Ares Capital Corporation — Q1 2024 Form 10-Q Summary
Business context and reporting period
Ares Capital Corporation is a Maryland-based business development company and regulated investment company managed by Ares Capital Management LLC, a subsidiary of Ares Management Corporation. It invests primarily in first- and second-lien senior secured loans, subordinated debt, preferred equity and, to a lesser extent, common equity in middle-market companies. The filing covers the unaudited three months ended March 31, 2024, compared with the three months ended March 31, 2023, and financial position compared with December 31, 2023.
Key financial metrics
| Metric | Q1 2024 | Q1 2023 / Prior period |
|---|---|---|
| Total investment income | $701 million | $618 million |
| Total expenses | $369 million | $298 million |
| Net investment income | $325 million | $318 million |
| Net realized gains (losses) | $(18) million | $(50) million |
| Net unrealized gains (losses) | $156 million | $10 million |
| Net increase in stockholders’ equity from operations | $449 million | $278 million |
| Basic and diluted earnings per share | $0.76 | $0.52 basic; $0.51 diluted |
| Net investment income per share | $0.55 | $0.60 |
| Cash flow from operating activities | $(21) million | $872 million provided |
| Dividends declared per share | $0.48 | $0.48 |
| Net asset value per share | $19.53 | $19.24 at December 31, 2023 |
Net investment income before taxes was $332 million, implying a net investment income margin of approximately 46% of investment income, compared with approximately 52% in Q1 2023. The ratio of net investment income to average net assets was 11.36% annualized, versus 12.74% in the prior-year quarter. The annualized ratio of operating expenses to average net assets increased to 12.79% from 12.31%.
Balance sheet, portfolio and liquidity
- Total assets were $24.3 billion and stockholders’ equity was $11.9 billion at March 31, 2024, compared with $23.8 billion and $11.2 billion, respectively, at December 31, 2023.
- Investments at fair value increased to $23.1 billion from $22.9 billion. The portfolio comprised $10.7 billion of first-lien senior secured loans, $3.2 billion of second-lien loans, $1.2 billion of senior subordinated loans, $2.5 billion of preferred equity, $2.0 billion invested in Ivy Hill Asset Management and $2.3 billion of other equity.
- Debt at carrying value was $11.7 billion, versus $11.9 billion at year-end. Principal debt outstanding was $11.8 billion, and the debt-to-equity ratio declined to 0.99:1.00 from 1.07:1.00.
- Asset coverage was 200%, above the statutory 150% minimum. Approximately $5.5 billion was available for additional borrowings under the facilities, subject to borrowing-base and other restrictions.
- Cash and cash equivalents were $509 million; cash, cash equivalents and restricted cash totaled $577 million.
- Loans on non-accrual represented 1.7% of investments at amortized cost and 0.7% at fair value, compared with 1.3% and 0.6%, respectively, at December 31, 2023.
- At fair value, 68% of investments were floating-rate, 13% fixed-rate, 10% non-income-producing, 1% non-accrual and 8% represented the equity investment in Ivy Hill Asset Management. Approximately 97% of variable-rate investments excluding SDLP Certificates had interest-rate floors.
Material changes versus comparable periods
- Investment income increased 13%, driven primarily by higher base rates, a larger average portfolio and increased capital structuring fees and dividend income.
- Average portfolio size increased to $22.7 billion from $21.7 billion, while weighted average portfolio yield increased to 11.4% from 10.9%.
- New investment commitments increased to $3.6 billion from $766 million. Investment commitments exited increased to $3.4 billion from $1.9 billion, resulting in net investment commitments of $140 million versus $(1.1) billion.
- Principal investments funded increased to $3.0 billion from $1.1 billion, while principal investments sold or repaid increased to $2.9 billion from $1.8 billion. Ninety-seven percent of new commitments were floating-rate.
- Net unrealized gains increased substantially to $156 million from $10 million, while net realized losses narrowed to $18 million from $50 million. The improvement was partly attributable to reversals of prior unrealized depreciation and higher fair values for certain investments.
- Interest and credit facility fees increased to $159 million from $139 million as average debt outstanding increased to $11.9 billion from $11.4 billion and the weighted average stated rate increased to 4.9% from 4.4%.
- Net investment income increased only modestly despite higher investment income because expenses, including interest expense, incentive fees and the GAAP capital gains incentive fee accrual, increased.
Guidance, outlook, risks and unusual items
- The filing does not provide formal earnings guidance. Management described Q1 credit markets as positive but noted persistent inflation and continued restrictive Federal Reserve policy.
- Management identifies risks from economic slowdown or recession, inflation, interest-rate movements, credit-market liquidity, portfolio-company performance, supply-chain disruption, geopolitical conflicts, cybersecurity events, regulation, litigation and the ability to access debt and equity capital.
- Most portfolio investments are valued using Level 3, unobservable inputs. Level 3 investments totaled $22.4 billion, or the substantial majority of the investment portfolio. Fair values may differ materially from eventual realizations, particularly in a forced sale.
- In March 2024, the company repaid $403 million of 2024 Convertible Notes using approximately $393 million of common stock and $10 million of cash, resulting in a $14 million realized loss on debt extinguishment and the issuance of approximately 20 million shares.
- GAAP included a $25 million capital gains incentive fee expense in Q1 2024, while no capital gains incentive fee was payable under the contractual investment advisory agreement. The cumulative GAAP accrual was $112 million at March 31, 2024.
- Unfunded revolving and delayed-draw commitments totaled $2.4 billion, with $60 million of net unfunded equity commitments. The company also had $54 million of letters of credit outstanding under portfolio-company commitments.
- Subsequent to quarter-end, the company amended its revolving credit facility, reducing total commitments to approximately $4.5 billion and extending selected revolving and maturity dates. It also amended the BNP Funding Facility and priced a $476 million term debt securitization expected to close in May 2024, subject to customary conditions.
- From April 1 through April 24, 2024, the company reported approximately $1.2 billion of new investment commitments, $249 million of exited commitments, and an investment backlog and pipeline of approximately $1.3 billion and $30 million, respectively. These transactions remain subject to conditions and may not close.
Most important facts for investors to verify
- Whether the increase in non-accrual investments and the portfolio’s Grade 1 and Grade 2 exposures leads to additional realized or unrealized losses.
- The sustainability of net investment income and the $0.48 quarterly dividend if base rates decline or portfolio credit costs increase.
- The timing and funding of the $900 million 2024 Notes maturity in June 2024 and the $476 million securitization expected to close in May 2024.
- The impact of Level 3 valuation assumptions, including market yields, discount rates and EBITDA multiples, on NAV and incentive-fee accruals.
- The availability of borrowing capacity after borrowing-base restrictions, facility amendments and upcoming debt maturities.
- Whether new investment commitments, the reported backlog and pipeline convert to funded investments without increasing credit or leverage risk.
- The composition and collectability of $2.4 billion of unfunded portfolio commitments, letters of credit and other guarantees.