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 June 30, 2013.

Key Financial Metrics

Material Changes vs. Prior Period

• Investment Income Growth: Total investment income increased by 16.2% year-over-year, driven primarily by a larger portfolio size (average amortized cost increased from $5.2 billion to $6.1 billion) and higher dividend income, particularly from Ivy Hill Asset Management, L.P. ($37.4 million vs. $9.5 million).
• Realized Gains vs. Losses: The company reported net realized gains of $20.3 million for the six months ended June 30, 2013, a significant improvement from net realized losses of $46.6 million in the same period in 2012.
• Unrealized Gains Decline: Net unrealized gains dropped significantly to $0.8 million from $80.8 million in the prior year period, largely due to reversals of previously recorded unrealized appreciation on assets that were sold or repaid.
• Expense Increases: Total expenses rose to $200.8 million from $174.8 million, reflecting higher interest and credit facility fees due to increased debt levels and higher base management and incentive fees tied to the larger asset base.
• Portfolio Expansion: Total investments at fair value grew by approximately $890 million compared to December 31, 2012, with new investment commitments totaling $1.6 billion for the six-month period.

Guidance, Outlook, and Risks

• Capital Deployment: The company continues to deploy capital aggressively, with a weighted average yield on new debt investments of 9.8% for the period. The portfolio remains heavily weighted toward floating-rate instruments (79% of investments at fair value).
• Debt Capacity: As of June 30, 2013, the company had approximately $1.2 billion available for additional borrowings under its credit facilities, subject to leverage and borrowing base restrictions. Asset coverage was 270%, well above the 200% regulatory minimum.
• Recent Developments: In July 2013 (subsequent to the period end), the company increased its Revolving Credit Facility commitments to $955 million and issued $300 million of new unsecured convertible senior notes due in 2019.
• Risks: Key risks include interest rate fluctuations (though mitigated by floating-rate assets), the valuation of illiquid private investments, and the creditworthiness of portfolio companies. The company notes that 1.9% of total investments at amortized cost were on non-accrual status as of June 30, 2013.

Investor Verification Checklist

• Valuation Methodology: Verify the board's fair value determinations for Level 3 assets, which comprise the vast majority of the portfolio, as these rely on unobservable inputs and management judgment.
• Non-Accrual Status: Monitor the 1.9% of investments on non-accrual status and the specific portfolio companies involved (e.g., eInstruction Corporation, Ciena Capital LLC) for potential credit deterioration.
• Debt Maturity Profile: Review the weighted average maturity of debt (8.7 years) and the mix of fixed vs. floating rate liabilities to assess refinancing risk and interest rate exposure.
• Related Party Transactions: Scrutinize transactions with Ivy Hill Asset Management, L.P. (a wholly-owned portfolio company), including the $37.4 million in dividend income and $35.0 million in investment sales during the period.
• Capital Gains Fee Accrual: Note the $73.5 million GAAP accrual for capital gains incentive fees, which is not currently payable under the investment advisory agreement but impacts reported expenses.