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: September 30, 2009
Business Overview: A closed-end, non-diversified management investment company regulated as a Business Development Company (BDC). The Company invests primarily in first and second lien senior loans and mezzanine debt of private middle-market companies, with a lesser focus on equity investments. It is externally managed by Ares Capital Management LLC.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2009 | Nine Months Ended Sep 30, 2009 | Dec 31, 2008 (Balance Sheet) |
|---|---|---|---|
| Total Investment Income | $60.9 million | $176.0 million | N/A |
| Net Investment Income | $32.9 million | $95.1 million | N/A |
| Net Increase in Equity (Operations) | $63.3 million | $133.1 million | N/A |
| Earnings Per Share (Basic/Diluted) | $0.62 | $1.34 | N/A |
| Total Assets | $2,065.1 million | N/A | $2,091.3 million |
| Total Investments (Fair Value) | $1,967.7 million | N/A | $1,973.0 million |
| Total Debt Outstanding | $767.9 million | N/A | $908.8 million |
| Cash and Cash Equivalents | $61.5 million | N/A | $89.4 million |
| Net Assets Per Share | $11.16 | N/A | $11.27 |
| Weighted Avg. Cost of Debt | 2.16% (3mo) | 2.21% (9mo) | 3.03% (Year End) |
Material Changes vs. Prior Period
- Investment Income: Total investment income decreased slightly by 2% ($1.2 million) for the three months ended September 30, 2009, compared to the same period in 2008. This was driven by a significant drop in capital structuring service fees due to fewer new commitments, partially offset by a 7% increase in interest income from a larger portfolio size.
- Expenses: Total expenses decreased by 6% ($1.8 million) for the quarter. Interest expense dropped 40% due to lower LIBOR rates and a reduced cost of debt (2.16% vs. 3.74% in 2008). However, professional fees increased due to $2.0 million in costs related to the proposed acquisition of Allied Capital Corporation.
- Realized Gains/Losses: The Company reported a net realized loss of $1.7 million for the quarter, compared to a gain of $4.6 million in the prior year. For the nine months, a significant $26.5 million realized gain was recognized from the extinguishment of debt (repurchase of CLO notes), offsetting investment losses.
- Unrealized Gains/Losses: Net unrealized gains of $32.0 million were recorded for the quarter, a sharp reversal from the $78.8 million unrealized losses in the same period of 2008. This improvement was driven by valuation increases in several portfolio companies, including ADF Restaurant Group and Imperial Capital Group.
- Debt Reduction: Total debt outstanding decreased from $908.8 million at year-end 2008 to $767.9 million at September 30, 2009, reflecting repayments and the conversion of the CP Funding Facility to an amortizing structure.
Guidance, Outlook, and Risks
- Acquisition of Allied Capital: On October 26, 2009, the Company entered into a definitive agreement to acquire Allied Capital Corporation in an all-stock transaction valued at approximately $648 million. The transaction is expected to close by the end of Q1 2010, subject to shareholder and regulatory approvals. Legal challenges to the merger have been filed by shareholders.
- SL Fund Acquisition: On October 30, 2009, the Company acquired Allied Capital's interests in the Senior Secured Loan Fund (SL Fund) for $165 million in cash.
- Liquidity and Capital Markets: Management notes that global market volatility has limited access to capital. The Company intends to adjust investment paces and pursue asset sales if necessary. As of September 30, 2009, approximately $453.9 million was available for additional borrowings under existing facilities.
- Valuation Risks: The Company emphasizes that the fair value of its investments is determined in good faith by the Board and may differ significantly from values realized in a forced liquidation. Approximately 98% of the portfolio is valued using Level 3 inputs (unobservable data).
- Interest Rate Risk: The Company is exposed to interest rate fluctuations. Approximately 57% of the portfolio is at fixed rates, while debt obligations are primarily variable. An interest rate swap agreement ($75 million notional) is in place to mitigate risk.
Investor Verification Checklist
- Merger Status: Verify the progress of the Allied Capital acquisition, including shareholder approval status and the outcome of pending litigation challenging the deal.
- Debt Facility Renewals: Confirm the status of refinancing for the Revolving Credit Facility (maturing Dec 2010) and the CP Funding Facility (maturing May 2012), given the tight credit market environment.
- Portfolio Valuations: Review the specific valuation methodologies and independent firm reviews for the top 10 portfolio companies that drove the $32 million unrealized gain in Q3.
- Non-Accrual Loans: Monitor the 5.3% of the portfolio (at amortized cost) currently on non-accrual status, specifically the performance of companies like Growing Family, Inc. and HB&G Building Products.
- Dividend Sustainability: Assess the ability to maintain the current dividend rate ($0.35 per share for Q3) given the mix of cash and payment-in-kind (PIK) income, noting that $33.0 million of PIK income was recorded for the nine-month period.