Michael Arougheti: Yes. I don’t really know — to your point, I don’t know where that’s coming from and you can’t paint the entire private credit market with the same brush. I’ll make a couple of comments. I do think that in some of these private executions that are syndicated loan proxies, one would expect that some syndicated loan documentation terms would find their way into the private market. That to me is not really newsworthy or noteworthy. In the core middle market, that is not the case. The structures continue to be strong. They’re as good as we’ve ever seen the pendulum has swung to be obviously more lender-friendly than borrower-friendly. And so it feels a little sensational, but — and I would expect that, that will continue.
The other thing I would just point out, if you actually go back and look at the history of covenant-light loans, there’s no evidence to say that covenant-light loans actually performed worse than covenanted loans. And I think the reason is twofold. One, the best quality credits are those that can actually command better structures. And number two, sad as it may be, oftentimes in syndicated structures, many of the participants in those syndicates of different structural constraints or agendas and so when you get into a restructuring conversation, you may have a CLO that can’t put new money in or can’t take a ratings downgrade. You may have a credit fund that is at the end of fund life and can’t participate in a junior security. And so, there’s all sorts of friction that you see in those syndicated loans that, frankly, when you have no covenants, it’s protective of value.
And I think that’s you could argue pretty strongly the covenant-light loans for the best borrowers will actually outperform. That’s actually what we saw happen through the GFC. I’d make one last comment, which is why I think everybody is so excited about private credit relative to traded credit, at least vis-à-vis defaults and loss given default. When you are in a private credit instrument, covenanted or not covenanted, it’s a bilateral agreement between a borrower and a lender or a very small lender group and there is no ability for anyone else in the market with a different agenda or different entry point to come into that security and destroy value. And oftentimes, in the traded market, obviously, you can see people coming into capital structure and being disruptive in a way that you just don’t see in the private market.
So even in the absence of covenants, they performed differently because you restructure them through a bilateral negotiation between borrower and lender and the deals that are getting done are no different than what we’ve seen for the last 30 years.
Patrick Davitt: Excellent. Thank you.
Operator: And our next question comes from the line of Mike Brown with KBW. Please proceed with your question.
Mike Brown: Great. I just wanted to follow up on the European waterfall fund dynamic. So Jarrod, it sounds like the amount that you guys were guiding to for the cumulative 2024 and 2025 period would be about in line with the base estimate that you had talked about in the past. You did talk about potential for a high estimate of 650 previously, if I recall correctly. So should we just assume that, that perhaps has been pushed out based on some of the duration commentary that you talked about, or does that high estimate still hold and it’s just a matter of the range is still somewhat wide and timing is still relatively uncertain at this point?
Jarrod Phillips: I think it’s more a case of that. It’s — in terms of looking at the overall environment, again, as I mentioned earlier in the call, if we start to see repayments happen faster, well, you’re going to come closer to that higher end of the range because you’re pulling a lot of that up. We’re trying to be as accurate as we can with that lower end of the range. But yes, I wouldn’t say that there’s really a change to the range. The good news is as I mentioned earlier, again, is that the crude balance continues to grow, and this is actually an advantageous market for that to be occurring in terms of extending the duration.
Mike Brown: Okay. Great. Thanks for that clarification. And I guess, the credit metrics, they just continue to hold up really well and seem to really be outperforming expectations. What is really kind of driving that strength in your view here, particularly for Ares? And then when does the pressure from higher rates on cash flows really start to have a greater impact? What kind of be your outlook here on the credit side, if we think out over the next 12 months to 18 months?
Michael Arougheti: It’s funny because we have not been in the recession camp for quite some time. And I think everyone just continues to hope for it, for some reason, it’s just not coming. And the simple answer without being cheeky is we just put up a 4.5% plus GDP print in the quarter and the economy is really strong, and we’re seeing that play out in our portfolios, and we’ve tried to articulate that one of the benefits that we have, given the breadth of our platform is that we’re seeing private market information roll through on a monthly basis. And for the most part, we’re seeing broad strength. There are obviously pockets of the economy that are weakening. There are certain segments of the consumer economy that are weaker, but taken in the aggregate, it paints a picture of continued economic strength.
I think Kipp and the team have done a good job talking about the credit metrics at ARCC, and I’d reiterate they’re consistent across the private credit book. But the biggest protection is coming from the loan to value positioning of those portfolios and the continued growth in EBITDA, which is obviously promoting dollar deleveraging. If you look at where those books sit today, they’re at about 1.6 times to 1.7 times interest coverage ratio on a very conservative definition of interest coverage, meaning pro forma for today’s rate environment, not trailing. And I think we all would agree that whether we get one or two hikes here that we’re towards the end. And so I think we feel more confident that we have, that we know that we’re in a safe place in terms of the interest coverage ratio.
Obviously, at these levels, if rates stay higher for a longer, any diminishment in fundamental performance, you’ll be having more conversations with more owners of companies and assets that we’re having now but again, I just want to highlight that is not necessarily a bad thing for credit performance. And if the past is any indicator, that probably has those books generating higher net rates of return, given their ability to participate in equity value and to get incremental margin and fees. And so again, I think the books are in a really good spot right now.
Mike Brown: Okay. Great. Thank you, Mike and Thank you, Jarrod
Operator: And we have reached the end of question-and-answer session. Therefore, I will turn the call back over to Michael Arougheti for closing remarks.
Carl Drake: Operator, Craig Siegenthaler missed the answer to one question, so we’re going to repeat that before Mike’s closing remarks. Craig asked what verticals in the alternative credit space as he most focused on or we’re most focused on, what are we avoiding and as Ares need to move this business further horizontally to fill in additional white spaces where you might now have investment staff today.
Michael Arougheti: Sure. So I hope what I say now is consistent with what I said before, at least for what you guys heard. Look, the simple answer is I do not think that we need to add capability. One of the reasons why our business is growing the way that it is, is that we are one of the larger teams and one of the better capitalized platforms in the market. We have a fully developed capability around most of the important relevant large segments of alternative credit, and that is a big advantage. This is a market that like other parts of the private credit landscape is moving to scale. We’re obviously growing alongside of it. And as we grow, we continue to invest in capability, both in different geographies and around different asset classes.
