Furthermore, should market interest rates decline, we believe the value of our attractive dividend yield that is well covered by core earnings and supported by a strong level of spillover income will become even more valued by equity investors. As we look to the future, we believe the company remains very well positioned to address what we see as a growing market opportunity. And the management team and the Board remain committed in continuing to build upon what we believe is a successful long-term track record. As always, we appreciate you joining the call today. We look forward to speaking with you next quarter. And with that operator, we'd like to open the line for questions.

[Operator Instructions] We'll take our first question from John Hecht with Jefferies.

Congratulations on the 20th anniversary, very cool. You've been talking -- well, I guess the whole market has been talking about this potential for when rates stabilize, if not drop and maybe people get a little bit more confident about the economy that there's this massive wave of private equity that needs to be somewhat churned. You've had a couple of good quarters of investment activity, and it sounds like the pipeline is good. I mean, are we now entering that phase of the market? And does that mean are you guys kind of bracing for a really active '25 at this point? Or is it too early to make that call?

I mean, I think -- I appreciate the comment, John. The last 2 quarters have been good. And I mean, the simple answer is yes, we remain pretty busy. I mean, I think getting the election behind us will help and then we'll obviously be getting into year-end, but I expect a busy year next year for sure.

Okay. And then just a quick question on Riverside and maybe give us a sense of what's their kind of origination, I guess, trend. And this sounds like it's lower middle market will -- so will that kind of take even to a slightly different asset class than you guys have been focused on in the last few years?

Yes. It’s Kort. I can jump in on that. I wouldn’t say it’s a slightly different asset class. I think the takeaway is Riverside is a very active lower middle market lender. It’s not a large team. It’s a 9-person team. We’ve known them for a really long time. And we have immediately integrated them into our team and our process, and they’re going to help us energize and double down on our commitment to cover the lower middle market even as we scale. And I think we’re excited to have them on board. They’re going to bring deals to our investment committee just like any of our other 200 investment professionals. And it should be a good thing for our broader market coverage.

Yes. I mean, all I'd say is something that I can add on to what Kort said, which is really the meat of the bone or the meat on the bone. Look, I mean, we've been at this 20 years, and the key is that you continue in our experience to build the best origination team you possibly can, which leads to the best outcomes. So we've been adding people in a whole host of different segments and industries and all of that for 20 years. Riverside is just another example of that, right? It's, as Kort mentioned, a lower middle market team that can add to what we're doing, and it remains our commitment to keep adding things that we think bring value to the company and the shareholders.

And Fin, as you know, we’ve talked a lot about our ability to cover all different parts of the market. And I think, again, this is just a reiteration of our commitment to that lower than the market. I think it might be natural for us as we scale to potentially take our eye off the ball or focus a little less on that part of the market. And I think we want to make sure that we are intentionally not doing that both with our existing team as well as adding resources here through the acquisition of Riverside. So hopefully, that helps.

We'll take our next question from Melissa Wedel with JPMorgan.

Congrats to everyone with a new or expanded role with the company. I was hoping to follow up on the comments about growing share with existing clients and as they sort of consolidate relationships. I assume that, that involves a good amount of refi activity that happened within the portfolio? Is that the case in the third quarter? And do have sort of a view on what that could look like going forward?

I mean, not really necessarily unless I think the point is we've got a very, very diverse set of clients, right? I mean, the company today literally has representation with 200-plus sponsors, and that doesn't even take into account industry groups and nonsponsored deals and all of that stuff. But look, the key is that we keep doing more with the folks that we want to do more with. And I think that the large players with big teams have been able to continue to capture more and more share with the most relevant clients. It's not just us, it's others. But the focus is there. It's not needing to be heavier on refi activity in our minds.

Yes. And in fact, I would say it's not a lot of refi activity. It's a lot of add-on capital activity into our existing portfolio companies to support growth in M&A. And the fact of the matter is we are providing more of that add-on capital than our other club members in those facilities, which is what's contributing to our market share gain. So it's definitely more of that and less refinancing.

Okay. I appreciate that context. Just as a follow-up, was there anything we should be thinking about in terms of sort of the timing of originations during the third quarter? I think they generally tend to be a little bit back-end loaded. Was there anything exacerbated in 3Q? Or is it pretty normal?

I think it was a pretty good quarter. I mean, comes and goes, unpredictable from quarter-to-quarter. But I don’t think there’s anything other than just circumstance and randomness.

We'll take our next question from Casey Alexander with Compass Point.

Happy anniversary. I noticed that your second lien exposure over the last 3 years have been cut by more than half from -- and so I'm wondering, have we been watching sort of a defined internal strategy on the run? Or is this more -- have to do more with the way that structure has changed across the private credit industry?

Yes. I mean, look, I can jump in on that. I think what you're seeing is a little bit more of a change in the market that's happening now. I'm not sure it's -- and we go through a lot of cycles. And what we're seeing now is a lot of unitranche transactions, and that's taking market share from the second lien market. And so I would not say that it's an intentional shift on our part. It's more us looking for good relative value in all market environments and investing into the opportunities that are in front of us. Obviously, we like the returns we're getting on the first lien asset class and leverage levels are still lower than the average, returns are higher. So we think it's a good place to be putting dollars, but we'll see how the market develops from here.

Okay. But then let me follow up on that question, okay? 53% of your portfolio is first lien. Kind of how does that balance between pure first lien versus unitranche? And when you do a unitranche, which is going into that first lien bucket, what type of yield premium are you generally getting on that relative to a pure first lien?

I mean, it’s a little bit in the eye of the beholder, right? We’ve talked about what a unitranche is versus the first lien term loan. That’s kind of a hard question to answer, to be honest, Casey.

We'll take our next question from Robert Dodd with Raymond James.

Congratulations to everybody on their new roles. A couple of questions mainly about your spreads and yields. I mean, I think, Scott in the prepared remarks said a dominant part of the decline in the weighted average yield this quarter was base rates. I mean, have you seen -- I mean, the 3-month LIBOR at the beginning of the quarter weren't that different from the beginning of the previous quarter, but it's not always that reset. Have you seen a shift in elections to -- or should we expect to see a shift in elections towards a shorter-term like 1 month if rates start falling versus 3 months or when the reset dates are happening or anything like that? Because it seems like normal course, new month resets at the beginning of the quarter shouldn't have had that much impact this quarter. For fourth quarter, yes. But could you give us any color around that?

Yes. So I think the comment about the decline in the yields were really -- those yields we disclosed are at the end of the period. So the effects of that really have not flown through until really the following quarter. In terms of the resets, I mean, it will vary depending on the borrower. So usually, it's at a month end but we haven't really seen a shift yet in terms of the terms of the contracts from 3 to 1 just given the rates just recently moved.

I was just going to say just to hit it really hard on the head and put some math around it. I mean, we -- so there's been a 70 basis point decline in 3 months, so from Q2 to Q3. We've seen about 10 basis points of that flow through the numbers actually in Q3 due to the lag effect that occurs. So there will be a lag as these -- the base rate declines and we did not see much of that yet in this quarter. I think it's probably just important to highlight in our Q., we put out disclosure so that people can do the math. Every 100 basis point reduction in -- for results in a $0.03 quarterly reduction for us. So I think the good news is people can see there's a lot of cushion relative to our dividend, which was very purposeful and intentional because we knew that eventually, rates were going to decline. And we've operated through lots of different rate environments over our history and feel good about the ability to continue to do so.

Got it. And then kind of a follow-up on -- it looks this quarter like new onboarded not refinanced, not repriced, but new portfolio companies onboarded for first lien spreads looked like they were sub-500. And I mean, you've talked about spread compression before. That seems like -- I mean, that's the lowest I can find in a decade. I mean, is there something unique about this quarter? Or is that spread compression not just there, but getting worse? Can you give us any thoughts on that?

Yes. I mean, I think -- look, spreads we've said -- I think we said this last earnings call have come in at least 100 basis points this year, right, from the beginning of this year towards the finish as we come up upon it. There are plenty of large cap unitranches getting done with force, but middle market deals or not. So I'd just say that the range is generally kind of -- it's kind of a 450 to 550 market depending on quality of credit, size of company, et cetera, which when you consider the base rate plus the spread in the fees is still getting you to a pretty attractive gross unlevered return on the asset, in our opinion. So when -- I said this in an answer earlier, when the economy demonstrates strength and the portfolio is in good shape, people, Ares included, feel comfortable seeing returns go down modestly. So we expect that and I don't think it's -- I don't see it continuing, I think.

Well, that’s an important point, which is I think that they have actually stabilized. We did see spreads stabilize this past quarter relative to the prior quarters where there was consistent decline. So I think that’s an important point. And then Kipp’s point around looking at the absolute return, again, relative to our historical experience, we’re still getting 10% on senior debt at leverage levels that are well below historical averages. So I think on an absolute basis, we’re still feeling pretty good.

We'll take our next question from Doug Harter with UBS. Moving on, we'll take our next question from Kenneth Lee with RBC Capital Markets.

Just in terms of the portfolio there, it looks like average interest coverage ratios ticked up to 1.8x. Just wondering, do you still expect a pickup in terms of credit losses across the industry? Or are things just getting much better, especially with the potential rate outlook there?

I was forecasting, frankly, the things would get worse than they've gotten. I mean, I see it currently is stable, right? You have very low nonaccruals as a percentage of the portfolio, both on a fair value and cost basis. When we look at sort of the watch list names, 1s and 2s, again, the count has been pretty consistent. So at this point, for me, it's a little bit difficult to predict. I guess, we'll see what the economy does, and we'll see what the trajectory of rate decreases likely are. But I see it as a pretty stable picture. I don't see an increase in defaults. I don't see things also materially getting much better than this. They're pretty good from a credit quality perspective today when you look against the historical numbers.

Got you. And then just in terms of just a little bit of housekeeping. Any color around amendment activity you've seen in the quarter? And as well, any kind of revolver facility drawdowns that you want to highlight?

I’ll just say, amendment activity has been very stable, if not even a little bit lighter than normal. And then on the revolver draw point, revolver drawings – revolver draws at our portfolio companies have actually gone down this quarter versus prior quarter. So liquidity and our borrowers feels healthy.

We'll take our next question from Mark Hughes with Truist.

Exits in the fourth quarter, there was a chunk that went over to Ivy Hill, but it looked like the net activity was still negative. How do you see that playing out for the full quarter?

Yes. I think you're just talking about the post quarter end activity. It's 24 days. I think it's not -- yes. I wouldn't read too much into that. As you mentioned, $450 million of the exits were sales to Ivy Hill. Obviously, like you pointed out, still a net negative number, but the backlog we disclosed being in the mid-$2 billion level, we feel good about the level of activity out there.

Understood. And then the improvement in interest coverage, was that largely the lower portfolio yield? Or is there some improvement in the EBITDA? I think EBITDA was down a little bit sequentially, but that's -- could be misleading.

We saw EBITDA growth in the portfolio and slightly lower rates for portfolio companies.

Yes, the growth rate of EBITDA was down sequentially from 12% to 10%, but still 10% growth, which will help with the interest coverage math as well as the modest rate declines.

And then I did want to ask, Jim Miller, any plan to improve the 20-year process that's been put in place?

It's really difficult to come in after 20 years and improve something that's been run this well. That is...

You've been here for, what, 18 of the 20?

Yes, the first 2 years, I was not here, so they can take full credit on it. But no, I’m very excited to be part of the team, close to working with ARCC, but it’s – this is a great business with a great team. So nothing exciting from my end.

[Operator Instructions] We'll take our next question from Paul Johnson with KBW.

Congrats on 20 years as well as the upgrade. On the spread compressions that you've kind of seen this year, has that also impacted structuring fees at all for new deals? Or is it just maybe a little too early to tell just given we're still kind of waiting on M&A recovery?

I mean, I think you have to take it all together and say borrowers are looking at the all-in cost of financing fees, the base rate and obviously, spreads. A little bit of pressure on fees, too, the same way we've seen some pressure on spreads. We'll see where it goes from here. I don't think we have anything to take away quite yet.

Appreciate that. And then on just one line, emergency communications, saw that was removed from nonaccrual from last quarter. Is there anything you can say, I guess, on the resolution there? Is that still in the portfolio? Or has that been exited fully at this point?

It's been fully exited from the portfolio.

And last question just broader -- I mean, in terms of inflation, I guess, what do you see kind of from your broader observation of the portfolio? I mean, if we kind of last the worst points of inflation at this point has been -- sort of remain persistent. I mean, it seems to be a story that doesn't completely go away. Just kind of wondering just with the higher inflation outlook due to the potential outcome of the election.

We think it’s moderated a lot. I mean, if you follow us from quarter-to-quarter, it has been a theme that we actually had talked about and something that was very evident in our portfolio as far back as probably the third, fourth quarter of ‘21 as we sort of emerged from that difficult period with the pandemic, it continued and it was quite persistent. But I would say this year, even in the last year, it’s moderated quite a lot to levels that feel much more normalized on a go-forward basis.

We'll take our next question from Derek Hewett with Bank of America Merrill Lynch.

Reiterate the congratulations on the successful 20 years. My question has to do with PIK. So it's been stable at about 15% of revenue the past few quarters. So the first part of my question is, do you think PIK has peaked at these levels? And more importantly than that, what percentage of PIK was just temporarily built into the original deal to kind of give the borrower some additional flexibility versus kind of PIK related to any sort of borrower liquidity issues?

Yes. And I'll -- thanks, Derek. I think you know this, but for others who may not think about it quite the same way. We do a fair amount of junior capital investing at this company, and we think we do it quite well. And a portion of that is particularly in a higher interest rate environment, being able to structure deals that have PIK components. That's why we win business in a lot of these circumstances. And we're doing them in what we think are really high-quality companies that simply are needing to adjust to the higher rate environment and having less cash on hand. So the answer to your question is most of the PIK income is by choice, as I describe it, not as a concession for a portfolio company underperformance. It's very different from obviously where we were in 2000 where most of it was coming as a concession to companies that weren't open and weren't generating cash. But I think a lot -- in the BDC world is made of PIK and we spend a lot of time looking at the numbers. The number that I look at is just what percentage of your total interest and dividend income is PIK, right? And the number that I'm looking at for this quarter for the company is down pretty substantially from 2020, 2021 and 2022. So it just doesn't give me a significant amount of concern today because, again, most of this is by choice and part of our investment philosophy, and I think has been one of the reasons we've been able to generate such significant ROEs in, frankly, this company relative to some of the competition.

And we actually did disclose at our Investor Day, and it still holds true today, 90% of our PIK income was structured at the time of the investment versus only 10%, which is amendment oriented PIK.

Okay. And then my follow-up question is, are there any, like, for lack of a better term, like credit blind spots that investors need to kind of pay attention to within the sector, just given the surprisingly strong trends that we continue to see within the middle market?

Yes. I think personally, I think the one that everyone always misses is a lack of diversification. It’s not something that we get enough credit for at this company with 500-plus portfolios. We’re not exposed to a single name. And you’ve seen over time that we’ve had some credit problems, losses, whatever it may be, but over a 20-year history, investing in 4,000 companies. Diversification is actually a pretty big deal. And what you'll see, we get asked questions about, oh, what that’s – what happened to this portfolio of company. At the end of the day, most of the time, it doesn’t matter. And companies be able to generate really, really consistent results over a long period of time, which is why we really don’t comment very often on single name risks because we don’t believe the company actually has any.

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

Nothing as usual other than thanks for attending the call, and we will catch you next quarter. Have a great day.