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) under the Investment Company Act of 1940. The company is externally managed by Ares Capital Management LLC. This Form 10-Q covers the quarterly period ended September 30, 2013.

Key Financial Metrics

Material Changes vs. Prior Period

• Investment Income Growth: Total investment income increased 29.5% for the three months ended September 30, 2013, compared to the same period in 2012 ($246.8 million vs. $190.6 million). This was primarily driven by an increase in portfolio size (average amortized cost of $7.0 billion vs. $5.6 billion) and higher dividend income, including a $25.0 million distribution from Ivy Hill Asset Management, L.P. (IHAM).
• Expense Increases: Total expenses rose to $116.6 million for the quarter (from $99.1 million in 2012). Interest and credit facility fees increased due to higher average debt outstanding ($2.9 billion vs. $2.3 billion). Management and incentive fees also increased due to the larger asset base.
• Realized Gains: Net realized gains were $8.9 million for the quarter, a decrease from $27.7 million in the prior year quarter. This was largely due to a $40.3 million realized loss on the eInstruction Corporation investment, partially offset by gains from Component Hardware Group, Inc. and Financial Pacific Company.
• Unrealized Gains: Net unrealized gains were $5.6 million for the quarter, down significantly from $19.4 million in the prior year period.

Guidance, Outlook, and Risks

• Portfolio Composition: As of September 30, 2013, the portfolio consisted of 86.2% Grade 3 investments (neutral risk), 9.0% Grade 4 (favorable risk), 3.9% Grade 2 (increased risk), and 0.9% Grade 1 (substantially increased risk). Loans on non-accrual status represented 2.0% of total investments at amortized cost.
• Senior Secured Loan Program (SSLP): The company co-invests with GE in the SSLP. As of September 30, 2013, the SSLP had $7.6 billion in funded assets. The company's yield on its SSLP investment was 15.3%.
• Dividends: The company declared dividends of $0.38 per share for each of the first three quarters of 2013. In November 2013, the company declared a fourth quarter dividend of $0.38 per share plus two additional dividends of $0.05 per share each.
• Legal Proceedings: The company is a defendant in a lawsuit filed by the bankruptcy trustee of DSI Renal Holdings LLC alleging a "fraudulent transfer." The complaint seeks approximately $117 million in damages from the company. Management believes the claims are without merit.
• Subsequent Events: In October 2013, the company completed a public equity offering raising approximately $214.2 million. In November 2013, the SSLP's total available capital was increased to $11.0 billion.

Investor Verification Checklist

• Verify the impact of the $40.3 million realized loss on eInstruction Corporation on future earnings.
• Monitor the status of the DSI Renal Holdings LLC litigation and potential liability exposure.
• Review the performance of the Senior Secured Loan Program (SSLP) and the company's exposure to GE's senior notes within that vehicle.
• Assess the sustainability of dividend income from Ivy Hill Asset Management, L.P. (IHAM), which included significant non-recurring distributions in 2013.
• Track the utilization of the new equity capital raised in October 2013 and its effect on the company's leverage ratios and asset coverage.