ARES CAPITAL CORP. 10-Q Summary (Q3 2017)
Business Context and Reporting Period
Ares Capital Corporation (ARES) is a closed-end, non-diversified management investment company regulated as a Business Development Company (BDC). The company invests primarily in first lien senior secured loans, second lien senior secured loans, and mezzanine debt, with a smaller allocation to equity. This report covers the quarterly period ended September 30, 2017, and the nine months ended on that date. A significant event during the period was the integration of the American Capital Acquisition, completed in January 2017.
Key Financial Metrics
| Metric | Q3 2017 (3 Months) | Q3 2016 (3 Months) | YTD 2017 (9 Months) | YTD 2016 (9 Months) |
|---|---|---|---|---|
| Total Investment Income | $294 million | $258 million | $853 million | $752 million |
| Net Investment Income | $153 million | $138 million | $371 million | $356 million |
| Net Increase in Equity (Operations) | $139 million | $110 million | $435 million | $399 million |
| Diluted EPS | $0.33 | $0.35 | $1.02 | $1.27 |
| Total Assets | $12,041 million | $9,245 million (Dec 31, 2016) | N/A | N/A |
| Total Debt Outstanding | $4,640 million | $3,874 million (Dec 31, 2016) | N/A | N/A |
| Cash and Equivalents | $341 million | $223 million (Dec 31, 2016) | N/A | N/A |
| Net Assets Per Share | $16.49 | $16.45 (Dec 31, 2016) | N/A | N/A |
Material Changes vs. Prior Period
- Portfolio Growth: Total investments at fair value increased to $11.456 billion from $8.820 billion at year-end 2016, driven by the American Capital Acquisition and new originations. The portfolio is now 163% of net assets.
- Income Growth: Net investment income increased 11% year-over-year for the quarter and 4% year-over-year for the nine-month period, reflecting a larger asset base.
- EPS Decline: Diluted EPS decreased to $0.33 from $0.35 in Q3 2016, and $1.02 from $1.27 for the nine-month period. This decline is primarily due to a significant increase in the weighted average shares outstanding (426 million vs. 314 million) resulting from the stock issuance in the American Capital Acquisition.
- Debt Structure: Total debt increased to $4.64 billion. The company redeemed $183 million of October 2022 Notes in June 2017, incurring a $4 million realized loss on extinguishment. The Senior Secured Loan Program (SSLP) was effectively terminated in July 2017, with the company purchasing the remaining loans.
- Fee Waiver: In connection with the American Capital Acquisition, the investment adviser waived $10 million of income-based fees for the quarter and $20 million for the nine-month period.
Guidance, Outlook, and Risks
- Outlook: Management continues to focus on deploying capital into first and second lien senior secured loans. The company maintains a dividend reinvestment plan and a stock repurchase program (authorized up to $300 million, with $293 million remaining).
- Dividends: The company declared dividends of $0.38 per share for each of the three quarters in 2017, totaling $1.14 per share for the nine-month period.
- Risks:
- Valuation Uncertainty: Substantially all investments are valued using unobservable inputs (Level 3). Fair values may differ materially from realized values.
- Non-Accrual Status: As of September 30, 2017, 3.4% of total investments at amortized cost were on non-accrual status, up from 2.9% at year-end 2016.
- Liquidity: The company relies on borrowings to fund investments. Asset coverage ratio was 247% (excluding SBA Debentures).
- Commitments: The company has $609 million in net adjusted undrawn revolving and delayed draw loan commitments and $1 million in net adjusted unfunded private equity commitments.
Key Facts for Investor Verification
- Share Count Impact: Verify the impact of the 112 million shares issued in the American Capital Acquisition on future earnings per share dilution.
- Fee Waiver Duration: Confirm the remaining duration of the income-based fee waiver (10 quarters total, starting Q2 2017) and its effect on future expense ratios.
- Non-Accrual Portfolio: Review the specific portfolio companies on non-accrual status (3.4% of amortized cost) to assess credit risk exposure.
- Debt Maturity Profile: Analyze the weighted average maturity of debt (4.5 years) and upcoming maturities, including the 2018 Convertible Notes ($270 million principal).
- SSLP Termination: Understand the implications of the SSLP termination and the assumption of $1.6 billion in loans on the company's risk profile and yield.