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. Its investment objective is to generate current income and capital appreciation primarily through debt investments (first and second lien senior secured loans, mezzanine debt) and, to a lesser extent, equity investments in U.S. middle-market companies.
Reporting Period: Quarterly period ended March 31, 2015.
Key Financial Metrics
| Metric | Q1 2015 | Q1 2014 |
|---|---|---|
| Total Investment Income | $253.2 million | $239.7 million |
| Net Investment Income (NII) | $121.7 million | $112.3 million |
| Net Increase in Stockholders' Equity | $100.6 million | $117.0 million |
| Earnings Per Share (Basic & Diluted) | $0.32 | $0.39 |
| Total Assets | $8.92 billion | $9.50 billion (Dec 31, 2014) |
| Total Investments at Fair Value | $8.48 billion | $9.03 billion (Dec 31, 2014) |
| Total Debt Outstanding (Principal) | $3.50 billion | $4.00 billion (Dec 31, 2014) |
| Cash and Cash Equivalents | $132.0 million | $194.6 million (Dec 31, 2014) |
| Net Assets Per Share | $16.71 | $16.82 (Dec 31, 2014) |
| Weighted Average Yield (Debt & Income Producing) | 10.5% | 10.1% (Dec 31, 2014) |
Material Changes vs. Prior Period
- Investment Income Growth: Total investment income increased by $13.5 million (5.6%) compared to Q1 2014, driven primarily by a larger portfolio size (average amortized cost of $8.6 billion in Q1 2015 vs. $7.6 billion in Q1 2014).
- Net Income Decline: Despite higher investment income, the net increase in stockholders' equity decreased by $16.4 million (14.0%) year-over-year. This was primarily due to a significant increase in net unrealized losses ($49.0 million in Q1 2015 vs. $7.4 million in Q1 2014) and a realized loss on debt extinguishment of $3.8 million.
- Portfolio Reduction: The company reduced its investment portfolio by approximately $546 million in fair value from the prior quarter, resulting in a net reduction in investment commitments of $623.1 million for the quarter.
- Debt Reduction: Total debt principal outstanding decreased by approximately $500 million from December 31, 2014, to March 31, 2015, including the full redemption of the $143.8 million February 2022 Notes.
- Expense Fluctuation: Total operating expenses increased to $128.0 million from $122.0 million. However, the capital gains incentive fee resulted in a $4.2 million reduction in expense for Q1 2015, compared to a $0.9 million expense in Q1 2014.
Guidance, Outlook, and Risks
- Senior Secured Loan Program (SSLP): The company co-invests with General Electric (GE) in the SSLP. In April 2015, GE announced its intent to sell most assets of GE Capital, including its interest in the SSLP. While the program continues to operate, the company faces uncertainty regarding the future partnership and potential impact on earnings if the program ceases new investments.
- Valuation Risks: The company values the majority of its portfolio using Level 3 inputs (unobservable inputs). Significant changes in market yields, discount rates, or EBITDA multiples could materially affect fair value. Net unrealized losses of $49.0 million in Q1 2015 highlight the volatility of these valuations.
- Legal Proceedings: The company is a defendant in a lawsuit filed by the bankruptcy trustee of DSI Renal Holdings LLC, alleging fraudulent transfer. The plaintiff seeks approximately $117 million in damages from the company. Management believes the claims are without merit.
- Dividends: The company declared a total dividend of $0.43 per share for the quarter, consistent with the prior year period.
Key Facts for Investor Verification
- SSLP Partnership Status: Verify the outcome of the dialogue between Ares Capital and GE regarding the future of the Senior Secured Loan Program following GE's asset sale announcement.
- Unrealized Loss Drivers: Review the specific portfolio companies contributing to the $49.0 million in net unrealized losses, particularly the $20.1 million depreciation in Ivy Hill Asset Management, L.P.
- Debt Extinguishment: Confirm the impact of the $3.8 million realized loss on the redemption of the February 2022 Notes on future liquidity and interest expense.
- Non-Accrual Status: Monitor the 1.7% of total investments at amortized cost that were on non-accrual status as of March 31, 2015.
- DSI Renal Litigation: Track developments in the DSI Renal Holdings LLC lawsuit, which seeks significant damages.