Ares Capital Corporation — Q3 2022 Form 10-Q Summary
Business context and reporting period
Ares Capital Corporation is an externally managed business development company and regulated investment company that invests primarily in first- and second-lien senior secured loans, subordinated debt, preferred equity and, to a lesser extent, common equity of middle-market companies. This filing covers the quarter and nine months ended September 30, 2022. The financial statements are unaudited.
Key financial metrics
| Metric | Three months ended September 30, 2022 | Nine months ended September 30, 2022 |
|---|---|---|
| Total investment income | $537 million | $1.456 billion |
| Net investment income | $288 million | $743 million |
| Net investment income per share | Not separately presented | $1.51 |
| Net increase in stockholders’ equity from operations | $104 million | $426 million |
| Net income per common share | $0.21 | $0.86 |
| Net realized gains | $0 million | $55 million |
| Net unrealized gains (losses) | $(184) million | $(324) million |
| Net investment income margin | 53.6% | 51.0% |
Net investment income increased substantially year over year, while total net earnings declined because of unrealized investment losses. Operating cash flow was $(999) million for the nine-month period, offset by $875 million of financing cash flow. Cash, cash equivalents and restricted cash ended at $362 million, including $257 million of unrestricted cash and cash equivalents.
- Total investments at fair value were $21.339 billion, compared with $20.009 billion at December 31, 2021.
- Net assets were $9.436 billion, compared with $8.868 billion at year-end 2021.
- Net asset value per share declined to $18.56 from $18.96.
- Debt was $11.816 billion at carrying value, versus $11.020 billion at year-end; principal debt outstanding was $11.853 billion.
- Debt-to-equity was 1.27:1, and asset coverage was 179%, above the 150% regulatory minimum.
- Weighted-average stated debt cost increased to 3.8% from 3.1%; weighted-average debt maturity shortened to 3.8 years from 4.2 years.
- The portfolio’s weighted-average yield at fair value increased to 9.7% from 7.9% at year-end 2021.
- Dividends declared for the first nine months totaled $1.36 per share, including additional dividends.
Material changes versus comparable periods
- Quarterly investment income rose 21% year over year, primarily from portfolio growth and higher interest rates. Nine-month investment income increased 13%.
- Interest income increased, while capital structuring service fees fell to $32 million from $59 million in the quarter and to $94 million from $190 million for the nine months, reflecting lower transaction activity and fee percentages.
- Dividend income increased to $107 million from $54 million in the quarter and to $314 million from $158 million for the nine months, driven principally by higher dividends from Ivy Hill Asset Management and increased preferred-equity investments.
- Total expenses declined to $235 million from $253 million in the quarter and to $676 million from $771 million for the nine months. However, interest and credit facility fees increased to $120 million from $94 million in the quarter and to $314 million from $267 million for the nine months.
- Unrealized investment losses were $214 million in the quarter and $375 million for the nine months before foreign-currency and other transaction results, compared with unrealized gains in the prior-year periods. Management attributed the decline primarily to lower credit and equity market prices and higher required market yields.
- New investment commitments declined to $2.242 billion from $3.110 billion in the quarter. Net investment commitments were $246 million, compared with $847 million in the prior-year quarter.
- Loans on non-accrual status increased to 1.6% of investments at amortized cost, or 0.9% at fair value, from 0.8% and 0.5%, respectively, at year-end.
Guidance, outlook, risks and unusual items
The filing does not provide formal earnings or dividend guidance. Management expects continued sensitivity to rising interest rates, inflation, recession risk, tighter credit markets, supply-chain pressures, geopolitical developments and the transition away from LIBOR. Approximately 73% of investments at fair value were variable-rate, while most unsecured debt was fixed-rate; management estimates that a 100-basis-point increase in base rates would increase annual net income by approximately $173 million before income-based fees, assuming no portfolio or borrowing changes.
- Unfunded revolving and delayed-draw loan commitments totaled $2.685 billion, including $1.490 billion of delayed-draw commitments and $41 million of letters of credit outstanding.
- The Senior Direct Lending Program had $4.772 billion of funded loans, $311 million of approved delayed-draw commitments and one loan on non-accrual status. Ares’s unfunded SDLP commitment was $73 million.
- The company recorded a $48 million realized loss on extinguishment of debt after repaying the 2022 Convertible Notes at maturity.
- GAAP included a $72 million accrued capital gains incentive fee at September 30, although no capital gains incentive fee was payable under the advisory agreement at that date.
- Most investments were valued using Level 3, unobservable inputs. Level 3 investments totaled $20.977 billion, making valuation uncertainty material.
- From October 1 through October 20, 2022, the company made approximately $1.1 billion of new commitments, exited approximately $418 million of investments and reported an investment backlog of approximately $605 million.
- Key risks include portfolio-company credit deterioration, non-accruals, valuation volatility, leverage and refinancing needs, interest-rate and credit-spread movements, inflation, market illiquidity, foreign exchange, cybersecurity, the Russia-Ukraine conflict, and the potential effects of LIBOR cessation.
Most important facts for investors to verify
- Reconcile reported net investment income and earnings per share to the consolidated statements, particularly where the MD&A text contains apparent extraction inconsistencies.
- Review the maturity schedule and refinancing plan for the $750 million of 2023 Notes, $403 million of 2024 Convertible Notes and other upcoming debt maturities.
- Assess the increase in non-accrual investments and the exposure of lower-rated investments, including Grade 1 and Grade 2 positions.
- Evaluate whether Level 3 fair values, unrealized losses and portfolio-company leverage adequately reflect current credit-market conditions.
- Monitor coverage of dividends by recurring cash investment income, considering PIK income, non-recurring dividends, incentive fees and cash-flow timing.
- Confirm availability under secured facilities, borrowing-base restrictions, unfunded commitments and letters of credit before relying on stated liquidity.