Ares Capital Corporation Q2 FY2025 earnings call

• Solid second quarter results with core earnings per share of $0.50, annualized return on equity of 10%. Net asset value per share increased sequentially and year-over-year.
• Market conditions: Second quarter began with policy-driven volatility, but liquid credit markets reopened later. Active during volatility, with nearly 3/4 of gross commitments from incumbent relationships.
• Portfolio performance: Borrowers' weighted average organic EBITDA growth accelerated into double digits. Leverage levels below 5-year average, loan to value in low 40% range. Non-accrual levels still below historical average.
• Investment activity: Originated over $2.5 billion of new investment commitments, with 74% from incumbent borrowers. Portfolio diversified across 566 companies in 25 industries. Third quarter backlog healthy at $2.6 billion.

Ares Capital Corporation reported solid second quarter results with core earnings per share of $0.50, consistent with the prior quarter. GAAP net income per share was $0.52. The portfolio at fair value was $27.9 billion, up from prior periods. Revenue contribution details were not applicable as there are no distinct product segments detailed.

• Third quarter dividend of $0.48 per share payable on September 30. Estimate of $878 million available for distribution to stockholders in 2025. Expecting more active second half of the year based on growing pipeline.

• Tariff-related volatility impacting investment activity and portfolio companies. Modest uptick in non-accrual levels, but still below historical average. Geopolitical shifts and policy risks affecting portfolio companies.

Q: Can you talk about any improvement in terms spreads and upfront fees and how might that drive an NOI improvement on the go forward?

A: Yes, spreads showed stability with some tightening, volume picking up.

Q: For a follow-up on the off-balance sheet vehicles, the SDLP and Ivy Hill, those are a little smaller as a percent given the growth of ARCC, but seeing if you can hit on the ability or likelihood to expand those back to historical averages or peaks or wherever you might see fit?

A: Both vehicles are strategically important and wouldn't be surprised if they grow more.

Q: As you think about taking advantage of the growing pipeline that you talked about or deal activity you talked about, how are you weighing the balance between maybe taking leverage up versus continue going to issue new equity off of the ATM?

A: Balance between raising capital via ATM and leverage, with core earnings covering dividend and providing flexibility.

Q: On the credit side, if we can, I mean you added a couple -- a few more names to non-accrual but a couple of those were new, right? I mean [PRG] and KBS had defaulted before and been restructured and now they're back. So can you -- is it -- those are obviously kind of club deals. Is it getting harder because you've got a really good track record of doing this, but is it getting harder to restructure a club asset correctly the first time. Or is there anything systematic in there because it's relatively unusual for you guys to have an asset that gets restructured that becomes a problem again. Any color there?

A: A couple of names had been restructured, but not anything to read into, just idiosyncratic factors.

Q: You mentioned that in the activity that you're seeing recently has been a little bit more skewed to the upper middle market, which makes sense given the volatility. But as you talk about the activity in the pipeline looking pretty strong for the second half, are you seeing broaden out into the core and lower middle market as well.

A: Yes, seeing it broaden out across all different types and sizes of companies.

Q: I appreciate your commentary about spreads. I'm wondering, you're getting a little bit better pipeline filled. Is it your view that a real and dynamic increase in deal activity would help push spreads out to a little bit more attractive levels? Or is there just so much capacity out there that it's really hard for spreads to make much of a move.

A: Laws of supply and demand suggest more deal flow could widen spreads, but total yields are good, and leverage levels in new assets are stable.

Q: Just a maintenance question, and I'm sorry if I missed this, a couple of distractions. But a pretty good jump in dividend income quarter-over-quarter. Was there any onetime in that? Or was that just based upon growth of the vehicles?

A: Mix of recurring and nonrecurring, about $10 million from equity co-investments.

Q: As you look across your pipeline of potential originations there, and it sounds like you've been seeing a lot more of the upper end of the segments more recently, how did the relative pricing and returns for the smaller scale or more core middle market segment compared to the upper. Are you seeing more attractive returns in any particular segment?

A: Smaller companies generally have lower leverage and wider spreads, providing incremental yield.

Q: In terms of the equity co-investments, the exit side, I presume they were not driven by Ares Capital. They were not discretionary. Just want to double check that. And to the extent that they have any visibility, is there any potential outlook for further equity realizations? Or is it primarily driven by the sponsors?

A: Primarily driven by sponsors, not much control, sporadic, can't provide forward guidance.

Q: Just to follow up on a couple of things. I wanted to go back to the comments made about the impact of tariffs on portfolio companies. Are you still estimating a roughly mid-single-digit exposure across the portfolio to companies that could be impacted by tariffs sort of before any mitigating factors?

A: Feeling better this quarter, high-risk names now low single-digit percentage, portfolio companies can mitigate via pricing.

Q: And my last question I wanted to follow-up on the capital injection or the additional investment into IHAM this past quarter. I also noted that one of the comments on the -- in the deck about exited investments post quarter end included a sizable amount in the subordinated loan, the IHAM. So I'm just curious how we reconcile those 2 -- the flows into Ivy Hill this quarter and then apparently out of the sub-loan in 3Q.

A: Subordinated loan with Ivy Hill used as working capital line, proceeds sent back post quarter end.

Q: Touching Back on Ivy Hill, it seemed there was a slight shift in the gross commitment portion for first lien senior loans, which I'm guessing is largely a reflection of Ivy Hill repayments. So it was just an allocation rebalancing. But when you are looking at the balance of Ivy Hill, will there be more of a long-term shift in the target asset classes to balance the growth targets? Or a change in the target for first lien?

A: Ivy Hill has first lien investment strategy, no strategic changes planned.