Ares Capital Corporation (ARCC) Earnings Call Transcript & Summary

Good afternoon, everyone. Welcome to the Ares Capital Corporation's Third Quarter ended September 30, 2026 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded on Tuesday, October 27, 2026. I will now turn the call over to Mr. John Stilmar, Partner of Ares Public Markets Investor Relations. Please go ahead, sir.

Thank you, and good afternoon, everybody. Let me start with some important reminders. Comments made during the course of this conference call and webcast as well as the accompanying documents contain forward-looking statements and are subject to risks and uncertainties. The company's actual results could differ materially from those expressed in such forward-looking statements for any reason, including those listed in its SEC filings. Ares Capital Corporation assumes no obligation to update any such forward-looking statements. Please also note that past performance or market information is not a guarantee of future results. During this conference call, the company may discuss certain non-GAAP measures as defined by SEC Regulation G, such as core [indiscernible]. The company believes that core EPS provides useful information to investors regarding financial performance because it's one method the company uses to measure its financial condition and results of operations. A reconciliation of GAAP, net income per share, the most directly comparable GAAP financial measure to core EPS can be found in the company's final presentation for this call. In addition, reconciliations of these measures may also be found in our earnings release filed this morning with the SEC on Form 8-K. Certain information discussed on this conference call as well as the accompanying slide presentation include credit ratings and information related to portfolio companies was derived from or obtained from third-party sources and is not been independently verified, and accordingly, the company makes no representation or warranties with respect to this information. The company's third quarter September 30, 2026 earnings presentation can be found on the company's website at www.arescapitalcorp.com by clicking on the Third Quarter 2026 Earnings Presentation link on the Events and Presentations page of the Investor Resources section of Ares Capital Corporation's earnings release and Form 10-Q are also available on the company's website. Now I'd like to turn the call over to Kort Schnabel, Ares Capital Corporation's Chief Executive Officer. Kort?

Thanks, John, and hello, everyone, and thank you for joining our earnings call today. I'm joined by Jim Miller, our President; Jana Markowicz, our Chief Operating Officer; Scott Lem, our Chief Financial Officer; and other members of the management team, who will be available during our Q&A session. This morning, we reported solid third quarter results with core earnings of $0.46 per share, representing an annualized return on equity of approximately 9.5%. Our underlying investment portfolio remains healthy as borrower cash flow growth supports strong credit performance and steady net asset value per share. The level of nonaccruing loans and problem assets remains stable at historically low levels. Our earnings are well positioned to potentially benefit from an expected higher level of interest rates, and we entered the seasonally strongest fourth quarter from a position of considerable financial strength after taking a number of important actions to advance ARCC's strategic and financial priorities. Most notably, this morning, we announced our agreement to acquire MidCap Financial Investment Corporation, or MFIC. The transaction is expected to be modestly accretive to core earnings per share providing attractive financial benefits from the outset, while also creating strategic value that we believe adds value creation from this acquisition is the added scale that this broad-based and well-diversified portfolio brings to ARCC. With this combination, the MidCap Financial portfolio is expected to add over 200 additional incumbent positions, increasing our portfolio to over 800 portfolio companies and expanding the number of sponsors we have transacted with to over 600 sponsors. This will further strengthen our long-standing middle market presence and broaden the relationships from which we can generate future investment opportunities. Based on the depth of our due diligence on each investment in the portfolio, along with the capabilities of the broader Ares platform and direct financial support from Ares Management, we believe we have an excellent foundation in place for this transaction to add to our track record of successful acquisitions over our 22-year history as a public company. Importantly, it's central to our view on the quality of the portfolio, the vast majority of the discount to NAV was concentrated in a small percentage of investments that consisted primarily of situations that, in our view, involved greater uncertainty of business outcomes and resulted in wider bid-ask spreads. Consolidation has been an important part of our history. We have consistently used periods of market volatility and dislocation to create differentiated opportunities for our shareholders while building greater scale at a durable [indiscernible]. In fact, upon closing the Apollo Investment Corporation, ARCC will have acquired all 3 of the largest BDCs in operation at the time of our IPO over 20 years ago, including Allied Capital and American Capital. Our track record of disciplined consolidation has created significant value for our shareholders as both Allied and American Capital generated IRRs in excess of 20% over the 3 years following their respective acquisitions. The value of these acquisitions, however, has extended well beyond the assets we acquired. They have expanded our scale, deepened our sponsor and borrower relationships, broadened our incumbent portfolio and strengthened our ability to originate attractive investments. While we have similar view for the mid-cap acquisition, Ares positions the transaction as additive rather than transformative. Turning to the broader investment environment, macroeconomic shifts and geopolitical developments created greater uncertainty around transaction activity during the third quarter. Volatility around interest rates, inflation and global trade reduced visibility and elongated M&A processes. Importantly, we view much of the slower origination volume during the third quarter as a matter of timing since underlying deal review activity remained strong. In the third quarter, we reviewed more transactions than we did a year ago. And year-to-date, we have reviewed approximately 25% more transactions than in the prior year, including our specialized lending verticals has enabled us to review more than $1 trillion of potential investment transactions over the past 12 months. As transaction time lines have extended, more of that activity is carrying into the fourth quarter, providing greater visibility into the months ahead as borrowers and sponsors continue to place a premium on lenders that can provide certainty of close. So far in the fourth quarter, we have closed on $1.1 billion of commitments, and our investment backlog now stands at approximately $2.5 billion. When taken together, our post-quarter end originations and backlog are at historically strong levels which further supports our enthusiasm [indiscernible] for recovery in investing activity. More broadly, across the U.S. direct lending market, we continue to see a constructive environment for lenders. As we progress through the fourth quarter, we have substantial liquidity, extensive access to financing, a large and diversified incumbent portfolio and the connectivity of the broader Ares platform, leaving us well positioned to pursue opportunities as they emerge. With respect to our quarterly dividend, we continue to believe ARCC's current regular dividend appropriately reflects the underlying earnings power from quarter-to-quarter, the strength of our portfolio, attractive market pricing and terms the current interest rate environment and the expected benefits from the acquisition I discussed earlier, reinforce our confidence in the current dividend level. Our substantial spillover income provides additional flexibility during periods like quarterly earnings temporarily file. Ultimately, our focus remains the same: Use ARCC's financial strength, scale and connectivity to generate attractive long-term returns for our shareholders and maintain the stability of our regular quarterly dividend [indiscernible] as we have for more than 17 years. With that, I will turn the call over to Scott to take us through our financial results and balance sheet.

Thanks, Kort. I will begin by reviewing several key financial metrics from the third quarter and discuss our balance sheet and funding activity and conclude with an update on the dividend and taxable spillover income. This morning, we reported GAAP net income per share of $0.44, up from $0.24 in the second quarter of 2026. The sequential improvement was largely driven by net unrealized depreciation primarily from mark-to-market improvements on investments. Core earnings were $0.46 per share compared to $0.47 in the prior quarter, primarily reflecting lower capital structuring fees due to the longer transaction time lines Kort referenced alongside continued healthy portfolio performance. Looking forward, our earnings remain sensitive to changes in base rates, given the predominantly floating rate nature of our portfolio. Based on our balance sheet at quarter end, and assuming no change in our investment in borrowing structure, every 100 basis point [indiscernible] $0.02 per share of earnings tailwind for us per quarter. Keep in mind, the recent increase in base rates occurred just prior to quarter end. Given the timing of contractual rate resets across our floating rate loan portfolio, it typically takes about a quarter for changes, so we would expect to start seeing some of the interest income benefit in the fourth quarter. Turning to the balance sheet. Our total portfolio at fair value at the end of the third quarter was $29.2 billion compared with $29.3 billion at the end of the second quarter, primarily reflecting using net exit and repayment activity. Our net asset value ended the quarter at $13.9 billion or $19.31 per share, which represents a decrease of $0.04 per share [indiscernible] long-term record sector. Since inception, we have grown NAV per share by more than 25%, while also delivering stable and attractive dividends to our shareholders. Turning to our debt capital. We reported net leverage of 1.06x, [ debt to 0.12x ] last quarter. Pro forma for an unsettled trade payable related to a portfolio acquisition that closed at quarter end, our net leverage would have been 1.10x with approximately $7 billion of available liquidity. Our maturity profile remains well laddered with no unsecured note maturities for the remainder of 2026 and just $1.4 billion maturity in 2027. With modest leverage, substantial liquidity and limited near-term maturities, we have meaningful capacity to support new investment opportunities. We continue to strengthen that vision during the quarter through several financing activities. In September, we issued $750 million of 7-year unsecured notes due in 2033, at a spread of 185 basis points over treasuries representing the lowest new issue spread and longest duration in the BDC sector. In addition, we took advantage of favorable market conditions to reset our inaugural $476 million debt securitization, reducing its weighted average spread by 35 basis points by extending both its reinvestment period and final maturity. This low length of the duration and flexibility of our funding profile. We also enhanced our cost of capital during the quarter by accessing the commercial paper market under the $1 billion program applied last quarter. By maintaining $200 million to $300 million of commercial paper outstanding on average, during the quarter, we reduced our borrowing costs by approximately 70 basis points on these amounts compared with borrowing under our corporate revolver. At quarter end, we had no commercial paper outstanding. Taken together, these actions continue to advance our balance sheet objectives of maintaining diversified access to capital, lowering our funding costs where appropriate and preserving significant and liquidity and financial flexibility. Looking at a proven track record, we will remain increasingly important differentiators. As the highest-weighted BDC across all 3 major rating agencies, ARCC is well positioned to support our investment activity through changing market conditions. We believe the advantages have been important contributors to our long-term performance and will continue to serve us well across market cycles. Consistent with this approach, in conjunction with today's announcement to acquire upsized commitment to our existing Wells Fargo-led funding facility that we expect to close upon the consummation of the acquisition subject to customer and closing conditions. As we prepare for a larger pro forma portfolio, we remain proactive in expanding our funding capacity alongside the growth of the business. While we continue to explore additional financing opportunities ahead of closing, our significant existing liquidity, coupled with this upside, provides sufficient capacity to acquire [indiscernible]. Finally, our fourth quarter 2026 regular dividend of $0.48 per share is payable on December 29, as stockholders of record. As Kort mentioned, we are proud of the fact that ARCC is now [indiscernible]. Turning to our taxable income spillover. We finalized our 2025 tax returns and determined that we carry forward $983 million or $1.37 per share available for distribution of stockholders in 2026. As Kort mentioned, we believe our meaningful taxable income spillover provides further support for the long-term stability of our dividends and continues to be one of our significant differentiators. I will now turn the call over to Jim to walk through our investment activities.

Thank you, Scott. I'll start with some additional context on our investment activity and then discuss the performance and positioning of the portfolio. Against an uneven transaction environment, and navigating various economic and geopolitical cross currents, we continue to prioritize selectivity and maintaining our underwriting standards. . We originated $2.1 billion of new invented commitments during the quarter, while our closing ratio was moderately below our historical average of approximately 5%. We believe this discipline has been an important contributor to our long-term investment performance. At the same time, our scale incumbent relationships and broad market presence continue to provide access to attractive opportunities across a variety of channels, including opportunities outside of traditional transaction activity. In addition to agreeing to acquire MFIC, ARCC, alongside other Ares funds acquired a portfolio of high-quality loans from an institutional investor. This represents another good example of nontraditional transaction activity as this year's volatility reinforced Ares' position as a natural solution provider [indiscernible]. Our familiarity with many of the businesses and management teams represented in the portfolio, advantaged us in our underwriting of the portfolio and, in our view, allowed us to provide a differentiated solution. The transaction also added new borrowers to the portfolio, expanding ARCC's connectivity across the middle market and creating additional avenues for future investment. This transaction illustrates the value of both sides of our origination model [indiscernible] with existing borrowers while continuing to expand our opportunity set through new relationships. Furthermore, this fully performing portfolio was acquired at a modest discount, supporting what we view as attractive overall economics. Together with MFIC, this portfolio purchase demonstrates how ARCC's relationship with Ares, combined with the scale [indiscernible] and its ability to deliver differentiated solutions, can create value that extends well past the investments themselves. We believe those advantages become even more meaningful when markets are less predictable. Beyond these larger strategic opportunities, our existing portfolio provides a consistent source of opportunity across our investment activity. Approximately 60% of our third quarter commitments were with existing portfolio companies. And we have expanded our share of many of these borrowers' financing needs over time. These relationships allow us to invest behind the businesses and management teams we know well and where appropriate, increase our exposure to stronger performing borrowers [indiscernible] relative to the broader market. First lien spreads on our new originations widened 50 basis points from the prior quarter and leverage levels decreased by 0.5 turn, while terms and lender protections remain strong. Our broad opportunity set is supported by a diverse portfolio of 636 companies that continue to perform well. Our portfolio companies generated weighted average LTM organic EBITDA growth of approximately 7%, broadly in line with our long-term organic growth and excludes the impact from M&A. Performance across our largest industries was even stronger with our top 10 industries in aggregate growing above the portfolio average. Specifically within our software portfolio, we continue to see strong operating performance across our investments with organic LTM EBITDA growth in line with the broader portfolio average during the third quarter. Within our software portfolio, only 1 small loan is currently on nonaccrual. And our debt investment remains supported by loan-to-value ratios in the low 40% range, providing substantial equity value beneath our positions. More broadly, the strong operating performance we are seeing across the portfolio is complemented by stable credit metrics and capital structures. The average leverage of our borrowers was unchanged last quarter, and the weighted average interest coverage was 2x, with interest rates at 9/30 quarter end. Importantly, both metrics are consistent with their 5-year averages. As Kort mentioned, credit performance also remains healthy. Loan-to-value remained approximately 47%, below our 10-year average, providing meaningful equity support beneath our investments. Nonaccruals were unchanged sequentially at 2.4% of cost at 3% historical average. And the BDC historical average of approximately 4% over the same time frame. Our nonaccrual rate at fair value of [indiscernible]. Further supporting the strength of our portfolio, our overall risk ratings remained stable with a weighted average of [ 3.1 ] and 19% of the portfolio at fair value and our lowest risk category grade 4 where we expect to realize returns above our cost basis. The share of the portfolio in Grade 4 has increased over the past few quarters and remains above our 10-year average. Meanwhile, the share of our portfolio companies in our higher risk categories, grades 1 and 2 remains comfortably below our 10-year average and represents less than 1/3 of the assets in the lowest risk category 4. As we look ahead, we believe the combination of a healthy portfolio, differentiated sourcing relationships and our scale and breadth in the market positions us well as [indiscernible] this allows maintaining our underwriting standards and pursuing opportunities that offer attractive risk-adjusted returns. As always, we appreciate you joining us today. Operator, please open the line for questions.

[Operator Instructions] We'll go first this afternoon to Rick Shane of JPMorgan.

Obviously, interesting full circle to see you guys complete sort of the -- or get close to completing the trifecta of the 3 legacy BDCs, so that is exciting. I wanted to ask about the close rate on the quarter. You guys said it dipped below 5%. The pipeline for the last couple of quarters has been larger than sort of the origin nation growth, a function of you guys being deliberately more selective? Or is it just challenges of meeting of the minds as the market is repricing with borrowers and sponsors?

It's Jim. I would say it's a little bit of both of those things that you mentioned. I think that we are being slightly more selective in this environment, just given, obviously, all the volatility going on and uncertainty out there in the world and the economy. So that's a part of it. But additionally, it's just a slower overall deal environment, which is contributing to the more measured pace of origination as well.

As you guys closed the acquisition and rotate that portfolio, does this transaction in any way beyond sort of recycling of capital, create additional liquidity in a time when your peers and competitors are constrained?

Yes. We do think it should help us create more liquidity. Obviously, we're in a position of competitive strength right now. We already were in a great position of competitive strength given our superior liquidity position, and this should only [indiscernible].

Got it. Any way to quantify that beyond better?

[indiscernible] it's obviously a larger portfolio we're going to have. So we're going to have some more repayments. I think historically, we've seen repayment rates. So our portfolio would be 30%, 35%. So you just see natural turnover. And look, if we can actively sell things of the portfolio, we'll do that, too. We've got track we're doing that from our previous acquisition as well.

We go next now to Paul Johnson with KBW.

I think it's a very impressive structure of a deal that you guys have put forward to here for MFIC. I was curious in terms of the discount to MFIC's preliminary NAV in the acquisition price, I guess how much of that is kind of due to expected credit losses between now and closing versus, I guess, negotiating leverage, just given the discount and share in MFIC's shares prior to the announcement? And then I guess the second question I would have to that is are these, I guess, the conditions here in your ability to acquire as at a discount, is that unique, I guess, to this situation where there's sort of kind of one-off conditions to make that possible by the seller? Or is it something that could be replicated, I guess, elsewhere in other acquisitions in this space?

Yes. So on the discounts, I would say just repeat something that we said in the prepared remarks, which is and maybe provide a little more color on it, which is the portfolio was largely or is largely a performing portfolio. And the vast majority of the portfolio, we saw relatively eye to eye on the marks. There's a smaller percentage of the portfolio that has outcomes that are more uncertain on those names. And so that is [indiscernible]. I do want to highlight a really important point that I think is clear, but just to make sure it is, the cash consideration being provided by Ares Management is a really important component of the deal. It allows ARCC to buy the assets at an even deeper discounts while still providing the mid-cap shareholders with a nice [indiscernible] that piece certainly helped contribute to the deeper discount and made it really a great transaction for ARCC. As it pertains to any future transactions, obviously, not really a position to -- we're not in a position to speculate on that on a call like this or provide any kind of guidance, likelihood of acquisitions. The only thing to say is just obviously in this environment and given our competitive advantages and where our stock is trading relative to the peer set to review potential to capitalize on any other opportunities that might be out there.

Got it. That's very helpful. And in terms of just like the portfolio retention for mid-cap portfolio post closing, I guess, would you expect there to be [indiscernible] slowdown of originations in anticipation of closing? Or is the deal, I guess, simply small enough that I wouldn't expect any kind of change to the cadence?

Yes, you shouldn't expect to see any impact there, again, all the exciting and strategic transaction for us. So we don't expect any changes there.

Got it. And one last question for me on just credit. During the quarter, I guess, speaking a little bit more broadly to the portfolio company itself, but I was curious of your thoughts on the recent restructuring [indiscernible] of simpler software with the preferred capital being raised there. I was wondering if that particular deal offers, I guess, more of a blueprint for any other distressed software company in the market or just, I guess, more of a run-off scenario for this particular company? That's it for me.

Happy to take that. I think it is a good example and maybe a bit of a blueprint. But we've been talking about this for a while and sort of repeat it again, the software portfolio, just like many of the other companies in our portfolio that have a significant amount of equity value, we often see sponsor support to support equity value that remains in the company. We often see a set of outcomes that you saw with simpler with respect to repricing getting better document terms, a variety of different things that will achieve at a point in time when a negotiation takes place like that in a better place, but it does show and highlight what we think will happen often if there -- and has happened historically, very often in scenarios like that. So it's a great example. I think it's the right way to put it. It's a great example, and we sort of a playbook that we utilized often in situations like that.

We'll go next now to Arren Cyganovich at Truist.

Congrats on the transaction. I got a quick question on the accretion, the modest accretion assumption -- assumed with us, is the discount of that accretion, is this part of that discounted value assumed into the accretion. I feel like the deals from years past, a lot of the upside was kind of from, I don't know, loans or credits that you had marked down that had performed better than expected. Is that obviously, much smaller potential here, but is that also a potential opportunity on this transaction?

Yes, you got it exactly. So the accretion is really driven by 2 primary factors. The first is the discount and the higher yield that, that creates some of those assets. And the second is just our cost of capital dailies, the benefits we have of scale versus the mid-cap platform, and that will allow us also to generate the modest accretion that we're expecting.

And then kind of following up on Paul's question on maturity well, I'm sure everybody saw journarticle about that today or yesterday, and this is something we've been talking about, so it's not new. But maybe a little bit of an update on what you're doing to proactively get in front of maybe some of the credits that might be in that kind of situation. And where you might be in that process? You still have a decent runway until we get to '28?

Yes. I mean we saw the article. I think we can reflect back on the Ares portfolio more than the market. And we look at what we're seeing in the future with respect to maturities. And if you look at '28, '29, the percent of maturities that we're expecting in that period of time is pretty typical. It's a standard sort of market level. And so there isn't really anything there is really the short answer and we're always actively and proactively looking at maturities and how we want to extend ahead of that. And I think this topic comes up quite often when people talk about maturity walls, it's not really -- it doesn't really play out as people expect for whatever reason, I'm not sure why it becomes a focus over and over again. But we are -- we're not expecting any specific issue there. And we're always looking at ways to extend for the right companies. And the level there that we're seeing in, I think '28 is about 10%, something like that. So there's nothing meaningful for us to have to deal with.

Even if you go forward to 2029 is about 13% of the portfolio as well. So not super outsized numbers in those 2 years on our book. And again, I just underscore what Jim said about simpler as being a good example of how these maturities can get addressed. A company like that actually performing fine. It's a little over leverage. But again, thoughts of putting an equity, getting more time, first lien, second lien extending and giving the company more time to grow in into this capital structure.

We'll go next now to Kenneth Lee with RBC Capital Markets.

Just in terms of the MFIC transaction, do you anticipate any potential change in the management fee rate in terms of the portfolio that you're acquiring next?

We do that.

Great. And just one follow-up, if I in terms of the average portfolio yields that you saw in the quarter on a cost basis, they ticked up a little bit. Just wondering whether there is any specific drivers driving that pickup in portfolio yields there?

Thanks for the question. We're just seeing a better market for lending right now. I think we saw about 50 basis points wider in the market, slightly better leverage levels, slightly better terms. We are seeing based on some of the cross currents we mentioned, the probably syndicated the direct lending market has moved up. So it's just a market right now that we really like and the conditions have improved quarter-over-quarter. So -- and it's continuing.

And there's probably a little bit of the recent base rate increases that are now starting to creep into the numbers in a good way. There's a little bit of a lag effect, generally 1 quarter lag before that gets into our numbers. But I think you're starting to see a little bit of that as well. And all those things Jim talked about as well as the forecast for potential future base rate increases are what makes us feel confident about the go-forward picture on earnings.

We'll go next now to Jason Stewart with Compass Point.

In terms of the MFIC transaction, is it your anticipation that all will be funded within ARCC or whether it's going to go to the [indiscernible] vehicles? .

Yes. Thanks for the question. Nothing is definitive yet, but I guess I would say that I think Ivy Hill is expected to play a role in the transaction, just given the -- most of the assets in the portfolio are actually minority participations in these loans. And again, it's largely performing loan book. And so those 2 factors mean that bunch of these assets could be a strong fit for IVL asset management. But they're going to review the assets and make their own independent determination as to whether they want to purchase them, the start that review process between now and closing or even post closing, and we'll see where that shakes out. But I'd say it's likely and also so that IHM has also played an import role in our prior acquisitions about taking on the performing power those loan books.