Ares Capital (ARCC) Q2 2022 Earnings Call Transcript

Ares Capital (ARCC -0.77%)
Q2 2022 Earnings Call
Jul 26, 2022, 12:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good afternoon. Welcome to Ares Capital Corporation second quarter ended June 30th, 2022 earnings conference call. At this time, all participants are in a listen-only mode. As a reminder, this conference call is being recorded on Tuesday, July 26, 2022.

I'll now turn the call over to Mr. John Stilmar, managing director of Investor Relations.

John Stilmar -- Managing Director, Investor Relations

Thank you. Let me start with some important reminders. Comments made during the course of this conference call, and webcast, and an accompanying document 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 in its SEC filing.

Ares Capital Corporation has no obligation to update any such forward-looking statements. There's 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 the 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 core EPS to GAAP net income per share. The most directly comparable GAAP financial measure can be found in the company's slide presentation for this call. In addition, reconciliations of these measures may also be found in the earnings release filed this morning with the SEC on Form 8-K. All per share information discussed during this call is basic per share information.

The company's 10-Q filed the SEC this morning for more information. Certain information discussed in this conference call and the company's slide presentation, including information related to portfolio companies, was derived from third party sources and has not been independently verified. And accordingly, the company makes no such representation or warranty with respect to this information. The company's second quarter, June 30, 2022 earnings presentation can be found on the company's website www.arescapitalcorp.com by clicking on the second quarter 2022 earnings presentation link on the home page of the investor section of the website.

Ares Capital Corporation's earnings release and 10-Q also available on the company's website. I'll now turn the call over to Kipp DeVeer, Ares Capital Corporation's chief executive officer.

Kipp DeVeer -- Chief Executive Officer

Thanks, John. Hello, everyone. I hope you're all doing well, and we appreciate you joining our call today. I'm here with our co-presidents, Michael Smith, and Mitch Goldstein; our chief financial officer, Penni Roll; and several other members of the management team.

I'd like to start by highlighting our second quarter results, and then provide some thoughts on the changing market conditions, and how we're seeing things. This morning, we reported second quarter core earnings of $0.46 per share, an increase of approximately 10% compared to the first quarter, driven by the early benefits of rising interest rates, higher dividend income, and continued credit stability within the portfolio. Our NAV of $18.81 per share declined 1% quarter-over-quarter, largely due to unrealized losses we took to reflect wider credit spreads in the markets. These unrealized marks are to be expected, with more volatile markets.

However, I will say it's a welcome trend, as more volatile markets tend to provide more deal flow for direct lending participants, and most likely more interesting investment opportunities for the longer term. Volatility within the leveraged finance and equity markets continued during the second quarter, as central banks around the world became more aggressive in their fight with elevated inflation by rapidly raising interest rates. With this tightening monetary policy, our concerns over an economic slowdown or a recession have increased. Leveraged finance markets are experiencing significant spread widening, weak secondary liquidity, and minimal primary issuance, as the large banks are highly focused on working out their unsold inventory committed financing, many of which we believe are being held with significant losses.

During these times, we rely on a playbook that we've developed over the past 17 years. We try to be opportunistic on these situations with facts. We become incrementally more selective with our core deal flow, and focused on the highest quality investments, and to drive better pricing and terms. We aggressively manage our portfolio and we strive to build additional liquidity at the company.

Against this more volatile backdrop, the stability and scale of our capital is resulting in incremental demand from both our existing portfolio companies and from new borrowers, including some much larger companies that otherwise would turn to the liquid markets in less uncertain times. We believe our long standing and disciplined approach to investing has resulted in an attractive, highly diversified portfolio that is focused on upper middle market businesses that have significant long term franchise value and operate in resilient industries. Demonstrating our focus on diversification. Our average investment represents 0.2% of the portfolio, and this minimizes our exposure to any single portfolio company.

In addition, we focused on larger companies in recent years, and the weighted average EBITDA of our portfolio is now reached $179 million. This number is more than doubled over the past five years. Our experience in previous cycles has demonstrated that larger companies tend to be more resilient during market dislocation. All things being equal, we believe these larger companies have more diverse revenue streams, broader customer bases, deeper management teams, and more robust sources of capital.

These attributes should all serve to support the credit performance of our portfolio. While we recognize the increasingly complex operating environment that many companies face in today's economy, our portfolio companies are performing well. Our non-accrual cost remain well below our 10-year average, and we reported another quarter strong underlying portfolio company EBITDA growth. Furthermore, the weighted average loan to value on the aggregate loan portfolio remains comfortably below our five-year average of 51%, which reflects the significant structural support provided by the equity of our clients at both private equity backed companies and non-sponsored borrowers.

As we discussed our recent Analyst Day, we have a proactive and deeply embedded credit oriented culture. We believe our portfolio management team provides an important and differentiated element to our overall approach to risk management. During our quarterly portfolio review, our portfolio management team, alongside our deal team, put a heightened focus on the risks brought by today's high inflationary environment. While our analysis of our industry sectors and underlying company fundamentals is subjective, we take comfort that this quarter's review revealed only between 5% and 10% of our portfolio was in the higher risk category.

Specifically regarding the potential impact from inflationary pressures such as rising energy prices, supply chain disruption, and staffing shortage. Looking forward, we believe the continued increase in market interest rates presents a potential opportunity for the growth of our core earnings. Given our largely floating rate loan portfolio that is financed by mostly low cost, fixed rate, unsecured sources of financing. Penni will discuss in more detail.

If the full impact of the market rate moves this quarter had flowed through our entire quarter, we calculate that our second quarter core earnings could have been about 11% higher on a run rate basis. Additionally, said market rates increase 100 basis points from the June 30th levels, our quarterly core earnings could benefit by about $0.08 per share, or 17% increase over our second quarter core earnings. We believe the benefit of these market rate increases to earnings will be more impactful in the third quarter and beyond. We also do not believe the currently projected increase in rates will result in deteriorating credit performance.

Holding all else equal, including leverage at the borrower level, a 150 basis point increase in market rates would result in a weighted average interest coverage ratio in the portfolio of approximately two times. Importantly, this analysis doesn't consider any EBITDA growth or de-leveraging that is historically occurred in the portfolio. We feel good about the ability of our portfolio companies to navigate a higher rate environment. We believe these dynamics will further differentiator capital, many other income oriented alternatives in the market today.

Before I turn the call over to Penni, I wanted to highlight the dividend increase we announced this morning. As a result of our run rate core earnings outlook, and the expected further benefit from higher interest rates coupled with our strong portfolio performance, we increased our regular quarterly dividend to $0.42 per share to $0.43 per share for the third quarter. This amount is in addition to the $0.03 per share additional dividend that we've already declared for each of the third and fourth quarters this year. Let me now turn the call over to Penni to provide more details on second quarter results, and some other thoughts on the balance sheet position.

Penni Roll -- Chief Financial Officer

Thanks, Kipp. Good afternoon, everyone. Our core earnings per share of $0.46 for the second quarter of 2022 were $0.04 higher than a quarter ago, and down $0.07 from the same quarter a year ago. The second quarter of 2022 earnings were driven by strong recurring interest and dividend income, some higher one time nonrecurring dividends, and a solid level of capital structure and service fees from new originations.

Our GAAP earnings per share for the second quarter of 2022 were $0.22, which compares to $0.44 for the prior quarter, and $1.09 for the second quarter of 2021. Our GAAP earnings for the second quarter of 2022 included net realized and unrealized losses of $0.30 per share. The net realized and unrealized losses on our investments this quarter were largely a result of the unrealized losses we took for certain of our investments to reflect the current widening spread environment mentioned earlier. Our total portfolio at fair value at the end of the second quarter was $21.2 billion, and we had total assets of $21.8 billion.

As of June 30, 2022, the weighted average yield on our debt and other income producing securities at amortized cost was 9.5%, and the weighted average yield on total investments at amortized cost was 8.7%. The total investment yield at the end of the quarter increased approximately 60 basis points from last quarter, supported by the rise in base rates. As it relates to our future interest rate sensitivity, we remain well positioned to continue benefiting from a rising rate environment. As of June 30, 2022, 74% of our total portfolio at fair value was in floating rate investments.

As Kipp mentioned earlier, we expect continued increases in short term rates to have a positive impact on the net interest earnings performance of the company. For starters, we have yet to see the fourth quarter benefit from higher market rates that have already occurred in the second quarter. Given about 60% of the base rates for our floating rate loans currently reset every three months. And the increase in base rates through these research generally occurred in the latter part of the quarter.

Our second quarter earnings did not fully benefit from the increase in market rates reflected in our yields at quarter end. By holding all else equal for the second quarter, and assuming that the June 30th base rates were in effect for the fourth quarter, we estimate our second quarter core earnings would have been about $0.05 per share higher resulting in core earnings of approximately $0.51 per share, or about an 11% increase over our actual Q2 22 core EPS results. It is worth pointing out that this analysis does not forecast any other changes, including the incremental benefit from interest rate changes since June 30, 2022. To look at this with a longer term lens as of quarter end holding all else equal and after considering the impact of income based fees, we calculated that a further 100 basis point increase in market rates from June 30th could increase our annual earnings by approximately $0.31 per share, a 17% increase above this quarter's annualized core EPS.

We have provided details on our sensitivity to interest rate movements in this quarter's Form 10-Q for those who want to further examine these impacts. Shifting to our capitalization and liquidity during the quarter, we continued to enhance our liquidity by growing our committed debt capital more than $300 million by upsizing two of our revolving credit facilities. Aside from the base rate transition from LIBOR and SOFR, the terms of the two facilities remain the same, including the existing pricing. After considering our investment in capital activities during the quarter, we ended the second quarter with nearly $4.6 billion of total available liquidity, including available cash of $200 million and a debt to equity ratio net of the available cash of 1.25 times up from 1.06 times at the end of the first quarter.

Overall, with our significant [inaudible] and only $750 million in debt obligations maturing in the next 18 months, we believe our capital and liquidity remain one of our most significant competitive advantages, and positions us well to remain active patient investors. Before I conclude, I want to discuss our undistributed taxable income and our dividends. We currently estimate that our spillover income from 2021 into 2022 will be approximately $694 million or $1.41 per share. We believe having a strong and meaningful undistributed spillover supports our goal of maintaining a steady dividend throughout market cycles and sets us apart from many other BDCs that do not have this level of spillover.

This morning we announced that we declared a regular third quarter dividend of $0.43 per share, an increase to our regular dividend rate. The second such increase in the past year, the third such increase in the past six quarters, and our 53rd consecutive quarter of unchanged or growing dividends. This third quarter regular dividend is enhanced by the $0.03 per share additional third quarter dividend that we previously declared in February. Both are payable on September 30, 2022 to stockholders of record on September 15, 2022.

And now I'll turn the call over to Michael, to walk through our investment activities for the quarter.

Michael Smith -- Co-President

Thanks, Penni. I'm going to spend a few minutes providing more detail on our investments and portfolio performance for the second quarter, and then provide an update on post quarter end activity and our backlog and pipeline. During the second quarter, our team originated $3.1 billion of new investment commitments across 52 transactions in more than 20 distinct industries. 72% of the commitments issued were senior secured, and approximately 60% of the transactions were to incumbent borrowers.

As we noted in our Analyst Day, incumbent portfolio companies, which we have provided additional financings, have historically had greater EBITDA growth and stronger interest coverage ratios on average in comparison to the rest of our portfolio. We believe the opportunity to finance some of our best portfolio companies clearly provides informational and investing advantages. Additionally, we believe our track record and ability to finance a business as it grows continues to be a key differentiating advantage in today's dynamic market. Further to Kipp's point earlier about the upper middle market focus of our portfolio, the weighted average EBITDA of companies to whom we issued commitments during the quarter was $183 million as compared to the average EBITDA of exited investments of $102 million, while larger companies continue to be our focus.

We are reviewing transactions with EBITDA that ranges from approximately $10 million of EBITDA to more than $1 billion of EBITDA, and we continue to be very selective and only finance approximately 5% of the new deals we review. We believe that our selectivity and focus on high free cash flow businesses with market leadership positions ultimately results in a differentiated and attractively positioned portfolio. Our Portfolio company's performance during the quarter supports this view. The weighted average EBITDA growth of our portfolio companies over the last reported 12 month period was very strong at approximately 16%.

Importantly, this performance is broad based, with all of our top ten industry concentrations demonstrating a healthy level of positive EBITDA growth. It is also worth noting that industries where we have chosen to invest more heavily measured is industries that comprise 4% or more of the portfolio have experienced higher growth than the portfolio weighted average in aggregate. In terms of credit quality metrics, the weighted average portfolio grade at fair value for the quarter slightly improved to 3.2 and continues to be above the 10-year average of 3.0. Underscoring the overall stability of underlying portfolio companies, only 5% of our portfolio companies had a change in their portfolio grade this quarter, which is consistent with our five-year average.

We experienced more upgrades than downgrades for the quarter, which resulted in a decline in the number and percentage of our high risk grade one and grade two investments at fair value. Our non-accrual rated cost of 1.6% increased slightly from 1.2% at Q1 22, largely driven by the addition of one new non-accrual, but continues to be meaningfully below our 10-year average of 2.5%. Now, as Mitch and I do on a quarterly basis, I would like to shift our post quarter end investment activity and pipeline. From July 1st to July 20th, 2022, we made new investment commitments totaling $245 million, of which $142 million were funded.

We exited or were repaid on $379 million of investment commitments. As of July 20th, our backlog and pipeline stood at roughly $1.7 billion and $45 million respectively. Our backlog and pipeline contain investments that are subject to approvals and documentations, and may not close or we may sell a portion of these investments post-closing. I will now turn the call back over to Kipp for a few closing remarks.

Kipp DeVeer -- Chief Executive Officer

Thanks a lot, Michael. I conclude simply by saying, we believe that Ares Capital remains well positioned to navigate the economic and market uncertainty ahead. The stability of our capital, and our ability to be a strong and capable financial partner to our borrowers is likely to only be more valuable, and continue the trend of increasing borrower demand for private capital at scale. While we anticipate further market volatility and the potential for additional spread widening as the cycle progresses, we feel very good about our portfolio and the capabilities of our team.

The size and breadth of our teams experience through cycles positions us well to address any future challenges. We also feel the investing environment going forward should begin to look more and more attractive. There's confidence in our position, and the potential for meaningful earnings growth from rising interest rates is reflected in our election to raise our quarterly dividend. Like to finish quickly by taking a moment to thank our team, for their continued focus and dedication to the success of the company.

That concludes our prepared remarks. We'd be happy to open the line for questions.

Questions & Answers:

Operator

[Operator instruction] The Investor Relations team will be available to address any further questions at the conclusion of today's call. Our first question today comes from Melissa Wedel of J.P. Morgan. Please go ahead.

Your line is open.

Melissa Wedel -- J.P. Morgan -- Analyst

Thanks so much. The first question, I'm hoping that we can go back to the comment you made about the earnings potential being driven by higher rates into 3Q. I think you said it was an $0.08 increase potentially, and I guess I wanted to make sure I'm understanding sort of what's driving that. Is that based sort of 630 LIBOR rates? Or should we be thinking about that differently?

John Stilmar -- Managing Director, Investor Relations

Yeah, Melissa. I may put Penni in here to, I'm John for help on the numbers. It's a little technical in that the borrowers obviously reset LIBOR typically every three months. And the point is, as we got to the end of the quarter, we still had a bunch of companies that had not actually applied for their LIBOR resets, which when they do, will imply a much higher base borrowing rate.

So what we were trying to say is at the end of the quarter, if we pulled forward our expectation of what our interest income would look like with all of those LIBOR resets getting done, we're going evidence all that in Q3 we thought we had just $0.08 of additional earnings from where we kind of left off the June 30th. That makes sense?

Penni Roll -- Chief Financial Officer

Yeah. Maybe I'll just maybe add a couple minutes because I know we threw a lot of math at you on this, but kind of for this particular 100 basis points increase, there is some hypothetically, if you increase rates by 100 basis points from where we were on June 30, then we would have approximately $0.31 per year in additional core earnings, which translates to about $0.08 a quarter. Because we did not see the full benefit of rates in Q2, we're just saying further increases in base rates benefit the earnings. So the $0.08 is really more of the hypothetical side, where in addition to that, we said if you would have taken the full quarter of higher rates where they did reset to during the second quarter and had those rates in effect for the fourth quarter would have been $0.05 pro forma to Q2.

So you kind of have this $0.05 to $0.08 and there are two different metrics that work. But the second one is more just to say, look, we think we have further benefits from rising rates, and if you added 100 bps, it would be about $0.08 a quarter.

Melissa Wedel -- J.P. Morgan -- Analyst

OK. It does help. I appreciate that. I think.So on that potential 8% increase per quarter that you hypothetically laid out here, does that also include the impact of what we've seen on the dividend income line because we've seen a lot of growth there.

I know it's something you talked about in prior quarters, but I'm also wondering how much growth in dividend income from IHAM and recurring income in particular, are you sort of baking into that number? Thanks so much.

John Stilmar -- Managing Director, Investor Relations

So it doesn't include anything in regards to dividend income. In this quarter, we actually had a not necessarily expected one time dividend from an equity investment in a portfolio company, but then the [inaudible] share of the increase, as you can probably expect, is our continued investment in Ivy Hills. That's larger, it's going to just be paying us a larger dividend going forward.

Melissa Wedel -- J.P. Morgan -- Analyst

Thank you.

John Stilmar -- Managing Director, Investor Relations

Thank you.

Operator

Our next question comes from Finian O'Shea of Wells Fargo. Your line is open.

Finian O'Shea -- Wells Fargo Securities -- Analyst

Hi, everyone. Good afternoon. And another question on Ivy Hill, was the was the $379 million sold down this quarter, was that the total allotted amount from [inaudible] or are there other areas affiliated origination groups that may also syndicate down to two Ivy Hill?

Kipp DeVeer -- Chief Executive Officer

Yeah. That number is not part of the [inaudible] numbers. I just call that ordinary course then.

Finian O'Shea -- Wells Fargo Securities -- Analyst

All the 379 sold down was not. OK. That's helpful.

Kipp DeVeer -- Chief Executive Officer

That's right. [Inaudible] And with the analytic portfolio, I've held bought north of $1 billion of that portfolio. So those are two separate numbers.

Finian O'Shea -- Wells Fargo Securities -- Analyst

OK. Thanks so much.

Operator

Next in the queue today is Devin Ryan of JMP Securities, please go ahead.

Kevin Fultz -- JMP Securities -- Analyst

Hi. Thanks. This is Kevin Fultz on for Devin. Kipp, you mentioned that increased market volatility has led to an improved competitive environment with more attractive terms on new transactions.

I'm just curious if you could talk a bit about the shift to a more lender friendly environment and how that's materializing, both in terms of documentation and more specifically, if you could quantify how pricing has improved on the transactions.

Kipp DeVeer -- Chief Executive Officer

Yeah. I mean, I think we're in a bit of a volatile period. We made reference, obviously, to the fact that banks have underwritten some transactions that they are looking for liquidity on. Right.

That's probably going to continue through the remainder of the summer and even into the early part of the fall. So all it's done is simply widen what we're seeing in the public markets. And and thankfully now, I think we, and most of our other friends and competitors in the private lending space are widening pricing out as well. So, an early just preview is probably an additional 100 basis points of spread across most of the tranches as well as higher fees.

And we're also benefiting to your question from much more lender friendly documentation, reemergence of covenants and some of the smaller deals that perhaps tried to shed covenants during a frothy year period. So pretty much every aspect of the investing environment from pricing terms and documentation has all improved materially in the last 30 to 60 days.

Kevin Fultz -- JMP Securities -- Analyst

And then just looking at new commitment trends over the past two quarters, you've significantly reduced commitments to second lien loans. Just curious, is that mainly driven by less attractive spreads on second lien deals? Or is there an ongoing effort to reduce the mix of second loans in the portfolio given a more uncertain economic outlook?

Kipp DeVeer -- Chief Executive Officer

Yeah. I mean, I think, a little bit of that. I mean, probably less opportunity on the junior side. There are more unitranche is getting done.

But I do think also we saw got a large public facing credit platform here. So when we think about where we were in March and April, I think we took a pretty conservative tone around how we wanted to play at transitioning market. We might have been a little bit less busy than some others during the second quarter, certainly less busy than we could have been. But I think we were taking a bit of a pause as we expected a widening spread environment, and we were trying to make sure that we had capital here going through the summer into the fall to take advantage of kind of what we thought was an improving investment environment.

That's a little bit of everything, to your point.

Kevin Fultz -- JMP Securities -- Analyst

I'll leave it there, and congratulations on a really nice quarter.

Kipp DeVeer -- Chief Executive Officer

Thanks very much.

Operator

Our next question comes from John Hecht of Jefferies. Your line is open.

John Hecht

Morning, guys. Thanks very much for taking my questions. A quick question is, and this is sort of maybe a segue way from the last question a little bit. On your gross depreciation, Kipp, I think you cited that most of that was from credit spread widening.

Can you kind of allocate some of the gross depreciation to base rate changes versus credit spreads changes? I'm trying to just decipher how much of the change in your book value is tied to call it generic credit risk versus rates.

Kipp DeVeer -- Chief Executive Officer

Yeah. I mean I think, thanks for the question. We didn't see really material change in the overall credit in the portfolio. Most of what we observed was simply unrealized losses, pretty broadly across the portfolio in reference securities that we obviously look to to value the portfolio of mostly the loan market and the high yield market.

John Hecht

OK. And then just thinking about that, I mean, you guys obviously have a pretty detailed view and perspective on credit spreads. I mean, if you look at the past 15 years, including the great financial crisis, kind of where are we right now with respect to how credit spreads are impacting the market relative to, say, more extreme times? In other words, is do you see a lot more potential for widening spreads, or are we already at a point where the market's pressing and some stress pricing and some distress?

Kipp DeVeer -- Chief Executive Officer

I mean, it's a good question. I think, again, we're not seeing significant change in the overall credit metrics in the portfolio. That being said from evaluation, we're generally working off, April and May numbers. We're getting geared toward the end of the summer.

So I think the question will be what are the Q2 and Q3 numbers look like at some of these companies That's going to impact, I think, more potential stress in the portfolio than anything. Look, the other thing it's difficult to call right now, John, is everything's widening because there is this underwritten on syndicated backlog of some pretty large transactions that the banks are trying to clear out. And depending on how aggressive they are in clearing those, you can set some pretty low levels on price, which would imply very, very wide spreads. What I don't expect that's potentially come back, right, is deal flow is, I think a little bit lesser, and you don't have this unfortunate backlog of things to get to the market.

Look, I mean, I think you've had a very low base rate environment with base rates going up. Credit spreads typically only widen when you see defaults go up. And again, we're not seeing that really this is in our market in reference to the phenomenon of this summer and inventory trying to get cleared out. So we keep taking kind of a patient wait and see approach.

I don't have a great crystal ball on that one, I wish I did. But I think we're just taking a little bit of a patient wait and see approach as to how we get through the summer and into the fall.

John Hecht

Great. Thanks very much for the color.

Kipp DeVeer -- Chief Executive Officer

Thanks, John.

Operator

Our next question comes from Ryan Lynch of KBW. Please go ahead with your question.

Ryan Lynch -- Keefe, Bruyette and Woods -- Analyst

Hey, good morning, everybody. My first question is Ivy Hill has been just an incredible asset for you all. But my question is we've seen that have pretty considerable growth over the last four or five years, and really in particular the last last couple of years [inaudible] as well as the dividend growth of Ivy Hill. So could you talk about one, what is driving kind of the really accelerated growth that you guys are seeing achieving in Ivy Hill on the assets that are going in and what is what to sort of change in that marketplace, you kind of had that accelerated growth recently.

And then also, it's obviously done really well, generate very high income, but it's also becoming a very large portion of your portfolio now in a very diversified, kind of asset manager. It's not like individual, loan credit risk with that large investment. But is there any sort of size limitation? Is 8.5% your portfolio today? Is there any sort of cycle notation where you guys say, OK, this is enough, we're not going to grow this anymore?

Kipp DeVeer -- Chief Executive Officer

Yeah. I mean, there's not obviously it's a judgment call. It's been going up because they've done a great job, obviously managing portfolios of bank loan assets. And the cash on cash return, if you think about the dividend relative to the total investment we've made, has been very consistent and very attractive over a long period of time.

Look, when I see something that's 8.5% of the portfolio, it obviously begs the question you're asking, which is how large could it get? Should it get? Yeah, we just did a very large transaction. They're obviously buying this portfolio from [inaudible] They took out $1 billion of assets. We made a substantial investment in the company. That's a little bit of a needle mover for her this quarter relative to others.

But for me, and I would certainly pull the management team to for me, it's getting to be at the upper end, 8% or 9% positions is probably feeling pretty chunky. That being said, the underlying there is very diversified and we don't really have any concentration in terms of the dividend income coming from one particular investment there. So it's not something that's keeping me up at night, but it is starting to test the limits a little bit and is going to jump in here too.

Michael Smith -- Co-President

Yeah. One thing I want to make sure you understand interpreted the valuation of Ibos, there are a number of different mechanisms, right? There's the management fee as an asset manager, and we also invest in the subsurface of a lot of [inaudible] and levered loan funds that we manage because it's such a tremendous return for ARCC. Over our history, and remember, [inaudible] I think it has been around since 2010. We've had many times where other third party equity investors have invested in an [inaudible].

So if it ever came to a point and I agree with Kipp, it's getting up to the upper levels is probably still room to grow, but it ever came to a point, we've always had the ability to sell equity and continue to invest in the assets that drive the core of our business. So we have the many levers to pull to moderate the size of [inaudible].

Ryan Lynch -- Keefe, Bruyette and Woods -- Analyst

That's great.

Kipp DeVeer -- Chief Executive Officer

Hopefully that makes you understand and make sense.

Ryan Lynch -- Keefe, Bruyette and Woods -- Analyst

You know that that definitely makes sense. Any time spent a great asset. Just just you know, kind of where and how how do you guys feel comfortable with that? The other question I have, and I really do appreciate the color that you guys gave on kind of the run rate and in the quarter from kind of if you reset interest rates for the fourth quarter of Q2 and then also kind of the overall 100 basis points at the end of the quarter, you know, those statistics show and then kind of a forward LIBOR SOFR curve shows earnings are going to go up pretty meaningfully over the next several quarters likely. And so when I look at the core earnings today and the potential increases in the future, and then I look at your dividend that you have today and the one you declared for the third quarter, even with a $0.01 increase and then the $0.03, kind of special dividends you guys had at the end of the year, earnings look like they're going to be well above those combined when you kind of look at 2023 earnings potential.

And so can you remind us what are you guys thinking as far as dividend policies going forward? Is your expectation that kind of payout all of your earnings in the form of a dividend? And how you guys plan on achieving that via core dividends versus special dividends?

Kipp DeVeer -- Chief Executive Officer

Yes. So I, I think we all agree with your analysis. As you look forward, we think that we've got a great positive earnings trajectory here with a much, much higher base rate. We'd obviously been fighting these persistently low base rates for a long time, took advantage as an issuer.

But yes, we do pick up some very easy earnings going forward. And look, I'll just say, Ryan, we never talk about dividends beyond this quarter, but we felt highly confident in our ability to increase the dividend this quarter. And a couple that by saying we've also built a pretty substantial amount of spillover income, as you're aware, at the company. And I don't feel the need, frankly, to add any more to that number.

I could argue that number might even be a little bit high, which is why we've been using it to pay a special dividend throughout this year. So we feel good about the earnings trajectory and we feel good about the dividend where it is today and potentially growing from here.

Ryan Lynch -- Keefe, Bruyette and Woods -- Analyst

I appreciate the time today.

Kipp DeVeer -- Chief Executive Officer

Thanks for the question.

Operator

Our next question comes from Kenneth Lee of RBC Capital Markets. Your line is open.

Kenneth Lee -- RBC Capital Markets -- Analyst

Hi. Good afternoon, and thanks for taking my question. You mentioned in the prepared remarks in terms of the internal credit ratings, you saw more upgrades and downgrades within the portfolio. Just want to get a little bit more details behind, perhaps some of the drivers behind more of those upgrades.

Thanks.

Kipp DeVeer -- Chief Executive Officer

You know, it's what you'd expect. It's generally all around good credit performance. As we mentioned, we had one name that we had to add to non-accrual, which was a pretty, pretty small number in well below sort of our historical average, if you look. But now it's a large diversified portfolio kind of thing.

There's nothing in particular to pull out there. I'd say it was good credit performance all around, a couple of equity gains, I think in certain areas that probably moved that number up a little bit. But, there's it's a pretty broad and diversified portfolio. I don't think there are any big takeaways that that are worth sharing.

Kenneth Lee -- RBC Capital Markets -- Analyst

Got you. And just one follow-up question, if I may. I wonder if you could talk a little bit more about or share your thoughts on how leverage could spread over the near term. Just given the activity out there.

Kipp DeVeer -- Chief Executive Officer

Yeah. So we had a busier quarter, the annually, situation and the upsides that IBL kind of got us to a point where our leverage is now at the upper end of our target range at about 1.23 I think times on a net basis. Frankly, in a more volatile market like the one we're experiencing, I'd like to have that number come down. I think we all would.

That being said, the ability to upsize that IBL and the ability to make that portfolio acquisition that we did was just too attractive. So we we pushed the leverage to the upper end. But I think the goal longer term would be to be managing that down here in the third and fourth quarters.

Kenneth Lee -- RBC Capital Markets -- Analyst

Got you. Very helpful. Thanks again.

Kipp DeVeer -- Chief Executive Officer

Thank you.

Operator

Next, we have a question from Robert Dodd of Raymond James. Please proceed.

Robert Dodd -- Raymond James -- Analyst

Hi, everyone. Congrats on the quarter and the outlook. A question, kind of a bigger picture question in your size of your borrower has gone up a lot, and you've made comments about how those are more stable businesses, etc., etc.. Have a question.

Generally speaking, I would imagine you get to almost $200 million businesses. These are global businesses. The economic outlook right now to me looks a lot better in this headwinds in the U.S. But compared to Europe, for example, the clouds, they're less dark.

So can you give us any color on how much of the end customer demand for some of these larger businesses comes from those international markets where the economic outlook might be more troubled? And do you have any concerns on that front. Obviously, it might not showed up in the numbers yet because it's still more looking, looking backwards that again, the offset is affects can help on that side as well. So any color there. 

Kipp DeVeer -- Chief Executive Officer

Yeah. I mean, it's a good question. With the 400 name portfolio, I can't say I can actually give you an answer. We'd have to go back and dig through a lot of data.

For the most part, despite the size of these companies, they are U.S. companies. Right.  That's the primary focus of what we do here. We've got a very large business over in Europe, too, but we choose to do that away from the BDC.

So certainly with some of these businesses being large and global, I share your concern as we think about risk management. Europe does look more difficult I think, to your point than, than it does over here in the US. But just trying to get to the risk. In the heart of your question, we don't see any unusual risks in our portfolio where we're heavily weighted to Europe because we tend to be in some larger companies than other BDCs.

But again, we'd have to go through a whole lot of data to get a really good answer on that.

Robert Dodd -- Raymond James -- Analyst

I mean, just to follow, to hound you a little bit deeper, I mean S&P I think the estimate is 40 to 50 of the US domiciled companies obviously, but 40% to 50% of revenues are international. Do you have a ballpark estimate? Very ballpark. Maybe Yankee Stadium size. I mean,

Kipp DeVeer -- Chief Executive Officer

I would ballpark guess, that is I would guess that it is much, much lower. If you think about the industries in the sectors that we're in, the U.S. healthcare companies, software businesses, etc., I mean, a lot of this business is getting done in the States, Robert. So 40% in the S&P, that's a very large number, I think relative to where I would even guess at our portfolio.

I would guess that we're at like a ten relative to a 44 year index.

Robert Dodd -- Raymond James -- Analyst

Got it. Thank you. OK, perfect.

Kipp DeVeer -- Chief Executive Officer

Thanks for the question.

Operator

Our next question today comes from John Rowan of Janney Montgomery Scott. Please go ahead.

Unknown Speaker

Hi. This is [inaudible] on behalf of John Rowan. We're the unrecognized losses on directly originated loans or broadly syndicated loans.

Kipp DeVeer -- Chief Executive Officer

Both, I would assume.

Unknown Speaker

Is there any way to get a better breakdown on either or is that just altogether you're reporting the.

Kipp DeVeer -- Chief Executive Officer

Yeah. I mean we can probably go off line and pull that for you guys. I don't have it at my fingertips. I mean, the reality is most of what we're doing is directly source ones.

We don't have a lot of broadly syndicated loans on our balance sheet. But the larger borrowers, right. Large group of companies probably have quotes. And obviously we don't we, don't ignore quotes.

We look at even in a thin market, something that's quoted and we'll typically use that. But, again with there's not a significant focus at ARCC on broadly syndicated loans.

Unknown Speaker

All right. Thank you very much.

Operator

[Operator instruction] Our next question comes from Casey Alexander from Compass Point. Please go ahead.

Casey Alexander -- Compass Point Research and Trading -- Analyst

Hi. Good afternoon. This is Casey Alexander on behalf of Casey Alexander. It's just, I'm just kind of wondering this period of economic uncertainty or potential recession that we may or may not be going into or already in, seems is obviously far more telegraphed than the COVID recession.

And it allowed you to do an analysis that said 5% to 10% of your companies are in higher risk categories from inflation and supply chain impacts. Does the telegraphed nature of this particular cycle, as we go into it, give you a better opportunity to work with your portfolio companies, and just give them a better opportunity to prepare for it by bolstering balance sheets, managing expenses, And would it be your expectation that there would be a better outcome through this cycle of companies that are at a higher risk category than perhaps in the past?

Kipp DeVeer -- Chief Executive Officer

I think it's a great question. I think the simple answer is yes. And as we're all looking at our crystal balls, this is a situation,  we have a team here that's been doing this together, prior to even getting to areas 20 plus years. This to me feels like a very traditional, although being influenced by different reasons, credit cycle, right? Where you're going to have companies that are having more trouble operating.

And I do take your point. When you look back at Kobe, that was very unpredictable, something that we'd never experienced before that impacted portfolio companies in a way that we probably couldn't have expected on underwriting, and the credit cycle prior to that, for me in the GFC was really much more of a banking crisis, right, and something that was influenced away from traditional corporate credit. So we're taking some satisfaction that we've got a playbook to handle a more traditional credit situation. So, our deal teams and our portfolio management teams are obviously in regular contact with borrowers and with private equity firms.

But I think to your point, everybody sees what's happening now, and it's not happening so quickly that you can't take measures to mitigate and help companies operate through this. It feels like a much more traditional credit cycle, and we've got a very experienced team that I think knows how to navigate through that. So.

Casey Alexander -- Compass Point Research and Trading -- Analyst

All right. Great. Thanks for answering my question. I appreciate it.

Kipp DeVeer -- Chief Executive Officer

Thanks for representing yourself.

Operator

And finally, we have a follow up question from Ryan Lynch of KBW. Your line is open again.

Ryan Lynch -- Keefe, Bruyette and Woods -- Analyst

Hey, I just have a couple more questions. I appreciate the time. You mentioned earlier you prepared remarks, turning to [inaudible] new larger borrowers that would normally turn to the broadly syndicated Walmart. And now that those are under under some more stress, that you have the ability to underwrite some of those deals.

I know in the past some of the deals that could happen on the broadly syndicated loan market that maybe once the direct were out. I know in order to make the yield profile, sometimes you are participating in the second lead for those positions and you felt comfortable as such just because they were larger, safer borrowers. I'm just curious with that, with the kind of the stress and the uncertainty with the broadly syndicated loan market, as well as the increase in base rates we've seen recently. Are you able to participate in more of these in more traditional first lean or unitranche positions than you have in the past?

Kipp DeVeer -- Chief Executive Officer

I mean, I think what we're seeing, Ryan, because the traditional sort of bank led syndicate in a first lien, second lien or first lien sort of high yield issuances. It's just kind of really not there, particularly on the junior side. I mean, the market, I don't want to say is closed, but it's generally not operating very well around rated LBOs, getting sold by underwriters to new investors. So what's happening is there's a desire in particular on the parts of private equity firms and doing LBOs to find partners that they feel can offer certainty of closing.

And the preponderance of some of these larger unit tranches is help solve that. Right. That being said, we're trying to find the right balance between extracting better terms and extracting higher fees. There is sort of one of the few games in town that are available for those types of transactions.

And the good news is, is we're able to to push it there, but it doesn't happen overnight. But no, not nothing's different. I mean, I think we're as well positioned as we've been in past cycles where volatility comes in and makes the capital markets less reliable. We become, again, more reliable.

But you're right, the only difference maybe is the numbers are a little bit larger these days because we're bigger, and a lot of our competition is bigger.

Ryan Lynch -- Keefe, Bruyette and Woods -- Analyst

OK. That's helpful. And then the last one that I had was, obviously, you guys had put up very strong results, I would say, this quarter, the results, the volatility in the marketplace. But overall book value held up well, and non-accruals are still pretty strong, and well below your guys historical average.

So very good result. But I think everybody in the BDC, especially BDC investors are worried about kind of what is the next 12 months look like from a credit quality standpoint. You guys provided a statistic in your slides. I think they did mention on the call 60% EBITDA growth in your portfolio companies over the last 12 month period.

But I think the question that I think a lot of investors have, and I'm not sure if you get this with data from your portfolio companies, if you guys work on this, do you guys get any sort of forecast from portfolio companies of what they are expecting from an EBITDA growth over the next 12 months? Do you guys have any sort of forecasts that that you guys provide? Because I think that is kind of the real crux. And that's what really I think investors are worried about is what happens over the next 12 months in these portfolio companies.

Kipp DeVeer -- Chief Executive Officer

Well, I mean, I think there's there's some math. Yeah. I mean, that's obviously what we're talking about all the time here.  So, I mean, I share some concern. Am I truly worried? I actually think that with slower growth, which we will likely see again, because we're comping off some some COVID numbers.

Right. So there's a little bit of a nuance there. But yeah, I would expect slower growth in the portfolio. I think I've said publicly too, we would expect defaults broadly will go up.

That being said, we've always been able to manage those aspects of the company better than most. So we feel pretty confident. But yeah, I mean, I share your forecast for probably not as rosy a back half of the year as we've seen for the first 4 to 6 months of this year. And probably a little bit tougher sledding.

But again, a traditional credit cycle where two cases question, we can be out early, we can be proactive with companies expecting a weaker second half. It really doesn't keep me up at night. I mean, that's that's kind of what we do here during periods of less certainty and more volatility. As we obviously manage credit, we try to minimize non-accruals and losses, and we push forward.

But I share your concern and others.

Ryan Lynch -- Keefe, Bruyette and Woods -- Analyst

OK. And I appreciate the follow-up question. 

Kipp DeVeer -- Chief Executive Officer

Yeah. Thanks, Ryan.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Kipp DeVeer for any closing remarks.

Kipp DeVeer -- Chief Executive Officer

Hello, just thanks for everybody attending. We're happy with the quarter. Hope you enjoy the month of August and get some time with your friends and your families, because I think it's going to be an interesting one as we get positioned here for September and beyond. But thanks again for attending for that.

Operator

[Operator Signoff]

Duration: 0 minutes

Call participants:

John Stilmar -- Managing Director, Investor Relations

Kipp DeVeer -- Chief Executive Officer

Penni Roll -- Chief Financial Officer

Michael Smith -- Co-President

Melissa Wedel -- J.P. Morgan -- Analyst

Finian O'Shea -- Wells Fargo Securities -- Analyst

Kevin Fultz -- JMP Securities -- Analyst

John Hecht

Ryan Lynch -- Keefe, Bruyette and Woods -- Analyst

Kenneth Lee -- RBC Capital Markets -- Analyst

Robert Dodd -- Raymond James -- Analyst

Unknown Speaker

Casey Alexander -- Compass Point Research and Trading -- Analyst

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