Business Context and Reporting Period
Ares Capital Corporation (ARCC) is a closed-end, non-diversified management investment company regulated as a Business Development Company (BDC) under the Investment Company Act of 1940. The company is externally managed by Ares Capital Management LLC, a subsidiary of Ares Management L.P. Its investment objective is to generate current income and capital appreciation primarily through first and second lien senior secured loans, mezzanine debt, and equity investments in U.S. middle-market companies.
Reporting Period: Fiscal year ended December 31, 2015.
Key Financial Metrics
| Metric | 2015 | 2014 |
|---|---|---|
| Total Investment Income | $1,025.4 million | $989.0 million |
| Net Investment Income | $507.8 million | $437.8 million |
| Net Increase in Stockholders' Equity from Operations | $378.7 million | $591.0 million |
| Net Realized and Unrealized Gains (Losses) | ($129.1 million) | $153.2 million |
| Total Assets | $9,531.4 million | $9,497.8 million |
| Total Debt (Principal Amount) | $4,196.6 million | $3,999.3 million |
| Net Asset Value (NAV) per Share | $16.46 | $16.82 |
| Dividends Declared per Share | $1.57 | $1.57 |
| Weighted Average Yield (Debt at Fair Value) | 10.3% | 10.1% |
Material Changes vs. Prior Period
- Net Income Decline: Net increase in stockholders' equity from operations decreased by approximately 36% to $378.7 million in 2015 compared to $591.0 million in 2014. This was primarily driven by a shift from net realized and unrealized gains of $153.2 million in 2014 to net losses of $129.1 million in 2015.
- Unrealized Depreciation: The company recorded net unrealized depreciation of $246.2 million in 2015, compared to net unrealized appreciation of $59.4 million in 2014. Significant unrealized losses were attributed to the Senior Secured Loan Fund (SSLP) and specific portfolio companies such as Petroflow Energy Corporation and Ivy Hill Asset Management.
- Investment Income Growth: Total investment income increased 3.7% to $1,025.4 million, driven by a larger average portfolio size ($8.6 billion in 2015 vs. $8.1 billion in 2014). However, capital structuring service fees decreased due to lower new investment commitments.
- Expense Reduction: Total operating expenses decreased to $499.8 million from $532.9 million. This reduction was largely due to a reversal of capital gains incentive fees ($26.7 million credit in 2015 vs. $29.5 million expense in 2014) resulting from the net losses on investments.
- Debt Profile: Total debt principal increased to $4.2 billion. The weighted average stated interest rate on debt decreased to 4.4% from 4.9% in 2014, and the weighted average maturity decreased to 4.5 years from 6.5 years.
Guidance, Outlook, and Risks
Management Commentary and Outlook: Management highlighted that the decline in net income was largely due to market volatility and unrealized depreciation, rather than a deterioration in the underlying credit quality of the portfolio. The weighted average credit grade of the portfolio remained stable at 3.0. The company continues to focus on generating current income through its floating-rate portfolio, which represented 80% of investments at fair value.
Recent Developments:
- SSLP Transition: Following the sale of GE's U.S. Sponsor Finance business to CPPIB, the Senior Secured Loan Program (SSLP) ceased making new investments. GECC directed principal proceeds from SSLP repayments to repay its senior notes first, which is expected to reduce the yield on Ares Capital's subordinated certificates over time.
- New Joint Venture: In December 2015, the company established the Senior Direct Lending Program (SDLP) with Varagon Capital Partners to make first lien senior secured loans, with an aggregate capital commitment of $2.9 billion.
- Debt Repayment: In February 2016, the company repaid $575 million of February 2016 Convertible Notes at maturity.
Risks and Contingencies:
- Market Volatility: Continued volatility in global markets, including China and geopolitical unrest, poses risks to asset valuations and liquidity.
- Leverage: The company utilizes leverage to enhance returns. A decline in asset values could disproportionately reduce net asset value per share.
- Conflicts of Interest: As an externally managed BDC, there are inherent conflicts regarding fee structures and allocation of investment opportunities between Ares Capital and other Ares funds.
- Legal Proceedings: The company is a defendant in a lawsuit involving DSI Renal Holdings LLC, seeking approximately $117 million in damages. Management believes the claims are without merit.
Investor Verification Checklist
- Verify the impact of the SSLP wind-down on future yield, specifically the priority repayment of GE's senior notes.
- Review the specific portfolio companies contributing to the $246.2 million in net unrealized depreciation to assess credit risk concentration.
- Confirm the status of the $117 million legal claim from the DSI Renal Holdings bankruptcy trustee.
- Monitor the deployment of capital into the new Senior Direct Lending Program (SDLP) and its expected yield profile.
- Assess the company's ability to maintain its Regulated Investment Company (RIC) status given the mix of cash and non-cash (PIK) income.