INTRODUCTION: Game-day – i.e. calendar IIIQ 2024 BDC earnings season – is getting on the calendar. What should we expect? The BDC Reporter has some ideas, drawn from the experience of prior quarters; what we can glean from “subsequent developments” in the filings; recent news developments and – at least where earnings are concerned – from the estimates of the analyst community. Let begin with Ares Capital (ARCC) – the biggest public BDC and one which sets the standard across most of the metrics we track. As shown in the BDC Earnings Calendar in the Subscriber Tools section, ARCC will report on Wednesday, October 30, 2024 prior to the opening of the Nasdaq Global Select Market. “Ares Capital invites all interested persons to attend its webcast/conference call at 12:00 p.m. (Eastern Time) on the same day”.

Portfolio Size: As of the IIQ 2024, ARCC’s total investment assets at cost were $24.707bn and $24.973bn at fair market value (FMV) – making the BDC one of a small number of larger BDCs in the black on a value basis. Last quarter its AUM increased by 8%, matching the percentage growth rate of arch-rival Blackstone Secured Lending (BXSL) , 1% above Blue Owl (OBDC) and way above FS-KKR Capital (FSK) whose portfolio slightly shrank. Last quarter ARCC issued 26mn new shares and the BDC needed to grow its portfolio to stand still. In the IIIQ 2024, we wouldn’t be surprised if ARCC both continued to raise equity at a premium to book – as they’ve been doing a lot of late – and increased the size of the portfolio by somewhere between 5%-10%. After all ARCC has increased its portfolio over the last 3 years at an average percentage of 18% annually. With that said, portfolio AUM has dropped 3 times out of the last 12 quarters. Through July 24, 2024 net portfolio assets had increased by only $39mn but there’s been plenty of time for that to change.

Credit Performance: In the first six months of 2024 ARCC has booked only ($6mn) in net realized losses on investments – a rounding error for a BDC of this size and ($14mn) on extinguishment of debt. More than offseting those losses are $94mn in net unrealized gains. This was substantially better than in the same period the year before, which included ($131mn) in net realized losses.

However, when we look behind the curtain, the results in 2024 to date are more nuanced. Gross realized losses – across 3 companies – came to ($160mn) – equal to nearly half the BDC’s Net Investment Income in the period. The biggest loss related to the restructuring of SHO Holding I (aka Shoe For Crews) as part of a debt-for-equity swap. More than most of its peers – and with great success most of the time – ARCC is willing to book large second lien loan positions, as happened with SHO Holding I. (Nearly a fifth of the BDC’s portfolio at cost is invested in second lien debt and subordinated loans in portfolio companies). In this case, every dollar invested at cost was written off. That’s ($119mn). Now ARCC and its shareholders have to hope that the remainder of its debt invested in SHO Holding I and renamed Shoes For Crews Holdings – now consisting of about $22mn in a mix of debt and equity in the restructured company – can pay a little interest and result in an equity gain some fine day. The bottom line, though, is that the loss of capital here is permanent, causing ARCC to forgo about ($15mn) annually between the realized loss and the first lien debt converted into non-income producing equity in Shoes For Crews LLC. The BDC will be able to boast of the removal of the SHO Holding I debt from non-accrual but the cost has been high.

We’ll be looking at the valuation of the new entity’s common stock – valued at its $10.5mn cost as of the IIIQ 2024 for hints on how that restructured company is performing. Whatever that outcome the SHO Holding I write-off was a material setback for ARCC. Also essentially written off is ARCC’s debt and equity in Singer Sewing, which resulted in a ($20mn) permanent loss and ($21mn) in SSE Buyer’s restructuring.

Saving the quarter for ARCC was the sale of its equity position in Heelstone Renewable Energy, resulting in a mammoth net realized gain of $146mn – a great payday even by ARCC’s standards. This is all the more remarkable as the Heelstone investment just two years ago was not worth all that much. ARCC, though, injected more and more debt and equity in recent quarters leading to this excellent result. Offsetting credit losses with occasional equity gains has long been part of ARCC’s investment strategy and this episode has once again proven this works.

In the IIIQ 2024, we expect to see ARCC’s debt position in Pluralsight – and its largest unrealized loss in the IIQ 2024 – partly written off. As everyone knows by now, Pluralsight is being taken over by its lenders which will see a great deal of debt written off and some of the remainder either being converted into new loans or equity. Total exposure may also increase as the lender-owners advance new funds. Given that ARCC has already booked a ($40mn) write-down, though, we don’t expect much net change from Pluralsight.

We also expect a realized loss to be booked on Emergency Communications Networks. ARCC booked a ($12mn) unrealized loss on its $59mn invested at cost. In July the company was sold. We don’t expect much of a change in the net loss there either.

There’s mot enough room to review every underperforming company in this sort of detail. All we’ll say is that there were several other significant unrealized write-downs in the IIQ 2024, most of which have not been realized in the same way as SHO Holding and Emergency Communications. That leaves the door open to further write-downs in the IIIQ 2024 from these names alone. However, ARCC may yet pull out an unrealized or realized gain out of a hat so we won’t opine on how net losses will end in this coming quarter.

Net Asset Value Per Share (NAVPS): For the last two quarters, ARCC’s NAVPS has increased by 2% and by 6% over the past 12 months. Partly this has to do with credit performance as discussed above but most of the gain can be traced to the accretive value of selling new shares at a premium and ARCC’s policy of retain ing a good deal of its earnings rather than paying them out as distributions. If past is prolog – and both these factors continue to be operative – ARCC’s NAVPS in the IIIQ 2024 might reach $20.0 or better for the first time from $19.61 at mid-year.

Earnings: Through the first half of the year, ARCC’s Core Net Investment Income Per Share (CNIIPS) has come to $1.20 $0.59 in the first quarter and $0.61 in the second quarter. The consensus of the 14 (!) analysts covering the stock is deja vu all over again in the IIIQ and IVQ 2024: $0.59 per share. That brings the year to $2.38. Our sister publication – BDC Best Ideas – has also gotten into the game of guessing how much every BDC will earn, and is projecting full year CNIIPS of $2.37 – equal to the 2023 result. ARCC is very good at “managing” its earnings so we’re relatively confident that CNIIPS will fall somewhere within a narrow range on each side of $0.59. If ARCC fails to do so, what will be most interesting will not be the ultimate number but the reason.

Distributions: Through the first 9 months of 2024, ARCC has paid out a quarterly distribution of $0.48 three times. Not only has the payout remained unchanged in 2024, it’s been the same since the IVQ 2022. In the intervening period – which coincided with the highest interest rates in recent BDC history – management has paid out only one “special” for $0.03 per share. (By contrast – in this same time period BXSL has managed to increase its quarterly dividend by 28%). Chances are very good – given the projected earnings and the large amount of undistributed taxable income – we will get another $0.48 distribution announced in the IVQ 2024, for an annual total of $1.92. That’s also the projection of BDC Best Ideas. If correct, that will be the same payout in 2024 than in 2023.

There’s a small chance that ARCC – for technical tax reasons – will throw in – grudgingly we assume – a “special” dividend for 2024.

CONCLUSION

Neither the BDC Reporter – nor BDC Best Ideas or the analysts – expect anything but a “steady as she goes” performance from ARCC in the IIIQ 2024 across all the data we’ve discussed. That’s probably as management prefers. The “Return On Equity” – the NII divided by the net asset value – would clock in at a pretty good 11.8%, judged on historical standards and without getting above the BDC’s moderate target leverage. The BDC will be able to point to its “stable” dividend. (Shareholders, though, will note that compensation income continues to grow for the external manager even as distributions remain frozen, but that’s an aside we allow ourselves once in a while). We do concede, though, that overall credit conditions – which we have not had the time to discuss above – remain ABOVE AVERAGE at ARCC – a little surprising given the losses weighing some BDCs down and the several setbacks in the portfolio (Pluralsight, SHO Holding, Emergency Communications, etc).

PRICE PERFORMANCE

Since ARCC last reported quarterly results – on July 30 – its stock price – after an initial slump – has gone exactly nowhere. As the chart shows, the BDC is up 0.3%. By contrast, BIZD – the only BDC ETF – is off (3.0%). During this period a $0.48 distribution was paid.

At this point, the stock is trading at $21.05 – (3.6%) below its 52 week high. Given the $2.38 in projected 2024 earnings discussed above, the price to expected 2024 earnings comes to 8.9x. Going by the BDC Best Ideas data this is more than the 8.2x BDC average. The yield – assuming $1.92 paid in 2024 – is 9.1%. There are only 3 BDCs with a lower yield right now. The average BDC yield is 11.9%.