Ares Capital Corporation 10-Q Summary
Business context and reporting period
Ares Capital Corporation is an externally managed business development company and regulated investment company focused primarily on first-lien and second-lien senior secured loans, with additional subordinated debt, preferred equity and other equity investments. The filing covers the three and nine months ended September 30, 2023, compared with the comparable 2022 periods. Financial statements are unaudited.
Key financial metrics
| Metric | Q3 2023 | Q3 2022 | 9M 2023 | 9M 2022 |
|---|---|---|---|---|
| Total investment income | $655 million | $537 million | $1.907 billion | $1.456 billion |
| Net investment income | $289 million | $288 million | $921 million | $743 million |
| Net increase in stockholders’ equity from operations | $500 million | $104 million | $1.109 billion | $426 million |
| Basic earnings per share | $0.89 | $0.21 | $2.03 | $0.86 |
| Diluted earnings per share | $0.87 | $0.21 | $1.98 | $0.86 |
Calculated net investment income margin was approximately 44.1% in Q3 2023 versus 53.6% in Q3 2022, and approximately 48.3% for the first nine months of 2023 versus 51.0% in the prior-year period. The decline reflects higher financing and incentive-related expenses despite stronger investment income.
- Total investments at fair value were $21.929 billion at September 30, 2023, versus $21.780 billion at December 31, 2022.
- Portfolio weighted-average yield increased to 11.3% for Q3 2023 and 11.1% for the first nine months of 2023, compared with 9.2% and 8.5%, respectively, in the prior-year periods.
- Net asset value was $18.99 per share at September 30, 2023, compared with $18.40 at December 31, 2022. Stockholders’ equity was $10.815 billion versus $9.555 billion.
- Cash and cash equivalents were $527 million; cash, cash equivalents and restricted cash totaled $605 million.
- Net cash provided by operating activities was $870 million for the first nine months of 2023, compared with $999 million of cash used in operating activities in the prior-year period.
- Dividends declared were $0.48 per share in each quarter of the first nine months, totaling $1.44 per share or $798 million.
Debt, leverage and liquidity
- Total principal debt outstanding was $11.558 billion at September 30, 2023, with carrying value of $11.517 billion, down from $12.245 billion and $12.210 billion, respectively, at December 31, 2022.
- Debt-to-equity was 1.07x at September 30, 2023 versus 1.29x at year-end 2022. Regulatory asset coverage was 193%, above the 150% requirement.
- Weighted-average debt cost was 4.7%, versus 4.2% at December 31, 2022; weighted-average debt maturity was 3.2 years versus 3.6 years.
- Approximately $4.8 billion was available for additional borrowings under the facilities, subject to borrowing-base and other restrictions. The Revolving Credit Facility had $3.264 billion available after letters of credit.
- The company repaid $750 million of 2023 Notes at maturity in February 2023 and issued $600 million of January 2027 Notes in August 2023.
- The $403 million 2024 Convertible Notes mature March 1, 2024 and have a $19.49 conversion price as of September 30, 2023.
Material changes versus the prior comparable period
- Investment income increased 22% in Q3 and 31% for the first nine months, primarily from higher base rates and a larger average portfolio.
- Interest income increased to $495 million in Q3 and $1.441 billion for the first nine months, while dividend income increased to $128 million and $372 million, respectively.
- Investment commitments declined to $1.598 billion in Q3 2023 from $2.242 billion in Q3 2022. Net investment commitments increased to $318 million from $258 million because exited commitments declined more sharply.
- Interest and credit facility fees increased to $145 million in Q3 and $425 million for the first nine months, compared with $120 million and $314 million, reflecting higher rates.
- Net realized investment losses were $72 million in Q3 and $160 million for the first nine months, compared with net realized investment losses of $22 million and net gains of $23 million in the comparable periods.
- Net unrealized gains were $287 million in Q3 and $395 million for the first nine months, versus net unrealized losses of $184 million and $324 million in the prior-year periods.
- Portfolio credit quality improved modestly: non-accrual loans represented 1.2% of investments at amortized cost, or 0.6% at fair value, versus 1.7% and 1.1% at year-end 2022. Grade 1 investments increased to $165 million from $108 million, while Grade 2 investments declined to $1.261 billion from $1.342 billion.
- The company issued 48.5 million common shares for $918 million of net proceeds, including public and at-the-market offerings. No shares were repurchased under the repurchase program.
Outlook, risks, contingencies and unusual items
Management described credit markets as pressured by rising Treasury yields, inflation, tighter financial conditions, financial-market instability and recession risk. The filing provides no formal earnings or dividend guidance. Management stated that results may vary materially with portfolio activity, base rates, investment valuations, realized gains and losses, and financing costs.
- Approximately 69% of investments at fair value bore variable rates, while facilities generally bear variable rates without floors. Management estimates that a 100-basis-point increase in rates would increase annualized net income by approximately $105 million before income-based fees; a 100-basis-point decrease would reduce it by approximately $120 million.
- Approximately 96% of variable-rate investments excluding SDLP Certificates had interest-rate floors.
- Most investments are valued using Level 3, unobservable inputs. Level 3 investments were $21.198 billion, or the substantial majority of the portfolio, creating valuation and liquidity risk.
- Net adjusted unfunded revolving and delayed-draw commitments were $2.016 billion, including $869 million of delayed-draw commitments. Net adjusted unfunded equity commitments were $74 million, and the company had $53 million of additional SDLP commitments.
- The company had $47 million of portfolio-company letters of credit outstanding and $41 million of letters of credit under its separate Letter of Credit Facility.
- Investment-grade concentration remained significant: Software and Services represented 23.2% of fair value, followed by Financial Services at 12.2% and Health Care Services at 11.3%.
- From October 1 through October 18, 2023, the company made approximately $410 million of new commitments, exited approximately $158 million, and reported an investment backlog of approximately $820 million with no investment pipeline.
- Management reported effective disclosure controls and no material changes to internal control over financial reporting. The filing states that ordinary-course legal proceedings are not expected to have a material effect.
Most important facts for investors to verify
- Whether the $403 million 2024 Convertible Notes were refinanced, repaid or converted after the filing date.
- The sustainability of net investment income after higher borrowing costs, management fees and incentive fees.
- Credit performance and recovery prospects for Grade 1 investments and non-accrual loans, including the Center for Autism and Related Disorders exposure.
- The accuracy and sensitivity of Level 3 fair values, particularly under wider credit spreads, lower EBITDA multiples or forced-sale conditions.
- The funding requirements and credit quality associated with $2.016 billion of net adjusted unfunded commitments and $74 million of net adjusted unfunded equity commitments.
- Future dividend coverage, including the effect of PIK interest and dividends, which are recognized as income before cash collection.
- Upcoming debt maturities, facility reinvestment periods and compliance with asset-coverage, borrowing-base and other covenants.