Implications For ARCC And For The Sector

NEWS

NEW YORK–(BUSINESS WIRE)– Ares Capital Corporation (ARCC) announced that it has priced an underwritten public offering of $750 million in aggregate principal amount of 5.500% notes due 2030. The notes will mature on September 1, 2030 and may be redeemed in whole or in part at Ares Capital’s option at any time at par plus a “make-whole” premium, if applicable.

BofA Securities, Inc., J.P. Morgan Securities LLC, RBC Capital Markets, LLC, SMBC Nikko Securities America, Inc., Wells Fargo Securities, LLC, Barclays Capital Inc., BNP Paribas Securities Corp., CIBC World Markets Corp., Mizuho Securities USA LLC, MUFG Securities Americas Inc. and Truist Securities, Inc. are acting as joint book-running managers for this offering. HSBC Securities (USA) Inc., Morgan Stanley & Co. LLC, Regions Securities LLC, SG Americas Securities, LLC, BNY Mellon Capital Markets, LLC, Capital One Securities, Inc., Goldman Sachs & Co. LLC, ICBC Standard Bank Plc, Natixis Securities Americas LLC and U.S. Bancorp Investments, Inc. are acting as joint lead managers for this offering. Ares Management Capital Markets LLC, Deutsche Bank Securities Inc., ING Financial Markets LLC, R. Seelaus & Co., LLC, Academy Securities, Inc., Citigroup Global Markets Inc., Keefe, Bruyette & Woods, Inc., Loop Capital Markets LLC, Samuel A. Ramirez & Company, Inc. and Siebert Williams Shank & Co., LLC are acting as co-managers for this offering. The offering is expected to close on June 3, 2025, subject to customary closing conditions.

Ares Capital expects to use the net proceeds of this offering to repay certain outstanding indebtedness under its debt facilities. Ares Capital may reborrow under its debt facilities for general corporate purposes, which include investing in portfolio companies in accordance with its investment objective.

May 27, 2025 – Ares Capital Press Release

Ho Hum

As the chart below demonstrates, ARCC has a well ordered, “laddered” debt structure:

As a result, unsecured notes are being retired and replaced constantly.

Although not specifically referenced in the press release or in the filings, the debt just issued will help repay the $1.250bn in July 2025 Notes listed above.

That debt – issued in a very different environment in January 2020 – is priced at 3.250%.

Can’t Be Helped

ARCC, despite issuing this latest debt at a very narrow margin over equivalent Treasuries, will still see its interest bill increase as the July 2025 Notes wave goodbye.

This replacing of inexpensive notes with more expensive ones will continue – at least through 2026 – as $2.150bn in two other issues come due.

Overall that’s $5bn of debt that will cost 2.0%-3.0% more, or ($100mn) to ($150mn) a year.

Just to put these numbers into context, ARCC’s total interest cost was $715mn in 2024.

Better Than The Alternative

Furthermore, because of the inverted yield curve, the BDC would get no relief refinancing these notes with one of its Revolvers or other floating rate based, secured facilities.

The all-in cost on those amounts to something north of 6.0% right now and the prospect of the Fed cutting rates any time soon seems low.

Still, we’ll have to see if ARCC – as it has 3 times before of late – will swap out its fixed interest payments for floating on this latest issue.

If so, that will only increase how much ARCC pays to borrow in the short run.

The Fed would have to cut about 3 times (assuming a 0.25% drop each time) before ARCC would get any material benefit from such a strategic move.

Spreads

In the most recent quarter, the yield on all new investments added was 9.6%.

That’s likely not much changed currently given the more uncertain environment.

If we assume the new notes are used to finance incremental new investments at a time when ARCC is already leveraged over 1:1, the spread between what is received by ARCC and paid out in interest, management fee and incentive fee will amount to 2.5%.

• The calculation goes like this: 9.6 – 5.5 Interest – 1.0 Management Fee – 0.6 Incentive Fee = 2.5
• The comparable net margin on un-leveraged investments is 6.5%.
• The calculation goes like this:
• 9.6 – 1.5 Management Fee – 1.6 Incentive Fee = 6.5.

As we’ve noted multiple times before, as BDCs tap debt to grow their portfolios, the law of diminishing returns kicks in for shareholders.

Fixed Income Status

The fixed income market has been in turmoil of late as risk free rates rise due to the deficit; likely high inflation ahead and the uncertainty surrounding tariffs.

Maybe not coincidentally, we’ve not seen ANY publicly traded BDC Baby Bond issue come to market in months.

See the BDC Fixed Income Table, with the same 31 issues outstanding.

Even the institutional debt market in which ARCC – and most of its large peers, armed with their investment grade ratings – has been quieter.

As a result, it is encouraging both for the BDC’s own shareholders and those of other BDCs to see that the market is still operating, and – at least for ARCC – on generous terms.

Ever More

This is important because – as we’ve already discussed above – there are still many, many unsecured notes reaching maturity in 2025 and 2026.

If BDCs were forced to rely on their Revolvers alone to repay the unsecured note offerings issued in 2020-2021 this would result in a higher interest expense bill and would use up much of their borrowing capacity.

Undesirable

That’s a position that neither the BDCs nor the bank lenders that provide the bulk of the secured financings would like to see, especially if we are about to enter a difficult period for the economy and credit risk.

One of the great strengths of the BDC sector in recent years is that almost every BDC has been able since the GFC to wean itself off too great a reliance on its secured lenders by issuing covenant free, medium term, relatively inexpensive unsecured notes.

It would be a great step backward for the industry were that no longer possible.

By the way, this is not an academic issue.

A Little Worrying

Monroe Capital (MRCC) has unsecured notes coming due in February 2026 and the BDC seems to be preparing itself to repay the $135mn due with its ING Capital Revolver, as discussed in its latest 10-Q.

On February 27, 2025, the Company amended its revolving credit facility to provide additional flexibility for the Company to refinance the 2026 Notes, including, among other things, by modifying the borrowing base treatment of 2026 Notes and allowing for new indebtedness to be incurred to refinance the 2026 Notes.

MRCC- IQ 2025 10-Q

If this does occur, MRCC will be fully financed by its bank group, as opposed to the current 50/50 split between secured and unsecured.

Worth Watching

We’ll be keeping an eye out in the months ahead as to how – and at what cost – BDCs of all stripes replace their inexpensive, unsecured notes.

ARCC seems to be in good shape – even if the amount just raised is less than what is coming due – but that may not be the case for everyone.