Ares Capital Corporation 10-Q Summary
Business Context and Reporting Period
Company: Ares Capital Corporation (ARCC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2011
Business Overview: Ares Capital is a closed-end, non-diversified management investment company regulated as a Business Development Company (BDC). It invests primarily in first and second lien senior loans and mezzanine debt, with a lesser extent of equity investments. The company is externally managed by Ares Capital Management LLC. The reporting period includes the results of the combined company following the April 1, 2010, acquisition of Allied Capital Corporation.
Key Financial Metrics
| Metric | Q1 2011 | Q1 2010 |
|---|---|---|
| Total Investment Income | $135.7 million | $66.5 million |
| Total Expenses | $85.8 million | $35.0 million |
| Net Investment Income | $47.8 million | $31.7 million |
| Net Realized Gains (Losses) | $62.6 million | ($4.9 million) |
| Net Unrealized Gains (Losses) | $22.2 million | $49.6 million |
| Net Increase in Stockholders' Equity | $123.8 million | $76.4 million |
| Earnings Per Share (Basic & Diluted) | $0.61 | $0.61 |
| Total Assets | $4.71 billion | $4.56 billion (Dec 31, 2010) |
| Total Debt (Carrying Value) | $1.43 billion | $1.38 billion (Dec 31, 2010) |
| Cash and Cash Equivalents | $246.2 million | $100.8 million (Dec 31, 2010) |
| Net Assets Per Share | $15.45 | $14.92 (Dec 31, 2010) |
Material Changes vs. Prior Period
- Revenue Growth: Total investment income increased 104% year-over-year, driven primarily by the larger portfolio size resulting from the Allied Capital acquisition and increased new investment commitments ($502.3 million in Q1 2011 vs. $298.8 million in Q1 2010).
- Expense Increase: Total expenses rose 145% to $85.8 million. This was largely due to higher interest and credit facility fees ($30.2 million vs. $8.6 million) and increased management fees ($47.7 million total vs. $16.6 million) reflecting the larger asset base and net investment income.
- Realized Gains: The company reported net realized gains of $62.6 million, a significant improvement from net realized losses of $4.9 million in the prior year. This included approximately $95.2 million in gains from investments acquired in the Allied Acquisition.
- Debt Activity: The company redeemed the remaining balance of the 2011 Notes ($300.6 million principal) in March 2011, incurring a loss on extinguishment of debt of $8.9 million. Additionally, the company issued $575 million in February 2016 Convertible Notes and $230 million in June 2016 Convertible Notes during the quarter.
Guidance, Outlook, and Risks
- Portfolio Strategy: Management intends to continue rotating and repositioning the legacy Allied Capital portfolio, focusing on reducing holdings of lower-yielding, non-yielding, and non-core investments to rotate them into higher-yielding first and second lien senior loans.
- Investment Activity: As of April 29, 2011, the company had made new investment commitments of $171 million since March 31, 2011, with 95% in first lien senior secured debt. The investment backlog and pipeline stood at $520 million and $360 million, respectively.
- Dividends: A quarterly dividend of $0.35 per share was declared for the period ended March 31, 2011.
- Risk Factors:
- Valuation Risk: Substantially all investments are valued at fair value by the board of directors using unobservable inputs (Level 3), creating inherent uncertainty.
- Interest Rate Risk: The company is exposed to changes in interest rates. Approximately 50% of the portfolio is at variable rates, while a significant portion of debt is fixed.
- Amendment to Advisory Agreement: Stockholders are being asked to approve amendments to the investment advisory agreement that could lower the hurdle rate for incentive fees and change the calculation of the capital gains fee, potentially increasing fees payable to the adviser.
- Non-Accrual Status: As of March 31, 2011, 4.8% of total investments at amortized cost were on non-accrual status.
Key Facts for Investor Verification
- Debt Extinguishment Losses: Verify the impact of the $8.9 million loss on the extinguishment of the 2011 Notes and the subsequent $10.5 million loss on the extinguishment of the 2012 Notes (subsequent event).
- Incentive Fee Accruals: Note that while no capital gains incentive fee was payable under the agreement for the quarter, a GAAP accrual of $15.1 million was recorded, bringing the total GAAP accrual to $30.7 million.
- Convertible Notes: Confirm the terms and conversion prices of the newly issued $805 million in convertible notes (February and June 2016 series) and their impact on potential dilution.
- Portfolio Yield: The weighted average yield of the total portfolio at fair value was 10.0% as of March 31, 2011.
- Asset Coverage: The company maintained an asset coverage ratio of 321% as of March 31, 2011, well above the 200% minimum required by the Investment Company Act.