Ares Capital Corp (ARCC) Q4 2022 Earnings Call Transcript

Ares Capital Corp (NASDAQ:ARCC) Q4 2022 Earnings Conference Call February 7, 2023 12:00 PM ET

Company Participants

John Stilmar – MD, Public IR & Communications

Kipp DeVeer – CEO & Director

Penelope Roll – CFO

Kort Schnabel – Co-President

Conference Call Participants

Melissa Wedel – JPMorgan Chase & Co.

Ryan Lynch – KBW

Casey Alexander – Compass Point Research & Trading

Robert Dodd – Raymond James

Erik Zwick – Hovde Group

Kenneth Lee – RBC Capital Markets

Kevin Fultz – JMP Securities

Mark Hughes – Truist Securities

Operator

Good afternoon, and welcome to Ares Capital Corporation’s Fourth Quarter and Year Ended December 31, 2022 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded on Tuesday, February 7, 2023.

I will now hand the call over to Mr. John Stilmar, Managing Director of Ares Investor Relations. Please go ahead.

John Stilmar

Good afternoon, everybody. Let me start with some important reminders. Comments made during the course of this conference call and webcast as well as 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, 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 operation. A reconciliation of core EPS to basic and diluted net income per share, the most directly comparable financial measures can be found in the accompanying slide presentation for this call.

In addition, the 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 in this conference call and the accompanying 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 representation or warranty in respect of this information. The company’s fourth quarter and year-end December 31, 2022 earnings presentation can be found on the company’s website at www.arescapitalcorp.com by clicking on the fourth quarter 2022 earnings presentation link on the home page of the Investor Resources section. Ares Capital Corporation’s earnings release and Form 10-K are 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

Thanks, John. Hello, everyone, and thanks for joining our earnings call today. I’m here with our Co-President, Mitch Goldstein and Kort Schnabel; our Chief Financial Officer, Penni Roll; our newly appointed Chief Operating Officer, Jana Markowicz and other members of the management team. For those of you who don’t know ready know, Jana has been an important member of the Ares direct lending team for over 18 years, and we’re delighted to have joined the executive team at Ares Capital.

Jana currently serves as a Chief Operating Officer, Head of Product Management and Investor Relations for our U.S. Direct Lending strategy. Our newly pointed President, Kort Schnabel will speak later in the call, but I’d like to formally welcome him as well. Kort has been instrumental in helping us grow and manage the U.S. Direct Lending business over the last 19 years, and we’re thrilled to have him on board. A warm welcome to both of them.

This morning, we reported strong results for the fourth quarter and the full year. We generated record quarterly core earnings per share, $0.63. This 26% quarterly increase in core earnings was largely driven by the benefit of rising market interest rates and our net interest income, but also from strong capital structure and fee income on the fourth quarter transactions.

For the year, our core EPS of $2.02 matched from a prior record in 2021. On a GAAP basis, our fourth quarter and full year earnings of $0.34 per share and $1.21 per share, respectively, were below our core earnings and has been recognised $0.03 per share and $1.08 per share, respectively, of net unrealized depreciation due largely to widening market yields.

Despite these markdowns, which we’ve taken stride with the transitioning market, we generated net realized gains from the full year 2022 as we continue to deliver positive realized gains in excess of our losses. The realized gains and losses is the more important metric in grading our performance than the unrealized gains and losses, which has substantially less impact on our long-term results. In our view, our track record of strong credit performance compared with other BDCs demonstrates the merits of our long-tenured proven investment process as we work to deliver differentiated results to our shareholders.

I’d now like to shift and provide some thoughts on the market and the economic environment. 2022, as a year of transition for the U.S. economy and one that brought significant volatility to the capital markets. As overall capital formation slowed in both the liquid and private credit markets, we believe the competitive dynamics and the risk-reward environment for Ares Capital shifted positively can be as attractive as we’ve seen in quite some time.

Market spreads on new deals are at least 100 to 150 basis points higher than at year-end 2021, and we believe that the total return opportunity afforded by the higher base rate in addition to the spread expansion is very compelling. These enhanced economics are being achieved in transactions that also have reduced leverage and meaningfully better documentation. We think this is an exciting development for our new investment business, and we remain active in the market.

To dig in a bit deeper, the senior loans that we originated in the fourth quarter had a weighted average yield of more than 10.5%, with weighted average leverage less than 5x debt-to-EBITDA. Many of these investments focused on larger businesses. We provided loans to companies with a weighted average EBITDA of more than $500 million in the fourth quarter.

We believe the volatility of 2022 also continues to widen the fairway for us and to expand the market in direct lending generally. Larger companies continue to shift their focus to private capital alternatives as a preferred and more reliable source of financing for their businesses.

And with challenges faced by the banks due to risk capital constraints and the lack of liquidity in the syndicated market, we believe private lenders have steadily gained share throughout 2022. This has led to our involvement with larger companies.

At year-end 2022, the weighted average EBITDA of our portfolio companies reached $275 million, an increase from $162 million at the end of 2021 and meaningfully above the weighted average from 5 years ago of $62 million. We believe this offers significant benefits to Ares Capital as we grow as larger companies generally have stronger credit profiles as a result of more diverse revenue streams, broader customer bases and more experienced management teams.

As demand for our capital solutions has grown, we’ve responded by continuing to augment our direct origination capabilities through continued hiring and the addition of new capabilities. Today, we believe we employ the largest direct lending team in the United States with approximately 170 dedicated investment professionals. We believe that the scale of our team enables us to have complete market coverage by industry and by geography and to drive compelling opportunities in every channel that we target.

For example, despite a 22% drop in U.S. M&A volumes, and a 45% decline in broadly syndicated transaction volumes in 2022, we reviewed more than $500 billion in transactions. This volume is comparable with or even slightly higher than the amount we reviewed in 2021, which was the busiest year in the company’s history. Despite this, during periods of volatility, our inclination is to become incrementally more selective on new deals and utilize the experience of our large and tenured portfolio management team to focus on risk management efforts.

We do have an expectation that a slower U.S. economy and the higher rate environment will create more stress in the portfolio, and we’re focused on getting ahead of it as we have in past economic and market cycles. Led by partners with an average of over 15 years tenure at Ares, we believe we have the largest and most experienced portfolio management team when compared with other direct lenders. And this team works in collaboration with our core investment teams to actively monitor and engage with our borrowers and sponsors.

Our goal is to identify problems early and develop strategies to maximize our outcomes in companies that are underperforming to plan or having more difficulty in the higher interest rate environment. The economic benefits from our credit and portfolio management process have led to a strong culture focused on downside protection and risk mitigation in our lending activities. Since inception, Ares Capital has generated a cumulative 1% net realized gain rate on our investments. This means that along with generating gains on many investments, we have also successfully minimized losses in the portfolio in more difficult times.

One statistic to call out here, we’ve actually achieved about 0.9x multiple on invested capital on all the loans that have been placed on nonaccrual over the years. Despite the more challenging backdrop and the higher prevailing interest rates, we feel the portfolio is defensively positioned today due to our long-standing underwriting strategy of focusing on market-leading companies with high free cash flows and what we believe to be resilient industries.

Using market interest rate levels at year-end, our overall interest coverage for the total portfolio was 1.8x. These strong coverage metrics allowed us to receive 99% of contractual interest in our portfolio during the fourth quarter. The health of the portfolio is also demonstrated by stable weighted average portfolio grade and nonaccrual rates to remain quite low relative to historical averages. Finally, the strength of our portfolio continues to benefit from the substantial amount of equity invested in our companies. Most often from large and well-established private equity firms.

At year-end 2022, we calculated the weighted average loan-to-value in the portfolio to be approximately 45%, which we believe gives us strong cushion to the downside in these loans. These metrics, along with our positive view of the company’s earnings power, support of our decision to increase our regular quarterly dividend 3x during 2022, moving from $0.41 per share in the fourth quarter of 2021 to $0.48 per share in the fourth quarter of 2022 which builds on our long-term track record of delivering consistent dividend growth.

2022 represents our 13th consecutive year of stable or increasing regular dividends to our shareholders. Supplementing this growing regular dividend, we paid $0.12 per share of additional dividends in 2022, resulting in $1.87 per share of dividends for the year, which represented a 15% increase in total dividends versus 2021.

With that, let me turn the call over to Penni to provide more details on our financial results and some further thoughts on our balance sheet.

Penelope Roll

Thanks, Kipp. For the fourth quarter of 2022, we had a record level of core earnings of $0.63 per share compared to $0.50 per share in the prior quarter and $0.58 per share in the fourth quarter of 2021.

For the full year 2022, our core earnings per share was $2.02, matching the core earnings per share for 2021. Our 2022 earnings significantly benefited from the increase in market interest rates driving a 17% increase in net interest and dividend income per share as compared to 2021. The growth in these recurring earnings roughly offset the decline in capital structuring fees in 2022 relative to the higher fees earned during the more active 2021.

On a GAAP basis, we reported GAAP net income per share of $0.34 for the fourth quarter of 2022 compared to $0.21 in the prior quarter and $0.83 in the fourth quarter of 2021. For the year, we reported GAAP net income per share of $1.21 compared to $3.51 per share for 2021.

Our core earnings for 2022 as compared to 2021 and was stable year-over-year, where our GAAP net income for 2022 was reduced by the net unrealized depreciation taken on the portfolio throughout the year, driven primarily by market volatility. Conversely, our GAAP net income for 2021 benefited from the net unrealized appreciation seen on the portfolio throughout that year as we saw a rebound from valuation declines incurred in 2020 as a result of COVID. While we have seen volatility in asset values over the past few years, our underlying portfolio continues to perform well through this volatility, as Kipp mentioned earlier.

Our stockholders’ equity ended the year at $9.6 billion or $18.40 per share compared to $9.4 billion or $18.56 per share at the end of the third quarter 2022 and $8.9 billion or $18.96 per share at the end of 2021.

Our portfolio at fair value at the end of the year grew to $21.8 billion, up modestly from $21.3 billion at the end of the third quarter and more meaningfully from $20 billion at the end of 2021.

The weighted average yield on our debt and other income-producing securities at amortized cost was 11.6% at December 31, 2022, as compared to 10.7% at September 30, 2022, and 8.7% at December 31, 2021. The weighted average yield on total investments at amortized cost was 10.5%, which increased from 9.6% at September 30, 2022, and 7.9% at December 31, 2021. The yields on our portfolio reflect rates given our predominantly floating rate loan portfolio.

Shifting to our capitalization and liquidity. We ended the fourth quarter with a debt-to-equity ratio net of available cash of 1.26x. Pro forma for the $223 million equity offering that we closed in January of 2023, our debt-to-equity ratio, net of the available cash declined to 1.21x. Our liquidity position remained strong with approximately $3.9 billion of total available liquidity, including available cash, pro forma for our financing activities in the beginning of this year.

After accounting for the $750 million of unsecured notes that come due this month, our next nearest debt maturity is not until March of next year. With this level of dry powder, we believe that we remain well positioned to take advantage of the current investing environment. As Kipp stated earlier, we declared a first quarter 2023 dividend of $0.48 per share. This dividend is payable on March 31, 2023, to stockholders of record on March 15, 2023, and is consistent with our fourth quarter 2022 dividend.

We continue to consider our taxable income and the amount of spillover when setting our overall dividend. We recognized that we had a strong level of core earnings for the year, which far outpaced the total dividends we paid. When looking at our taxable income for the year, our current estimate of undistributed taxable income sometimes referred to as our spillover at year-end 2022 is $675 million or approximately $1.27 per share after considering the shares issued in our January equity raise.

This spillover reflects the realization of a tax deduction related to a legacy Allied Capital investment which reduced our total taxable income for the year and thus reduced our spillover.

After considering this deduction, our estimated spillover for 2022 is generally in line with the $678 million that we carried over last year. Importantly, this 2022 spillover level is more than 2.5x greater than our current regular quarterly dividend rate.

We continue to believe that having a healthy level of spillover income is beneficial to the stability of our dividend. We will continue to monitor our undistributed earnings and balance these levels against prudent capital management considerations.

With that, I would like to welcome Kort to his first Earnings Call and will now turn it over to him to walk through our investment activities.

Kort Schnabel

Thanks, Penni, and hello, everyone. Before I get started, I just want to say, after 21 years at Ares I could not be more excited to serve as new Co-President of Ares Capital Corporation and for the opportunity to help lead our company into the future.

I look forward to spending more time with all of you on the phone here in the months and years ahead. Okay. Let’s move it forward, and I can provide more detail on our investment activity and portfolio performance for the fourth quarter. I will then conclude with an update on post quarter end activity, backlog and pipeline.

Over the course of 2022, we completed over 180 investments across 23 distinct industries. In line with the overall loan portfolio, the top 3 industries where we made new financing commitments in 2022 were software and services, health care services and commercial and professional services. Our new investments were made into what we believe are high-quality companies, which present opportunities for attractive risk-adjusted returns, driven by lower leverage levels, tighter credit documents and higher spreads.

As we’ve seen in the past, periods of volatility amplify the secular shift towards private capital. This dynamic is clearly illustrated by LCD’s recent report which shows that 98% of the new LBO issuance in the fourth quarter of 2022 was completed by private capital providers, a market traditionally supported by the broadly syndicated channel. We believe that our scale, competitive position and flexible capital have enabled us to take advantage of these opportunities.

Importantly, we were a lead arranger on 85% of our investment during 2022 and 95% of our investments in the fourth quarter. The ability to lead transactions is an important benefit we derive from our trusted relationships, our scale and the attractiveness of the capital solutions we provide. We strongly believe our approach provides us greater control over capital structures, pricing and documents, and longer term, better tools to drive successful credit outcomes. We also believe the size and quality of our incumbent portfolio drives differentiated access to attractive investments.

In 2022, over 50% of our new commitments were to existing borrowers, which is consistent with our history. Incumbency enables us to support our strong performing portfolio companies that we know well, which we believe limits underwriting risk on new commitments. Shifting to our portfolio. As of year-end 2022, our portfolio remained well diversified across 466 different borrowers, with an average hold size of only 0.2% at fair value. Excluding our investment in Ivy Hill and the SDLP, which we believe are diversified on their own, no single investment accounts for more than 2% of the portfolio at fair value, and our top 10 largest investments totaled just 11.8%.

We believe the diversification of our portfolio differentiates us from our competitors as it reduces the impact to the overall portfolio from any single negative credit event at an individual portfolio company. We also believe this diversification plays a significant role in ensuring that we have predictable revenue, which gives us confidence in the level of dividend we have declared. Kipp discussed this a bit earlier as well, but we do believe the fundamentals and overall credit performance of our portfolio remain healthy.

The weighted average EBITDA of our underlying portfolio companies demonstrated solid growth in the fourth quarter, expanding 11% year-over-year. This overall healthy EBITDA growth is skewed to our larger industry concentrations, which, in aggregate, are growing at a faster rate than our smaller industry concentrations in the overall portfolio. This underscores what we believe are one of the many merits of not being a benchmark style investor as we are able to be selective, not only in regard to the companies we are financing, but also the industries we target more generally.

The weighted average grade of our portfolio companies of 3.2 was consistent with last quarter and improved slightly from 3.1 in the fourth quarter of 2021. Also, our portfolio management team believes that the share of companies that were highly impacted by inflationary pressures, supply chain disruptions and staffing shortages remained at stable and manageable levels. By our measures, those impacted represent less than 10% of the total loan portfolio. Our nonaccrual rate during the fourth quarter increased slightly as we added 1 net new company to nonaccrual, resulting in nonaccruals at cost of 1.7% as compared to 1.6% in the third quarter of 2022. Our nonaccrual rate is currently below our average during 2021 and well below our 10-year average of 2.4%.

Amendment activity continues to represent a small number of companies relative to the size of our portfolio, although it has picked up since prior quarter. We do expect that amendment activity is likely to increase in future periods as well, but remain manageable. It is important to note that the amendments we enter into often come with positive to us as the lender in the form of fees, incremental spread, tighter documents and sponsor equity injections. Finally, I’ll provide a brief update on our post quarter end investment activity and pipeline.

From January 1 through February 1, 2023, we made new investment commitments totaling $226 million, of which $158 million were funded. We exited or repaid on $372 million of investment commitments. As of February 1, our backlog and pipeline stood at roughly $265 million. 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.

So while it’s been a pretty slow start to the year, even for the typically seasonally slow first quarter, we do expect things should pick up here in regular course.

And I will now turn the call back over to Kipp for some closing remarks.

Kipp DeVeer

Thanks a lot, Kort. We’re thrilled to formally have you on board here at the company, and I know you’ll add a ton of value here and Co-President with Mitch. In closing, 2022 was a year of strong performance for the company, and we believe that we’re well positioned to navigate through any uncertainty that lies ahead.

Our long track record of successfully managing the company throughout economic and market cycles, provides us with confidence as we enter a different environment in 2023 and likely beyond. Over the past 10 years through September 30, 2022, which is the latest full reporting quarter for all the BDCs, Ares Capital has differentiated itself versus the competition in almost every relevant performance metric. The company has delivered the highest regular base dividend per share growth rate, the highest NAV per share growth rate, the highest total return on its NAV and the best equity return on our stock.

In each case, when compared with every other externally managed BDC with a market capitalization of over $700 million that’s been publicly traded for the last 10 years. Let me close by saying that we’re deeply grateful to our investors for the trust and confidence they’ve demonstrated in areas and their support to the company. I’d also like to thank our team for their hard work and their dedication throughout 2022.

With that, operator, I think we can open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question today comes from the line of Melissa Wedel from JPMorgan.

Melissa Wedel

To start, I thought maybe we could just touch on the dividend policy. I know that you’ve talked about how you’ve approached that both today, but also in the past. I guess compared to where you were last year in paying out a small supplemental dividend per quarter, is there anything that we should read into the fact that you didn’t establish something similar headed into ’23, especially with the level of earnings power currently embedded in the portfolio?

Kipp DeVeer

Melissa, it’s Kipp. No, I don’t think there’s anything to read into it. We obviously chose to increase the dividend pretty materially. The regular dividend last quarter from $0.43 to $0.48 to obviously acknowledge the increased earnings power.

We said we were going to reevaluate the spillover, which when we trued up from a tax perspective is kind of the same as it was at year-end last year. So we really tried to pursue the increase through a regular increase rather than a special. But I don’t think there’s anything to read into. And obviously, we have opportunities going forward to do other things, whether it’s a regular increase or a special in the future. But I wouldn’t read anything into it.

Melissa Wedel

Okay. And then a follow-up to your comments about sort of nonaccrual rates and how they compare to sort of the historical average portfolio. You did say that you expect stress to increase from incredibly low levels currently. In that context, are you expecting sort of a reversion to mean for this portfolio? Or are you expecting that to take a bit higher than the long-term average?

Kipp DeVeer

Yes. I mean it’s hard to tell. We obviously tried to lay out in the prepared remarks. I did, and I think Kort did as well. look, our expectation that it’s probably going to be a more volatile year than we would expect the increase in amendment activity and all of that to lead to increases in nonaccruals and defaults, not only for us, but we expect for our competitors and focus in the business in general.

Based on how we see the portfolio and the economy as a whole though, I think more of a reversion to average is likely. We get asked the question a little bit differently than you asked at most of, but I’ll ask the question that we had asked instead of the one you asked, which is we don’t expect the current environment is going to create an extraordinary amount of defaults that flow through historical averages. We see this as a pretty regular credit cycle where defaults are likely to go up and not exceed the averages. I think is how we’re seeing things today.

Operator

The next question today comes from the line of Ryan Lynch from KBW.

Ryan Lynch

First question I just had was, if I look at your capital restructuring fees, they basically doubled this quarter versus the prior quarter on kind of a modest level of increasing commitments in the quarter. Was there anything kind of onetime going on in the numbers this quarter? Or is that just kind of more indicative of the current lender-friendly environment allowing you to kind of generate more economics from the deals you guys are joining?

Kipp DeVeer

Yes. I mean nothing extraordinary. I mean I think we’re — fees generally for new deals are higher. Is the simple answer, Ryan.

Ryan Lynch

Okay. Okay. So just the particular ones you guys had this quarter were higher fee deals.

Kipp DeVeer

Yes. I mean the average fee rate on new commitments is higher relative to the average and relative to prior quarters.

Ryan Lynch

The other one I had, you mentioned portfolio monitoring being a big competitive advantage for Ares versus some others. And I do believe that you guys do have a more robust and deeper portfolio monitoring team.

I’m just curious, can you maybe help me understand why that is a competitive advantage that if you have a business which is potentially going to come under stress because of the economic environment they’re in. What can that portfolio monitor team actually go in and do that can actually create better outcomes versus a different platform who maybe isn’t able to get as early or maybe be creative in their solutions?

Kipp DeVeer

Yes. I mean I think it’s — we could go on and on about this, to be honest, for a while, but I’ll try not to. I mean I think our philosophy, and Kort mentioned this, too, is we want to bring substantial flexible capital solutions into the companies that we onboard into the portfolio. The way that we underwrite and the way that we approach our transactions is a lead investor helps us, right, because we’re a substantial source of capital, we have direct relationships with either private equity firms and/or companies and/or management teams, where I think we’re viewed as a valued partner rather than just money.

And that value partnership transitions all the way through post closing and in the monitoring stage. So I would say it’s pretty easy on the companies that are performing well, right? In the LBO lending business, club financial statements, you don’t do much and you celebrate the fact that the company is performing at plan or better.

In the underperformers, we’re able to actually leverage the nature of that underwriting the nature of that relationship, et cetera, to be very early, right? We try not to be surprised. Our management teams and the owners of companies where we’re invested typically don’t want us to be surprised, right? So when things are not performing to plan, we tend to be in the room. We have quality information we can often provide other portfolio company data and information in existing industries where we’re particularly deep to help management teams understand some of the complexities that they may be experiencing.

But it really is all about that early intervention, seeing the early warning signs and good communication. How can we help? We can help in a whole host of different ways. We can provide amendments and modifications. We can change the nature of the loans that we’ve underwritten because we have the flexibility to do that. We can bring capital to the table if it’s needed in situations where liquidity is less than optimal. Hopefully, that gives you a flavor for it, Ray, but we go on quite a while about that.

Operator

The next question today comes from the line of Casey Alexander from Compass Point.

Casey Alexander

First of all, welcome to the new team members. Congratulations on your assignment to Ares Capital. Most of my questions have been asked. I just wondered the amendments and modifications that you do, they drive a certain amount of fee income. Does that show up also in capital structuring and servicing fees? And would we expect that to sort of impact the level of capital structure and servicing fees in 2023?

Kipp DeVeer

Yes. I appreciate those comments around Kort and Jana. The amendment fees do show up in the structuring fees line, again, with the…

Penelope Roll

Other income line [indiscernible].

Kipp DeVeer

Sorry, Penni is telling me now it shows up in the other income line. So you’ll see it there. And will you see a modest increase there if there are more amendments in the portfolio? Probably. But these are huge fees. We’re charging, right? They tend to be 50 basis points or less depending on severity of outcome.

Operator

Next question today comes from the line of Kevin Fultz from JMP Securities.

Kevin Fultz

I want to start with a question on NII. Clearly, the earnings power of the portfolio was used to rate environment. I’m just curious what you think net investment income generation will look like when we eventually transition to a neutral rate environment? And then also to kind of follow on from a previous question, how you’re balancing elevated rates versus growing the core dividend?

Kipp DeVeer

Yes. I mean, Melissa asked the question as well about the dividend before. I mean, the answer to your question is I don’t know because I don’t know what the normal rate environment is going to be. I think we’re working on an expectation that rates are elevated. They likely will go up from here.

They likely will not stay there. We can all debate how long folks think they’ll stay there or not, but our best guess would be that rates will normalize and begin coming back down. My own personal view is we’re unlikely to see a 30 basis point LIBOR or SOFR again anytime soon. And that I think a lot of folks may look back is that potentially being a bit of a failed experiment. So our base case probably has rates down the line way out, normalizing down certainly from here, but my guess is as good as has as to where that is.

It’s been one of the reasons that we were cautious about raising the dividend as much as we did last quarter and frankly chose not to raise the dividend this quarter because we’d like a stronger view on where we see rates normalizing in the future.

Kevin Fultz

Okay. That all makes sense. And then my follow-up relates to the handful of companies in the portfolio that are underperforming expectations. I’m just curious to the issues you’re seeing there are more specific to inflation supply chain issues or more so the impact of rising debt service costs.

Kipp DeVeer

Yes, it’s a little bit of both, to be honest. We started seeing the inflation that everyone’s been reading about in the portfolio as far back as probably the fall of ’21. So it’s not that we weren’t expecting that.

I bundle a lot of these operating concerns for companies into the same bucket, whether it’s need to pass through price increases, labor shortages, production challenges, supply issues, it’s just harder running companies these days.

I think for our management teams than it’s been in a while. To your point, though, that being said, there are other companies that are not experiencing any of those issues, which simply have a lot of depth and are dealing with higher debt service costs and very limited negative influence on their overall operating results, but just dealing with higher rates. So I’d say it’s a little bit of both.

Kevin Fultz

Congratulations on a nice quarter.

Operator

The next question today comes from the line of Robert Dodd from Raymond James.

Robert Dodd

Can you give us any thought that you’ve experienced to start on house sponsors react in terms of making amendment requests or injecting capital in terms of different lines, right? I mean whether it’s financial stress, i.e., higher rates, or operational strength, does that tend to or economic stress, does that tend to change how the sponsors respond in terms of in getting more capital or asking for amendments and how fast, et cetera? This is a lot of — I mean, just high interest is one thing, but deteriorating economic environment or something else. I mean, any color on how those different environments interact with sponsors coming to you?

Kipp DeVeer

I mean I guess the only thing that comes to mind, to be honest, is most of the sponsors that we deal with are long-standing and valued sort of relationships where we’ve done multiple deals with them over multiple years. And we find that when companies are experiencing issues regardless of perhaps the driver of that issue, that if the private equity firm is kind of happily invested in the company.

It’s a somewhat recent investment, particularly in the last fund or the fund prior to that, i.e., it’s fresh and they feel that they still have the ability to generate an equity return despite a blip or 2 along the way that an amendment and often the continued investment of equity in that company is good for them and it’s good for their limited partners. It tends to be good for us as well.

The places where sponsors often walk away as you would probably imagine, are either companies that are materially underperforming where they don’t see the ability to earn an equity return or recovery regardless of almost any outcome that you can create or potentially sort of that old fund problem, right? We do hear occasionally how it was in a fund that we raised 10-plus years ago, and we don’t have any more capital to support it, the funds out of its investment period, et cetera.

So I think some of that is more common than a sponsor feeling good or bad about a potential investment, whether it’s rates or the supply chain, right? It tends to be just how they think about their position and obviously, their investors’ capital on a go-forward basis more than anything else.

Operator

The next question today comes from the line of Kenneth Lee from RBC.

Kenneth Lee

Just one on the portfolio activity in the fourth quarter in terms of originations and repayments both increased sequentially. Wondering how much of that was potentially due to the normal year-end seasonality? And how much of that could be due to either a shift towards larger borrowers and/or other trends, just given the elevated activity came in despite slowing economic conditions.

Kipp DeVeer

I mean don’t know — I mean I’m looking at Kort. I don’t think there was anything unusual about the fourth quarter.

Kort Schnabel

I think — it’s Kort. I think it’s a mix. It’s what you said, it’s a mix of both. It’s a little bit of the seasonality. And certainly, as we’re seeing larger borrowers and larger opportunities come in, that drove some of it also. And probably on the earlier fee question as well, obviously, fee rates are up, but we did have the opportunity to underwrite a few larger deals in the fourth quarter, and that helps drive some syndication and structuring fee income as well for us.

Kenneth Lee

Got you. Very helpful there. And just one more follow-up. In terms of the spillover income and realizing that there’s some regulatory constraints around that. Are there any other specific factors or other events that could drive a decision towards either paying out a portion in terms of a special dividend versus retaining some versus increasing the regular dividend there?

Kipp DeVeer

I mean not really beyond anything that we’ve discussed, Kenneth, to be honest.

Operator

The next question today comes from the line of Mark Hughes from Truist.

Mark Hughes

The weighted average — the portfolio weighted average EBITDA up pretty substantially over the last year. How important is that in credit performance relative to other measures like net leverage or interest coverage, how important is just the size factor?

Kipp DeVeer

It’s reasonably important. I made the point in the prepared remarks, but I’ll just reiterate it. I mean larger companies tend to be more diverse, right, in terms of their revenue and their profits.

They tend to have greater reason to exist, right, on the downside to the extent you need to actually work things out. And in the private equity landscape, they frankly tend to be owned by larger better capitalized, better established private equity firms and almost all the time, they have better management teams and small cap companies.

So I would tell you, I’d much rather lend 5x debt-to-EBITDA if it was $300 million EBITDA company that I would do a $10 million EBITDA company. And we’ve seen that the credit profile of these larger businesses is just better for a host of those reasons.

Mark Hughes

Understood. Then looking at the backlog and pipeline, it looks like there’s household, personal products, pharma, maybe that’s a little more defensive. Is that — am I reading that properly? Is that something on your part or just those deals are more likely to be getting down these days?

Kipp DeVeer

Yes, I mean, I think we’re being pretty cautious in the current environment. Those examples, in particular, things that are common industries when we target investments regardless of whether it was a backlog for this quarter or not. But yes, we’re definitely taking a more defensive posture wanting to see how 2023 plays out. The backlog is pretty light as Kort was talking about going into Q1, and we’re hopeful it picks up. And my guess is it will be more diversified and larger here as winter comes to an end in the spring rolls around and folks reevaluate deal activity and how to get things done for the remainder of the year. But I think that backlog, the industry mix is in line with what we’ve done historically.

Operator

[Operator Instructions]. The next question today comes from the line of Erik Zwick from Hovde Group.

Erik Zwick

Just a question on your capital structure and that you’ve raised equity a few times over the past few quarters. And just curious how you look at that today versus raising additional unsecured debt? And then what that might mean for kind of your plans as you project the 23 year at this point?

Kipp DeVeer

Yes. Thanks for the question, Erik. We don’t really talk a lot about our capital raising plan. I mean, look, the equity issuance for us is a pretty strong statement that we have a desire to grow the company because we see the investment opportunity around us as being exceedingly attractive.

Hand in hand with that is obviously the fact that we try to maintain a leverage ratio somewhere between 0.9 and 1.25x our equity capital base, and we’re at the upper end of that. So the equity raise, there was certainly a consideration as well around the leverage ratio and how we thought about availability. Plans for raising capital or TBD, we’ll see how the environment looks around us. We’ve got a maturity on a bond deal here in the next week or 2, if I remember correctly, which we can satisfy with existing borrowings.

So we don’t have any need to go out and raise that capital, but we’re always opportunistic and thoughtful — that market seems to be — the high-grade market seems to be finally healing a little bit, and our existing unsecured notes are trading better, I’d say, more in line with market reality. So hopefully, that market is reopening for us. But we’ll see for the remainder of this year, and we’re probably not going to provide any comments beyond that in terms of our thoughts around capital raising, if that’s all right. But thanks for the question.

Erik Zwick

That was helpful, particularly with regard to the fact — kind of the trading of those unsecured notes and that market seems to be loosening. So — that’s all I had today.

Operator

This concludes our question-and-answer session. I’d like to turn the conference back over to Mr. DeVeer for any closing remarks. Please go ahead.

Kipp DeVeer

I don’t have any other than to thank everybody for joining us today, and we look forward to being in touch and finding you on this call next quarter.