ARCC

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) and treated as a Regulated Investment Company (RIC). The company is externally managed by Ares Capital Management LLC. This summary covers the quarterly period ended June 30, 2015.

Key Financial Metrics

Material Changes vs. Prior Period

• Investment Income Growth: Total investment income increased to $249.5 million for the quarter (from $224.9 million in Q2 2014) and $502.7 million for the six months (from $464.6 million in 2014). This was primarily driven by an increase in the portfolio size (average amortized cost rose from $7.8 billion to $8.4 billion for the quarter).
• Realized Gains: The company reported net realized gains of $24.2 million for the quarter and $56.0 million for the six months, a significant improvement from net realized losses of $48.5 million and $36.4 million in the comparable 2014 periods.
• Unrealized Gains/Losses: Net unrealized gains were $13.8 million for the quarter but turned into a net unrealized loss of $35.3 million for the six months ended June 30, 2015, compared to significant unrealized gains in the prior year.
• Expense Increases: Total operating expenses rose to $138.4 million for the quarter and $266.4 million for the six months, driven by higher interest and credit facility fees due to increased debt levels, as well as higher management fees due to the larger asset base.
• Debt Reduction: Total debt decreased from $3.92 billion at year-end 2014 to $3.58 billion as of June 30, 2015, despite new borrowings, due to significant repayments and repurchases of debt ($1.06 billion in the six months).

Guidance, Outlook, and Risks

• Senior Secured Loan Program (SSLP): GE announced the sale of its U.S. Sponsor Finance business (which partners with ARCC in the SSLP) to the Canada Pension Plan Investment Board (CPPIB). ARCC notified the SSLP of its election to terminate its obligation to present new investment opportunities to the SSLP. The company expects the SSLP portfolio to decline over time as loans are repaid, reducing the portion of earnings attributable to this program.
• New Joint Venture: In June 2015, ARCC announced a new joint venture, the Senior Direct Lending Program (SDLP), with Varagon Capital Partners to make first lien senior secured loans to middle-market companies.
• Dividends: The company declared dividends of $0.81 per share for the six months ended June 30, 2015. The company maintains a dividend reinvestment plan.
• Risks: Key risks include the valuation of illiquid investments, the impact of interest rate fluctuations, the financial condition of portfolio companies, and the potential for unrealized losses to differ from realized outcomes. The company also faces litigation regarding a purported fraudulent transfer involving a former portfolio company (DSI Renal Holdings), though management believes the claims are without merit.

Investor Verification Checklist

• SSLP Transition: Verify the impact of the GE/CPPIB transaction on future revenue streams from the Senior Secured Loan Program and the timeline for the wind-down of new SSLP investments.
• Portfolio Quality: Review the credit grade distribution (86.4% Grade 3, 9.4% Grade 4) and the 1.3% of investments on non-accrual status to assess credit risk.
• Debt Maturity Profile: Examine the maturity schedule of the $3.58 billion debt, particularly the Convertible Unsecured Notes maturing in 2016 and 2017, to assess refinancing needs.
• Unrealized Volatility: Monitor the swing in unrealized gains/losses, which shifted from a gain in the quarter to a loss for the six-month period, indicating valuation sensitivity.
• Legal Proceedings: Track the status of the DSI Renal Holdings litigation, which seeks approximately $117 million in damages from ARCC.