R. Kipp DeVeer, CEO, Ares Capital

Thanks very much for that kind introduction. Some of the things I think that were picked up in that panel about liquidity and about hedge funds, generally speaking, and private equity, I think will be parts of the presentation that I'll give here today. But let me just provide a little bit of an introduction as to where I'd like to start. Perhaps my introduction beyond that, I work at a firm called Ares. We are a global alternatives firm with about 80 billion of capital under management today and roughly 800 people across the globe, 16 offices. But our primary business today is in the U.S. and Europe, generally speaking, and we organize ourselves across these four verticals more than anything else. What I'll spend a lot of time talking on today, what we thought was best suited for this conference, and frankly what we got invited out to talk about, was our U.S. listed BDC. That's actually our 10-year anniversary of that public company tomorrow, and that was the impetus for coming out and speaking at the event. So for those of you that don't understand just at the ground floor, what I'm likely to get into today, direct lending is generally speaking for us non-bank lending to middle market companies. It's a very large business; it's about 200 billion a year of new issuance. And what we're talking about is generally loans and equity investments in businesses that have somewhere between 10 million of EBITDA and 100 million of EBITDA. And the theme that you'll see is these are companies that generally have been left behind by the banks over time. And I have a bunch of slides to talk about as we progress through the presentation. But so we're clear, a lot of what we're doing is lending into private equity transactions, but we do also go direct to middle market companies. We try to be flexible, we try to be transaction-oriented, and unlike liquid bonds, loans, etc., most of what we do we hold three, four, five years. So everything's private, it's unrated, and it's sub-investment grade, which is one of the reasons that the banks have shied away from this over time. But again, we think we're making very conservative loans to these companies that we hold over a substantial period of time. We actively manage the portfolio, and of course, investing in illiquid securities today gives us a meaningful yield premium. So in a world, per the prior panel, where folks are looking for yield and are looking for less correlated risk, we think that we've been able to offer that.

I'll take you through some slides on some things you probably know and hopefully some things that you don't on what's going on inside the banks and what's happened over the last 15 to 20 years. But the way that we see the market is represented generally by this very complicated chart that I've got up here on the screen. To make it easy, though, what we've seen over time is the large banks consolidate, focus on billion-dollar-plus businesses that are interested in global transactions that can drive a very broad opportunity set for the banks. Below that, really, has formed a very large network of regional banks that increasingly are just not interested in our business for a whole host of reasons. And what's left us is a very, very active opportunity set of about 200,000 U.S. businesses that we feel are underserved, generally speaking. And what we've seen over time is a whole handful—this is over a 15 to 20-year period that we've been doing this—a whole handful of different types of institutional capital sources try to fill that void. And this is that sort of larger blue, I guess, oval there on the right: business development companies, private hedge funds, the middle market CLO community, and lots of institutional investors, I think like you all in the room, have been bringing capital into this space to support the exit of bank money in our industry now for 15, 20 years.

So some of the dynamics: why has this all happened? Number one, the bank's business has changed a lot over the last 20 years. I've spent my career up until 10 years ago at Ares in banks—JPMorgan, at a French bank, at a Canadian bank—and we saw the movie with our team that's been together for a very long time. Our business simply, in a world of consolidated banks, particularly in the U.S., just does not move the needle anymore. We've seen capacity leave the market, we've seen shifting risk tolerance in banks, we've obviously seen an incredible change in the regulatory environment. And this has been going on now in the U.S. for 15 to 20 years as businesses like Ares have developed to fill the void. And I did make a point, just we do have a business in Europe as well. This has all really been institutionalizing and occurring here in the U.S. now for 20 years; it's just happening in Europe, and we've been building a business over there to take that opportunity. But as you all look around and think about allocating to direct lending, we do think that's a very, very exciting opportunity and one that's definitely more of a growth opportunity. We still think the U.S. has a tremendous amount of growth, but Europe's just getting going for a lot of the same reasons.

Some attempts at headlines: I think everybody's been reading in different financial publications about the banks not being able to make loans to this transaction or that transaction. All driven, obviously, by things like Basel III, Dodd-Frank, the Volcker Rule, and most recently all of the OCC guidance around leverage lending in particular. The regulators looking at the bank simply do not want the banks making highly leveraged loans. They understand that that's one of the things that obviously put us where we were back in '08, '09, and the regulations specifically around our asset classes is thicker than it's been in quite a while.

So the changing competitive landscape in the U.S.: we always like to show this chart. When we started the business 15 years ago inside banks, we used to underwrite transactions and sell them down, syndicate them to a lot of the folks on the left. And you'll see some names, obviously, of some old banks where I think a lot of us probably used to have checking accounts and all that that don't exist anymore. But the reality is, 15, 20 years ago, all of these banks were in the leveraged lending business, and they've either all been consolidated largely into a couple of the trillion-plus-dollar financial institutions here that again have just taken all of the interest out of this market to focus on larger businesses. The reality is the top five banks today in the U.S. own about 46 percent of the industry's total assets. It's a staggering number. And the nature of those assets, when you really get through it, makes you realize—and this is a complicated but important slide—it makes you realize that banks of every level no longer make CNI loans, generally speaking. So if you look at the universal banks' balance sheets and you see bottom left, the percentage of their assets that are CNI loans, eight percent. And people say, 'Oh, well, that's getting filled now by the mid-size banks, by the regional banks.' But in fact, when you get through the asset composition of both the U.S. mid-size banks and the community banks in the country today, you'll see that the CNI loan percentages are extraordinarily low. And the reason for that is there are a couple different reasons for that. Generally, the banks over the last 10 years have really rebuilt their businesses around real estate and around consumer activities—insurance, credit cards, all of that—and they've gotten out of the lending business. We get lots of questions about, 'Well, isn't that going to change? Banks have delevered, they sure want to make loans.' And if you follow banks, you hear all about the deposit ratio being extraordinarily high and the fact that banks do want to make CNI loans. But the real issue is they don't have any people to do it anymore. They've completely de-staffed those businesses, and when they do re-enter them, they tend to re-enter in very safe, very low-leveraged transactions, asset-based finance, and frankly, not the things that we're doing. So we don't feel that that's a real constraint for us going forward.

So perhaps to get into the next piece, what's happened? There's still a very large market here; it's not like these companies have completely run out of money and had no ability to borrow. What you've seen is just a very dramatic change in the funding sources for middle market credit. The BDCs, the insurance companies, finance companies, etc., have completely shifted. Whereas the banks used to be 80 percent of our market, they're now about 20, and all of these institutional players have taken significant share over the years. BDCs alone have become a very, very significant source of new deal flow. This will show you that over the last five years, BDCs generally, as they've grown, have originated about 90 billion of middle market loans, generally speaking, that they've held, and that number does continue to grow. And I'll make some comparisons and some parallels as to what we think is happening in the space a few slides later. But this new funding mechanism is driving a significant amount of growth, and I think is worth people's consideration in the room as you guys are all looking at a whole host of different assets to invest in. And I'll touch on that towards the conclusion.

But maybe just a quick commercial for us: we do, 10 years later today, have the largest BDC. We've got a roughly eight-billion-dollar portfolio today, about 202 portfolio companies at the end of the second quarter, and since 2004, we've invested almost 18 billion of middle market credit in this public company, and I'm happy to say have a pretty good track record. We've got a 10-year history of asset growth. So we started as a very small company, we've grown organically, we're up to about 80 people just that are out originating assets across our business—New York, Chicago, Atlanta, D.C., Dallas, Los Angeles. So a lot of what we're doing is just having feet out on the street and really reproducing the same sort of coverage that the banks had 20 years ago. That's a key element to sort of what we do day to day. We have also been able to grow our company through acquisition. During the downturn in 2009, we were able to actually acquire a company that was about our size at the time, as we were roughly two billion of assets at that point, and picked up a distressed business in our space through a merger that took us to the four billion you see in 2010. But since then, it's been all organic, and I think on the backs of obviously investor interest and good performance.

I know we're a little bit behind, so I think I'm going to flip through this. But for the folks in the private equity business in this room, we do have active dialogues with about 350 private equity sponsors. I think you'd see us in the private equity business as one of the most active coverage lenders in that space. We've closed transactions with over 150 different private equity firms, but our business has really changed. That's really where it started; it's changing as something a lot more broad than that. So over time, we've gone direct to companies. We've built a very sophisticated origination infrastructure to do that. We brought on teams in the project finance space and in the energy space recently, which are two places that we've seen the banks really start to dial back from. We brought a venture lending team in. So there are all these adjacencies to our business that continue to evolve because of the banks' exit from certain pieces of the market.

This is a really complicated slide, but the takeaway is we feel, if you look at the number in the bottom, this is the average yield that we've found. The average total return is slightly higher than that, but the average yield that we've found over a 10-year cycle—we, of course, are influenced by interest rates. We actively manage our portfolio, and the color-coded bars are meant to represent the way that we can actively manage our assets. But we do make senior loans, we make unit tranche loans, we invest in second lien assets, we make mezzanine loans, we make equity investments. And the key, we think, to good credit performance over time is really being able to move that around. At this point of time, we actually see pretty frothy credit markets. This is a time where we're being conservative, we're being patient, waiting for things to break a little bit, because obviously with rates this low, unlikely to go up next year, and credit spreads about as tight as they've been since '06, folks like us get a touch cautious. But the good news, I think, for investors looking at our company is we've been able to generate a very, very solid return across different interest rate cycles, different credit markets. I mean, I'll talk about the dividend performance, but the ROE at ARCC over the last 10 years has been about 14 to our shareholders. So if you've owned the stock for 10 years, you've been happy. We went public, as I mentioned, 10 years ago at 15 bucks a share, and I think we've now paid about 15 bucks in dividends, and stock trades at 16-something today, I haven't looked.

So why should everyone in this room care? Because I know we've got a very broad group of people. Some folks I think here kind of live in the same world that I do, and based on that panel and the fact that I only understood about half of what our panelists were talking about in the prior panel, I clearly don't live in their world. But when you look at what the alternative managers in the space are doing, the BDCs in particular structure that are picking up a tremendous amount of momentum. So as you all think about the asset classes and think about shopping for managers, if you do that, and allocating assets, almost every large alternatives firm these days either has a public BDC, has a private BDC, or is intending to list a public BDC sometime soon. So you go through the names, you know, beyond the folks on the screen, there's a whole host of other large managers that continue to enter the space—Oaktree, Oak Hill, etc. So loads and loads of folks behind this. I think the reason for it is when you look at the BDC market today, I think there are roughly 40 BDCs. The total market cap of the public BDCs today is around 40 billion dollars. It's pretty small, and there's also a private market that's a roughly 20-billion-dollar market. And the way that we think about it, I think a lot of other folks do, is we see the development of this market much like the development of MLPs and REITs over the last 20 years. You know, when you look at the sizes of those markets, the REIT market today is about 670 billion of market cap relative to where we are. The MLP space, based on these numbers, around 250 billion of market cap. And obviously, these again, in a world where people do want yield and back to the point about liquidity, where you can get yield and total return in a liquid vehicle, in public company stock that you can sell every day, it offers investors a tremendous, we think, total return, but also it gives you real flexibility in managing your assets.

I went through most of this. This really again is our commercial, and I think I've hit on a lot of this. But one of the things that's important and perhaps misunderstood, we think, about BDCs: everybody always thinks BDCs are very speculative and very risky. And I would actually make the case that we're in fact not. You know, we've got an incredibly transparent financial statement. We list every loan that we make to companies, and these are simply middle market loans to businesses that obviously come in and out of the balance sheet. We value our portfolio with third parties. Got a very conservative funding model. So the good news for us is we have permanent equity capital in a public company, and we have long-dated liabilities. Unlike 10 years ago, where most of the BDCs in the space financed themselves with short-term secured debt, we actually have, generally speaking, mostly five-, seven-, ten-year unsecured liabilities these days. So it puts the business just in a wonderful position to continue earning dividends and generating returns to shareholders. The company's paid almost two billion dollars of dividends to shareholders over the last 10 years, and I think the total return on the stock has also been anchored by the fact that the credit performance in the portfolio, testament to the team, has been excellent. On the roughly 8.7 billion of realized investments that we've made over the last 10 years, we have a 13 IRR. We've had one year where we've actually lost money, not surprisingly, in 2009. And if you look over that 10-year period, we've actually generated about 220 million dollars of gains for our investors, which is a bit unusual on a lending business.

And just as you think about allocating to the space and as you think about looking for managers, do choose wisely. Manager selection, as you all know, is important. But we do think that the BDCs, and in particular our company, sets up quite favorably versus a bunch of the other things that you can buy that have daily liquidity, whether it's a high yield index, the S&P 500, or any of the others on the side. And in the choose wisely bucket, look, we've also had a long track record here of outperforming most of our peers. So away from us, and maybe I'll open it up for questions. I think this is a space—the point of the discussion today is this is a space that I think will and should warrant a lot of future investor attention. It's undersized, it offers a lot of benefits relative to what you can purchase in a credit hedge fund or a locked-up private equity structure, which a lot of other managers over the last 10, 15 years have used to invest in these asset classes. But the ability to deliver yield and total return in a company where for the investor they have the benefit of daily liquidity, we think it's a powerful thing. We think it'll keep growing. So we'll wrap up. Thanks so much.