ARCC

Ares Capital Corporation (ARCC) - 10-Q Summary

Business Context and Reporting Period

This report covers the quarterly period ended September 30, 2006. Ares Capital Corporation 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 invests primarily in first and second lien senior loans, mezzanine debt, and equity securities of private U.S. middle-market companies. It is externally managed by Ares Capital Management LLC.

Key Financial Metrics

Performance (Nine Months Ended Sept 30, 2006)

• Total Investment Income: $82,512,850 (vs. $26,960,196 in 2005). Driven by portfolio growth and increased capital structuring fees.
• Total Expenses: $39,272,954 (vs. $11,417,954 in 2005). Significant increase in interest expense ($10.1M vs $0.7M) due to higher leverage.
• Net Investment Income: $38,312,425 (vs. $15,542,242 in 2005).
• Net Realized Gains: $26,102,809 (vs. $10,343,115 in 2005).
• Net Unrealized Gains/Losses: $(15,738,399) (vs. $102,696 in 2005). Driven by reversals of prior period appreciation and depreciation on specific portfolio companies.
• Net Increase in Stockholders' Equity: $48,676,835.
• Earnings Per Share (Basic & Diluted): $1.19 (vs. $1.33 in 2005).

Material Changes and Portfolio Activity

• Portfolio Expansion: Total investments grew by approximately 76% from year-end 2005. The number of portfolio companies increased from 38 to 56.
• Leverage Increase: Debt increased from $18 million to $366 million. This includes a new $400 million debt securitization (ARCC CLO) completed in July 2006, with $264 million outstanding as of period end. The Revolving Credit Facility had $87 million outstanding.
• Capital Raising: Completed a public add-on offering in July 2006, raising approximately $162 million net of costs.
• Yield: The weighted average yield on the entire portfolio was 11.36% as of September 30, 2006, up from 10.88% at year-end 2005.
• Investment Grades: The weighted average investment grade of debt in the portfolio was 3.0 (on a scale of 1-4, where 4 is lowest risk), compared to 3.1 at year-end 2005.

Outlook, Risks, and Contingencies

• Dividends: The Company declared a dividend of $0.40 per share for the quarter ended September 30, 2006. Subsequent to the period end, an additional dividend of $0.10 per share was declared.
• Commitments: As of September 30, 2006, the Company had $50.2 million in unfunded commitments for revolving senior secured loans and $2.7 million in standby letters of credit outstanding.
• Interest Rate Risk: Approximately 54% of the portfolio is at variable rates. A 100 basis point increase in base rates would increase interest income by ~$6.7 million and interest expense by ~$3.7 million annually.
• Valuation Risk: A significant portion of the portfolio consists of private securities valued by the Board of Directors. The filing notes that fair values may differ significantly from values in a ready market.
• Regulatory Compliance: The Company must maintain an asset coverage ratio of at least 200% to borrow under the 1940 Act. As of period end, the ratio of total debt to equity was 0.50:1.00, indicating compliance.

Investor Verification Checklist

• Verify the sustainability of the 11.36% portfolio yield given the increase in leverage and interest rates.
• Review the specific details of the $15.7 million net unrealized loss, particularly the reversals related to CICQ, LP and depreciation in Berkline/Benchcraft Holdings LLC.
• Assess the impact of the new $400 million CLO securitization on future liquidity and refinancing risks.
• Monitor the $50.2 million in unfunded commitments and the Company's ability to deploy capital at attractive yields.
• Confirm the Company's continued qualification as a Regulated Investment Company (RIC) to avoid corporate-level taxation.