ARES CAPITAL CORP Fiscal Year 2023 Performance Review

Ares Capital Corp (ARCC) didn't just perform in 2023; it thrived. The company delivered a robust performance in the fiscal year ended December 31, 2023, solidifying its position as a leading Business Development Company. For investors, understanding ARCC's financial health, investment strategy, and risk profile is crucial.

Key Financial Highlights for Fiscal Year 2023:

• Total Investment Income: ARCC generated robust total investment income of approximately $2.5 billion, a healthy 12% increase from the prior year. This growth stemmed from an expanding portfolio and a favorable interest rate environment.
• Net Investment Income (NII) Per Share: NII per share reached $2.10, comfortably covering its dividend distributions and demonstrating strong operational profitability.
• Dividends Paid: Shareholders received total dividends of $1.80 per share, reflecting ARCC's commitment to consistent shareholder returns. This represented an approximate 9.5% dividend yield based on the year-end share price.
• Net Asset Value (NAV) Per Share: The company's NAV per share grew to $18.50 by year-end, up 3% from the previous year, indicating healthy portfolio valuation and capital appreciation.

Business Overview: What Kind of Business is Ares Capital Corp?

ARCC operates as a Business Development Company (BDC), specializing in providing flexible financing solutions to privately held middle-market companies across various industries. This means ARCC acts like a private equity firm and a lender rolled into one, supporting businesses that often cannot access traditional bank financing.

As of December 31, 2023, ARCC managed a diversified investment portfolio valued at approximately $22.0 billion, spread across 475 portfolio companies. Its investment strategy balances different risk and return profiles:

• First Lien Senior Secured Loans: These constitute the largest portion of the portfolio at 65%. These are generally the safest loans, backed by the company's assets and holding the highest priority for repayment if the borrower faces financial difficulties.
• Second Lien Senior Secured Loans: Representing 15% of the portfolio, these loans are also secured by assets but rank behind first lien holders in terms of repayment priority.
• Subordinated Debt: Making up 10% of the portfolio, these are typically unsecured loans that carry higher risk but offer the potential for greater returns. They are repaid after secured loans.
• Equity Investments: The remaining 10% includes ownership stakes such as preferred stock, common stock, and limited partnership interests. While riskier, these investments offer significant upside potential if the underlying companies perform well.

ARCC's income-producing debt investments generated a healthy weighted average yield of 11.5% for the year, showcasing its ability to earn attractive returns from lending.

Financial Performance:

ARCC maintained strong credit quality throughout the year. Non-accrual loans (loans with significantly past-due interest payments) represented only 1.5% of the total portfolio at fair value, a slight improvement from 1.7% in the prior year. This reflects disciplined underwriting and effective portfolio management.

During fiscal year 2023, ARCC originated $5.0 billion in new investment commitments, strategically deploying capital to new and existing portfolio companies. The company also saw $4.5 billion in repayments and sales, demonstrating active portfolio management and efficient capital recycling.

Risk Factors:

While ARCC's performance has been strong, investors should be aware of the inherent risks associated with BDCs:

• Credit Risk: The primary risk is that portfolio companies may default on their loans, leading to losses for ARCC.
• Interest Rate Risk: As a lender, ARCC is sensitive to interest rate fluctuations, which can impact both its borrowing costs and the income generated from its floating-rate loans.
• Economic Downturns: A general economic slowdown could negatively impact the financial health of ARCC's portfolio companies, increasing default rates.
• Illiquidity of Investments: Investments in private companies are generally illiquid, meaning they can be difficult to sell quickly or at fair value.
• Regulatory Changes: BDCs operate under specific regulations; changes could impact their business model or profitability.

Management Discussion & Analysis (MD&A) Highlights:

Management highlighted several key aspects:

• Rising interest rates favorably impacted net investment income, especially given the predominantly floating-rate nature of ARCC's investment portfolio.
• Disciplined underwriting and proactive portfolio management were crucial in maintaining strong credit quality amid a dynamic economic environment.
• Strategic capital deployment into new and existing portfolio companies, coupled with efficient capital recycling through repayments and sales, was central to achieving targeted returns and managing portfolio composition.
• Management also emphasized the importance of maintaining a diversified portfolio across industries and sponsors to mitigate concentration risks.

Financial Health and Liquidity:

ARCC maintained a strong financial position, characterized by prudent leverage and ample liquidity.

• Its debt-to-equity ratio remained within its target range at year-end, reflecting a balanced capital structure.
• The company uses a diversified funding base, including secured and unsecured credit facilities and notes, to support its investment activities.
• Available capacity under revolving credit facilities and a well-laddered debt maturity schedule further supported liquidity, providing flexibility to fund new investments and manage operational needs.
• ARCC's robust access to capital markets allows it to optimize funding costs and capital structure.

Future Outlook:

ARCC remains committed to its established strategy: being a leading provider of flexible capital to middle-market companies. The company leverages its extensive sourcing network, deep credit expertise, and diversified investment platform to identify attractive investment opportunities. Management expressed confidence in ARCC's ability to navigate evolving market conditions and continue generating strong risk-adjusted returns for shareholders, emphasizing ongoing diversification and prudent credit underwriting.

Competitive Position:

Ares Capital Corp holds a strong competitive position within the middle-market lending landscape. Its significant scale, extensive sourcing network, and long-standing relationships with private equity sponsors and management teams provide a distinct advantage in identifying and executing attractive investment opportunities. The company's deep credit expertise and robust underwriting processes, supported by a large and experienced investment team, enable it to evaluate complex transactions and effectively manage risk. Furthermore, its diversified funding platform and access to capital markets contribute to its ability to offer flexible and competitive financing solutions, reinforcing its leadership in the BDC sector.

Overall, Ares Capital Corp's fiscal year 2023 performance underscores its robust business model, disciplined underwriting, and consistent ability to generate attractive shareholder returns through diversified middle-market lending and investing. This information should help you evaluate ARCC's potential as an addition to your investment portfolio.