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). The company invests primarily in first and second lien senior loans and mezzanine debt of private middle-market companies. This report covers the quarterly period ended March 31, 2009.

Key Financial Metrics

Material Changes vs. Prior Period

• Profitability Surge: Net increase in stockholders' equity rose significantly to $35.0 million from $9.2 million in the prior year quarter. This was primarily driven by a $26.5 million realized gain on the extinguishment of debt resulting from the repurchase of CLO notes.
• Investment Income Growth: Total investment income increased 7% to $56.0 million, driven by a larger portfolio size (average investments at fair value increased from $1.8 billion to $2.0 billion) and higher yields, despite a 68% drop in capital structuring service fees due to fewer new commitments.
• Expense Reduction: Total expenses decreased 3% to $25.8 million. Interest and credit facility fees dropped 34% to $6.6 million due to significantly lower LIBOR rates (average cost of debt fell from 5.10% to 2.96%).
• Unrealized Losses: The company recorded net unrealized losses of $19.9 million, compared to $17.0 million in the prior year. Significant depreciation occurred in portfolio companies such as Reflexite Corporation ($8.1 million) and Growing Family, Inc. ($3.4 million).
• Liquidity: Cash and cash equivalents declined by $41.4 million to $48.0 million, reflecting dividend payments and net investment activity.

Guidance, Outlook, and Risks

• Market Conditions: Management notes that global market volatility has limited access to capital markets. The company intends to adjust investment paces, be more selective, and pursue asset sales to maintain liquidity.
• Financing Updates (Subsequent Events): On May 7, 2009, the company amended its CP Funding Facility, converting it to an amortizing facility, extending maturity to 2012, and reducing availability to $225 million. It also entered a commitment for a new $200 million revolving facility with Wachovia Bank N.A., subject to definitive documentation.
• Dividends: A quarterly dividend of $0.42 per share was declared. The company utilized open market purchases to satisfy the dividend reinvestment plan.
• Risks: Key risks include the illiquidity of portfolio investments, potential inability to refinance debt facilities on acceptable terms, and the impact of credit market disruptions on fair value measurements. Approximately 5.7% of total investments at amortized cost were on non-accrual status as of March 31, 2009.

Investor Verification Checklist

• Debt Extinguishment Gain: Verify the sustainability of earnings given the $26.5 million one-time gain from CLO note repurchases.
• Debt Refinancing: Monitor the execution of the new $200 million revolving facility and the amended CP Funding Facility terms, as these are critical for future liquidity.
• Non-Accrual Status: Review the specific portfolio companies on non-accrual status (5.7% of amortized cost) and the adequacy of fair value write-downs.
• Unrealized Losses: Assess the magnitude of unrealized losses ($19.9 million) and the specific drivers (e.g., Reflexite Corporation) to gauge portfolio health.
• Dividend Coverage: Confirm that net investment income continues to cover the $0.42 per share dividend distribution in the absence of one-time gains.