Financial Institutions Conference. My name is Kenneth Lee. I'm a senior equity analyst covering the business development companies or BDC sector, and welcome to our industry panel. In conversation with leading BDCs, I'm very pleased to have with us our panelists: Kort Schnabel, Co-President of Ares Capital Corporation. Kort is also a partner in the Ares Credit Group and co-head of the U.S. Direct Lending. Then to his left, we have Craig Packer, CEO of each of the Blue Owl BDCs, including Blue Owl Capital Corporation. Craig is also the co-president of Blue Owl. Then to his left, we have Jonathan Bock, co-CEO of Blackstone Secured Lending Fund, as well as of Blackstone Private Credit Fund. Jonathan is also a global head of market research for Blackstone Credit.
And then to his left, we have Josh Easterly, Chairman and CEO of Sixth Street Specialty Lending, and also Co-CIO of the investment advisor. Welcome, everyone.
Okay.
Thanks for having us.
Before we dive in, perhaps each of our panelists can give a quick overview of their respective companies, and we'll start off with you, Kort.
Sure. Thanks, everybody, for coming. Ares Capital Corporation is a $22 billion publicly traded business development company with the largest publicly traded BDC that exists out there. We had our IPO back in 2004, so we've got a 20-year public track record out there delivering industry-leading results. Ares Capital sits within the broader direct lending business at Ares Management, which is about $120 billion of AUM, but Ares Capital is the flagship direct lending vehicle for us at Ares, the most flexible vehicle that we operate.
Hi. I'm Craig Packer. I co-founded a business called Owl Rock Capital about eight years ago. Eventually, we merged that and became Blue Owl Capital, publicly traded alternative asset manager with about $160 billion of AUM. About half of that is the credit business that we originally started, which I run, primarily an upper-middle market direct lending business. The very first fund, now our second largest fund, is OBDC, which is our publicly traded BDC, which, again, primarily upper-middle market, firstly in sponsor-backed lending, second largest by market cap, depending upon what day you measure it, about $13 billion worth of assets. We have six other BDCs, four in the diversified space and then three in the tech space, software lending primarily.
Hi. Jonathan Bock. I'm at Blackstone Secured Lending, and so we both have a public BDC, BXSL. I'm also the co-CEO of BCRED, Blackstone Private Credit Fund, which is a non-traded BDC, so there will be some questions on that. Blackstone's a $300 billion credit franchise, roughly half of that in private credit strategies, and of that, roughly half is tied to the BDCs. So, pleasure to be here.
Great. Hi. I'm Josh Easterly. I'm the co-founder of Sixth Street. As we talked about, Sixth Street is about $75 billion of assets under management, focused predominantly on credit and credit-like investing. And we have, I don't know, $14 billion of AUM in direct lending. And TSLX has been public for 10 years now, which has about $3.5 billion of assets.
Great. Well, we're going to keep this discussion relatively interactive, so periodically, I will pause to open it up to the floor and see if there's any questions from the audience. And obviously, the panelists can always chime in on various topics as well. So let's just kick it off. Let's start off at a high level here, and I'll direct the first question to you, Jonathan. Let's start off at a high level. BDCs as a sector has really evolved over the past few years, and we've been hearing a lot about private credit. Could you talk about where the industry has been and how it has evolved more recently?
Maybe starting about where it's been. So believe it or not, maybe a sad statement, my entire career has been nothing but BDCs. So I graduated the University of Illinois, which means two things: I'm good at accounting and bad at football. And then my wife and I went to the big city. We went to St. Louis, Missouri. And so starting at A.G. Edwards, right, had an opportunity to see what effectively was the institutionalization of this space from the very beginning. And so to talk about that evolution, think about what you saw back in 2004 early on, and you'll hear that from those esteemed managers on this panel: smaller transactions, smaller companies, predominantly Mezz, asset liability mismatches because no one thought anything could go wrong. And then you fast-forward 20 years.
Here you see a substantial influx of very talented, very well-known institutional managers in the space that are, in my view, operating and working to operate and make this space better. The level of transparency only continues to increase. And so from that evolution, what you're seeing is a space that's more investable, more transparent, generally with larger transactions, and over time, allowing you to make better-informed decisions on managers to support or managers not to. That didn't happen because there wasn't enough information. You only had two, effectively two, back in the day. So it's a remarkable evolution. There's still more to go. But looking back to where we've been starting 20 years ago, it's a remarkable change.
I think this path accelerated in the global financial crisis, which the fractionalization of risk was the intended consequence of the regulatory environment out of the global financial crisis. The taxpayer wrote a $700 billion put. That put caused people to basically make the decision to utilize banks, make them utility-like, increase capital requirements. I think credit formation is the lifeblood of growth in any economy. So credit formation had to find a landing place, and it found a landing place in BDCs, particularly. We started one out of the global financial crisis. Craig did it on a much larger scale. But I think this was the intended consequence of that regulatory environment where people didn't want to have to talk about bailing out banks.
So quite frankly, the model, when you look at what happened at Silicon Valley Bank, the model's much more durable as a provider of credit than the bank model. The bank model is this idea of lending long and borrowing short, and they have a real inherent asset liability mismatch. And the rating agencies who I think have got it wrong and wrong over and over again had thought the panacea was the ability to hold deposits. Those deposits went elsewhere. They weren't able to borrow at the Fed window. And when you look at our business model, we're much more, if anything, we probably borrow long on the margin and lend a little short, but pretty matched. And so we don't have that inherent risk, and there's no taxpayer put. So I think this space in alternative credit, no matter what Jamie Dimon says, is here to stay.
That narrative is protectionist. I think this was born out of the global financial crisis and, quite frankly, is the intended consequence of that regulatory environment.
It's a function of who also managed the capital. Because I would say early on, you still had, even years after the global financial crisis, I'll say, managers of different size, different scale, different levels of professionalism. And now, given the fact that the industry and the asset class itself is truly that, oftentimes, folks like to think of investments as asset classes early on until it really transitions. Now you have every large brand name involved, which is important. There's good and bad about that, which we'll get to. But it doesn't happen without a change in terms of who was running the capital early on. And the folks here are a testament to that.
That was a great overview. Then for the next topic, let's talk about the origination side, and I'll direct this question to you, Craig, to start off. Last year, BDCs were able to take advantage of a muted, broadly syndicated loan market. Right now, those markets look normalized. Could you talk about the potential impact on origination activity and return profiles in light of the normalization?
Sure. So it's so interesting, the framing of this question. I grew up really in the broadly syndicated markets. I ran the leveraged finance business at Goldman Sachs and spent 25 years at Goldman and Credit Suisse originating high-yield bonds and leveraged loans to distribute. When I decided to join my partners in launching a credit business, the question for the first four or five years is, why would you do that? How could there possibly be enough opportunities for a product that rightly belongs to the banks to distribute? And then that came roaring forward because we had a period of time when the public markets were dislocated, and it became so obvious that the banks don't, in this market, actually lend. There's this nostalgic sense that competing with banks that are making loans would stop 30 years ago.
They're in the movie business.
They're in a short-term commitment, sell it into the public loan and high-yield bond market. And so I ran that business. It's very simple. Can we sell it or not? And when you can't sell it, you don't commit to it. And there was a period of time that got really highlighted, first half of last year, end of the year prior, when the public markets were shut, the banks had a lot of commitments. They couldn't sell. They got out. And so in that period of time, it really showcased what we all can offer. And direct lending, the financing was available. It just was being provided by direct lenders 100%. And it was great. It was shooting fish in a barrel. We could get great returns, great deals. But that's not the normal state of affairs.
And so now the public markets are open, so the banks are willing to underwrite. And it just shows you how far it's come that just the simple act of them doing what they've been doing for the last 30 years seems noteworthy, that they're even able to do it. And so you just have to the normal state of affairs is a well-functioning public market with banks willing to commit, with direct lenders such as ourselves able to provide similar solutions in greater and greater scale and more choices for the private equity firms of which market and choosing. Now, I will tell you that the secular shift continues to be towards direct lending. Their preference is to do it with direct lending: why? Certainty, privacy, customization, the fact that we're always open, the fact that we can grow, the fact that they know their lenders.
That's the trend, and that is continuing to head in our direction. But there's going to be this cyclical. There are going to be periods of time when the public markets are shut. We're going to get really high market share and more normal. We're in normal now, and it's going to shift back and forth. So there's nothing profound in the current market environment. It's the normal market environment. And we compete with the public markets. We compete quite effectively, but it's a price check. The sponsors are well aware of what their options are on the public markets. We're always going to get a premium. We're always going to get way better covenant protections. But when the public market's very strong, we have to offer some relative value, and there will be some deals that go in that direction.
That's healthy, and that's really where we are right now.
Yeah. I find it fascinating, all the talk out there about banks competing with private credit and the world's going to explode and structures are going to collapse. We think exactly as you just said, Craig, which is just it's back to normal. The thing we always point to is 2021 was a record year in volumes for us, and I'm sure all of us up here. We had fantastic years putting new money to work. Banks were extremely active in 2021 as well. It's just a different product. It's simply just a different product, and the borrower has a choice. By the way, we work collaboratively with banks as well. Banks lend to us, provide financing against our funds, give us credit facilities. We hire banks to sell unsecured bonds for our BDCs.
So there's a collaboration and a symbiotic relationship that we've sort of worked on and grown up with together as well. So back to normal, I think, is the right way to say.
And just to tie the first question to the second question, the evolution of direct lending and this bank, why do we have so much to do? It's because the pie's growing. Because the direct lending space can offer bigger and bigger solutions, the sponsors are able to use direct lending for bigger and bigger companies. And so when it's not more capital chasing the same deals, it's more capital now accessing a bigger part of the market. The evolution point, and I think this is very important and powerful for investors, and you guys touched on it, generally, the bigger companies we're financing today, they're just better companies. So the assets that we're putting into BDCs writ large are just higher-quality assets because they're much bigger companies. And I think that along with the institutionalization of the space, it's just a higher-quality asset class.
That was great. And then the next topic, and I'll direct this one to you, Kort. M&A activity was really slow last year. And could you talk about expectations around a potential pickup in M&A activity later this year? And what are the key drivers for those expectations? And just to close out this thought, how dependent would originations be on a pickup in activity?
Sure. Yeah. So a couple of different questions, I guess, in there. In terms of just overall M&A activity in the space, look, I think the ingredients are in place for M&A activity to continue to rebound and come back to more normalized levels, maybe even exceed normalized levels. I think you're seeing a few different factors going on that are driving that. So first of all, LPs to private equity firms have been patiently waiting for return of capital. And getting return of capital on a relatively normal basis is important to those LPs. And it's been a long time now, 12-18 months, where we've had really kind of a log jam in the M&A market and buyers and sellers not being able to transact.
And so there is absolutely increasing pressure being put on private equity firms by their limited partners to sell assets and return some capital, get it reinvested in a new vintage, satisfy liquidity needs on the part of those LPs. So that pressure is building for sellers. On the buyer side of the equation, there's a lot of dry powder that's been raised by private equity firms that has remained unspent for the last 18 months. And there is a time clock ticking on that capital. And so those two forces on both ends of the equation are going to create a better environment for buyers and sellers to transact. I think at the same time, we're seeing stabilization and more certainty in the overall interest rate environment. We're seeing that the economic underpinnings of the economy, revenue and EBITDA, are growing.
The economy remains healthy despite everyone worrying about the lag effect of rate increases, credit tightening. We're still seeing the economic activity continue to be strong. So from a buyer perspective, the inputs they're putting into their model in terms of expectations on where rates will go, in terms of expectations on performance of the portfolio companies is in a tighter band. There's more confidence. And that's going to allow buyers to be more aggressive when they're bidding for assets, right? So all of these ingredients, I think, started to create. We saw the pickup in M&A activity in the third and Q4 last year. We at Ares, and I'm sure all of us up on the stage saw our volumes start to pick up in the Q3 and Q4 .
As I said, those ingredients are in place for that volume to likely continue to pick up here across the industry as we head into 2024. I will say it's been a little bit of a slower start to the year than we might have expected, but it's still early. Certainly, we're seeing more volume than last year at this time. So those are my thoughts on the environment, the activity. I think how dependent are originations on the M&A environment was the second part. Certainly, our activity is dependent. Our origination is dependent. Having M&A and assets trading will drive activity. But it's not the only factor, right? I think as a large BDC, one of the larger BDCs, and all of us up here enjoy the benefit of having a large portfolio, right?
So at Ares, we have $120 billion in the ground in companies, 600 different companies in our U.S. direct lending business. Those companies are dynamic companies. They're always changing. They're looking for new capital. They need capital for their growth initiatives, their CapEx initiatives. They're tuck-in acquisitions. And tuck-in acquisitions have remained still relatively robust. And so we have the good fortune to be able to provide capital into those existing portfolio companies. And we all enjoy the fact that there is a little bit of a competitive moat around our existing portfolios. It's difficult for each of us to come in and provide financing to our competitors' portfolio companies when there's an existing lending relationship in place. And so through this past period where things were slower, we just provided more capital into that existing portfolio. So it's a driver. It's not the only driver.
We are looking forward to the activity, hopefully picking up across the industry.
Then just on a related note, and this one, I'll direct to you, Josh, on new investments, wondering if you could just provide a little bit more color as to what you're seeing in terms of documentation, terms, pricing, any other details?
I get that question? Look, I think if you look at compared to Q4, Q3 of 2022, and first half of 2023, things have got marginally tighter, for sure, not shockingly. There were people that didn't have capital during those times. We were lucky enough to have a lot of capital. But things have got tighter. The broader syndicate and loan market's back. So I'd say generally, things are tighter by 50-100 basis points on a spread basis, which I think is still pretty good risk-adjusted return for what you're doing. I think underwriting standards are still pretty high. So LTVs, multiples where you are on the cap structure are still relatively low. And that's, I think, the benefit of higher rates.
Higher rates have brought down leverage given the binding constraint is now a debt service coverage ratio or a fixed charge coverage ratio versus the binding constraint in 2021 was probably leverage because rates were at zero. So I think it's still a pretty good vintage. I think as importantly as Kort, I think Craig mentioned, the economy's in pretty good shape. The shocking thing, I think, for many observers who have been investors for a long time, which is the efficacy of the rate move has been very much muted. And earnings growth has continued to be a lot better than people thought. And I think the reason why is post-global financial crisis, the consumer termed out their interest costs. And so their DV01 on every basis point of interest rate didn't really move the needle. Somebody has a 30-year fixed-rate mortgage, rates go up 200 basis points.
They're not moving, but they're not, and they had a lot of wage growth. So I think earnings have been a shock to most people. So I think things have got tighter, but the risk of just returns was still pretty good.
That's good color there. Maybe we could just take a moment to pause here and see if there's any questions from the floor or the audience before we proceed further. Okay then. Let's go on to the next one. I'll direct this one to you, John. This dovetails with the earlier comments about the evolution of the industry. Wonder if you could just talk a little bit more about the competitive activity you're seeing across the industry. And in particular, we've seen a lot of new entrants. We've seen the traction of private credit in general, significant growth of non-traded BDCs. Certainly, the market backdrop has been very favorable. So just want to give a little bit more commentary around that.
So if you're thinking about new interest, maybe let's just start with a baseline. Ask the audience a question. How many people think there are over 100 private credit managers in the market today? Raise your hand. Okay. There's a couple. All right. Good. Over 200. Over 500. There are 1,400 private credit managers today. Now, less than 1% of those effectively operate with the same level of scale as the folks on this panel. And so what you see with the increase in entrants, there are going to be levels of pockets where risk return can get bid down. I think you'll hear from folks on this panel that you're going to see that in the smaller deals, in the smaller transactions.
Because to the extent that you're able to stand up a private credit manager, that's where you'll likely compete because it's very difficult to compete for very, very large-scale transactions without a capital base that needs to remain diversified. And so I'd say that really where you see that pickup and where you see the competitive markets really starting to compress comes in that lower level, right? And so to the extent that there's quite a bit of competition, this is another question. If you look at the marketplace, just looking at aggregate market data, we'll use Lincoln here, for example. I know you're familiar with it, Ken. I think they had an interest rate coverage stat or the average interest rate coverage for the market as well as the tail risk, which is the percentage companies below an ICR of 1 was roughly 17% for the whole market.
And they value everyone. So I'll let you determine the efficacy of that data point. But here's the other part that I found interesting, that roughly 70% of that stat of that ICR below 1, 17%, 70% of that was to companies at $50 million and EBITDA or less. So stress in the system is being felt. Stress in the system is being felt in the more fragile company. At the same time, that's where you start to see a higher level of new entrants. So my guess is if you look at the number of folks that are on this stage, there'll be a level of dispersion based on really where you chose to invest. Doesn't mean you won't have great managers in some areas. Doesn't mean you won't have bad managers in others.
But as you have more and more interest in this space, you're going to start to find capitals flowing to where it can flow easiest. It's very hard to operate at this level. And we start to say that that's going to lead to a level of dispersion in the future.
All right. John, this is Dennana. I think it's, by the way, I would ask Craig this. Craig, today, would you have started Blue Owl knowing I mean, I know you would have done it where you did it. But today, beginning.
It'd be harder.
It'd be harder. It's a really the fixed cost on compliance, the fixed cost on technology, 30% or 25% of our firm's engineers. It is a really hard business to get into.
What's the chance your firm are engineers?
We're not spending enough, I'm worried.
On what they're doing? What are they doing?
I have no idea. Our business is more complicated, in a sense, not better, more complicated.
Careful if we're talking too much about costs. We're going to sound like the banks.
No, I'm just saying it's a hard business to get into. I mean.
The question clients ask us all the time because they're being approached for fundraising for new entrants. Our collective success has attracted others to see if they can replicate it. It's a lot harder today than it was. But the clients say, "Well, I'm being approached. Is there too much competition?" And this scale point is critical to compete in certainly what we think is the highest quality opportunity set. We prefer upper-middle market sponsor-backed. Everybody can have a view on that. That's what we prefer. You need to be scaled. We're $80 billion. We can write a billion-dollar check. There are a handful of us that can compete for that. When you're reading about firms that have raised $2 billion, $3 billion, and they have a brand name and it might seem like a competitor, it really isn't. They're too small.
It's not to say that they won't have the ability to deploy the capital. They probably will figure out a way to do that. But they're not offering a comparable solution to what we can provide. And the private equity firms, which are by far the largest generator of these types of loans, well understand that. And they're not going to invest any time in relationships with the smaller managers because it's not strategic to them. So it's really a pyramid. And it's concentrated in a handful of us. And we compete in one sense, but we are co-lenders all the time.
I was going to make that.
We are aligned all the time. We take comfort in each other having very high quality underwriting standards and that if there's a credit that we're in together, that's going to have an issue. We are now highly aligned in protecting our collective capital. There's just a handful of us. We're a new entrant, 8 years in. But it's very few. It's very difficult to come in now and recreate that.
I was going to make the point on the collaboration, especially when you think about the different segments of the market and the upper-middle market. In these larger deals that are getting done, multi-billion-dollar transactions, it often takes several of us together to put that transaction together, that club together versus the lower-middle market. You might have a bunch of different private credit providers trying to provide the transaction. Every single private credit provider can clear that deal themselves. And the remaining people will get zero. Whereas in these larger deals, we're really kind of partnering in a lot of cases. So the competitive dynamics can actually be less in the larger transactions counterintuitively. You're getting larger, more diversified credits with less competition because of that dynamic.
The only thing I will say that we probably do a little differently, maybe at Ares, is we do still provide lots of financing to middle and small-sized companies in addition to the large companies. That's kind of core to our model. We have an extremely large team, just been at this for 20 years now. We do think that's also important to get in with smaller borrowers and get in early. I mentioned that power of incumbency and then be in with them as they grow. And that's been important to our strategy. But we're more selective in that smaller end of the market. And what I would say is we're trafficking in that flow. And if we're not providing financing to that company, it's because we passed on that business.
And so the smaller private credit providers are generally getting access to those deals after we've already looked at it and passed on it. So there's a little bit of an adverse selection also that these smaller lenders are suffering from.
Ken, Craig made a great point because there is a point where you have to think about assets under management, but specifically direct lending. Because there's a point where you have very large brand-name asset managers that might have a lot of capital but have done so in public markets for many years. We like to say this, or I find that private credit's not a hobby, right? It's never a hobby for Josh or Craig. If not, this was the dedicated career. It requires level specialization, multiple engineers, right? In terms of working, it's a very dedicated talent set. So here's the issue. If you're trying to build that off the ground, even if you have a capital base or a perceived capital base saying that your total AUM for the asset manager is multiple trillions of dollars, you're effectively getting a point across.
It's not necessarily reality because I'm not sure private credit rises to the level of a hobby.
I think what John's saying is BlackRock can't write a billion-dollar check in private credit.
He said it. I didn't.
I mean, I think that's what you're saying. I think there's six guys that can do it, and BlackRock isn't one of them.
Josh is making the point because really, you start to have to differentiate how long you've done this and where.
That's a great discussion point.
What were you saying?
Let's talk about credit performance here. I'll direct this one to you, Craig. I think Josh talked about this and alluded briefly upon this. Maybe we could just flesh it out a little bit further. For many of you, non-accrual rates have been very low. This is despite elevated rates, concerns around economic slowdown. Could you talk about what's going on here? Specifically, what are you seeing within your portfolio or portfolio companies?
So a year ago, everybody was worried about credit performance. I certainly was. Rates were up already. And I think there was a general expectation of a recession, combination of higher rates, recession. There's going to be a significant pickup in credit issues. We thought there'd be some pickup, but it'd be manageable. It wound up really not seeing much of a pickup at all. Credit performance was really strong last year. And I think that in fairness, that was a large part because the economy didn't turn over. The economy was very good, continues to be very good. You can all pick your favorite adjectives around it. But I think it's a moderately growing economy. We see low single-digit revenue growth, low single-digit EBITDA growth. Now, I'll just speak for ourselves. We're not trying to be an early read on the U.S. economy.
We're decidedly trying to be an all-weather, recession-resistant portfolio. We avoid a lot of the cyclicals. We're not going to be an early read. For the companies that we in our portfolio, they're doing well. I think we benefited last year also from some post-COVID supply chain unsnarling and some raw material and distribution cost reductions. That flowed through. Sitting here right now, short-term rates are still high. There's an expectation that they're going to come down. Until they actually come down, we're going to continue to be cautious. I think it's going to continue to be a reasonable economy for our companies. Our companies will do well. I think last year, though, was a real testimony to the strength of the quality of the companies in the direct lending space.
I think that there still had been and maybe still some of you may feel this way, a lingering misperception that we're lending to kind of subprime borrowers that in moments of weakness, that there's going to be this great ripple effect. And it's just misplaced. They're big companies. Our portfolio, our average EBITDA is $200 million. These are multi-billion-dollar companies backed by sophisticated private equity firms. They're large. They're important in their space. They have strategic value to other companies. And they have moves. They have really good management teams. They have good sponsors. The sponsors have more equity in the companies than we have debt in the companies. If there's a problem, they bring in new management team, bring in new capital. And so even when we had issues, by and large, those issues were solved by the private equity firm to retain control of the company.
We don't have to be perfect credit selectors. You should not invest in any of us expecting us to be perfect. The companies have their own issues. Our job is to make sure that, one, we're very few, we're diversified. And two, when the companies have issues, that we get very high recoveries. I think this is one of the things that's underestimated about direct lending. I find people have a knee-jerk reaction to take public market recoveries and lower them as if we're doing riskier. I think it's the inverse because of our credit selection and the sectors. We're in companies that will have higher recoveries. Our documents are way better. Our information is way better. And our time horizon to work out problems is completely different. So I think even when there are issues, we've had a few, not too many, but our recoveries are actually quite good.
I tell clients to model in $.70-$.80 . But we're trying to get par back on our problems. And if you have a diversified portfolio and the problems get back $.80-$.90 , you're going to have great returns. So it's a combination. The economy's better. Credits are good. And we have a much better ability to get high recoveries on our problems.
A couple of quick stats in our portfolio that are interesting goes to your point around industry selection and picking good credits. We saw the Q4 , we reported 9% average EBITDA growth across our portfolio companies. That compares to 0% flat growth in the S&P 500 EBITDA. We're looking at key indicators that show us that maybe there's still a lag effect coming from the rate rise. And we're just not seeing it. Amendment activity, flat, not ticking up. Revolver draws. We're the revolver provider to a lot of our companies. These companies are not utilizing their revolvers in any bigger way. In fact, revolver draws at our companies are slightly down. So you would start to see those leading indicators pointing to signs of stress if companies were struggling with liquidity. And it's just really not happening.
I don't often admit that. I steal something from Blue Owl. I mean, I think this idea that industry selection private credit has a very big skew in industry selection. And I would say except for healthcare services, it's done a very, very good job. And so it's financed if you look at a broadly syndicated loan portfolio financed by a CLO, the diversity scores are probably somewhere between 70 and 100. Private credit's probably 30-35. And so I think we've been able to be much better at picking industries and have the flexibility to do so versus being kind of own the market. And I think when you look at the alpha in credit performance, it's really because of industry selection skew and higher recoveries and a better doc, generally.
So when people say, "Oh, you must get adversely selected," it's really offset by our ability to skew those things to the positive. And so I don't know what the percentage of software and technology in the BSL market. It's a lot higher in private credit.
And then, just relatedly, and I think it was touched upon briefly, maybe, Kort, you can just talk a little bit more about the downside protections. And I think Craig mentioned about maximizing recovery rates. What are the specific downside protections you get in this investment? So, should there be a downturn?
Yeah. We did touch on a lot of it, maybe just to hit on a few of the key points again. It was talked about a little bit earlier on leverage on our funds. But you got to remember, the leverage profile of BDCs is very low, very conservative. We all operate in the low kind of near 1x debt to equity. Certainly, the low 1x range. We're capped at 2x. From a regulatory standpoint, none of us ever go near that. That compares to buyers of syndicated loans that are 4x, 5x, 6x levered, banks 10x levered. So the underlying leverage is just much, much lower than other buyers of credit. We are match-funded. This was also mentioned. I'm just going to underline it again. It's so important, right? We are not taking deposits that can be fleeting.
Our liability structures are long-term in nature. We're accessing the unsecured bond market in a really meaningful way now. Even our secured financing at Ares doesn't have mark-to-market features. So that strength and stability of the balance sheet allows us to be patient and navigate periods of stress in a much calmer way, right? There's no triggers that are making us sell our assets. So we can sit there and work together with our partners, the owners of the assets, to achieve better outcomes. And then getting to that point, again, already a little bit touched on. But in large part, the owners of these assets are private equity firms. We've got excellent relationships with these private equity firms. We're often in many, many deals together at the same time with these firms. So our futures and our destinies are somewhat intertwined.
And so there are natural incentives to work together to come up with better outcomes in a downside scenario and maximize the recovery for ourselves and for them. The first course of action is private equity firm, you're the owner. You solve the liquidity problem. And in large part, they do. They have. And we expect them to continue to support the portfolio companies, especially with the loan-to-values that today are much lower than they used to be. Loan-to-values today, we're putting money out at 40%-45% loan-to-value. It used to be 55%-60%. So the equity checks and the incentives are even greater for private equity firms to support. If they don't support, we're in a better position to work out these credits than broadly syndicated loan buyers are. Goes back again to that relationship.
But it also goes to the fact that we are holding the majority of these loans, if not all, the entirety of the loan. We've structured the documents ourselves. And so we control our destiny in terms of understanding how to work these loans out. We also all have sophisticated portfolio management or structuring teams. We're not afraid, if we need to, to take the keys and own the company and put more capital in ourselves and get through the other side. None of us have that business model, but on purpose, obviously. But we're not afraid to do it if we need to do it. And that allows us to achieve all those factors, allow us to achieve the lower loss rates. It was already said. I'm just going to say it again. You got to look at the data.
The loss rates in private credit are lower than the loss rates in the broadly syndicated loan market, in the high-yield market. There's data over a long period of time to support this. That misconception around lower credit quality is just really kind of not true.
Gotcha. And just to round out this discussion in terms of credit performance, and I'll direct this next question to you, John. Just talk about what your portfolio companies are seeing in terms of having to manage their interest expense, especially given elevated base rates.
I think you can expect that if you look at interest coverage, which near the beginning certainly was 2x-2.5 x, right now portfolios held up remarkably well, right? Right around, as of the Q4 , about 1.8 x. That's relative to the market, about 1.4 x, if you're going to use the Lincoln data. To the extent this was a question of, I think Craig outlined, we've seen a relatively healthy economy. I'd say this. I'd say we're starting to see that additional dispersion come out. We've seen several folks at BDCs show the level of loss, whether it's loss of NAV or new non-accruals. And so is it all idiosyncratic? No, not necessarily.
It just depends on where folks chose to focus and the incentives that they had as it relates to how they managed the portfolio and the size and scale of the institution. Let's say this. You could expect the level of pressure and defaults across the market to increase. But you'll certainly see some manage that better than others. So we're fortunate. But that was a lot more deliberate on the front end in terms of where you invested. To Josh's point, that's generating that attractive return.
That's a great segue to our next question. This one is for you, Josh. Could you just talk a little bit more about the outlook for alternative credit, more specialized financing opportunities there?
Yeah. I mean, look, I think what's happened. I think of the market as corporate credit, non-corporate credit, investment-grade, non-investment-grade. Those are kind of the matrices. And I think what's happening in non-investment-grade corporate credit, for sure, you're going to see happen in non-investment-grade non-corporate credit. And so people have different names for it, specialty finance, rediscount, asset-backed finance, asset-based finance. That market's a bigger TAM than corporate credit. It's harder because in some ways, it's not one vertical. Corporate credit is homogeneous except for the industries. And in asset-backed finance, whatever you want to call it, it's very heterogeneous. Unsecured consumers are unsecured consumer versus autos versus in autos, there's prime, non-prime, subprime. And so there's equipment finance. There's esoterics like aircraft. So I think that most definitely is happening. I think, again, you have this structural sorry. You have this structural issue.
That was not my phone ringing. You have this structural issue with banks and this convergence between insurance companies, alternative asset managers that are converging where they're the ultimate holder of credit since banks are no longer lenders except for basically investment-grade companies. And they're providing wholesale financing to the alt space. But because we're better holders of that credit, we have better liability structures, we're able to attract talent, there's most definitely going to continue that shift. I think there's no way around it, which, again, is why Jamie Dimon's on the stage getting upset because he has such the banks have such an embedded fee stream from the moving business because the moving business, they got underwriting fees. And then they would trade the securities. And they clipped a quarter on the trade.
The market and people who need capital and issuers are saying, "I can just go to the person who's going to store it and own it." And that's happening across the asset class. So I think that's here to stay.
Just for the record, Josh has gotten JP Morgan and BlackRock. So we'll see whatever he gets.
By the way, I used to pick on the space. Now I'm picking on not the space, so. I calculated it. I think this is the right math. I think JP Morgan, on the non-investment-grade corporate credit side, probably has like a $4 billion-$5 billion annual high-margin revenue business between trading and underwriting. I don't know what Goldman's number is. You probably remember. It's a $2.7 trillion market, sorry, it's a $3 trillion market between a high-yield and leveraged loan. They're making fees across that ecosystem: CLO issuance, underwriting, trading. So, yeah, if you're JP Morgan, you get upset. Because that's being disintermediated, I think Goldman has not kind of been as loud about it because they're hedged. They got an alternative credit business. So they're like, "I'm going to win one way or the other." JP Morgan doesn't have that business.
Let's take a moment here and pause to see if there are any questions from the floor before we proceed. Oh, we got one right over there. The mic is coming around.
You seem to be casting a scenario where the banks never come back into the sector that's non-investment-grade lending. Is that your communal view?
Look, my view is you can't ever say never. You give up a lot of option value in the short term. Never is a long time. What I would say is that the regulatory environment's only getting tougher. The business model is more painful for banks. The human capital doesn't really want to work at a bank anymore. They'd rather work at an alternative asset management firm. And so I think there's a lot of structural reasons why you could see in the foreseeable future that that is the case. And look, when you look at the risk-weighted asset if you look at the risk-weighted assets and that banks get on wholesale financing in SPV format, it's a pretty good business form. And so the return on equity is pretty good. So I think structurally, that's changed. I think the big watch-out is that they have a high-margin markets business.
When you look at M&A for banks, JP Morgan, GS, etc., they're the lead partly because they have balance sheet and partly because they're in this moving business. If you level that playing field, they have to compete against a lot of other people, Lazard, etc. So I mean, they're upset. But this was the intentional outcome, not the unintended consequence, the intentional outcome of the regulatory reform post-global financial crisis.
I just want to make sure we're all speaking the same language. The banks pulled out of holding non-investment-grade loans.
Long time ago.
A long time ago. I would point you to Glass-Steagall going away and the convergence of the commercial banks and the investment banks. The commercial banks chose to adopt the investment banking model of distributing risk rather than hold it. The loan market we're talking about was invented by Jimmy Lee at JP Morgan as a way for JP Morgan to be able to provide lending to clients without having to hold it on its balance sheet and sell it to institutions. They became an intermediate distributor. There's nothing preventing them from doing that right now. They can do it. They don't want to hold the loans. There's high capital charges. It's non-investment-grade risk. They don't want to take that risk on their balance sheets. They want to earn fees by distributing it.
What's happening is that was a great model, it was a very profitable model to distribute the risk and earn fees. It worked great. Except now there's an alternative to the borrowers. It does not involve intermediation. It's direct. We can offer certainty. If you were a borrower in anything, you want to borrow money to buy a home, would you want to borrow from a bank that gives you a fixed rate or one that says, "Well, it could be this or it could be that. We'll have to see later"? It's that simple. We can give them certainty. With that certainty, they're choosing it. So that's what they're losing. They're not squawking about losing the ability to lend. They can lend today. What they're squawking about is that the market is moving away from distributed solutions to direct solutions. Now, borrowers are choosing to do that.
We're offering them the ability to do that because we have much bigger pools of capital where it's now a viable alternative. It's a better solution. That's why it's going in that direction.
Craig, I think you would agree. I think it's capital prohibitive from banks to hold non-investment-grade credit in size. They can't be in the non, at least the big banks, it's capital prohibitive.
I would agree. But again, I just take the lens back. It's no different than other asset classes. Banks, they use their origination and customer-facing franchise and then distribute into the markets. They don't want to hold mortgages. They distribute the mortgages. And it's the same thing in this asset class. So they never say never. I agree. Sure, never is a long time. But are the banks? They're in the business of distributing risk. They're staying in that business. They're just losing share. Are they going to go back to, "We want to hold." For regulators, which would seem to fly in the face of every regulatory development in the last 20 years, say, "Okay, we want you to hold this risk more." Would they want to do it and lower the capital charges? I mean, it's possible. But I don't think anybody would think it's a likely outcome.
I mean, yeah. And look, I think just to put a chair in that, when the taxpayers wrote a $700 billion check in TARP, there was national upheaval. And politicians were like, "We can't ever do this again. We can't write this put for the taxpayer and bail out banks." And so this was an intended consequence.
Just for the record, I still like working at a bank. Let's move on.
Can you give a pplause in here?
That's very good. Let's move on to the next topic. Craig, and this one's for you. Macro backdrop here and rates. If base rates were to decline later this year, could you talk about implications for net investment income, dividends, NAV?
It's not complicated. We lend out at floating rates. We have liabilities. Some are fixed, some are floating. But generally, we've benefited from floating rates when rates went up. If rates go down, that's going to hurt our income. Everybody should know that. It's very clear. I tell our clients that all the time. I think we use the forward curve. We don't consider ourselves that have any particular expertise or projecting out rates. But it's moving around. I think maybe it won't go down as much or as fast. But we expect at some point in the next 12-24 months, rates will be lower. In that environment, income that'll hit net investment income. We may get some offset in the short term from more repayments because we're in an environment where rates are going down. You'd expect some repayments. Repayments were pretty light last year.
So there may be some short-term impact. But we model out as we think about dividends and the like, we model out reduced rates over time. Net asset value is more a function of spreads. If spreads compress, the value of our assets will go up a bit. Generally speaking, we benefit from good credit performance and over-earning our dividend to drive net asset value. Last year, that was terrific. We earn a bit less. We may not generate as much net asset value from that. So there may be some. There was great tailwinds last year. Those winds might shift a bit. But credit quality in that environment should be a positive. Take a step back. The asset class is designed to offer a premium, consistent dividend yield versus the alternatives in all market environments.
The world where base rates are a lot lower, we might earn a bit less. You might earn a bit less in our funds. You're just going to earn more than your alternative investment. That will still be the case whether rates are high, rates are low, as long as we do a good job for credit selection. I do think that again, I'll just speak for ourselves. We think about that hard when we're designing our dividend, not to get into too much specifics. We're taking into account some expectation for base rates to come down as we think about our dividend levels. Not long ago, they were below 1%. Now, they're at 5.3%. So this is dynamic. I think the expectation now is maybe rates get to the mid-3s in a couple of years.
And so that'll all work if rates go back to sub-1%, which right now, nobody's thinking about. But if they do, yeah, you've got to look back to where we were a couple of years ago. It's just math. And that's the way the asset class is designed.
I think it's funny how when rates are going up, everybody's worried about credit quality and credit's going to explode the business. And then rates start going down. And everybody said, "Rates go down, it's going to blow up the economic model." So there's always something to worry about. There are some other factors to our business model that can help offset, right? So when rates go down, generally, you're going to see transaction volume go up. And we benefit from upfront fees. When there's higher transaction volume, we're making upfront fees. The more loans we make, the higher the transaction fee revenue stream. That's a high-margin drop-down to the bottom line type revenue stream. That'll help offset. We're running at a pretty low leverage multiple right now to the bottom end of the range that we advertise. We're around 1x debt to equity, as I mentioned earlier.
That's another tool we have, right? We can go back up on leverage, nothing crazy, 1.25x leverage. That's going to help move the needle a little bit on earnings. So there are some toggles that we have. And obviously, the conservative dividend policy, I echo those thoughts. We're running lots of scenarios around that as well.
Okay. Great. And then, Kort, we'll stick with you then for the next one. On the liability side, how do you think about the funding mix, especially given the rate environment and the outlook there?
Yeah. We just like to have diversified, durable sources of funding on our liability structure, nice laddered maturities. So we're never up against a significant amount of maturities in any given year and forced to issue a lot of debt in a certain market environment that might not be favorable. So we're consistent issuers in all market environments. Just did a billion-dollar unsecured bond deal a month ago. Obviously, rates aren't ideal right now. Still priced pretty well in this market environment. So we're going to be issuing consistently. We do have about 70% of our liabilities are unsecured debt liabilities right now, which is really nice because it means that our secured debt, which is only 30%, is really over-collateralized, right?
So not only do we have a lot of liquidity right now with our undrawn revolvers and cash positions at Ares Capital, but we have the ability to have more secured debt if we needed to in a rainy day, given that enormous unsecured debt mix. So we're just looking for that balance. We're not really trying to make a bet on interest rates. We don't feel like that's what we get paid for. We get paid to put in place a durable structure, pick great assets, great credits, originate as many opportunities as we can, be very selective, wait to good industries. And good things happen when we do that.
Can I just say I'm in a bit of a mission on this? Away from the stocks, one of the most mispriced assets is BDC unsecured bonds. BDC unsecured bonds are investment grade, mid-BBB, weak-BBB. And they trade like weak-BBB, maybe high-BBB. Spreads trade anywhere, all of our bonds, I think anywhere from 220 over to 320 over, it should be 150 basis points tighter. Makes no sense. It's just an early market developing. There's a lot of investment-grade buyers that just don't look at them. It's becoming an increasingly important part of the investment-grade bond market. It's a drop in the bucket in the investment-grade bond market. There should be plenty of demand. And we'll see where we are in 2 years. But in 2 years, at some point, it's going to be 150 basis points tighter.
This is a funny one because if you sit in front of the rating agencies and it's the same bucket of loans, same bucket of loans, and you say, "Here's that bucket of loans. And my advance is here. This is a CLO, AAA, single A. You put it into BDC. Same exact loans, AA, B.
BBB trading like a BBB.
So you end up in a situation where this evolution, it's taken place in the equity market. It'll take place in the debt markets as well. But it requires a level of time, education, and interestingly, trust. And a lot of that comes based on the folks that are leading that market and the top of the pyramid.
I think there's a little nuance here, by the way. BDCs can't retain capital.
No. But there's a point. Just as it relates to the underlying loans.
I got it. But CLOs can retain capital. They get equity. They get cash flow turned off to the equity. They buy loans at discounts. They self-cure. BDCs can't do that.
A lender to a BDC has the ability to effectively shut down the cash flows and wind down.
I had a much simpler proposition. I don't have to convince anyone we're AAA.
By the way, I agree.
We're actually BBB. And we trade like.
Just trade it as BBB.
We trade like a BBB credit. That should be easy enough.
We are BDC. We should be BDC. And we trade like crap. I would say the good news is the good news is the asset class, because it's only 1x levered, it moves the needle on the margin. It's not like 20 basis points in a CLO is 200-300 basis points of return.
I want the 20 basis points.
You'll get it at some point.
By the way, the history of the markets, I'm going to say I don't think there's ever been a moment where a dollar of unsecured bond in a BDC has ever lost a penny, entire history of the market. Because there's a regulatory cap on leverage, it's just not a very levered asset class. It's almost impossible. Go home, try to come up with a model where BDC bonds lose value. You're going to find it almost impossible to do.
In the corner case, you can retain capital because you have NOLs to offset losses. Generally, you can't retain capital.
That's a great note to end on. Why don't we just wrap it up here then? Everyone, just join me in a round of applause for our panelists. Great discussion.