ARCC - NASDAQ

Good afternoon, everyone. Welcome to Ares Capital Corporation's Third Quarter Ended September 30, 2025 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded on Tuesday, October 28, 2025. I will now turn the call over to Mr. John Stilmar, a partner on Ares Public Markets Investor Relations team. Please go ahead, sir.

Great. Thank you, and good afternoon, everyone. 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 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 is 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 relating to portfolio companies, was derived from third-party sources and has not been independently verified. And accordingly, the company makes no representation or warranties with respect to this information. The company's third quarter ended September 30, 2025 earnings presentation can be found on the company's website at www.arescapitalcorp.com by clicking on the Third Quarter 2025 Earnings Presentation link of the homepage of the Investor Resources section of our web page. Ares Capital Corporation's earnings release and Form 10-Q are also available on the company's website. I will now turn the call over to Kort Schnabel, Ares Capital Corporation's Chief Executive Officer. Kort?

Thanks, John, and hello, everyone, and thanks for joining our earnings call today. I'm joined by Jim Miller, our President; Jana Markowicz, our Chief Operating Officer; Scott Lem, our Chief Financial Officer; and other members of the management team who will be available during our Q&A session. I'd like to start by highlighting our third quarter results, and we'll follow that with some thoughts on current market conditions and our positioning. This morning, we reported strong third quarter results with stable core earnings of $0.50 per share, exceeding our regular quarterly dividend and generating an annualized return on equity of 10%. GAAP earnings of $0.57 per share increased almost 10% sequentially and included robust net realized gains from the exit of a previously restructured portfolio company as well as several equity co-investments. These outcomes led to another quarter of NAV growth, marking the ninth NAV increase in the past 10 quarters and underscoring our position as one of the few BDCs with consistent and growing dividends and cumulative NAV per share growth over the last 10 years. Let me start with our views on the market environment and how we are positioned. New issue transaction volumes are returning to a more normalized pace, driven by greater clarity on tariffs and the direction of short-term interest rates and narrowing bid-ask spreads on buyouts. With this healthier market backdrop, we saw a noticeable acceleration in the volume of transactions under review, both sequentially and compared to the prior year, with more deals reviewed in September than in any month this year. We also received an increase in requests from advisers who are running sale processes and looking for our indicative terms and pricing. Amid a firming market for M&A and Ares's leading presence in U.S. and global direct lending, we reviewed more than $875 billion in estimated transactions over the last 12 months, which was a record for us and supports our view that the market continues to expand. As a reminder, we view our origination scale, which enables us to be highly selective as a critical driver of our long-term credit performance. The breadth of our origination platform provides the opportunity to pass on transactions when we cannot find acceptable documentation, terms or pricing. Our scale and sector specialization enhances our market knowledge and underwriting capabilities while also providing us a real-time view of relative value in the market. These factors contributed to net deployment for ARCC of $1.3 billion in the third quarter, more than double the prior quarter, while remaining highly selective on the transactions we pursued. Our focus on investing in the highest quality credits continues to support strong fundamental credit metrics. The last 12 months organic EBITDA growth for our portfolio companies remains in the low double digits, which is well in excess of market growth rates. Our interest coverage increased further to over 2x and weighted average loan to values continue to be in the low 40% range. Our strong credit quality is also evidenced by our declining nonaccruals on a quarter-over-quarter basis, along with net realized and unrealized gains and growth in NAV per share for the third quarter. We also take comfort in our portfolio's focus on domestic service-oriented businesses, which mitigates risks associated with tariffs, shifts in government spending and other recent policy changes. Our third quarter net realized gains reinforced our long-term track record of generating over $1 billion of net realized gains in excess of realized losses since our inception over 2 decades ago. Our differentiated results stem from our extensive origination capabilities, allowing for selectivity and strong underwriting as well as our large and experienced portfolio management team, which focuses not just on minimizing losses, but also on maximizing returns when situations don't go as planned. We also benefit from our deliberate equity co-investment strategy that has generated attractive returns over time. Our third quarter results illustrate the value we provide to our shareholders from realized equity gains. Most notably, we recognized a $262 million realized gain on the sale of Potomac Energy Center, a previously underperforming investment that was on nonaccrual in the past and was then restructured and ultimately owned by ARCC. With the restructuring of Potomac's balance sheet, the incremental capital we invested, our proactive management of the company and patience, we were able to achieve an IRR of approximately 15% on our investment rather than incurring a loss. We also generated net realized gains from the exit of 3 equity co-investments, generating over $30 million in realized proceeds and representing a 2.5x multiple on our original invested capital and an average gross IRR in excess of 30%. This supports our track record of generating an average gross IRR on our equity co-investment portfolio that was more than double the S&P 500 total return over the last 10 years. Collectively, our net realized gain performance, both this quarter and cumulatively underscores the strength of our investment strategy and deep portfolio management capabilities that drive differentiated results for our investors. As I noted earlier, we believe our portfolio remains healthy and demonstrates solid underlying credit trends. With respect to risks recently in the headlines, we have no exposure to First Brands or Tricolor nor do we have any exposure to non-prime consumer finance firms like Tricolor. Following the recent events at First Brands, we have been asked about whether our portfolio companies use receivables financing and if such financing poses any hidden risks for us. We do not believe there are hidden risks in our portfolio from the small number of portfolio companies that may use receivables financing. Additionally, as part of a normal ordinary course business practice, our team thoroughly diligences any receivables financing arrangement, along with vetting the broader capital structure of the business during the underwriting process. If such financing remains in place post close, it is typically subject to strict parameters and is monitored during the life of our investment. These structural safeguards are a core part of our documentation standards and in our view, represent one of the strengths in our documentation, especially in comparison to the broadly syndicated market. Like First Brands and Tricolor, another topic that has been in the headlines recently is software and the potential risks posed by AI. Let me make a few comments on how we have carefully constructed our software portfolio over 2 decades of investing in this sector and why we believe AI is much more of an opportunity than a risk for our software borrowers. As a starting point, our software loans are financed at what we believe are conservative leverage levels with an average loan-to-value ratio of only 36% and none of our software loans are currently on nonaccrual. Our focus is on financing large, market-leading and well-capitalized software companies with strong growth prospects. As an example, our software portfolio companies have a weighted average EBITDA of over $350 million, and they continue to demonstrate strong double-digit EBITDA growth over the last 12 months. Our borrowers are generally backed by leading sponsors in the software industry who not only have substantial capital resources, but are also proactively investing in their platforms to embrace the changes and potential prompted by AI. While we believe AI excels at analyzing data and generating high-quality content, it typically does not provide the foundational infrastructure required for critical business operations or systems of record. These functions still rely heavily on traditional software systems that can securely store data and facilitate complex transactions. We have, therefore, historically focused almost entirely on financing software companies that operate B2B platforms and typically serve highly regulated industries, leverage proprietary data or deliver repeatable, consistent results core to business operations. Importantly, these companies are deeply embedded within customer operations and also benefit from high switching costs given the risk of business disruption from moving to alternative vendors, which, in our view, provides additional layers of durability and resilience against potential AI disruption. While we believe AI poses minimal risk to our software loans, advancements in AI remain an important component to future value creation for these businesses. For example, insights generated by AI can enhance these foundational systems by improving analytics, user experience and operational efficiencies while serving as a valuable complement and not typically a replacement for mission-critical software. Importantly, these views reflect Ares's ongoing collaboration among our highly experienced software investment team, our in-house software analysts and Ares' in-house AI experts at BootstrapLabs, a leading AI-focused venture capital investment team that joined the Ares platform a few years ago. We leverage our entire platform to drive credit decisions on each software transaction we consider as well as in our quarterly valuation and risk assessment processes led by our portfolio management team. Now before turning the call over to Scott, let me address our outlook on our future earnings potential and dividend levels in light of market expectations for further declines in short-term interest rates. We believe there are distinct competitive and financial factors that position ARCC to maintain its current dividend level for the foreseeable future despite the potential headwinds to earnings posed by lower short-term interest rates. As a starting point, in the third quarter of 2025, our core earnings continued to exceed our dividend. Second, during the last period of rising short-term interest rates in 2022 to '23, we intentionally set our dividend at a level equivalent to a 9% to 10% ROE, which is a level we have historically achieved through different interest rate cycles over the last 20 years. We set the dividend at this level because we believe we can sustain this level of profitability through market cycles. The third point worth highlighting on this topic is what we view as our unique financial position with multiple levers to expand earnings or offset headwinds solely from falling market rates. Notably, our balance sheet leverage remains around 1x, which is well below the upper end of our target range of 1.25x, giving us ample flexibility to drive higher earnings by supporting prudent growth using our efficient sources of capital. We also believe there is growth potential to capitalize on higher-yielding opportunities within our 30% nonqualifying asset basket, including through strategic investments like Ivy Hill and SDLP. Additionally, given the prospects for a more active environment alongside our origination scale, we believe there is potential for increased velocity of capital, which could drive additional capital structuring fees to further support our earnings. Lastly, the historical strength of our earnings and credit performance has provided us with $1.26 per share in spillover income, which is equivalent to more than 2 quarters of our current dividends. We believe this level of spillover income gives further visibility to our investors since it provides a cushion to support our quarterly dividends in the event of temporary shortfalls in our quarterly earnings. In summary, we had a strong quarter with healthy credit performance and financial results that demonstrate our enduring competitive advantages. And with that, I'll turn the call over to Scott to walk us through our financial results and the continued progress we're making on our strong balance sheet.

Thanks, Kort. This morning, we reported GAAP net income per share of $0.57 for the third quarter of 2025 compared to $0.52 in the prior quarter and $0.62 in the third quarter of 2024. We also reported core earnings per share of $0.50 compared to $0.50 in the prior quarter and $0.58 for the same period a year ago. This is the 20th consecutive quarter of our core earnings exceeding our regular dividend, demonstrating our ability to consistently cover our dividends. Drilling a bit more into the net realized gains that Kort highlighted earlier, we generated $247 million of net realized gains on investments during the third quarter, which represents our second highest net realized gain quarter since our inception and brings our cumulative net realized gains on investments since inception to approximately $1.1 billion. Similar to last quarter, we incurred capital gains taxes related to certain of the net realized gains, which amounted to $72 million in the third quarter. While we do not typically pay taxes on the annual income we generate, we occasionally incur taxes on certain gross realized gains. Even net of these taxes, our net realized gains on investments remained a healthy $175 million for the third quarter. Turning to the balance sheet. Our total portfolio at fair value at the end of the quarter was $28.7 billion, which increased from $27.9 billion at the end of the second quarter and $25.9 billion a year ago. Shifting to our funding and capital position. We have remained active in adding capacity, extending our debt maturities and reducing costs in our committed facilities. In July, we added nearly $500 million of additional capacity across our credit facilities. We also reduced the drawn spreads on 2 of our credit facilities by 20 basis points each to 180 basis points over SOFR and extended the maturities on both to July 2030. We continue to benefit from our long-standing banking relationships, which are supported by our scale as well as our long-term track record through cycles. The significant diversification of our overall portfolio also has direct benefits for our credit facilities, enhancing the attractiveness of the collateral pool that supports the facilities. For context, our asset-based bank credit facility advance rates are generally similar to the AA-rated tranche of a typical middle market CLO. It is important to highlight that a AA middle market CLO tranche has never defaulted. With this low level of risk, the current bank capital framework supports a return on capital for our banks that is significantly more attractive than if the banks held the individual loans directly on their own balance sheets. Beyond the systemic benefits that this type of lending provides, the banking system as a whole, the strength of our relationships and economics that we can provide to our banks further strengthens our ability to be an investor through all cycles. In addition to our continued engagement with our banking partners, we also further expanded our nonbank capital sources in September by issuing $650 million of unsecured notes priced at 5.1% and maturing in January 2031. These notes were issued at a spread inside of our previous notes issuance in June. Consistent with our recent offerings, we swapped this issuance to floating rate, therefore, positioning our funding costs to decrease with expected declines in SOFR. As a reminder, ARCC remains the highest rated BDC across the 3 major rating agencies. In addition to the strategic advantages embedded in our funding, our overall liquidity position remains strong, totaling $6.2 billion, including available cash. In terms of our leverage, we ended the first quarter with a debt-to-equity ratio net of available cash of 1.02x. We believe our significant amount of dry powder positions us well to actively support both our existing and new portfolio companies. Finally, our fourth quarter 2025 dividend of $0.48 per share is payable on December 30 to stockholders of record on December 15. ARCC has been paying stable or increasing regular quarterly dividends for 65 consecutive quarters. In terms of our taxable income spillover, we finalized our 2024 tax returns and determined that we carried forward $878 million or $1.26 per share available for distribution to stockholders in 2025. As Kort stated, we believe our meaningful taxable income spillover provides further support for the long-term stability of our dividends and continues to be one of our significant differentiators. I will now turn the call over to Jim to walk through our investment activities.

Thank you, Scott. I will now provide some additional details on our investment activity, our portfolio performance and our positioning. In the third quarter, our team originated over $3.9 billion in new investment commitments, an increase of more than 50% from the previous quarter. About half of our originations supported M&A-driven transactions such as LBOs and add-on acquisitions, which highlights our ability to benefit from the early signs of a more active and M&A-driven market environment. Further reflecting this broader trend of growing M&A, approximately 60% of our third quarter originations were with new borrowers, a shift from the past few quarters where the majority of our originations were from incumbent borrowers. We believe the shift reflected an influx of high-quality companies coming to market in the early part of a potential M&A cycle. Our origination activity continues to underscore our broad market coverage. About 1/4 of our new investments were made in companies with EBITDA below $50 million, which highlights our strong presence in the core middle market and lower middle market as well as the more visible upper middle market. On the upper end of the market, we led the $5.5 billion financing for the take-private transaction of Dun & Bradstreet, the largest private credit LBO recorded to date. This well-established, high-quality company with strong recurring cash flows chose Ares to lead their financing as an alternative to the syndicated markets due to our flexibility and execution certainty. Alongside this increased activity, our credit spreads remained stable. Our new first lien commitments in the third quarter were completed at spreads that were consistent with the prior quarter and actually 20 basis points higher than the prior 12-month average. We achieved these pricing results with attractive risk profiles as well as the spread per unit of leverage on first lien loans completed in the third quarter was the highest in more than a year. Our broad origination team and flexible approach continue to drive our ability to source opportunities with differentiated yield profiles, including the selective use of PIK preferred investments. In the third quarter, we generated an IRR in excess of 20% on the exit of 3 preferred PIK investments. These PIK preferred securities are invested in large established companies with an average EBITDA of roughly $480 million. Our PIK preferred investments have a low double-digit fixed rate yield and implied loan-to-value ratios in the 50% to 60% range. On average, we value these investments at 98% of cost at the end of the third quarter. Reflecting a more active market environment, we experienced increased repayments through change of control transactions, including from investments that were accruing PIK income. As a result, and as disclosed in our cash flow statement, these full repayments generated PIK collections that were actually greater than the aggregate amount of PIK income we accrued for the third quarter. Shifting to our portfolio. Our $28.7 billion portfolio at fair value increased nearly 3% quarter-over-quarter and over 10% year-over-year, further underscoring the extent of our origination scale at ARCC, even during the slower transaction environment experienced in the market over the past year. Our portfolio continues to be highly diversified across 587 companies and 25 different industries. This means that a single investment accounts for just 0.2% of the portfolio on average and our largest investment in any single company, excluding our investments in SDLP and Ivy Hill is less than 2% of the portfolio. We believe our emphasis on portfolio diversification and industry selection reduces the frequency and impact of negative credit events on the company. As Kort mentioned, the credit quality of our portfolio continued to demonstrate strength and resilience in the quarter. Our nonaccruals at cost ended the quarter at 1.8%, down 20 basis points from the prior quarter. This remains well below our 2.8% historical average since the great financial crisis and the BDC industry historical average of 3.8% over the same time frame. Our nonaccrual rate at fair value also decreased by 20 basis points to 1%. Finally, on credit, our Grade 1 and 2 investments representing our lowest 2 rating buckets in the aggregate declined from 4.5% to 3.6% of the portfolio at fair value quarter-over-quarter and our portfolio companies' average leverage levels and interest coverage ratios both improved when compared to last quarter and the prior year. The health of our portfolio is also reflected in the profitability and growth profile of our borrowers. In the third quarter, the weighted average organic LTM EBITDA growth of our portfolio companies was again over 10%. Importantly, this EBITDA growth rate was more than double that of the broadly syndicated market based on a second quarter analysis done by JPMorgan. Additionally, both our sponsored and nonsponsored companies are growing EBITDA at consistent rates. As a reminder, we believe our industry specialization has allowed us to further penetrate the nonsponsored market as well as service the sponsored market in a differentiated way. Further to my earlier point on our extensive market coverage and its role in attracting strong, high-performing companies within the middle market, we continue to see healthy growth across the lower core and upper middle market segments of our portfolio. Importantly, size is not a distinguishing factor of performance in our portfolio as companies with EBITDA of less than $25 million had EBITDA growth that was modestly higher than the rest of our portfolio. Looking ahead, we are seeing healthy transaction activity levels so far in the fourth quarter. Our total commitments for the fourth quarter to date through October 23, 2025, were $735 million, and our backlog reached a new record of $3 billion as of October 23, 2025. As a reminder, 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. In closing, our strong earnings this quarter are underpinned by many durable advantages that we believe continue to drive differentiated results for our investors. In today's environment, we remain focused on leveraging our origination scale to see as wide an opportunity set as possible, maintaining our rigorous credit standards, negotiating appropriate documentation and being highly selective around deal flow. We remain confident that sticking to our long-standing principles will support our ability to continue to capitalize on new opportunities and build on our track record of strong performance. We are proud that our declared fourth quarter dividend of $0.48 per share extends a record of over 16 straight years of stable or increasing regular dividends for our shareholders. As always, we appreciate you joining today, and we look forward to speaking with you in the future. With that, operator, please open the line for questions.

[Operator Instructions]. Additionally, the Investor Relations team will be available to address any further questions at the conclusion of today's call. With that, we'll go first this afternoon to Finian O'Shea with Wells Fargo.

Kort, I just want to hit on a couple of your inputs on dividend coverage. One, with the sort of traditional levers, more on-balance sheet leverage, more perhaps junior or alpha laden opportunities. Can you remind us if on an allocable capital framework, ARCC is different to have more of this stuff tilt toward it versus ACIF as the market opens up for this kind of opportunity? Or should the 2 vehicles continue to become essentially the same going forward?

Yes. Thanks, Fin. Yes, both vehicles will get allocated any kind of deal based on the available capital math, and that is an allocation policy that we've had in place for a very long time and has not changed. Obviously, those types of transactions have been more muted of late, but I do think as we see overall transaction activity increase and in particular, changes in control activity and even potentially as rates do decline further, that hopefully will create more junior capital opportunities. We've seen that be a product of those kinds of trends in the past. And ARCC will certainly get its fair share of those transactions.

I appreciate that. And just to be clear, like that -- maybe I could have worded it better. That math is the same overall for a percentage of allocation to the more junior or plus 700 or sports equity and so forth?

Yes. I would also just say that ACIF has a different yield profile than ARCC. So that's also part of the decision-making in terms of the assets that may go into those funds as well.

But yes, if you're talking about different types of assets, whether it's sports and media or infrastructure assets or any kind of assets, it's all based on mandate of the fund, of which ARCC obviously has an extremely diverse and flexible mandate and then available capital. And so that's how those deals get allocated. And ARCC, obviously, being our most flexible vehicle gets a sliver, gets a piece of almost everything we do.

I appreciate that. And if I could do one on the spillover component. Can you give us color on how big of an input that would be to support the base dividend? Would you run it all the way down before cutting the base dividend or halfway down? Is there sort of a target or threshold there as to how much support that would be? And that's all for me.

Yes, Fin, I mean, I don't -- look, first of all, we have a lot of confidence as we talked about in prepared remarks of covering the dividend in the foreseeable future. And we're running lots of different modeling scenarios, including base rate declines as forecasted in the curve or further declines, all different kinds of scenarios, obviously, liability costs. And we just feel very confident. So I don't know that I really want to speculate in terms of where we would be in the instance well into the future that, that doesn't hold up. But I think the reason why we talk about the spillover income is because it does provide additional stability to the dividend if needed, if core earnings temporarily drops below the dividend level. We have rarely seen that in the course of our history. But the amount of spillover hopefully just provides a lot of comfort for shareholders. But I don't think it's worth speculating as to all the different scenarios that could occur and how much of that spillover we might need to use.

We'll go next now to John Hecht at Jefferies.

You guys gave a lot of information about the market and your sustainable competitive advantages in the call. But if you kind of step higher level, I'm wondering how you -- thinking more about broadly in the industry, how would you describe competition in light of the fact that spreads are fairly narrow, there's a lot out there, but also over the last few weeks as there's been a couple of [indiscernible] that have probably caused some disruption or reverberations industry-wide. Kind of how do you -- the 1-minute kind of explanation of your perspective of industry competition?

Yes. Look, I think it's a competitive environment as it's always been over our 21-year history. It's just sometimes new competitors come in, some competitors leave. Obviously, we've seen as the industry has matured and we've moved upmarket, certain competitors compete upmarket with us. We have a different set of competitors that compete in the middle market and in the lower middle market. We've talked a lot about how we believe we are the only scaled direct lender that competes across lots and lots of different markets. And then when we go into our non-sponsored origination in the various industry verticals, we see a whole another set of competitors. So it's really hard to generalize. The events of the last few weeks, I would say it's a little too early to say. But so far, there's been no real significant impact to the competitive landscape. If you're talking about just the news around Tricolor and First Brands and a few of these issues that are cropping up in the broadly syndicated market. It's not really impacting our market that much so far. And again, I think it probably does highlight that our documents and protections and our credit selection is differentiated relative to the broadly syndicated market. So long-winded answer of saying a little too early to say and no real impact so far.

I'll add one thing, Kort. We also get the benefit when the broadly syndicated market does see [ reberations ], as you said, that's a great time for private credit. Those are moments in time where we can take market share from the broadly syndicated market and people are looking for that certainty. So those moments and sometimes they're short a week or 2, sometimes they're a month or longer. Those moments tend to be quite favorable for us.

Yes, that makes sense. And second, a nonrelated question, I'm just curious if there's an update on some of the, call it, regulatory opportunities like AFFE. Just I haven't heard much about that for a few months, and I'm wondering if there's anything to discuss there.

Nothing all that meaningful, John. I mean there was some temporary excitement around progress that had occurred down in Washington on that front. But it's hard for us to get too excited because we've seen it kind of go up and down in its momentum over the last few decades, frankly. So we try not to read in too much to the movements kind of month-to-month or even year-to-year.

We'll go next now to Arren Cyganovich at Truist Securities.

Just following on the line of questioning about where are we in the cycle? Is it a late cycle where it got tight credit spreads. You laid out a lot of reasons why things continue to go well for you with EBITDA is rising at your portfolio companies, a lot of activity. What are some of the guideposts that you're looking for that would maybe cause you to be a little bit more strict in terms of your underwriting? And what are some of those things that we might be able to monitor from afar?

Yes, it's not too complicated. I mean, certainly, underlying EBITDA growth or potential reductions in that growth would be something we would look at. We're always looking sector by sector as well. We talk about the overall portfolio average EBITDA growth, which again remains double-digit growth and bounces around here and there, but still remains really strong. But we're looking underneath the hood there at all the individual industries that are driving that growth, and we're not really seeing any trends in certain industries that would lead us to believe that there are points of weakness in any kind of individual sector. So if we did see those, we would certainly point those out. But that would be #1 on the list. Obviously, overall access to capital, the flow of credit in the markets. Historically, when you see credit start to seize up, that can also then flow through and create problems for businesses and lead to downturns. Again, we're seeing that actually go the other way now in terms of increased activity in the M&A market. Our transaction volume and opportunities remain really strong. So that would be something else to look for. But again, no signs on the horizon there. So I don't -- there's nothing we're seeing here at Ares Capital that would tell us that we're nearing the end of any kind of cycle. Certainly, from an M&A standpoint, the M&A cycle, I think we feel like we're at sort of an early end of a new cycle that's beginning. And you can see that in our origination numbers this quarter, which tilted toward 60% new borrowers for the first time in a long time, usually trending around 50% or even more in the last year or 2, 30%, 40%, went up to 60%. Change of control transactions were over half of our originations. So I think the M&A market really is picking up. And I think that's also a sign that people feel good about the stability of the economy, where we're going, underlying businesses, and we're seeing that reflected in that transaction volume. So that would be my answer to your question.

Yes. No, that's very helpful and largely what I would have expected, but it's good to hear you said. And the second question is kind of a quicker one, but the -- you had commented on September being one of the busiest months, but spreads on first lien for your investments in the third quarter actually rose a little bit. It seems a little bit backwards. Obviously, not a big amount. I think you said 20 basis points, but just curious as to those dynamics.

I think the dynamics are that it reflects the broad origination funnel that we are able to capitalize on here by virtue of being managed by Ares Management and all the different deals that we're able to see come into the platform and originate. I mean it's -- yes, I'm glad you pointed it out. Look, we put out $3.9 billion of gross originations in the third quarter at an average spread of SOFR plus 560 and that went into borrowers at an average leverage of 4.8x. So we certainly feel like it is a good investing environment to be in despite the fact that it is competitive like we talked about before. We think we have meaningful competitive advantages in terms of the types of deals we see, and it will be interesting to compare our originations and those metrics that I just put out relative to our competitors as we see people put out earnings over the coming weeks.

We'll go next now to Melissa Wedel at JPMorgan.

I think from our conversations, it seems like what's been driving some of the price action in the industry the last few months has been concerns about 2 things. One is earnings power and the second would be credit. I think you've addressed the credit, you're not seeing anything thematic and certainly showing up in the nonaccrual rates. I was hoping to dig in a little bit more on the earnings power and follow up on some of the levers that you talked about earlier that you could pull. One of the things you talked about was being a bit below the top end of your target range in terms of portfolio leverage of 1.25. Given that you have bandwidth there to increase leverage at the portfolio level, I'm curious how you're thinking about using the at-the-market program, especially as share prices have declined.

Yes, sure. Thanks for the question. So I think as you probably can see, we've been reducing the amount of at-the-market issuances over the last 3 quarters. So we went from $400 million to $500 million a quarter down to, I think it's $300 million last quarter, down to $200 million this quarter. So that's been influenced by a view that we are operating slightly below the midpoint of the range on leverage, that 0.9 to 1.25x range and our desire to get a little bit more into leverage here over time. Again, we do like the position that we're in at 1x. It's a conservative place to be. It positions us well to capitalize on opportunities in the market. As Jim mentioned earlier, maybe there's an opportunity the broadly syndicated market seizes up. We want to be in a position to have that kind of financial flexibility. But we do think it's appropriate to potentially start moderating that ATM, which is what we've done over the last several quarters, not to say what the future will hold, but that's been our view. So I don't know too much more to say on that topic, Melissa, but hopefully, that's helpful.

It is, and I appreciate that. And then in terms of further optimizing the nonqualifying asset bucket, I'm curious if there's anything in particular or forthcoming in the near term on that? And if not, maybe more generally, would you think about additional assets there that would be similar to your current exposures in IHAM or SDLP? Or would it be a different type of exposure? And just how you're thinking about that sort of longer term?

Sure. Yes, sure. One good piece of news that we certainly are happy to report is on the SDLP joint venture, which is that we did recently amend the documents in that joint venture and our relationship with our liability providers or the joint ventures liability providers to lower the cost of capital on those liabilities, which did result in a 100 basis point increase in the yield on the SDLP that you can see in our numbers on a go-forward basis. So I think that will provide a nice boost to the return on that program. I think our ability to increase the utilization of SDLP and to help IHAM hopefully achieve more growth as well will partially be based on the overall transaction volume in the market and our ability to originate, which again has been increasing. So that gives us confidence that we should be able to better utilize some of those joint ventures and structures within our 30% basket. I think, Melissa, that's probably -- hopefully, does that answer your question? Or is there something else you were getting at there?

No, that is helpful.

We'll go next now to Casey Alexander at Compass Point.

My first question, and it might sound a little convoluted, but we've gone through this mini hysteria created by the wet blanket of the words private credit thrown over the entire arena as if it's all encompassing. So first of all, you should change the name of what you do and take the words private credit out of it. But I'm wondering if this mini hysteria, did you notice any even temporary stall in the market? There's so much over the last couple of quarters of there were more loans leaving the directly originated private credit arena for the broadly syndicated market. Have you felt some relief from that because clearly, the banks have been twisting themselves into knots over this. And also, spreads have been at all-time tights, which, again, doesn't presuppose a real credit crisis. Does it feel like you might see new origination spreads in the broadly syndicated market widen out a little bit, which would also allow you some more spread relief?

Sure. Thanks, Casey. So a few things in there. I think, first of all, yes, much -- too much noise made about the banks and private credit and fighting over assets. I really think that, that is way overstated. We, as an industry, have been both working together with banks and competing with banks on transactions for decades. This is really nothing new. It's just that I think the dollar amount of the transactions as an industry that we're now providing have gotten to the point where it's starting to get more attention. But the dynamic is really nothing all that new. Banks are great partners for us. They provide leverage facilities on a lot of our funds, including obviously ARCC. And there are movements in the market from time to time where borrowers are more apt to lean toward broadly syndicated transactions, sometimes borrowers more apt to lean toward private credit transactions. The longer-term trend is obviously borrowers moving more toward private credit transactions because of the value of certainty knowing that the capital is going to be there in all market environments. And every time we go through a period of volatility where the broadly syndicated market gets choppy and maybe can't support its borrowers or banks get hung on transactions that they're looking to syndicate that just reinforces that long-term trend and makes it so that borrowers are more apt to consider private credit even when banks are back in the broadly syndicated markets back. So the banks broadly syndicated market this year. But on the whole, more transactions were still done in the private credit market than the broadly syndicated market. So I think on that, not much more there to add, Casey, but we can get more into it if there's something specific that I missed there in that part. I guess on the question about spread widening, I think you were -- sorry, maybe restate the spread question again.

Well, just before we had this mini hysteria over private credit driven by 2 loans that went bad, spreads were at all-time tights. So I'm just wondering if you've seen -- and a lot of that driven by really aggressive bidding in the broadly syndicated market, have you seen any deals in the broadly syndicated market that might indicate that they're widening out a little bit because you guys do, to a certain extent, price against that market.

Yes. Well, I think Jim actually made that point, which is it could create that opportunity. It's a little early. I just think it's a little early. I'm not going to say that we've really seen that cause an effect exactly yet where all of a sudden, we're seeing deals chip our way because of that. But certainly, that would -- could potentially be an outcome. I think what really matters is how long and sustained the sort of concern or dislocation or spread widening in the broadly syndicated market lasts because our market one of the benefits of our market, I think, certainly for borrowers is that we don't move in lockstep with the broadly syndicated market, right? We lag a little bit. We're a little bit more stable. We take a longer-term view because we're holding these assets. We're not looking to sell the assets. So we're not going to move up and down 25, 50 basis points in line with the broadly syndicated market when it moves. So I think time will tell. We'll just have to wait and see.

All right. And I do have one follow-on. I think that's a great answer, though. In the recent developments, you pointed out that in your exits, you recognized total net realized losses of $67 million. Can you tell us where that was relative to their third quarter marks? I mean is there likely to be an unrealized offset to that because they were close to the marks? Or is there some difference in there?

They're pretty much right at the marks.

That's what I assume since it was so close after the end of the quarter.

We'll go next now to Doug Harter with UBS.

Hoping you could talk about your expected pace of exits in the near term and how that might influence the kind of the velocity of portfolio turnover and fee income you can generate?

It usually moves kind of in lockstep with overall transaction volume in the market and new originations. So we've talked about that in the past, too. People get sometimes a little concerned when transaction volume declines like we saw in the second quarter of this year, but then exits decline as well. So they kind of move together and the net number really is, I think, a more important number to look at. Obviously, this quarter was very strong on a net basis as well, over $1 billion, even though the exits did increase. So I don't know that I can provide anything super insightful there other than just to say it kind of moves together with overall transaction volume.

We'll go next now to Robert Dodd with Raymond James.

In talking about supporting earnings power, et cetera, I mean one thing that stood out to me this quarter is other income looked quite high. I mean, by any historic standards. I mean that's not usually where the origination fees go, but it could be amendments, can be consulting. Can you give us any idea like what drove that? And is that now going to be more geared to just what activity is rather than -- which obviously drives the capital structuring fees? Or has there been more of an effort to seek out like consulting kind of fee arrangements? And maybe is that going to be an ongoing story in terms of one of the tools to support earnings power?

Yes. Thanks, Robert. That's mainly typically like transaction or like amendment type fees. So I would not necessarily say that's replicatable every quarter. So really more onetime in nature. The capital structure fees are really more indicative of the origination volume.

Yes. Got it. On the AI question, I mean, like you mentioned, you have the in-house think tank for lack of a better term from several years back. How has that changed over the last couple of years. How you go about underwriting software? I mean you laid out in the prepared remarks all the ways you do it currently. But I mean, is that fundamentally in any way different today because of the in-house AI expertise? Or is it just always been that way?

Yes. No, great question. Look, I think multipart answer. Number one, it's always been that way in terms of our desire to provide capital to software that is foundational and infrastructure-like in its business model, i.e., software that is highly ingrained in the workflows of its customer base that powers off of -- and a key part of its value prop is off of a proprietary database. And in a lot of times, software that is provided into highly regulated end markets that are extremely reliant on high-quality data and accuracy of data and auditability of data. So that has always been our strategy in software for decades. And so that really hasn't changed. I think what -- over the last few years, when -- with the rise of AI and obviously, our focus -- our focus on making sure that our portfolio is defensively positioned and certainly, any new investment we make is defensively positioned. Obviously, we're spending a lot more time thinking now about what AI is good at and what it's not good at to ensure that we continue to build a portfolio that is resistant to disruption. And when you think about what AI is good at, it's really good at creating content, can create amazing content so much faster than humans can. It is very good at analyzing and synthesizing lots of data. It doesn't actually house the data. It's not a database, but it can synthesize lots of data. And so you want to make sure that you're not investing in software companies that are simply providing content, learning modules delivered over software that can be disrupted. So those are the kind of areas we're trying to make sure that we're staying away from or software companies that are just analyzing third-party data. That would be something to stay away from. I think we want to make sure we're still very focused on providing software to companies that are actually powering businesses and are entrenched in businesses and are infrastructure like in their nature.

We'll go next now to Paul Johnson with KBW.

Just one a little bit further on Doug's questions for exits, but I'm just wondering if you have any sort of updated outlook, I guess, in terms of monetizations and sort of further gains from realizations this year or if the Potomac intermediate kind of represents more of the meaningful opportunity there near term?

Yes. Look, I think, obviously, our strategy is to leverage our portfolio management team to make sure, as I said in the prepared remarks, we are not only avoiding losses, but capitalizing on potential opportunities to make big gains. Potomac is a great example, but it's not the only example over our history, and I can certainly guess that it's not going to be the only example going forward into the future. I can't give forward-looking guidance or remarks about what might be the next big gain, obviously. But I guess what I would say is we provide a lot of disclosure for all of our investors in our SOI, in our 10-Q and 10-K, and you could see every investment we have, the nature of that investment, you can see the investments we have that are restructured where we own equity or own the businesses outright via those restructurings. And that could provide some clues as to what might be sitting in the portfolio that could provide future gains. But I'd venture a guess that, that will not be the last one that you guys will see.

Appreciate that. Very helpful. And then last one is just kind of higher level I had. But we see like a mega financing deal like the EA SPORTS JPMorgan-led deal there, LBO financing. Does the deal of that size do enough, I guess, to kind of soak up any sort of oversupply of capital in the financing markets? Or is kind of the reality we would need to see a number of those to really accelerate sort of a balance of the supply and demand of capital in the private credit market.

Yes, I think it helps. I mean I don't know if that one deal alone is going to move markets. You probably need several, but that's a lot of capital. So I think if we start to see -- and again, it's just emblematic of what I said earlier, the markets are functioning very well. The credit market money is flowing, buyouts, new buyouts are happening. And if we start to see a number of these larger buyouts, I do think actually that will start to potentially widen spreads, soak up demand in the broadly syndicated market, move deals back our way. So every deal like that, I think, helps.

In the market, we're seeing a fair amount of the regular way activity, but we're also seeing a regular cadence of larger transactions, right? That's becoming more common. Records are broken over and over again, but it's really more about the regular cadence of large transactions that helps absorb the capital into the market.

We'll go next now to Kenneth Lee at RBC Capital Markets.

Just one for me. And you touched upon this in your prepared remarks around receivables financing and more broadly, I guess, when you look at any kind of off-balance sheet financing, I wonder if you could just remind us how does Ares Capital avoid such situations? And more specifically, how are they flagged during the due diligence process when you're making new investments?

Yes. Well, so they're flagged during the due diligence process by an exhaustive analysis of all of the company's liabilities on balance sheet and off balance sheet. We obviously have in almost every transaction, we do new transaction. We have a quality of learnings provider that's coming in and doing a third-party report, scrubbing numbers, asking lots and lots of questions. Companies are required to disclose their liabilities to us as part of the reps and warranties. So it is [indiscernible] at the outset and at the underwriting of the transaction. And then on a go-forward basis, we have protections in the document. We have baskets that limit securitization facilities, which includes factoring of receivables and all different sorts of off-balance sheet liabilities, and those baskets are tight. And we talk a lot about the baskets in the private credit market or the documents in the private credit market being tighter than the documents in the broadly syndicated market. And this is just one very good public example of something where the broadly syndicated market documents were a little bit looser. And I don't expect that you would see that occur in one of our transactions.

We'll go next now to Sean-Paul Adams at B. Riley Securities.

Most of my questions have already been asked and answered. But on the portfolio grade, the weighting improved quarter-over-quarter and the median nonaccruals declined. Do you view any general improvements in the economic environment? Or is it just a reflection of the runoff of nonaccruals from the portfolio?

I think the economic environment is pretty stable. So I think it's just the runoff of a couple of the nonaccruals. The number obviously bounces around a little bit quarter-to-quarter. The movement wasn't anything extreme. So I don't think there's much to read into there.

Got it. And as a quick follow-up, on spreads, you guys talked about this pretty in depth, but there is a race towards the bottom. Is there a kind of a bottom that you're envisioning as far as spread level declines just among the general economic environment for deal flow?

Yes. I mean it's just hard to prognosticate and look forward and say where everything is going to go. I guess I'd just point to you a couple of things. Number one, spreads for the last 3 quarters now have been stable in the market. So it feels like we've found a bottom for now. And I think that's due to just overall transaction activity starting to come back. I think it's also due to just the fact that private credit managers have dividends to pay, and we sort of found where this floor seems to be at least now for the last 3 or 4 quarters. So that's one important point to look at. Again, I would probably just remind people, our third quarter originations showed spread widening, modest, but some spread widening. I talked about it already. We put out $3.9 billion at [indiscernible] 560 at 4.8x leverage. So that feels like a pretty good environment to be investing into and doesn't really suggest that we are in a race to the bottom type environment. But like I said, not going to sit here and really try to predict too much what's going to happen in the future.

We'll go next now to Ethan Kay at Lucid Capital Markets.

Maybe nitpicking here a little bit given very solid results, but dividend income came in a tad bit softer quarter-over-quarter. It looks like the distribution from Ivy Hill was stable. There were some exits of equity positions that you guys talked about, which ostensibly is a factor there. But can you talk about if there was maybe anything else that might have contributed to that kind of evolution in dividend income? And then as a quick follow-up, can you kind of remind us of the sensitivity of IHAM dividend to changes in interest rates given the fact that it's largely underlying -- the underlying is largely floating rate debt.

Yes. On the dividend, yes, you hit it. There's a couple of things there. There were some nonrecurring dividends that we got last quarter, but we also just saw some of the exits of our preferred yielding preferred equity that exited the quarter. And so the dividend income came down with those 2 factors. I will note that most of those preferred investments that paid off were picking. So it certainly helped the collection of our PIK, which I know has been a hot topic with investors as of late.

Yes, we didn't even really hit that, but we had a great PIK collections quarter. I knew we do get a lot of questions about that, and that obviously just occurred with pickup in transaction volume. And I think on the Ivy Hill question, I think you're asking about sustainability of Ivy Hill dividends and interest rate sensitivity. I mean, obviously, yes, Ivy Hill invests in floating rate assets. They have floating rate liabilities as well. And we think about the Ivy Hill dividend very similarly to the ARCC dividend, where we think there are reasons why we think it's very sustainable. One thing I'll point out is like the ARCC dividend, Ivy Hill is currently outearning its dividend pretty materially in the third quarter, we were about 107% dividend coverage at Ivy Hill. And there also exists $130 million of retained earnings down at Ivy Hill as well. So we feel like there's a lot of reasons why that dividend should be sustainable in all different kinds of environments.

[Operator Instructions]. We'll go next now to Brian McKenna at Citizens.

So credit quality remains resilient. And as you mentioned, nonaccruals still well below that historical 3% average. But why do you think credit has been so resilient outside of any broader macro reasons? Is it where your exposure sit from a sector perspective, how you structure deals and price risk? Or is it being driven by greater levels of scale? And as your platform gets bigger and bigger, it's really just driving better outcomes for all stakeholders through the cycle.

Yes. Thanks, Brian. All of the above for sure. I think as a reminder, one of the benefits of running a BDC is we don't have to manage to an index. So we can select industries that are defensive and that work well for credit investing. So we've avoided a lot of industries that have been showing softness of late. And we've been leaning into industries that are very consistent growers. And so I think certainly, industry selection and industry diversification as well have been really important drivers of our outperformance on credit. And then certainly, look, you mentioned scale. So I have to take the opportunity to hit on that. The scale of our platform is unmatched and our ability to originate an incredibly broad amount of deals into our system allows us to be very, very selective, right? The more opportunities we can see, the more selective we can be and the better able we are to find the market-leading companies, the best companies in all of these different industries and then choose to invest in those companies and then pass on the other opportunities. If your funnel is more narrow, obviously, our job is to put money to work. And so you're going to put money to work into lower quality companies. So that larger funnel, I think, is a huge advantage comes from our scale, comes from our size of our team, the tenure of our team as well, the fact that we've all been working together for such a long time. And I think just the DNA in our system around underwriting and credit has been passed down and just continues to get reinforced throughout the year. So I think you hit on all the reasons, Brian, but thanks for giving me the opportunity to talk more about them.

Yes, sure thing. I appreciate the context as always. And then just one quick one, if I may. And you touched on this a little bit, but looking back historically at periods of volatility, really when liquidity dries up, how much incremental spread on average have you been able to capture in those environments? I appreciate every period of volatility is a little bit different, but I'm trying to figure out, is there a way to quantify this dynamic? And ultimately, how much incremental ROE is generated from these types of situations through the cycle for ARCC?

I don't know there's a way to really quantify it just because everything is so different. It all depends on so many different factors, right? It's what's the broadly syndicated market doing, what are base rates doing? How bad do people feel about the dislocation? I mean a couple of examples just to point to recently with the Liberation Day and the tariffs back in April, there was probably a multi-week period where we were able to capture 50 basis points of increased spread and maybe another 50 basis points of increased upfront fee. So call it, maybe 75 basis points or so of total yield. But that wasn't very long lasting, but there were certainly a couple of transactions that were going into signing that we were able to move terms on and rightly so because it was an uncomfortable and a difficult period to be investing in for most people. And then you look back in the period in 2022, late 2022 and early 2023, I think we saw spreads widen by 150 basis points back then and fees probably widened by 100 basis points upfront fees, and that was more driven just by banks exiting the market, the broadly syndicated market shutting down entirely because banks were hung on transactions as rates rose and they couldn't sell them. And so that just created a huge imbalance in the competitive landscape and the supply of capital. So really, it's just -- those are 2 recent examples of very different movements in spread and for different reasons, and it's just really hard to generalize.

Mr. Schnabel, it appears we have no further questions this afternoon. Sir, I'd like to turn the conference back to you for any closing comments.

Okay. Great. Thank you all for joining us today and for all your continued support, and we look forward to seeing you on our next quarterly call.