Ares Capital Corporation (ARCC 0.64%) is the leader in the business development company industry. With a balance sheet that towers to $7.7 billion, it's the undisputed king of private finance.
Here are three metrics that show the company's excellent quarter:
1. Core earnings per share rocketed to $0.48 per share
Ares Capital reports what it calls "Core EPS," which is earnings per share minus the impact of management fees, taxes, and realized or unrealized gains or losses. Core EPS is a good indicator of what the company can earn from interest, fees, and dividends on a run rate. Thus, it tends to be a good baseline for what Ares Capital can pay out in dividends.
This quarter, Core EPS surged to $0.48 per share, up from $0.38 in the prior quarter, and $0.42 year over year. The third and fourth quarter tend to be particularly active in private finance as business owners look to get deals closed before year-end for tax purposes. Adjusting for a one-time dividend from portfolio company Ivy Hill Asset Management, Ares Capital's third-quarter core earnings would still surpass last year's per-share earnings at $0.44 per share.
2. Senior secured loans grow to 45% of the portfolio
A bull market tends to lead to loftier private equity deals. Ares Capital is moderating this risk by making new originations in first lien and senior secured loans, which are the first in line to be repaid in the event of a default.
This quarter, Ares Capital used new originations to push first lien debt to 45% of the portfolio. Management has stated in many conference calls and shareholder meetings that they're willing to actively manage the portfolio through the cycle. In the early days of the economic recovery, Ares Capital took more junior debt with higher yields. Now, Ares Capital appears to be moving toward safer securities.
Source: Ares Capital's 3rd Quarter Presentation
More senior debt on the books has had an impact on its weighted average debt yields of 10.6%, down from 11.6% one year ago. But it's worth noting that 82% of its portfolio is now floating rate vs. 74% of its portfolio this time last year. Thus, the company has better exposure to a rising rate environment.
3. The 90% rule
After a great quarter, Ares Capital is building on its "spillover income," or income to shareholders that hasn't been paid out in a dividend. Next quarter, Ares Capital will pay its normal $0.38 quarterly dividend with a $0.05 special dividend on top. It's possible that in 2014 the company will announce a larger quarterly dividend to avoid a 4% excise tax on retained earnings.
If $0.44 in core earnings per share does continue into 2014, Ares Capital will have to increase either its special dividends or quarterly dividends in order to comply with a requirement to pay out 90% of income to shareholders.
