Melissa Wedel: All right. Understood. Just as a follow-up to looking at Slide 18, addressing the backlog and pipeline, noticed that there is a particular waiting towards insurance services in the backlog and pipeline. And I was just hoping you guys could provide a little context about the opportunity that you’re seeing in that particular industry? Thanks.
Kipp DeVeer: Yes. I mean, whenever we snap a quarter like that, it’s hard. I mean, there is no – that’s one or two big particular deals, obviously, in that sector. It’s an active area of new investing for a lot of private equity firms. We have a significant portfolio in that market or in that industry, rather. So I think it’s just reflective probably of one or two big deals that happen to pull into the same quarter, but nothing other than that to take away.
Operator: Our next question comes from Ryan Lynch with KBW.
Ryan Lynch: Hi, good morning. I’d like to also congratulate Penni and Scott for the new roles and transitions. My first question has to do with – you mentioned the broadly syndicated loan market and some of the liquid markets, maybe just gaining a little more footing here recently. I know you’ve talked about in the past building up a lot of relationship with a lot of these borrowers just the reason they’re choosing your products and your relationship with the Ares versus those liquid markets. But I’m just curious, do you have any sense of – just maybe a ballpark of what percentage of your portfolio borrowers are of the size where they could access the broadly syndicated loan market or liquid markets, but choose to partner with Ares because if the broadly syndicated loan market comes back very strongly, I would just assume that that could potentially be a potential higher risk of refinancing.
Kipp DeVeer: Yes. I mean I was just hit mute and asked Scott, nothing off the top of my head, Ryan. It’s a good question. I mean, look, I think when as you know the markets are a little bit more volatile, direct lending will capture a larger share of those big transactions that just feel difficult, again, in a volatile market. I think the syndicated market, if you look just at the segmentation of the portfolio is probably focused on $300 million, $400 million of EBITDA and above, right, and that number has grown over time. And as I made the point in the prepared remarks, we do feel that if you look over a 10-year period, direct lending has continued to kind of show its value proposition to the larger companies. So I’ll see if we can dig around in the numbers a little bit and come up with an estimation, but I guess probably 10% or – just guessing, 10% or 20% of our deal flow is probably stuff that came to us as a result of the syndicated markets just sort of not working for a while.
But let me go front a few numbers with Scott and the team, and we’ll see if we can come up with something a little bit better than that.
Ryan Lynch: Sure and I appreciate that. I understand it may not be at your fingertips. The other question I had was, you just kind of talked about from a high level, probably some credit deterioration across the space, maybe in your portfolio, but maybe just across the space broadly. I think we were all a little bit surprised about how strong the economy was in 2023. Is your prediction or estimation that credit is going to probably deteriorate in 2024? Is that based on more of a slowing of the economy? Is that based on base rates just being elevated at the levels where they are now and that sort of finally having an impact on borrowers? Or is that based on some sort of just maybe credit normalization or a combination of all that? I just love that you could just unpack what gives you kind of the thought behind kind of saying that you expect credit…
Kipp DeVeer: Yes, again, it’s…
Ryan Lynch: …kind of deteriorate.
Kipp DeVeer: It’s probably the second one. I mean I share your comment that I actually think that the economy is proving to be more resilient than perhaps higher, a lot of other people expected. We all remarked a little bit that we’re – we report this EBITDA growth number on a quarterly basis, and we actually saw the first increase, right, on an LTM metric in a bunch of quarters, right, with EBITDA growth around 9% versus 6% the prior quarter. So the company performance is good. But I think to your question, it’s probably number two, which is just – it takes a little bit of time. And when you look at the underperformers, dealing with higher debt service costs because rates, as I said earlier, we think are likely to remain higher for longer.
It just continues to deplete cash flow and create issues for companies that probably hope they’d be delevering, but aren’t. So you really just look to the watch list and the non-accruals in our company and probably others and say they’re hanging on for now, but it’s probably just a matter of time before there needs to be a fix there, and that’s likely to create some more issues in defaults just as time moves along, right, and as things kind of mature a little bit in response to higher rates for a bit longer. But again, I don’t think it’s anything that we can’t handle, right? I don’t think it’s particularly severe. We have a very significant, as you guys know, portfolio management and risk management team and infrastructure to handle some of the underperformance.
So look, if we go through a more traditional credit cycle where defaults inch up and we have to resolve some more situations and then you start over and you continue to grow from a new base, I actually think that’s a pretty constructive backdrop for credit and for this company.
Kort Schnabel: Maybe just one other comment on the liquid syndicated market point because it’s certainly getting a lot of attention as we obviously knew the liquid syndicated market was going to come back, and we’ve been providing alternative solutions against that market for 20 years. And the value proposition of private credit only becomes stronger anytime we go through these periods of dislocation. So we kind of – we actually almost welcome back the syndicated market a little bit because it will increase transaction volume, heal the markets, and as Kipp mentioned in the prepared remarks, boost our structuring fees. So I think it’s just a continuation of what we’ve seen throughout our history but with further proof of our value proposition.
Operator: Our next question comes from Robert Dodd with Raymond James.
Robert Dodd: Good morning. I want to pile on and say congratulations to Scott and also say thank you to Penni for all the work she has done over the years helping build our areas but also the space as a whole. On – coming back to kind of a liquidity question because when I look at the numbers, I mean PIK collections with the lowest we’ve seen in many quarters, interest receivable was a high, you’ve mentioned that some of the borrowers across the industry are living more on the revolver. I mean – that certainly seems to be an inclination for borrowers to hang on to as much cash as they can for as long as they can. Do you think that could really accelerate if rates remain high for longer? I mean is this the beginning of a problem if rates don’t – a big problem, I mean obviously there is deterioration? But how does that tie in with how bad could it be if say rates are still 4.5% by the end of the year?
Kipp DeVeer: Yes, thanks Robert. I mean I’ll try to maybe reinforce some of the comments that I made but we’re not seeing an increase lately last couple of quarters in revolver draws, right. So again it would coach me to say look at the underperformers where we’re expecting to have to work things a little bit. But all in all, we think that the interest coverage levels have sort of bottomed 1.6%, 1.7%. We don’t think rates are obviously going up from here. And we think most of the companies in the portfolio when you think about non-accruals and percentage of the portfolio marked 1 and 2, which are kind of the underperformers, really have gone up the last couple of quarters and we’re well below 10%. So I think we know where the potential credit issues are in the portfolio and 90-plus percent of the portfolio is performing quite well and having no real issue with higher rates for longer, right?
The PIK interest is actually lower on a year-over-year basis and again we’re into these companies with very, very low loan to values. So it’s just thinking again about the ones and twos, the underperformers, and how we achieve resolutions there. But all in all, the portfolio is performing quite well and I think the economy, I think, it was Ryan’s question is better than we might have expected at this point after a pretty dramatic tightening cycle. So we’re feeling…
Robert Dodd: Understood. Yes, I mean and to your point I mean the draws on your delayed draw and your revolver commitment actually declined this quarter versus last quarter.
Kipp DeVeer: Yes.
Robert Dodd: So I mean that raises a hypothetical if you will. If a semi-struggling portfolio company would come to you and ask for a liquidity revolver what scale of concessions would you be looking for at this point from the company or sponsor? I mean would it just be a no or would it be something you would consider given the environment with appropriate levels of maybe Godzilla-like concessions?
Kipp DeVeer: Yes, I mean it’s hard to generalize in that every – every name is obviously different. In most of the situations where companies are perhaps not achieving the performance they were hoping for and have liquidity concerns we’re looking to the owners of companies to provide liquidity. And as I mentioned in the past we’re happy to be part of the solution where we can take a portion of our cash interest and perhaps convert to PIK for a short period of time but more often than not it really is on the owners of these companies to deliver solutions for us as the lender. So, I hope that answers the question, but this is the same as it’s always been.
Operator: Our next question comes from Mark Hughes with Truist.
Mark Hughes: Yes, thank you. Good morning. And congratulations Scott and Penni. It looked like you had the – there is more first lien activity in the fourth quarter and in January so far. Is that just what the better opportunities were or is there some intentionality there?
