NEWS

On April 29, 2025 Ares Capital (ARCC) held its IQ 2025 earnings conference call.

ANALYSIS

The BDC Reporter edited the full transcript of the conference call, focusing only on credit-related issues discussed in the prepared remarks and then in the Q&A. Here is the result and below that you’ll find an AI-generated summary.

“Kort Schnabel Ares Capital Corporation – Partner & Co-Head of U.S. Direct Lending

…Our credit quality remains strong and stable with our non accrual loans and lower risk rated credits at historically low levels. 

…We remain confident in ARCC’s ability to successfully navigate future market conditions as we believe Ares has one of the most seasoned and experienced investment teams in the industry. Our investment committee members have been investing together at Ares for over 16 years on average, which fosters a consistent approach to credit quality and portfolio construction. Furthermore, all 4 of us on ARCC’s executive management team have been at Ares since before the great financial crisis.

…Our confidence is also underpinned by the overall health of our portfolio companies, which continue to exhibit strong credit results.

We ended the first quarter with sequentially lower non accruals, which continued to be well below our average and the BDC peer group historical average. Our portfolio companies are reporting double-digit organic LTM EBITDA growth and are levered on a debt-to-EBITDA basis below our 5-year average. This lower level of leverage can also be seen through our portfolio’s historically low average loan to value which currently sits in the low 40% range.

Tariffs

We also take comfort in the fact that our portfolio is focused on domestic service-oriented businesses, which should be more insulated from the direct impacts of higher tariffs. On that point, we are carefully monitoring the potential direct and indirect results of higher tariffs, and we are proactively engaging with portfolio companies to mitigate the potential impact of tariffs on our portfolio. While trade policies and their economic impacts remain highly dynamic, we only have a small number of borrowers that we believe are most directly exposed to the potential impacts from tariffs — particularly those that have higher exposure to China.

Specifically, these borrowers comprise only a mid-single-digit share of our portfolio today and we believe these companies are starting from a position of financial strength and flexibility. Importantly, this exposure assessment does not include any mitigants these companies can potentially implement such as adjusting pricing or the ability to transition supply chains. Additionally, our portfolio management team, one of the largest and most experienced in the industry is continuously monitoring the portfolio, and is prepared to respond quickly to potential tariff changes…

Scott C. Lem Ares Capital Corporation – CFO & Treasurer

We remain hopeful for some potential portfolio realized gains in the coming quarters, which may further enhance our taxable income spillover. We believe our meaningful taxable income spillover provides further long-term stability for our dividends and is a significant differentiator for us.

Mark R. Affolter Ares Management Corporation – Partner & Co-Head of U.S. Direct Lending

In recent quarters, we have been focusing on the less competitive core middle market segment, which is composed of companies with $50 million to $100 million of EBITDA — this trend is reflected in the weighted average EBITDA of our portfolio companies, which decreased for the fifth consecutive quarter to $274 million. Our median EBITDA remains around $80 million and has been fairly consistent over the past few quarters, underscoring our ongoing presence in all parts of the middle market. Additionally, this quarter, we achieved a higher yield per unit of leverage on our first lien originations than our post-COVID average.

Turning to the portfolio. We ended the quarter with $27.1 billion of investments at fair value, a 1.5% increase from the prior quarter. We believe our long-standing underwriting strategy of focusing on market-leading companies with high free cash flows and what we believe to be resilient, service-oriented industries will be important drivers of stability and differentiation in the quarters ahead.

We believe another point of differentiation is our disciplined approach to risk management and portfolio diversification. With 566 portfolio companies at the end of the first quarter and an average position size of less than 0.2% of the portfolio on average. We are able to mitigate the impact of negative credit events in any 1onecompany or industry.

The health of our portfolio can be seen in the 12% weighted average LTM EBITDA growth of our portfolio companies, which increased modestly from 11% in the prior quarter and was broad-based across both industries in which we invest and the various company size ranges. Another measure highlighting the health of our portfolio is the low leverage of our underlying portfolio companies. At 5.7x debt-to-EBITDA, this weighted average leverage level is the lowest we have seen since the first quarter of 2020. Coupled with this, our interest coverage is strengthening, currently near 2x. 

Beyond that, our non accruals at cost ended up the quarter at 1.5%, down 20 basis points from the prior quarter. This remains well below our 2.8% historical average since the great financial crisis, and the BDC industry historical average of 3.8% over the same time frame. Our nonaccrual rate at fair value also decreased by 10 basis points to 0.9%. The percentage of our portfolio at fair value in grade 1 and 2 names decreased a further 10 basis points sequentially, ending the quarter at 2.8%, the lowest level we have seen since 2010.

As a final point on our portfolio quality, when comparing our current position to our position just prior to COVID, the last major challenging economic period. Our portfolio companies today have 17% lower loan-to-value ratios on average, underscoring the greater equity value beneath our positions today than at the year-end 2019. Our portfolio has also become even more diversified as the number of companies in our portfolio has increased by 60% to 566. As a reminder, our portfolio performed very well through COVID with lower non accruals, lower realized losses and better ROEs than BDC peers on average over the course of 2020 and 2021.

In addition to our strong performance through COVID, we are one of the few BDCs that operated under the severe stress of the great financial crisis from 2007 to 2010, and one of an even smaller subset that did that so successfully. In addition to our distinct competitive advantages, we believe a key driver of this performance across cycles is also our flexible mandate that allows us to opportunistically invest across the capital structure.

Questions and Answers

Finian Patrick O’Shea Wells Fargo Securities, LLC, Research Division – Vice President and Senior Equity Analyst

Okay. A follow-up. It sounds like you had done a lot of work on tariffs — seeing if you could expand on the — if you could drill down on what you meant by exposed or impacted for the portfolio names. Is that — is that like in the context of a percentage of EBITDA, for example, or any color you could give there?

Scott C. Lem Ares Capital Corporation – CFO & Treasurer

Yes. I mean, we essentially — well, first of all, we reached out to every single portfolio company and we’re in touch with them on a regular basis, obviously. So it wasn’t anything super unusual. But we did the work to create a bottoms-up analysis and really try to understand, first and foremost, which companies import products — and then of those companies, which companies are importing products from high tariff countries.

And obviously, that high tariff country data point moves around week-to-week. But based on what we see today, there’s a mid-single-digit exposure, as we said in the prepared remarks, in our portfolio for those kinds of companies that are importing those products. We benefit from investing in and waiting toward domestic companies that are more service-oriented. And so that helped minimize that percentage.

And then on the second part of your question, yes, this is really important. This is an exposure analysis, not an impact analysis. And we don’t know yet what the actual impact will be, but I’ll just say, we obviously — we just went through a pretty significant supply chain disruption period coming out of COVID where we saw a lot of inflation and a lot of supply chain disruption.And our portfolio companies were able to pass on pricing and did pretty well through that. So that’s what we mean by exposure, not impact. These companies could have ways to mitigate the exposure that they have and find ways to soften the effect. So we just don’t know how it’s going to play out. But hopefully, that helps and answers your question.

Operator

And your next question comes from the line of Robert Dodd with Raymond James.

Robert James Dodd Raymond James & Associates, Inc., Research Division – Director & Research Analyst

I appreciate the commentary on the potential tariff impact of importing goods. Have you done any analysis here? I mean I don’t expect there’ll be a lot of exposure going the other way, obviously, with … tariffs. I mean, as you say, services, not a lot of manufacturing and exporting, but have you done any analysis on that side to see if you have exposure to that kind of impact if those …ariffs do stick long term?

Robert Kipp DeVeer Ares Capital Corporation – CEO & Director

Yes. We’ve looked at that as well. As you said, it’s very unclear as to how that’s going to play out. We have minimal exposure as well on that front. I think it’s interesting, right? Not only is there a potential risk factor, I guess, of exporting and retaliatory tariffs. There’s also just multiple domino effects and spill-on effects of how this could play out, right?

Second order impacts — their order impacts. What happens does inflation dampen consumer demand and obviously, everybody is wondering if this potentially tip us into a recession. I think all we can really do is look at our portfolio, try to quantify the first order impacts and we’ll see how the rest plays out. I think what we come back to is just our conservative underwriting or every time we underwrite any new deal, we’re always looking at the supply chain. We’re looking at supply concentration.

We’re making sure that our companies don’t have any material supply concentration. And obviously, we’re always underwriting as if there’s going to be a recession next year when we’re running downside cases or credit investors, we’re always worried about a recession all the time. So we just kind of fall back on that. Robert, and our experience operating through prior periods of softness. Obviously, it will be harder work if we do end up going through that kind of period, but we think we’re prepared.

Robert James Dodd Raymond James & Associates, Inc., Research Division – Director & Research Analyst

Got it. And just kind of a follow-up, credit related, but not tariffs. I mean a few years back, the whole industry, not necessarily just your pool, but the whole industry went through kind of an issue with physician office roll-ups. Now obviously, there’s a lot of veterinary office roll-ups across the industry as well, and 1 of them obviously was put on nonaccrual this quarter. So — is this the beginning of a cycle of that same kind of problem that the issues have moved and now it’s the veterinary office roll-ups and we’re going to see a lot more problems in that sector or what are your thoughts? Because, obviously, you put [Pathway Vet Alliance LLC and Jedi Group Holdings LLC with a cost of $76mn and a FMV of $50mn]  on nonaccrual this quarter?

Robert Kipp DeVeer Ares Capital Corporation – CEO & Director

Yes. Yes, probably, Robert, I don’t know that can help you too much on a forward outlook on what that’s going to be. I guess all I would say in terms of our portfolio and our exposure to that is it’s really minimal. We have less than less than 2% of our portfolio in physician practice management businesses. That includes that. So we really just don’t have a lot of exposure to that part of the market. I probably just won’t venture a guess as to what happens to the future of the veterinary space.

Operator

Your next question comes from the line of Melissa Wedel with JPMorgan.

Melissa Wedel JPMorgan Chase & Co, Research Division – VP of U.S. Equity Research

A lot of mine have been answered already, but I wanted to follow up on a comment made during the prepared remarks about, again, around assessing the direct exposure to tariffs, but that’s not including mitigating factors that companies could implement. You also made a comment that we’re ready to respond quickly in those situations. Can you just elaborate on that a little bit? What does that look like? Is that restructuring? Is that something else?

Robert Kipp DeVeer Ares Capital Corporation – CEO & Director

Yes, the response you’re asking if that impact does come through?

Melissa Wedel JPMorgan Chase & Co, Research Division – VP of U.S. Equity Research

Yes.

Robert Kipp DeVeer Ares Capital Corporation – CEO & Director

Yes. Look, I think that just comes back to our playbook that we employ when portfolio companies aren’t going according to plan, whether it’s tariff-related or related to any other reason. And just so what we do in that situation is, obviously, we are proactive, as I already said, in terms of getting ahead of the situation. So we’re in dialogue with those mid-single-digit percentages of our portfolio companies that are potentially exposed to tariffs. We’re having conversations with them now about what they’re planning to do, what their liquidity forecast looks like, how well funded are they?

And obviously, we’re in dialogue with the owners of those companies, which mainly are private equity firms that we’ve been doing business with for a long time. and preparing for what we need to do. And our actions can take many forms. But generally, we look to help be part of the solution. And the first thing we say is, if you’re the owner of the business, we expect you to contribute to the liquidity needs.

And if our private equity partners step up and provide liquidity, then we will help be part of that solution by offering to pick a portion of our interest for a short period of time in exchange for a premium and in exchange for that capital contribution to help these companies get through these types of periods. We did that during COVID very successfully. We saw lots of equity contributions come into our portfolio companies. Yes, we did PIK interest. Our PIK exposure went up for a short period of time, but that has all come down. And again, we weathered through that storm pretty darn well. So that’s step 1 in the playbook.

If the private equity owner or any owner of the business is not willing to step up, then yes, we are not afraid to own a business if we need to. We have the capabilities. We’ve got the management expertise and owning businesses through those kinds of cycles has actually produced a lot of gains for us over a long period of time. So we’re not afraid to roll up our sleeves and do that if we need to.

Melissa Wedel JPMorgan Chase & Co, Research Division – VP of U.S. Equity Research

I appreciate that. Thanks for going into detail there. I would agree with an earlier comment that was made about a sizable backlog into 2Q and the amount of activity seems to be pretty robust despite a more uncertain environment. Given the uncertainty around tariff policy, which I assume is what’s driving slower decision-making from borrowers. I guess I want to clarify if it’s primarily tariff policy, if you’re hearing any other consternation from borrowers about moving forward with capital allocation projects. But then also on that sizable backlog, do you think there’s maybe an incremental degree of uncertainty on how much of that will close just because of this elevated volatility that we’re in right now.

Melissa Wedel JPMorgan Chase & Co, Research Division – VP of U.S. Equity Research

A little one there. I think there’s a general assumption that uncertainty and the decision to — or maybe the propensity to delay capital allocation decisions right now has to do with tariffs uncertainty. I just was curious if you’re hearing anything beyond that, any broader macro concerns from your borrowers?

Robert Kipp DeVeer Ares Capital Corporation – CEO & Director

Yes. Most of it’s around the tariffs. It’s probably a little early to say. It stands to reason, obviously, given recession risk is higher that you might see some other companies hold off on capital spending. It’s just a little early to — for us to say that we’re seeing that — seeing any kind of real trend there yet, though.

Operator

And your next question comes from the line of Doug Harter with UBS.

Douglas Michael Harter UBS Investment Bank, Research Division – Analyst

Just on the unrealized marks in the quarter. Can you talk about whether those were kind of broad-based or more asset specific that led to the marks?

Robert Kipp DeVeer Ares Capital Corporation – CEO & Director

Yes, the latter, a little more asset specific. And again, not really anything that is drawing any kind of trend that we can identify just a little more esoteric one-off.

Mark Douglas Hughes Truist Securities, Inc., Research Division – Managing Director

Yes. Okay. And then you also mentioned the potential for realized gains in coming quarters to help boost NAV — is that based on some visibility that you’ve got your pipeline that you can see on that front is more favorable? Or is that just a general comment?

Robert Kipp DeVeer Ares Capital Corporation – CEO & Director

Yes. I wouldn’t say it necessarily boosts NAV because where we have to mark our portfolio to fair value. So I think as you — there’s a couple of names that you’ve seen the value gone up. As those realized, that would get added to our taxable income and our realizable spillover income?

Mark Douglas Hughes Truist Securities, Inc., Research Division – Managing Director

Fair enough. Is that — like I say, is there more potential for that more visibility? Or again, was that a general comment?

Robert Kipp DeVeer Ares Capital Corporation – CEO & Director

Yes. I mean we can’t comment on specific transactions, but I think there’s a couple you’re probably seeing you can — the pattern of it going up over time. And our hope is that a couple of those can get realized this year.

Operator

And our next question comes from the line of Sean Paul Adams with B. Riley Securities. .

Unknown Analyst

Touching on non accruals, I know we’d be kind of the topic to death, but the feedback that you received from portfolio companies, existing non accruals and also your analysis on kind of tariff exposure — can you touch on if you’re seeing any thematic patterns in portfolio stress or sectors or industries that have just proactively had outreach in dialogue?

Robert Kipp DeVeer Ares Capital Corporation – CEO & Director

Yes. I appreciate the question. It’s something we’re always looking for and trying to draw conclusions around trends to inform our behavior around new investing. Unfortunately, there’s just nothing that we’re really seeing yet that we can comment on that is that we can draw any conclusions around there being a trend. So we’ll just have to kind of wait and see, but we can keep talking about that in future quarters”.

VIEWS

Shocking

We remain surprised – in a good way – by how well ARCC’s huge, bellwether, portfolio performs from a credit standpoint, going by what management tells us.

If we are on the edge of a tariff-induced recession, the very low level of existing non-accruals; the growing EBITDA of the companies in the portfolio and their robust debt service coverage numbers all bode well.

We also agree that the PE groups who own most of the portfolio companies are very financially committed and should serve as a first line of defense should there be a broad crisis.

The days when LBOs were financed 10% with equity and 90% with debt are long, long gone but remain so in the popular imagination – and that of some journalists; incorrectly perceived as some sort of house of cards.

Ready And Able

Moreover – as ARCC ominously warns – should a PE group fail to support its company, there is no doubt that BDCs have the staffing, capital and commitment to “step in” where necessary and take control.

Virtually all credit activity in the recent quarters when companies have stumbled has consisted of debt-for-equity swaps, where the BDCs have asserted control to keep the underlying businesses going and – usually – advanced more funds to aid with liquidity.

(We should point out that this has saved countless jobs and had a positive knock-on effect on the entire economy – something the BDCs themselves should make more of).

One of the latest examples is Securus Technologies/Aventiv. Click here for a free article from BDC Credit Reporter, written on April 17, 2025.

With That Said

Nonetheless, there’s no doubt that the IQ 2025 was slightly sub-par from a credit standpoint.

Not discussed much on the CC was the fact that unrealized depreciation of ($354mn) exceeded unrealized gains of $252mn.

The 10-Q shows those unrealized losses were spread over multiple companies:

Gone Forever

Furthermore, there were 4 realized losses in the period

The back stories of all the companies above – and ARCC’s role therein – can be found in the BDC Credit Reporter.

All the companies have been restructured in one way or another.

On The Plus Side

ARCC was fortunate in having some offsetting realized gains which kept net realized losses to ($92mn) and another $31mn in favorable Forex gains.

Furthermore – as mentioned on the CC – there are a couple of investments that might be or sold for a profit in 2025 that will reduce the balance of losses this year.