ARES CAPITAL CORPORATION The information contained in this section should be read in conjunction with the Selected Financial Data and our financial statements and notes thereto appearing elsewhere in this Annual Report. In addition, some of the statements in this Annual Report (including in the following discussion) constitute forward- looking statements, which relate to future events or the future performance or financial condition ofAres Capital Corporation (the "Company," "Ares Capital ," "we," "us," or "our"). The forward-looking statements contained in this report involve a number of risks and uncertainties, including statements concerning: • our, or our portfolio companies', future business, operations, operating results or prospects;
• the return or impact of current and future investments;
• the impact of a protracted decline in the liquidity of credit markets
on our business;
• the impact of fluctuations in interest rates on our business;
• the impact of changes in laws or regulations (including the
interpretation thereof), including the Tax Cuts and Jobs Act and the
Small Business Credit Availability Act, governing our operations or the
operations of our portfolio companies or the operations of our
competitors;
• the valuation of our investments in portfolio companies, particularly
those having no liquid trading market;
• our ability to recover unrealized losses;
• market conditions and our ability to access alternative debt markets
and additional debt and equity capital and our ability to manage our
capital resources effectively;
• our contractual arrangements and relationships with third parties,
including parties to our co-investment program;
• the general economy and its impact on the industries in which we invest;
• uncertainty surrounding the financial stability of the United States ,
Europe and China ;
• the social, geopolitical, financial, trade and legal implications of Brexit;
• Middle East turmoil and the potential for volatility in energy prices
and its impact on the industries in which we invest;
• the financial condition of our current and prospective portfolio
companies and their ability to achieve their objectives;
• our expected financings and investments;
• our ability to successfully complete and integrate any acquisitions;
• the outcome and impact of any litigation;
• the adequacy of our cash resources and working capital;
• the timing, form and amount of any dividend distributions;
• the timing of cash flows, if any, from the operations of our portfolio
companies; and
• the ability of our investment adviser to locate suitable investments
for us and to monitor and administer our investments.
We use words such as "anticipates," "believes," "expects," "intends," "will,"
"should," "may" and similar expressions to identify forward-looking statements,
although not all forward-looking statements include these words. Our actual
results and
60
--------------------------------------------------------------------------------condition could differ materially from those implied or expressed in the forward-looking statements for any reason, including the factors set forth in "Risk Factors" and the other information included in this Annual Report.
We have based the forward-looking statements included in this Annual Report on information available to us on the date of this Annual Report, and we assume no obligation to update any such forward-looking statements. Although we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, you are advised to consult any additional disclosures that we may make directly to you or through reports that we have filed or in the future may file with theSecurities and Exchange Commission ("SEC"), including annual reports on Form 10-K, registration statements on Form N-2, quarterly reports on Form 10-Q and current reports on Form 8-K. OVERVIEW We are a specialty finance company that is a closed-end, non-diversified management investment company incorporated inMaryland . We have elected to be regulated as a business development company ("BDC") under the Investment Company Act of 1940, as amended (together with the rules and regulations promulgated thereunder, the "Investment Company Act"). We are externally managed byAres Capital Management LLC ("Ares Capital Management " or our "investment adviser"), a subsidiary of Ares Management Corporation (NYSE: ARES) ("Ares Management"), a publicly traded, leading global alternative asset manager, pursuant to our investment advisory and management agreement.Ares Operations LLC ("Ares Operations" or our "administrator"), a subsidiary of Ares Management, provides certain administrative and other services necessary for us to operate. Our investment objective is to generate both current income and capital appreciation through debt and equity investments. We invest primarily in first lien senior secured loans (including "unitranche" loans, which are loans that combine both senior and mezzanine debt, generally in a first lien position), second lien senior secured loans and mezzanine debt, which in some cases includes an equity component like warrants. To a lesser extent, we also make preferred and/or common equity investments, which have generally been non-control equity investments, of less than$20 million (usually in conjunction with a concurrent debt investment). However, we may increase the size or change the nature of these investments. Since our initial public offering ("IPO") onOctober 8, 2004 throughDecember 31, 2019 , our exited investments resulted in an asset level realized gross internal rate of return to us of approximately 14% (based on original cash invested, net of syndications, of approximately$27.4 billion and total proceeds from such exited investments of approximately$34.8 billion ). Internal rate of return is the discount rate that makes the net present value of all cash flows related to a particular investment equal to zero. Internal rate of return is gross of expenses related to investments as these expenses are not allocable to specific investments. Investments are considered to be exited when the original investment objective has been achieved through the receipt of cash and/or non-cash consideration upon the repayment of a debt investment or sale of an investment or through the determination that no further consideration was collectible and, thus, a loss may have been realized. Approximately 60% of these exited investments resulted in an asset level realized gross internal rate of return to us of 10% or greater. Additionally, since our IPO onOctober 8, 2004 throughDecember 31, 2019 , our realized gains have exceeded our realized losses by approximately$0.9 billion (excluding a one-time gain on the acquisition ofAllied Capital Corporation ("Allied Capital ") inApril 2010 (the "Allied Acquisition") and realized gains/losses from the extinguishment of debt and other transactions). For this same time period, our average annualized net realized gain rate was approximately 1.1% (excluding a one-time gain on the acquisition ofAllied Capital and realized gains/losses from the extinguishment of debt and other transactions). Net realized gain/loss rates for a particular period are the amount of net realized gains/losses during such period divided by the average quarterly investments at amortized cost in such period. Information included herein regarding internal rates of return, realized gains and losses and annualized net realized gain rates are historical results relating to our past performance and are not necessarily indicative of future results, the achievement of which cannot be assured. As a BDC, we are required to comply with certain regulatory requirements. For instance, we generally have to invest at least 70% of our total assets in "qualifying assets," including securities and indebtedness of privateU.S. companies and certain publicU.S. companies, cash, cash equivalents,U.S. government securities and high-quality debt investments that mature in one year or less. We also may invest up to 30% of our portfolio in non-qualifying assets, as permitted by the Investment Company Act. Specifically, as part of this 30% basket, we may invest in entities that are not considered "eligible 61 -------------------------------------------------------------------------------- portfolio companies" (as defined in the Investment Company Act), including companies located outside ofthe United States , entities that are operating pursuant to certain exceptions under the Investment Company Act, and publicly traded entities whose public equity market capitalization exceeds the levels provided for under the Investment Company Act. We have elected to be treated as a regulated investment company ("RIC") under the Internal Revenue Code of 1986, as amended (the "Code"), and operate in a manner so as to qualify for the tax treatment applicable to RICs. To qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements and timely distribute to our stockholders generally at least 90% of our investment company taxable income, as defined by the Code, for each year. Pursuant to this election, we generally will not have to payU.S. federal corporate-level taxes on any income that we distribute to our stockholders provided that we satisfy those requirements. 62 --------------------------------------------------------------------------------
PORTFOLIO AND INVESTMENT ACTIVITY
Our investment activity for the years endedDecember 31, 2019 and 2018 is presented below. For the Years Ended December 31, (dollar amounts in millions) 2019 2018 New investment commitments(1): New portfolio companies $ 3,639 $ 3,754 Existing portfolio companies 3,622 4,291 Total new investment commitments(2) 7,261 8,045
Less:
Investment commitments exited(3) (5,350 ) (6,476 ) Net investment commitments $ 1,911 $ 1,569 Principal amount of investments funded: First lien senior secured loans $ 4,431 $ 4,465 Second lien senior secured loans 1,344 1,607 Subordinated certificates of the SDLP(4) 407 252 Senior subordinated loans 252 376 Preferred equity securities 215 130 Other equity securities 180 346 Total $ 6,829 $ 7,176 Principal amount of investments sold or repaid: First lien senior secured loans $ 3,809 $ 3,762 Second lien senior secured loans 850 1,657 Subordinated certificates of the SDLP(4) 150 88 Senior subordinated loans 222 718 Collateralized loan obligations 4 71 Preferred equity securities 21 80 Other equity securities 42 64 Total $ 5,098 $ 6,440 Number of new investment commitments(5) 163 172 Average new investment commitment amount $ 45 $ 47
Weighted average term for new investment commitments (in months)
73 76
Percentage of new investment commitments at floating rates 94 % 94 %
Percentage of new investment commitments at fixed rates 2 % 2 %
Weighted average yield of debt and other income producing securities(6): Funded during the period at amortized cost
9.2 % 9.0 %
Funded during the period at fair value(7) 9.3 % 9.1 %
Exited or repaid during the period at amortized cost 9.1 % 9.2 %
Exited or repaid during the period at fair value(7) 9.1 % 9.2 %
_______________________________________________________________________________
(1) New investment commitments include new agreements to fund revolving loans
or delayed draw loans. See "Off Balance Sheet Arrangements" as well as
Note 7 to our consolidated financial statements for the year ended
December 31, 2019 , for more information on our commitments to fund
revolving loans or delayed draw loans.
(2) Includes both funded and unfunded commitments. Of these new investment
commitments, we funded $5.9 billion and $6.6 billion for the years ended
December 31, 2019 and 2018, respectively.
63--------------------------------------------------------------------------------
(3) Includes both funded and unfunded commitments. For the years ended
of unfunded commitments of
(4) See "Senior Direct Lending Program" below and Note 4 to our consolidated
financial statements for the year ended December 31, 2019 for more
information on the SDLP (as defined below).
(5) Number of new investment commitments represents each commitment to aparticular portfolio company or a commitment to multiple companies as part
of an individual transaction (e.g., the purchase of a portfolio of
investments).
(6) "Weighted average yield of debt and other income producing securities" is
computed as (a) the annual stated interest rate or yield earned plus the
net annual amortization of original issue discount and market discount or
premium earned on accruing debt and other income producing securities,
divided by (b) the total accruing debt and other income producing
securities at amortized cost or at fair value, as applicable.
(7) Represents fair value for investments in the portfolio as of the most
recent prior quarter end, if applicable.
As of December 31, 2019 and 2018, our investments consisted of the following:
As of December 31,
2019 2018
(in millions) Amortized Cost Fair Value Amortized Cost Fair Value
First lien senior secured loans(1) $ 6,606 $ 6,372 $ 5,976 $ 5,836
Second lien senior secured loans 4,439 4,334 3,878 3,657
Subordinated certificates of the SDLP(2) 909 909 652 652
Senior subordinated loans 815 822 717 727
Collateralized loan obligations 40 35 44 45
Preferred equity securities 815 728 576 444
Other equity securities 1,072 1,226 911 1,056
Total $ 14,696 $ 14,426 $ 12,754 $ 12,417 _______________________________________________________________________________
(1) First lien senior secured loans include certain loans that we classify as
"unitranche" loans. The total amortized cost and fair value of the loans
that we classified as "unitranche" loans were
million, respectively, as of December 31, 2019 , and $1,535 million and
$1,488 million , respectively, as of December 31, 2018 .
(2) The proceeds from these certificates were applied to co-investments with
Varagon Capital Partners ("Varagon") and its clients to fund first lien
senior secured loans to 23 and 21 different borrowers as of December 31,
2019 and 2018, respectively.
The weighted average yields at amortized cost and fair value of the following
portions of our portfolio as of
64
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As of December 31,
2019 2018
Amortized Cost Fair Value Amortized Cost Fair Value
Debt and other income producing
securities(1) 9.6 % 9.7 % 10.2 % 10.3 %
Total portfolio(2) 8.6 % 8.7 % 9.0 % 9.3 %
First lien senior secured loans(2) 7.7 % 7.9 % 8.4 % 8.7 %
Second lien senior secured loans(2) 10.2 % 10.4 %
10.4 % 11.1 %
Subordinated certificates of the
SDLP(2)(3) 14.5 % 14.5 % 15.0 % 15.0 %
Senior subordinated loans(2) 11.4 % 11.3 % 12.7 % 12.5 %
Collateralized loan obligations 16.9 % 18.9 % 22.7 % 22.2 %
Income producing equity
securities(2) 12.5 % 12.3 % 13.5 % 13.4 %
_______________________________________________________________________________
(1) "Weighted average yield of debt and other income producing securities" is
computed as (a) the annual stated interest rate or yield earned plus the
net annual amortization of original issue discount and market discount or
premium earned on accruing debt and other income producing securities,
divided by (b) the total accruing debt and other income producing
securities at amortized cost or at fair value as applicable.
(2) "Weighted average yields" are computed as (a) the annual stated interest
rate or yield earned plus the net annual amortization of original issue
discount and market discount or premium earned on the relevant accruing
debt and other income producing securities, divided by (b) the total
relevant investments at amortized cost or at fair value as applicable.
(3) The proceeds from these certificates were applied to co-investments with
Varagon and its clients to fund first lien senior secured loans.
Ares Capital Management , our investment adviser, employs an investment rating
system to categorize our investments. In addition to various risk management and
monitoring tools, our investment adviser grades the credit risk of all
investments on a scale of 1 to 4 no less frequently than quarterly. This system
is intended primarily to reflect the underlying risk of a portfolio investment
relative to our initial cost basis in respect of such portfolio investment
(i.e., at the time of origination or acquisition), although it may also take
into account under certain circumstances the performance of the portfolio
company's business, the collateral coverage of the investment and other relevant
factors. Under this system, investments with a grade of 4 involve the least
amount of risk to our initial cost basis. The trends and risk factors for this
investment since origination or acquisition are generally favorable, which may
include the performance of the portfolio company or a potential exit.
Investments graded 3 involve a level of risk to our initial cost basis that is
similar to the risk to our initial cost basis at the time of origination or
acquisition. This portfolio company is generally performing as expected and the
risk factors to our ability to ultimately recoup the cost of our investment are
neutral to favorable. All investments or acquired investments in new portfolio
companies are initially assessed a grade of 3. Investments graded 2 indicate
that the risk to our ability to recoup the initial cost basis of such investment
has increased materially since origination or acquisition, including as a result
of factors such as declining performance and non-compliance with debt covenants;
however, payments are generally not more than 120 days past due. An investment
grade of 1 indicates that the risk to our ability to recoup the initial cost
basis of such investment has substantially increased since origination or
acquisition, and the portfolio company likely has materially declining
performance. For debt investments with an investment grade of 1, most or all of
the debt covenants are out of compliance and payments are substantially
delinquent. For investments graded 1, it is anticipated that we will not recoup
our initial cost basis and may realize a substantial loss of our initial cost
basis upon exit. For investments graded 1 or 2, our investment adviser enhances
its level of scrutiny over the monitoring of such portfolio company. The grade
of a portfolio investment may be reduced or increased over time.
65
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Set forth below is the grade distribution of our portfolio companies as of
As of December 31,
2019 2018
(dollar amounts Number of Number of
in millions) Fair Value % Companies % Fair Value % Companies %
Grade 1 $ 92 0.6 % 19 5.4 % $ 107 0.9 % 18 5.2 %
Grade 2 688 4.8 % 14 4.0 % 455 3.7 % 12 3.5 %
Grade 3 12,407 86.0 % 301 85.0 % 10,680 85.9 % 300 87.2 %
Grade 4 1,239 8.6 % 20 5.6 % 1,175 9.5 % 14 4.1 %
Total $ 14,426 100.0 % 354 100.0 % $ 12,417 100.0 % 344 100.0 %
As of
As ofDecember 31, 2019 , investments on non-accrual status represented 1.9% and 0.9% of the total investments at amortized cost and at fair value, respectively. As ofDecember 31, 2018 , investments on non-accrual status represented 2.5% and 0.6% of the total investments at amortized cost and at fair value, respectively.
Senior Direct Lending Program
We have established a joint venture with Varagon to make certain first lien senior secured loans, including certain stretch senior and unitranche loans, primarily toU.S. middle-market companies. Varagon was formed in 2013 as a lending platform by American International Group, Inc. and other partners. The joint venture is called theSenior Direct Lending Program, LLC (d/b/a the "Senior Direct Lending Program" or the "SDLP"). InJuly 2016 , we and Varagon and its clients completed the initial funding of the SDLP. The SDLP may generally commit and hold individual loans of up to$350 million . The SDLP is capitalized as transactions are completed and all portfolio decisions and generally all other decisions in respect of the SDLP must be approved by an investment committee of the SDLP consisting of representatives of ours and Varagon (with approval from a representative of each required). We provide capital to the SDLP in the form of subordinated certificates (the "SDLP Certificates"), and Varagon and its clients provide capital to the SDLP in the form of senior notes, intermediate funding notes and SDLP Certificates. As ofDecember 31, 2019 , we and a client of Varagon owned 87.5% and 12.5%, respectively, of the outstanding SDLP Certificates. As ofDecember 31, 2019 and 2018, we and Varagon and its clients had agreed to make capital available to the SDLP of$6.2 billion and$6.4 billion , respectively, in the aggregate, of which$1,444 million and$1,444 million , respectively, is to be made available from us. This capital will only be committed to the SDLP upon approval of transactions by the investment committee of the SDLP. Below is a summary of the funded capital and unfunded capital commitments of the SDLP. As of December 31, (in millions) 2019 2018 Total capital funded to the SDLP(1)$ 3,899 $ 3,104 Total capital funded to the SDLP by the Company(1)$ 909 $ 652 Total unfunded capital commitments to the SDLP(2)$ 404
$ 94 ___________________________________________________________________________
(1) At principal amount.
(2) These commitments have been approved by the investment committee of the
SDLP and will be funded as the transactions are completed.
The SDLP Certificates pay a coupon equal to the London Interbank Offered Rate
("LIBOR") plus 8.0% and also entitle the holders thereof to receive a portion of
the excess cash flow from the loan portfolio, after expenses, which may result
in a return to the holders of the SDLP Certificates that is greater than the
stated coupon. The SDLP Certificates are junior in right of payment to the
senior notes and intermediate funding notes.
66
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The amortized cost and fair value of our SDLP Certificates were $909 million and
$909 million , respectively, as of December 31, 2019 and $652 million and $652
million , respectively, as of December 31, 2018 . Our yield on our investment in
the SDLP Certificates at amortized cost and fair value was 14.5% and 14.5%,
respectively, as of December 31, 2019 and 15.0% and 15.0%, respectively, as of
December 31, 2018 . For the years ended December 31, 2019 , 2018 and 2017, we
earned interest income of $122 million , $87 million and $52 million ,
respectively, from our investment in the SDLP Certificates. We are also entitled
to certain fees in connection with the SDLP. For the years ended December 31,
2019 , 2018 and 2017, in connection with the SDLP, we earned capital structuring
service and other fees totaling $25 million , $16 million and $11 million ,
respectively.
As of December 31, 2019 and 2018, the portfolio was comprised of all first lien
senior secured loans primarily to U.S. middle-market companies and were in
industries similar to the companies in our portfolio. As of December 31, 2019
and 2018, none of the loans were on non-accrual status. Below is a summary of
the SDLP's portfolio as of December 31, 2019 and 2018:
As of December 31 ,
(dollar amounts in millions) 2019 2018
Total first lien senior secured loans(1)(2)$ 3,892 $ 3,086 Weighted average yield on first lien senior secured loans(3) 7.7 % 8.4 % Largest loan to a single borrower(1)$ 348 $ 249 Total of five largest loans to borrowers(1)$ 1,391 $ 1,132 Number of borrowers in the SDLP 23
21
Commitments to fund delayed draw loans(4)$ 404
_______________________________________________________________________________
(1) At principal amount.
(2) First lien senior secured loans include certain loans that the SDLP
classifies as "unitranche" loans. As of December 31, 2019 and 2018, the
total principal amount of loans in the SDLP portfolio that the SDLP
classified as "unitranche" loans was
respectively.
(3) Computed as (a) the annual stated interest rate on accruing
first lien senior secured loans, divided by (b) total first
lien senior secured loans at principal amount.
(4) As discussed above, these commitments have been approved by the investment
committee of the SDLP.
Selected financial information for the SDLP as of and for the years ended
As of December 31 ,
(in millions) 2019 2018
Selected Balance Sheet Information: Investments at fair value (amortized cost of$3,892 and$3,086 , respectively)$ 3,817 $ 3,043 Other assets 92 92 Total assets$ 3,909 $ 3,135 Senior notes$ 2,769 $ 2,189 Intermediate funding notes 92 171 Other liabilities 63 54 Total liabilities 2,924 2,414 Subordinated certificates and members' capital 985 721 Total liabilities and members' capital$ 3,909 $ 3,135 67
--------------------------------------------------------------------------------
For the Years Ended December 31,
(in millions) 2019 2018
Selected Statement of Operations Information:
Total interest and other income $ 291 $ 232
Interest expense 137 116
Other expenses 14 12
Total expenses 151 128
Net investment income 140 104
Net realized and unrealized losses on investments (36 ) (21 )
Net increase in members' capital resulting from operations $ 104 $ 83
68
--------------------------------------------------------------------------------
SDLP Loan Portfolio as of December 31, 2019
(dollar
amounts
in millions) Stated
Portfolio Interest Principal Fair
Company Business Description Maturity Date Rate(1) Amount Value(2)
42 North Dental services provider 5/2022 7.9 % $ 152.3 $ 152.3
Dental, LLC
(3)
ADCS Clinics Dermatology practice 5/2022 7.7 % 77.8 77.0
Intermediate
Holdings, LLC (3) AEP Holdings, Distributor of non-discretionary, 8/2021 7.9 % 158.3 150.4 Inc. (3)(4) mission-critical aftermarket replacement parts BakeMark Manufacturer and distributor of 8/2023 7.2 % 245.3 245.3 Holdings, Inc. specialty bakery ingredients Center for Autism treatment and services 11/2024 5.9 % 117.8 117.8 Autism and provider specializing in applied Related behavior analysis therapyDisorders, LLC (3) Chariot Manufacturer of aftermarket golf 9/2021 8.4 % 99.7 98.7 Acquisition, cart parts and accessories LLC (3) D4C Dental Dental services provider 12/2022 8.2 % 179.9 179.9 Brands, Inc. (3)(4) Emergency Provider of mission critical 6/2023 8.2 % 219.2 190.7 Communications emergency mass notification Network, LLC solutions (3) Entertainment Provider of entertainment workforce 5/2026 7.7 % 348.1 348.1 Partners and production management solutions Canada ULC (3)(4) Excelligence Developer, manufacturer and retailer 4/2023 7.9 % 145.0 118.9 Learning of educational products Corporation (3) FS Squared Provider of on-site vending and 3/2025 7.2 % 181.7 181.7
Holding Corp. micro-market solutions to employers
(3)(4)
4/2024 8.4 % 125.5 125.5
(3)(4) integrity software solutions
provider
ISS Provider of repairs, refurbishments 6/2020 8.9 % 80.2 79.4
Compressors and services to the broader
Industries, industrial end user markets
Inc.
KeyImpact Foodservice sales and marketing 11/2021 8.0 % 74.0 74.0
Holdings, Inc. agency
(4)
n2y Holding, Developer of cloud-based special 11/2026 7.9 % 131.3 129.9
LLC (3) education platform
Nordco Inc. Manufacturer of railroad 8/2020 8.4 % 110.1 106.8
(3) maintenance-of-way machinery
Pegasus Provider of plant maintenance and 5/2025 7.7 %
270.1 267.5
Intermediate scheduling software
Holdings, LLC
(3)(4)
Penn Detroit Distributor of aftermarket parts to 12/2021 8.2 % 77.6 77.6
Diesel the heavy-duty truck industry
Allison, LLC SM Wellness Breast cancer screening provider 8/2024 7.4 %
226.6 226.6
Holdings, Inc.
(3)(4)
TDG Group Operator of multiple franchise 5/2024 7.4 % 246.3 246.3
Holding concepts primarily related to home
Company (3)(4) maintenance or repairs
THG Multi-line insurance broker 12/2026 7.7 % 214.8 212.6
Acquisition,
LLC (3)
Towne Parking management and hospitality 5/2022 7.2 % 130.0 128.7
280.8 280.8
Group, Inc. pest and animal control products
(3)
$ 3,892.4 $ 3,816.5 ______________________________________
(1) Represents the weighted average annual stated interest rate as of
December 31, 2019 . All interest rates are payable in cash.
(2) Represents the fair value in accordance with Accounting Standards
Codification 820-10, Fair Value Measurements and Disclosures ("ASC
820-10"). The determination of such fair value is not included in our
board of directors valuation process described elsewhere herein.
(3) We also hold a portion of this company's first lien senior secured loan.
(4) We hold an equity investment in this company.
69
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SDLP Loan Portfolio as of December 31, 2018
(dollar amounts
in millions) Stated
Portfolio Interest Principal Fair
Company Business Description Maturity Date Rate(1) Amount Value(2)
42 North Dental services provider 5/2022 8.4 % $ 126.8 $ 126.8
Dental, LLC
(fka Gentle
Communications,
LLC (3))
ADCS Billings Dermatology practice 5/2022 8.3 % 78.6 76.3
Intermediate
Holdings, LLC
(3)
AEP Holdings, Distributor of non-discretionary, 8/2021 8.5 % 160.0 156.8
Inc. (3)(4) mission-critical aftermarket
replacement parts
BakeMark Manufacturer and distributor of 8/2023 7.8 % 247.8 247.7
Holdings, Inc. specialty bakery ingredients
(3)
Center for Autism treatment and services 12/2022 6.5 % 119.0 117.8
Autism and provider specializing in applied
Related behavior analysis therapy
Disorders, LLC
(3)
Chariot Manufacturer of aftermarket golf 9/2021 9.3 % 102.5 101.5
Acquisition, cart parts and accessories
LLC (3)
Chesapeake Provider of central institutional 11/2023 8.6 % 198.4 198.4
Research review boards over clinical trials
Review, LLC (3)
D4C Dental Dental services provider 12/2022 9.0 % 161.1 161.1
Brands, Inc.
(3)(4)
Emergency Provider of mission critical 6/2023 8.8 % 221.2 214.7
Communications emergency mass notification
Network, LLC solutions
(3)
EN Engineering, National utility services firm 6/2021 7.0 % 86.4 86.4
LLC (3) providing engineering and
consulting services to natural gas,
electric power and other energy and
industrial end markets
Excelligence Developer, manufacturer and 4/2023 8.5 % 147.6 127.2
Holdings retailer of educational products
Corporation (3)
Infogix, Inc. Enterprise data analytics and 4/2024 8.8 % 126.8 126.8
(3)(4) integrity software solutions
provider
ISS Compressors Provider of repairs, refurbishments 6/2020 9.4 % 76.4 76.4
Industries, and services to the broader
Inc. industrial end user markets
KeyImpact Foodservice sales and marketing 11/2021 8.7 % 74.8 74.8
Holdings, Inc. agency
(4)
Nordco Inc. (3) Manufacturer of railroad 8/2020 8.9 % 110.1 105.7
maintenance-of-way machinery
Pegasus Provider of plant maintenance and 11/2022 8.5 % 176.2 176.2
Intermediate scheduling software
Holdings, LLC
(3)
Penn Detroit Distributor of aftermarket parts to 12/2021 8.8 % 78.4 78.4
Diesel Allison the heavy-duty truck industry
LLC
SM Wellness Breast cancer screening provider 8/2024 8.0 % 213.0 211.9
Holdings, Inc.
and SM Holdco,
Inc. (3)(4)
TDG Group Operator of multiple franchise 5/2024 8.3 % 248.8 246.3
Holding Company concepts primarily related to home
(3)(4) maintenance or repairs
Towne Holdings, Parking management and hospitality 5/2022 7.8 % 131.3 131.3
Inc. services provider
Woodstream Manufacturer of natural solution 5/2022 8.9 % 201.0 200.9
Corporation (3) pest and animal control products
$ 3,086.2 $ 3,043.4 ____________________________________________________________________________
(1) Represents the weighted average annual stated interest rate as of
December 31, 2018 . All interest rates are payable in cash.
(2) Represents the fair value in accordance with ASC 820-10. The determination
of such fair value is not included in our board of directors valuation
process described elsewhere herein.
(3) We also hold a portion of this company's first lien senior secured loan.
(4) We hold an equity investment in this company.
70
--------------------------------------------------------------------------------RESULTS OF OPERATIONS
For the years ended
Operating results for the years endedDecember 31, 2019 and 2018 were as follows: For the Years Ended December 31, (in millions) 2019 2018 Total investment income $ 1,528 $ 1,337 Total expenses, net of waiver of income based fees 701 624 Net investment income before income taxes 827 713 Income tax expense, including excise tax 16 19 Net investment income 811 694
Net realized gains (losses) on investments, foreign currency and other transactions
(65 ) 419
Net unrealized gains (losses) on investments, foreign currency and other transactions
47 (255 )
Net increase in stockholders' equity resulting from
operations $ 793 $ 858
Net income can vary substantially from period to period due to various factors,
including acquisitions, the level of new investment commitments, the recognition
of realized gains and losses and unrealized appreciation and depreciation. As a
result, comparisons of net increase in stockholders' equity resulting from
operations may not be meaningful.
Investment Income
For the Years Ended December 31 ,
(in millions) 2019 2018
Interest income from investments $ 1,180 $
1,041
Capital structuring service fees 162 143 Dividend income 152 97 Other income 34 56 Total investment income $ 1,528$ 1,337 The increase in interest income from investments for the year endedDecember 31, 2019 from the comparable period in 2018 was primarily due to an increase in the average size of our portfolio. The size of our portfolio increased from an average of$11.9 billion at amortized cost for the year endedDecember 31, 2018 to$13.6 billion at amortized cost for the comparable period in 2019. The increase in capital structuring service fees for the year endedDecember 31, 2019 was primarily due to the increase in the weighted average capital structuring service fees, which increased from 1.8% for the year endedDecember 31, 2018 to 2.2% for the comparable period in 2019. This increase was primarily due to an increase in transactions with larger portfolio companies in larger issuances, which resulted in higher fee opportunities for us during the year endedDecember 31, 2019 as compared to the comparable period in 2018. Dividend income for the years endedDecember 31, 2019 and 2018 included dividends received fromIvy Hill Asset Management, L.P. ("IHAM"), a wholly owned portfolio company, totaling$68 million and$58 million , respectively. Dividend income for the year endedDecember 31, 2019 included other recurring dividends of$69 million compared to$27 million for the comparable period in 2018 as a result of an increase in income producing equity securities, primarily consisting of preferred equity securities. 71
--------------------------------------------------------------------------------
Operating Expenses
For the Years Ended December 31,
(in millions) 2019 2018
Interest and credit facility fees $ 291 $ 240
Base management fees 205 180
Income based fees 194 169
Capital gains incentive fees(1) (4 ) 33
Administrative fees 14 13
Other general and administrative 31 29
Total operating expenses 731 664
Waiver of income based fees (30 ) (40 )Total expenses, net of waiver of income based fees $ 701
$ 624
_______________________________________________________________________________
(1) Calculated in accordance withU.S. generally accepted
accounting principles ("GAAP") as discussed below.
Interest and credit facility fees for the years ended
For the Years Ended December 31,
(in millions) 2019 2018
Stated interest expense $ 253 $ 200
Credit facility fees 12 17
Amortization of debt issuance costs 18 18
Net accretion of discount on notes payable 8 5
Total interest and credit facility fees $ 291 Stated interest expense for the year endedDecember 31, 2019 increased from the comparable period in 2018 primarily due to the increase in our average principal amount of debt outstanding. EffectiveJune 21, 2019 , our asset coverage requirement applicable to senior securities was reduced from 200% to 150%, and as a result, our debt to equity ratio increased to 0.95x as ofDecember 31, 2019 from 0.73x as ofDecember 31, 2018 , which increased our total debt outstanding and resulting interest expense more so than if our asset coverage requirement had remained at 200%. For the year endedDecember 31, 2019 , our average debt outstanding increased to$6.2 billion as compared to$4.8 billion for the comparable period in 2018. The weighted average stated interest rate on our outstanding debt was 4.1% for both the year endedDecember 31, 2019 and for the comparable period in 2018. Credit facility fees for the year endedDecember 31, 2019 were lower from the comparable period in 2018 primarily due to higher utilization of our revolving facilities resulting in lower unused commitment fees. The increase in base management fees for the year endedDecember 31, 2019 from the comparable period in 2018 was primarily due to the increase in the average size of our portfolio for the year endedDecember 31, 2019 as compared to the year endedDecember 31, 2018 . The increase in income based fees for the year endedDecember 31, 2019 from the comparable period in 2018 was primarily due to the pre-incentive fee net investment income, as defined in the investment advisory and management agreement, for the year endedDecember 31, 2019 being higher than in the comparable period in 2018. In addition, in connection with the acquisition ofAmerican Capital, Ltd. ("American Capital ") (the "American Capital Acquisition"),Ares Capital Management waived$10 million of income based fees for each of the ten calendar quarters beginning with the second calendar quarter of 2017 and ending with the third calendar quarter of 2019 (the "Fee Waiver"). The years endedDecember 31, 2019 and 2018 reflect the Fee Waiver of$30 million and$40 million , respectively. See Notes 3 and 16 to our consolidated financial statements for the year endedDecember 31, 2019 for additional information regarding the American Capital Acquisition. For the year endedDecember 31, 2019 , the reduction in the capital gains incentive fee calculated in accordance with GAAP was$4 million . For the year endedDecember 31, 2018 , the capital gains incentive fee calculated in accordance to GAAP was$33 million . The capital gains incentive fee accrual for the year endedDecember 31, 2019 changed from the comparable period in 2018 primarily due to net losses on investments, foreign currency and other transactions of$18 million for the year endedDecember 31, 2019 compared to net gains of$164 million for the year endedDecember 31, 2018 . The 72 -------------------------------------------------------------------------------- capital gains incentive fee accrued under GAAP includes an accrual related to unrealized capital appreciation, whereas the capital gains incentive fee actually payable under our investment advisory and management agreement does not. There can be no assurance that such unrealized capital appreciation will be realized in the future. The accrual for any capital gains incentive fee under GAAP in a given period may result in an additional expense if such cumulative amount is greater than in the prior period or a reduction of previously recorded expense if such cumulative amount is less than in the prior period. If such cumulative amount is negative, then there is no accrual. As ofDecember 31, 2019 and 2018, the total capital gains incentive fee accrual calculated in accordance with GAAP was$58 million and$112 million , respectively. As ofDecember 31, 2019 , there was no capital gains incentive fee actually payable under our investment advisory and management agreement. As ofDecember 31, 2018 , the capital gains incentive fee actually payable under our investment advisory and management agreement was$50 million , which was paid in the first quarter of 2019. See Note 3 to our consolidated financial statements for the year endedDecember 31, 2019 , for more information on the base management fees, income based fees and capital gains incentive fees. Administrative fees represent fees paid to Ares Operations for our allocable portion of overhead and other expenses incurred by Ares Operations in performing its obligations under the administration agreement, including our allocable portion of the compensation, rent and other expenses of certain of our executive officers and their respective staffs.
Other general and administrative expenses include, among other costs, professional fees, insurance, fees and expenses related to evaluating and making investments in portfolio companies and independent directors' fees.
Income Tax Expense, Including Excise Tax
We have elected to be treated as a RIC under the Code and operate in a manner so as to qualify for the tax treatment applicable to RICs. To qualify as a RIC, we must (among other requirements) meet certain source-of-income and asset diversification requirements and timely distribute to our stockholders at least 90% of our investment company taxable income, as defined by the Code, for each year. We have made and intend to continue to make the requisite distributions to our stockholders which will generally relieve us fromU.S. federal corporate-level income taxes. Depending on the level of taxable income earned in a tax year, we may choose to carry forward such taxable income in excess of current year dividend distributions from such current year taxable income into the next tax year and pay a 4% excise tax on such income, as required. To the extent that we determine that our estimated current year taxable income will be in excess of estimated dividend distributions for the current year from such income, we accrue excise tax, if any, on estimated excess taxable income as such taxable income is earned. For the years endedDecember 31, 2019 and 2018, we recorded a net expense of$15 million and$14 million , respectively, forU.S. federal excise tax. Certain of our consolidated subsidiaries are subject toU.S. federal and state income taxes. For the years endedDecember 31, 2019 and 2018, we recorded a net tax expense of$1 million and$5 million , respectively, for these subsidiaries. The income tax expense for our taxable consolidated subsidiaries will vary depending on the level of realized gains from the exits of investments held by such taxable subsidiaries during the respective periods.
Net Realized Gains/Losses
The net realized gains (losses) from the sales, repayments or exits of investments during the years endedDecember 31, 2019 and 2018 were comprised of the following: For the Years Ended December 31, (in millions) 2019 2018 Sales, repayments or exits of investments(1) $ 4,879 $ 6,780 Net realized gains (losses) on investments: Gross realized gains $ 78 $ 465 Gross realized losses (205 ) (59 ) Total net realized gains (losses) on investments $ (127 ) $ 406 _______________________________________________________________________________
(1) Includes$1,141 million and$472 million of investments sold to IHAM and certain vehicles managed by IHAM during the years endedDecember 31, 2019
and 2018, respectively. Net realized losses of
respectively, were recorded on these transactions with IHAM during the
years ended December 31, 2019 and 2018.
73--------------------------------------------------------------------------------
See Note 4 to our consolidated financial statements for the year ended
The net realized losses on investments during the year endedDecember 31, 2019 consisted of the following: (in millions) Net Realized GainsPortfolio Company (Losses)Soil Safe, Inc. andSoil Safe Acquisition Corp. $
13
Petroflow Energy Corporation and TexOak Petro Holdings LLC (33 ) Indra Holdings Corp. (62 ) New Trident Holdcorp, Inc. (96 ) Other, net 51 Total $ (127 ) During the year endedDecember 31, 2019 , we also recognized net realized gains on foreign currency and other transactions of$16 million . We also recognized a realized gain of$46 million in connection with the receipt of a litigation judgment payment related to a former portfolio company ofAmerican Capital . See Note 17 to our consolidated financial statements for the year endedDecember 31, 2019 for more information. The net realized gains on investments during the year endedDecember 31, 2018 consisted of the following: (in millions) Portfolio Company Net Realized Gains (Losses) Alcami Holdings, LLC $ 324 Accruent, LLC 27 Varsity Brands Holding Co., Inc. 14 Imperial Capital Private Opportunities, LP 12 Things Remembered, Inc. (16 ) Other, net 45 Total $ 406
During the year ended
Net Unrealized Gains/Losses
We value our portfolio investments quarterly and the changes in value are
recorded as unrealized gains or losses in our consolidated statement of
operations. Net unrealized gains and losses on investments for the years ended
For the Years Ended December 31,
(in millions) 2019 2018
Unrealized appreciation $ 178 $ 137
Unrealized depreciation (310 ) (275 )Net unrealized (appreciation) depreciation reversed related to net realized gains or losses(1)
193 (133 )
Total net unrealized gains (losses) on investments $ 61
$ (271 )
_______________________________________________________________________________
(1) The net unrealized (appreciation) depreciation reversed related to net
realized gains or losses represents the unrealized appreciation or
depreciation recorded on the related asset at the end of the prior period.
74
--------------------------------------------------------------------------------
The changes in net unrealized appreciation and depreciation on investments
during the year ended
Net Unrealized
(in millions) Appreciation
Portfolio Company (Depreciation)
Instituto de Banca y Comercio, Inc. & Leeds IV Advisors, Inc. $ 21
Dynatrace, Inc. 17
10 ADG, LLC and RC IV GEDC Investor LLC (13 ) Alcami Corporation and ACM Holdings I, LLC (15 ) Eckler Industries, Inc. and Eckler Purchaser LLC (20 ) VPROP Operating, LLC and Vista Proppants and Logistics, LLC (47 ) Other, net (85 ) Total $ (132 )
During the year ended
The changes in net unrealized appreciation and depreciation on investments during the year endedDecember 31, 2018 consisted of the following: (in millions) Portfolio Company Net Unrealized Appreciation (Depreciation) OTG Management, LLC $ 25 PERC Holdings 1 LLC 11 SCM Insurance Services Inc.(10 ) ADF Capital, Inc. (11 ) Teasdale Foods, Inc. (11 ) R3 Education Inc. (12 ) Eckler Industries, Inc. (13 ) Indra Holdings Corp. (15 ) Singer Sewing Company (15 ) New Trident Holdcorp, Inc. (49 ) Other, net (38 ) Total $ (138 )
During the year ended
For the years ended
The comparison of the fiscal years endedDecember 31, 2018 and 2017 can be found in our annual report on Form 10-K for the fiscal year endedDecember 31, 2018 located within Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, which is incorporated by reference herein.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Our liquidity and capital resources are generated primarily from the net
proceeds of public offerings of equity and debt securities, advances from the
Revolving Credit Facility, the Revolving Funding Facility and the SMBC Funding
Facility (each as defined below, and together, the "Facilities"), net proceeds
from the issuance of other securities, including unsecured notes, as well as
cash flows from operations.
75-------------------------------------------------------------------------------- EffectiveJune 21, 2019 , our asset coverage requirement applicable to senior securities was reduced from 200% to 150% (i.e., we are able to borrow up totwo dollars for every dollar we have in assets less all liabilities and indebtedness not represented by senior securities issued by us). Prior toJune 21, 2019 , in accordance with the Investment Company Act, we were allowed to borrow amounts such that our asset coverage, calculated pursuant to the Investment Company Act, was at least 200% after such borrowings. As ofDecember 31, 2019 , we had$176 million in cash and cash equivalents and$7.1 billion in total aggregate principal amount of debt outstanding ($7.0 billion at carrying value) and our asset coverage was 204%. Subject to leverage, borrowing base and other restrictions, we had approximately$2.0 billion available for additional borrowings under the Facilities as ofDecember 31, 2019 . We may from time to time seek to retire or repurchase our common stock through cash purchases, as well as retire, cancel or purchase our outstanding debt through cash purchases and/or exchanges, in open market purchases, privately negotiated transactions or otherwise. The amounts involved may be material. In addition, we may from time to time enter into additional debt facilities, increase the size of existing facilities or issue additional debt securities, including secured debt, unsecured debt and/or debt securities convertible into common stock. Any such purchases or exchanges of common stock or outstanding debt, or incurrence or issuance of additional debt would be subject to prevailing market conditions, our liquidity requirements, contractual and regulatory restrictions and other factors.
Equity Capital Activities
As of
InNovember 2019 , we entered into separate equity distribution agreements with two sales agents (the "Equity Distribution Agreements"), pursuant to which we may from time to time issue and sell shares of our common stock having an aggregate offering amount of up to$500 million . Subject to the terms and conditions of the Equity Distribution Agreements, sales of common stock, if any, may be made in transactions that are deemed to be an "at the market offering" as defined in Rule 415(a)(4) under the Securities Act of 1933, as amended. During the year endedDecember 31, 2019 , we issued and sold 3.5 million shares of common stock under the Equity Distribution Agreements, with net proceeds totaling$64 million , after deducting sales agents' commissions and certain offering expenses of approximately$1 million . As ofDecember 31, 2019 , common stock with an aggregate offering amount of$435 million remained available for issuance under the Equity Distribution Agreements. In addition to equity issuances under the Equity Distribution Agreements, we also issued common stock in connection with our dividend reinvestment program during the year endedDecember 31, 2019 . There were no other issuances of our equity securities during the years endedDecember 31, 2019 and 2018. We are authorized under our stock repurchase program to purchase up to$500 million in the aggregate of our outstanding common stock in the open market at certain thresholds below our net asset value per share, in accordance with the guidelines specified in Rule 10b-18 under the Securities Exchange Act of 1934, as amended. The timing, manner, price and amount of any share repurchases will be determined by us, in our discretion, based upon the evaluation of economic and market conditions, stock price, applicable legal and regulatory requirements and other factors. The program does not require us to repurchase any specific number of shares, and we cannot assure stockholders that any shares will be repurchased under the program. The expiration date of the stock repurchase program isFebruary 15, 2020 . The program may be suspended, extended, modified or discontinued at any time. As ofDecember 31, 2019 , we had repurchased a total of 0.5 million shares of our common stock in the open market under the stock repurchase program since its inception inSeptember 2015 , at an average price of$13.92 per share, including commissions paid, leaving approximately$493 million available for additional repurchases under the program. During the years endedDecember 31, 2019 and 2018, we did not repurchase any shares of our common stock under the stock repurchase program.
See "Recent Developments," as well as Note 18 to our consolidated financial
statements for the year ended
76
--------------------------------------------------------------------------------Debt Capital Activities
Our debt obligations consisted of the following as ofDecember 31, 2019 and 2018: As of December 31, 2019 2018 Total Total Aggregate Aggregate Principal Principal Amount Amount Available/ Principal Amount Carrying Available/ Principal Amount Carrying (in millions) Outstanding(1) Outstanding Value Outstanding(1) Outstanding Value Revolving Credit Facility $ 3,365 (2) $ 2,250$ 2,250 $ 2,133 $ 1,064$ 1,064 Revolving Funding Facility 1,275 638 638 1,000 520 520 SMBC Funding Facility 650 (3) 301 301 400 245 245 2019 Convertible Notes - - - 300 300 300 (4) 2022 Convertible Notes 388 388 377 (4) 388 388 372 (4) 2024 Convertible Notes 403 403 389 (4) - - - 2020 Notes - - - (5) 600 600 598 (5) 2022 Notes 600 600 597 (6) 600 600 595 (6) 2023 Notes 750 750 746 (7) 750 750 744 (7) 2024 Notes 900 900 895 (8) - - - March 2025 Notes 600 600 594 (9) 600 600 593 (9) 2047 Notes 230 230 184 (10) 230 230 183 (10) Total $ 9,161 $ 7,060$ 6,971 $ 7,001 $ 5,297$ 5,214
________________________________________
(1) Subject to borrowing base, leverage and other restrictions. Represents the
total aggregate amount committed or outstanding, as applicable, under such
instrument.
(2) Provides for a feature that allows us, under certain circumstances, toincrease the size of the Revolving Credit Facility (as defined below) to a
maximum of $5.0 billion .
(3) Provides for a feature that allows ACJB (as defined below), under certain
circumstances, to increase the size of the SMBC Funding Facility (as
defined below) to a maximum of $1.0 billion .
(4) Represents the aggregate principal amount outstanding of the Convertible
Unsecured Notes (as defined below). As of
unamortized debt issuance costs and the unaccreted discount for the 2022
Convertible Notes and the 2024 Convertible Notes (each as defined below)
were
the total unamortized debt issuance costs and the unaccreted discount for
the 2019 Convertible Notes and the 2022 Convertible Notes were
and $16 million , respectively.
(5) Represents the aggregate principal amount outstanding of the 2020 Notes
(as defined below) less unamortized debt issuance costs and the net
unaccreted discount recorded upon the issuances of the 2020 Notes. As of
December 31, 2018 , the total unamortized debt issuance costs and the net unaccreted discount was$2 million .
(6) Represents the aggregate principal amount outstanding of the 2022 Notes
(as defined below), less unamortized debt issuance costs and the net
unaccreted discount recorded upon the issuances of the 2022 Notes. As of
the net unaccreted discount were
(7) Represents the aggregate principal amount outstanding of the 2023 Notes
(as defined below), less unamortized debt issuance costs and the
unaccreted discount recorded upon the issuance of the 2023 Notes. As of
the unaccreted discount was $4 million and $6 million , respectively.
77--------------------------------------------------------------------------------
(8) Represents the aggregate principal amount outstanding of the 2024 Notes
(as defined below), less unamortized debt issuance costs and the net
unaccreted discount recorded upon the issuance of the 2024 Notes. As of
unaccreted discount was
(9) Represents the aggregate principal amount outstanding of the
Notes (as defined below), less unamortized debt issuance costs and the
unaccreted discount recorded upon the issuance of the
of
and the unaccreted discount was
(10) Represents the aggregate principal amount outstanding of the 2047 Notes
(as defined below) less unamortized debt issuance costs and the unaccreted
discount recorded upon the assumption of the 2047 Notes. As of December
31, 2019 and 2018, the total unaccreted purchased discount was
and $47 million , respectively.
The weighted average stated interest rate and weighted average maturity, both
on aggregate principal amount outstanding, of all our debt outstanding as of
December 31, 2019 were 3.9% and 4.7 years, respectively, and as of December 31,
2018 were 4.1% and 4.8 years, respectively.
The ratio of total principal amount of debt outstanding to stockholders' equity
as of December 31, 2019 was 0.95:1.00 compared to 0.73:1.00 as of December 31,
2018 .
Revolving Credit Facility
We are party to a senior secured revolving credit facility (as amended and
restated, the "Revolving Credit Facility"), which allows us to borrow up to $3.4
billion at any one time outstanding. The Revolving Credit Facility consists of a
$674 million term loan tranche with a stated maturity date of March 30, 2024 and
a $2.7 billion revolving tranche. For the revolving tranche, the end of the
revolving period and the stated maturity date are March 30, 2023 and March 30,
2024 , respectively. The Revolving Credit Facility also provides for a feature
that allows us, under certain circumstances, to increase the overall size of the
Revolving Credit Facility to a maximum of $5.0 billion . The interest rate
charged on the Revolving Credit Facility is based on an applicable spread of
either 1.75% or 1.875% over LIBOR or 0.75% or 0.875% over an "alternate base
rate" (as defined in the agreements governing the Revolving Credit Facility), in
each case, determined monthly based on the total amount of the borrowing base
relative to the total commitments of the Revolving Credit Facility and other
debt, if any, secured by the same collateral as the Revolving Credit Facility.
As of December 31, 2019 , the interest rate in effect was LIBOR plus 1.75%. We
are also required to pay a letter of credit fee of either 2.00% or 2.125% per
annum on letters of credit issued, determined monthly based on the total amount
of the borrowing base relative to the total commitments of the Revolving Credit
Facility and other debt, if any, secured by the same collateral as the Revolving
Credit Facility. Additionally, we are required to pay a commitment fee of 0.375%
per annum on any unused portion of the Revolving Credit Facility. As of
December 31, 2019 , there was $2.3 billion outstanding under the Revolving Credit
Facility and we were in compliance in all material respects with the terms of
the Revolving Credit Facility.
Revolving Funding Facility
We and our consolidated subsidiary,Ares Capital CP Funding LLC ("Ares Capital CP"), are party to a revolving funding facility (as amended, the "Revolving Funding Facility"), which as ofDecember 31, 2019 allowed Ares Capital CP to borrow up to$1.3 billion at any one time outstanding. The Revolving Funding Facility is secured by all of the assets held by, and the membership interest in, Ares Capital CP. As ofDecember 31, 2019 , the end of the reinvestment period and the stated maturity date for the Revolving Funding Facility wasJanuary 3, 2022 andJanuary 3, 2024 , respectively. The interest rate charged on the Revolving Funding Facility is based on LIBOR plus 2.00% per annum or a "base rate" (as defined in the agreements governing the Revolving Funding Facility) plus 1.00% per annum. Ares Capital CP is also required to pay a commitment fee of between 0.50% and 1.50% per annum depending on the size of the unused portion of the Revolving Funding Facility. As ofDecember 31, 2019 , there was$638 million outstanding under the Revolving Funding Facility and we andAres Capital CP were in compliance in all material respects with the terms of the Revolving Funding Facility. See "Recent Developments," as well as Note 18 to our consolidated financial statements for the year endedDecember 31, 2019 for a subsequent event relating to the Revolving Funding Facility.
SMBC Funding Facility
We and our consolidated subsidiary,Ares Capital JB Funding LLC ("ACJB"), are party to a revolving funding facility (as amended, the "SMBC Funding Facility"), with ACJB, as the borrower, andSumitomo Mitsui Banking Corporation ("SMBC"), as the administrative agent, collateral agent and lender, which as ofDecember 31, 2019 allowed ACJB to borrow 78 -------------------------------------------------------------------------------- up to$650 million at any one time outstanding. The SMBC Funding Facility also provides for a feature that allows ACJB, subject to receiving certain consents, to increase the overall size of the SMBC Funding Facility to$1.0 billion . The SMBC Funding Facility is secured by all of the assets held by ACJB. The end of the reinvestment period and the stated maturity date for the SMBC Funding Facility areSeptember 10, 2022 andSeptember 10, 2024 , respectively. The reinvestment period and the stated maturity date are both subject to two one-year extensions by mutual agreement. The interest rate charged on the SMBC Funding Facility is based on an applicable spread of either 1.75% or 2.00% over LIBOR or 0.75% or 1.00% over a "base rate" (as defined in the agreements governing the SMBC Funding Facility), in each case, determined monthly based on the amount of the average borrowings outstanding under the SMBC Funding Facility. As ofDecember 31, 2019 , the interest rate in effect was LIBOR plus 1.75%. ACJB is also required to pay a commitment fee of between 0.50% and 1.00% per annum depending on the size of the unused portion of the SMBC Funding Facility. As ofDecember 31, 2019 , there was$301 million outstanding under the SMBC Funding Facility and we and ACJB were in compliance in all material respects with the terms of the SMBC Funding Facility. See "Recent Developments," as well as Note 18 to our consolidated financial statements for the year endedDecember 31, 2019 for a subsequent event relating to the SMBC Funding Facility.
Convertible Unsecured Notes
We have issued$388 million in aggregate principal amount of unsecured convertible notes that mature onFebruary 1, 2022 (the "2022 Convertible Notes") and$403 million aggregate principal amount of unsecured convertible notes that mature onMarch 1, 2024 (the "2024 Convertible Notes" and together with the 2022 Convertible Notes, the "Convertible Unsecured Notes"). The Convertible Unsecured Notes mature upon their respective maturity dates unless previously converted or repurchased in accordance with their terms. We do not have the right to redeem the Convertible Unsecured Notes prior to maturity. The 2022 Convertible Notes and the 2024 Convertible Notes bear interest at a rate of 3.75% and 4.625%, respectively, per year, payable semi-annually. In certain circumstances, assuming the respective conversion date below has not already passed, the Convertible Unsecured Notes will be convertible into cash, shares of our common stock or a combination of cash and shares of our common stock, at our election, at their respective conversion rates (listed below as ofDecember 31, 2019 ) subject to customary anti-dilution adjustments and the requirements of their respective indenture (the "Convertible Unsecured Notes Indentures"). Prior to the close of business on the business day immediately preceding their respective conversion date (listed below), holders may convert their Convertible Unsecured Notes only under certain circumstances set forth in the Convertible Unsecured Notes Indentures. On or after their respective conversion dates until the close of business on the scheduled trading day immediately preceding the maturity date for the 2022 Convertible Notes and the second scheduled trading day immediately preceding the maturity date for the 2024 Convertible Notes, holders may convert their Convertible Unsecured Notes at any time. In addition, if we engage in certain corporate events as described in their respective Convertible Unsecured Notes Indenture, holders of the Convertible Unsecured Notes may require us to repurchase for cash all or part of the Convertible Unsecured Notes at a repurchase price equal to 100% of the principal amount of the Convertible Unsecured Notes to be repurchased, plus accrued and unpaid interest through, but excluding, the required repurchase date.
In
Certain key terms related to the convertible features for each of the
Convertible Unsecured Notes as of
2022 2024
Convertible Notes Convertible Notes
Conversion premium 15.0 % 15.0 %
Closing stock price at issuance $ 16.86 $ 17.29
Closing stock price date January 23, 2017 March 5, 2019
Conversion price(1) $ 19.20 $ 19.88
Conversion rate (shares per one thousand dollar
principal amount)(1) 52.0943 50.2930
Conversion dates August 1, 2021 December 1, 2023
________________________________________
(1) Represents conversion price and conversion rate, as applicable, as of
will be made on the conversion date.
79--------------------------------------------------------------------------------
Unsecured Notes
2020 Notes
InDecember 2019 , we redeemed the entire$600 million in aggregate principal amount of unsecured notes that were scheduled to mature onJanuary 15, 2020 and bore interest at a rate of 3.875% per year (the "2020 Notes") in accordance with the terms of the indenture governing the 2020 Notes. The 2020 Notes were redeemed at par plus accrued and unpaid interest for a total redemption price of approximately$610 million .
2022 Notes
We have issued$600 million in aggregate principal amount of unsecured notes that mature onJanuary 19, 2022 and bear interest at a rate of 3.625% per year (the "2022 Notes"). The 2022 Notes require payment of interest semi-annually, and all principal is due upon maturity. The 2022 Notes may be redeemed in whole or in part at any time at our option at a redemption price equal to par plus a "make whole" premium, if applicable, as determined pursuant to the indenture governing the 2022 Notes, and any accrued and unpaid interest.
2023 Notes
We have issued$750 million in aggregate principal amount of unsecured notes that mature onFebruary 10, 2023 and bear interest at a rate of 3.500% per year (the "2023 Notes"). The 2023 Notes require payment of interest semi-annually, and all principal is due upon maturity. The 2023 Notes may be redeemed in whole or in part at any time at our option at a redemption price equal to par plus a "make whole" premium, if applicable, as determined pursuant to the indenture governing the 2023 Notes, and any accrued and unpaid interest.
2024 Notes
We have issued$900 million in aggregate principal amount of unsecured notes that mature onJune 10, 2024 and bear interest at a rate of 4.200% per year (the ''2024 Notes''). The 2024 Notes require payment of interest semi-annually, and all principal is due upon maturity. The 2024 Notes may be redeemed in whole or in part at any time at our option at a redemption price equal to par plus a ''make whole'' premium, if applicable, as determined pursuant to the indenture governing the 2024 Notes, and any accrued and unpaid interest.
We have issued$600 million in aggregate principal amount of unsecured notes that mature onMarch 1, 2025 and bear interest at a rate of 4.250% per year (the "March 2025 Notes"). TheMarch 2025 Notes require payment of interest semi-annually, and all principal is due upon maturity. TheMarch 2025 Notes may be redeemed in whole or in part at any time at our option at a redemption price equal to par plus a "make whole" premium, if applicable, as determined pursuant to the indenture governing theMarch 2025 Notes, and any accrued and unpaid interest.
2047 Notes
As part of the Allied Acquisition, we assumed$230 million in aggregate principal amount of unsecured notes that mature onApril 15, 2047 and bear interest at a rate of 6.875% (the "2047 Notes" and together with the 2022 Notes, the 2023 Notes, the 2024 Notes and theMarch 2025 Notes, the "Unsecured Notes"). The 2047 Notes require payment of interest quarterly, and all principal is due upon maturity. These notes are redeemable in whole or in part at any time or from time to time at our option, at a par redemption price of$25.00 per security plus accrued and unpaid interest.
See "Recent Developments," as well as Note 18 to our consolidated financial
statements for the year ended
As ofDecember 31, 2019 , we were in compliance in all material respects with the terms of the Convertible Unsecured Notes Indentures and the indentures governing the Unsecured Notes. The Convertible Unsecured Notes and the Unsecured Notes are our senior unsecured obligations and rank senior in right of payment to any future indebtedness that is expressly subordinated in right of payment to the Convertible Unsecured Notes and the Unsecured Notes; equal in right of payment to our existing and future unsecured indebtedness that is not expressly subordinated; effectively junior in right of payment to any of our secured indebtedness (including existing unsecured 80 -------------------------------------------------------------------------------- indebtedness that we later secure) to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness (including trade payables) incurred by our subsidiaries, financing vehicles or similar facilities.
See Note 5 to our consolidated financial statements for the year ended
CONTRACTUAL OBLIGATIONS
A summary of the maturities of our principal amounts of debt and other
contractual payment obligations as of
Payments Due by Period
Less than After
(in millions) Total 1 year 1-3 years 3-5 years 5 years
Revolving Credit Facility $ 2,250 $ - $ - $ 2,250 (1) $ -
Revolving Funding Facility 638 - - 638 (2) -
SMBC Funding Facility 301 - - 301 (3) -
2022 Convertible Notes 388 - 388 - -
2024 Convertible Notes 403 - - 403 -
2022 Notes 600 - 600 - -
2023 Notes 750 - - 750 -
2024 Notes 900 - - 900 -
March 2025 Notes 600 - - - 600
2047 Notes 230 - - - 230
Operating lease obligations(4) 136 24 48 40 24
$ 7,196 $ 24 $ 1,036 $ 5,282 $ 854 _______________________________________________________________________________
(1) The Revolving Credit Facility consists of a
with a stated maturity date of
revolving tranche. For the revolving tranche, the end of the revolving
period and the stated maturity date are
respectively. We are required to repay any outstanding principal amounts
under such revolving tranche on a monthly basis equal to 1/12th of the
outstanding principal amount at the end of the revolving period.
(2) As of December 31, 2019 , the end of the reinvestment period for the
Revolving Funding Facility was
this reinvestment period and prior to the stated maturity date of January
3, 2024, any principal proceeds from sales and repayments of loan assets
held by Ares Capital CP will be used to repay the aggregate principal
amount outstanding.
(3) The end of the reinvestment period for the SMBC Funding Facility is
prior to the stated maturity date of
proceeds from sales and repayments of loan assets held by ACJB will be
used to repay the aggregate principal amount outstanding.
(4) We are obligated under a number of operating leases and subleases to pay
for office spaces with terms ranging from approximately three to seven
years. See Note 7 to our consolidated financial statements for the year
ended
OFF BALANCE SHEET ARRANGEMENTS
We have various commitments to fund investments in our portfolio, as described below.
As of
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As of December 31 ,
(in millions) 2019 2018
Total revolving and delayed draw loan commitments$ 2,174 $ 1,915 Less: drawn commitments (459 ) (377 ) Total undrawn commitments 1,715 1,538 Less: commitments substantially at our discretion (6 ) (6 ) Total net adjusted undrawn revolving and delayed draw loan commitments$ 1,709 $ 1,532 Included within the total revolving and delayed draw loan commitments as ofDecember 31, 2019 and 2018 were delayed draw loan commitments totaling$633 million and$627 million , respectively. Our commitment to fund delayed draw loans is triggered upon the satisfaction of certain pre-negotiated terms and conditions. Generally, the most significant and uncertain term requires the borrower to satisfy a specific use of proceeds covenant. The use of proceeds covenant typically requires the borrower to use the additional loans for the specific purpose of a permitted acquisition or permitted investment, for example. In addition to the use of proceeds covenant, the borrower is generally required to satisfy additional negotiated covenants (including specified leverage levels). Also included within the total revolving and delayed draw loan commitments as ofDecember 31, 2019 were commitments to issue up to$338 million in letters of credit through a financial intermediary on behalf of certain portfolio companies. As ofDecember 31, 2019 , we had$38 million in letters of credit issued and outstanding under these commitments on behalf of the portfolio companies. For all these letters of credit issued and outstanding, we would be required to make payments to third parties if the portfolio companies were to default on their related payment obligations. Of these letters of credit,$32 million expire in 2020 and$6 million expire in 2021. As ofDecember 31, 2019 , we recorded a liability of$1 million for certain letters of credit issued and outstanding and none of the other letters of credit issued and outstanding were recorded as a liability on our balance sheet as such other letters of credit are considered in the valuation of the investments in the portfolio company. We also have commitments to co-invest in the SDLP for our portion of the SDLP's commitments to fund delayed draw loans to certain portfolio companies of the SDLP. See "Senior Direct Lending Program" above and Note 4 to our consolidated financial statements for the year endedDecember 31, 2019 for more information. As ofDecember 31, 2019 and 2018, we were party to subscription agreements to fund equity investments in private equity investment partnerships as follows: As of December 31, (in millions) 2019 2018 Total private equity commitments$ 117 $ 114 Less: funded private equity commitments (69 ) (73 ) Total unfunded private equity commitments 48 41
Less: private equity commitments substantially our discretion (48 )
(41 )
Total net adjusted unfunded private equity commitments $ -
$ -
In the ordinary course of business, we may sell certain of our investments to
third party purchasers. In particular, in connection with the sale of certain
controlled portfolio company equity investments (as well as certain other
sales), we have, and may continue to do so in the future, agreed to indemnify
such purchasers for future liabilities arising from the investments and the
related sale transaction. Such indemnification provisions have given rise to
liabilities in the past and may do so in the future.
In addition, in the ordinary course of business, we may guarantee certain
obligations in connection with our portfolio companies (in particular, certain
controlled portfolio companies). Under these guarantee arrangements, payments
may be required to be made to third parties if such guarantees are called upon
or if the portfolio companies were to default on their related obligations, as
applicable.
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RECENT DEVELOPMENTS
InJanuary 2020 , we issued$750 million in aggregate principal amount of unsecured notes, which bear interest at a rate of 3.250% per year and mature onJuly 15, 2025 (the ''July 2025 Notes''). TheJuly 2025 Notes require payment of interest semi-annually and all principal is due upon maturity. TheJuly 2025 Notes may be redeemed in whole or in part at any time at the our option at the redemption prices determined pursuant to the indenture governing theJuly 2025 Notes, and any accrued and unpaid interest. TheJuly 2025 Notes were issued at a discount to the principal amount.
In
InJanuary 2020 , we and Ares Capital CP entered into an agreement to amend the Revolving Funding Facility that, among other things, (a) increased the commitments under the Revolving Funding Facility from$1,275 million to$1,525 million , (b) extended the reinvestment period fromJanuary 3, 2022 toJanuary 31, 2023 and (c) extended the stated maturity date fromJanuary 3, 2024 toJanuary 31, 2025 . InFebruary 2020 , our board of directors authorized an amendment to our$500 million stock repurchase program to extend the expiration date of the program fromFebruary 15, 2020 toFebruary 15, 2021 . Under the stock repurchase program, we may repurchase up to$500 million in the aggregate of our outstanding common stock in the open market at a price per share that meets certain thresholds below our net asset value per share, in accordance with the guidelines specified in Rule 10b-18 of the Exchange Act. The timing, manner, price and amount of any share repurchases will be determined by us, in our discretion, based upon the evaluation of economic and market conditions, stock price, applicable legal and regulatory requirements and other factors. FromJanuary 1, 2020 throughFebruary 6, 2020 , we made new investment commitments of approximately$453 million , of which$361 million were funded. Of these new commitments, 61% were in first lien senior secured loans, 18% were in second lien senior secured loans, 17% were in senior subordinated loans and 4% were in other equity securities. Of the approximately$453 million of new investment commitments, 96% were floating rate and 4% were non-interest bearing. The weighted average yield of debt and other income producing securities funded during the period at amortized cost was 8.1%. We may seek to sell all or a portion of these new investment commitments, although there can be no assurance that we will be able to do so. FromJanuary 1, 2020 throughFebruary 6, 2020 , we exited approximately$282 million of investment commitments. Of the total investment commitments exited, 55% were first lien senior secured loans, 38% were second lien senior secured loans, 3% were senior subordinated loans, 3% were other equity securities and 1% were subordinated certificates of the SDLP. Of the approximately$282 million of exited investment commitments, 96% were floating rate, 3% were non-interest bearing and 1% were fixed rate. The weighted average yield of debt and other income producing securities exited or repaid during the period at amortized cost was 8.8%, and the weighted average yield on total investments exited or repaid during the period at amortized cost was 8.6%. On the approximately$282 million of investment commitments exited fromJanuary 1, 2020 throughFebruary 6, 2020 , we recognized total net realized gains of approximately$21 million . In addition, as ofFebruary 6, 2020 , we had an investment backlog and pipeline of approximately$735 million and$390 million , respectively. Investment backlog includes transactions approved by our investment adviser's investment committee and/or for which a formal mandate, letter of intent or a signed commitment have been issued, and therefore we believe are likely to close. Investment pipeline includes transactions where due diligence and analysis are in process, but no formal mandate, letter of intent or signed commitment have been issued. The consummation of any of the investments in this backlog and pipeline depends upon, among other things, one or more of the following: satisfactory completion of our due diligence investigation of the prospective portfolio company, our acceptance of the terms and structure of such investment and the execution and delivery of satisfactory transaction documentation. In addition, we may sell all or a portion of these investments and certain of these investments may result in the repayment of existing investments. We cannot assure you that we will make any of these investments or that we will sell all or any portion of these investments.
CRITICAL ACCOUNTING POLICIES
The preparation of our consolidated financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues, and expenses. Changes in the economic environment,
financial markets, and any other parameters used in determining such estimates
could cause actual results to differ. Our critical accounting policies,
including those relating to the valuation of our investment portfolio, are
described below. The critical accounting policies
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should be read in connection with our risk factors as disclosed in "Item 1A.
Risk Factors." See Note 2 to our consolidated financial statements for the year
ended December 31, 2019 for more information on our critical accounting
policies.
Investments
Investment transactions are recorded on the trade date. Realized gains or losses are measured by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment using the specific identification method without regard to unrealized gains or losses previously recognized, and include investments charged off during the period, net of recoveries. Unrealized gains or losses primarily reflect the change in investment values, including the reversal of previously recorded unrealized gains or losses when gains or losses are realized. Investments for which market quotations are readily available are typically valued at such market quotations. In order to validate market quotations, we look at a number of factors to determine if the quotations are representative of fair value, including the source and nature of the quotations. Debt and equity securities that are not publicly traded or whose market prices are not readily available (i.e., substantially all of our investments) are valued at fair value as determined in good faith by our board of directors, based on, among other things, the input of our investment adviser, audit committee and independent thirdparty valuation firms that have been engaged at the direction of our board of directors to assist in the valuation of each portfolio investment without a readily available market quotation at least once during a trailing 12month period (with certain de minimis exceptions) and under a valuation policy and a consistently applied valuation process. The valuation process is conducted at the end of each fiscal quarter, and a portion of our investment portfolio at fair value is subject to review by an independent valuation firm each quarter. In addition, our independent registered public accounting firm obtains an understanding of, and performs select procedures relating to, our investment valuation process within the context of performing the integrated audit. As part of the valuation process, we may take into account the following types of factors, if relevant, in determining the fair value of our investments: the enterprise value of a portfolio company (the entire value of the portfolio company to a market participant, including the sum of the values of debt and equity securities used to capitalize the enterprise at a point in time), the nature and realizable value of any collateral, the portfolio company's ability to make payments and its earnings and discounted cash flow, the markets in which the portfolio company does business, a comparison of the portfolio company's securities to any similar publicly traded securities, changes in the interest rate environment and the credit markets, which may affect the price at which similar investments would trade in their principal markets and other relevant factors. When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, we consider the pricing indicated by the external event to corroborate our valuation. Because there is not a readily available market value for most of the investments in our portfolio, we value substantially all of our portfolio investments at fair value as determined in good faith by our board of directors, as described herein. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments may fluctuate from period to period. Additionally, the fair value of our investments may differ significantly from the values that would have been used had a ready market existed for such investments and may differ materially from the values that we may ultimately realize. Further, such investments are generally subject to legal and other restrictions on resale or otherwise are less liquid than publicly traded securities. If we were required to liquidate a portfolio investment in a forced or liquidation sale, we could realize significantly less than the value at which we have recorded it.
In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the unrealized gains or losses reflected in the valuations currently assigned.
Our board of directors undertakes a multistep valuation process each quarter, as described below:
• Our quarterly valuation process begins with each portfolio company or
investment being initially valued by the investment professionals
responsible for the portfolio investment in conjunction with our
portfolio management team.
• Preliminary valuations are reviewed and discussed with our investment
adviser's management and investment professionals, and then valuation
recommendations are presented to our board of directors.
• The audit committee of our board of directors reviews these valuations,
as well as the input of third parties, including independent
thirdparty valuation firms who have reviewed a portion of the
investments in our portfolio at fair value.
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• Our board of directors discusses valuations and ultimately determines
the fair value of each investment in our portfolio without a readily
available market quotation in good faith based on, among other things,
the input of our investment adviser, audit committee and, where
applicable, independent thirdparty valuation firms.
Fair Value of Financial Instruments
We follow ASC 825-10, Recognition and Measurement of Financial Assets and
Financial Liabilities ("ASC 825-10"), which provides companies the option to
report selected financial assets and liabilities at fair value. ASC 825-10 also
establishes presentation and disclosure requirements designed to facilitate
comparisons between companies that choose different measurement attributes for
similar types of assets and liabilities and to more easily understand the effect
of the company's choice to use fair value on its earnings. ASC 825-10 also
requires entities to display the fair value of the selected assets and
liabilities on the face of the balance sheet. We have not elected the ASC 825-10
option to report selected financial assets and liabilities at fair value. With
the exception of the line items entitled "other assets" and "debt," which are
reported at amortized cost, all assets and liabilities approximate fair value on
the balance sheet. The carrying value of the lines titled "interest receivable,"
"receivable for open trades," "payable for open trades," "accounts payable and
other liabilities," "base management fees payable," "income based fees payable,"
"capital gains incentive fees payable" and "interest and facility fees payable"
approximate fair value due to their short maturity.
We also follow ASC 820-10, which expands the application of fair value
accounting. ASC 820-10 defines fair value, establishes a framework for measuring
fair value in accordance with GAAP and expands disclosure of fair value
measurements. ASC 820-10 determines fair value to be the price that would be
received for an investment in a current sale, which assumes an orderly
transaction between market participants on the measurement date. ASC 820-10
requires us to assume that the portfolio investment is sold in its principal
market to market participants or, in the absence of a principal market, the most
advantageous market, which may be a hypothetical market. Market participants are
defined as buyers and sellers in the principal or most advantageous market that
are independent, knowledgeable, and willing and able to transact. In accordance
with ASC 820-10, we have considered its principal market as the market in which
we exit our portfolio investments with the greatest volume and level of
activity. ASC 820-10 specifies a hierarchy of valuation techniques based on
whether the inputs to those valuation techniques are observable or unobservable.
In accordance with ASC 820-10, these inputs are summarized in the three broad
levels listed below:
• Level 1 - Valuations based on quoted prices in active markets for
identical assets or liabilities that we have the ability to access.
• Level 2 - Valuations based on quoted prices in markets that are not
active or for which all significant inputs are observable, either
directly or indirectly.
• Level 3 - Valuations based on inputs that are unobservable and
significant to the overall fair value measurement.
In addition to using the above inputs in investment valuations, we continue to
employ the net asset valuation policy approved by our board of directors that is
consistent with ASC 820-10. Consistent with our valuation policy, we evaluate
the source of inputs, including any markets in which our investments are trading
(or any markets in which securities with similar attributes are trading), in
determining fair value. Our valuation policy considers the fact that because
there is not a readily available market value for most of the investments in our
portfolio, the fair value of the investments must typically be determined using
unobservable inputs.
Our portfolio investments (other than as described below in the following
paragraph) are typically valued using two different valuation techniques. The
first valuation technique is an analysis of the enterprise value ("EV") of the
portfolio company. Enterprise value means the entire value of the portfolio
company to a market participant, including the sum of the values of debt and
equity securities used to capitalize the enterprise at a point in time. The
primary method for determining EV uses a multiple analysis whereby appropriate
multiples are applied to the portfolio company's EBITDA (generally defined as
net income before net interest expense, income tax expense, depreciation and
amortization). EBITDA multiples are typically determined based upon review of
market comparable transactions and publicly traded comparable companies, if any.
We may also employ other valuation multiples to determine EV, such as revenues
or, in the case of certain portfolio companies in the power generation industry,
kilowatt capacity. The second method for determining EV uses a discounted cash
flow analysis whereby future expected cash flows of the portfolio company are
discounted to determine a present value using estimated discount rates
(typically a weighted average cost of capital based on costs of debt and equity
consistent with current market conditions). The EV analysis is performed to
determine the value of equity investments, the value of debt investments in
portfolio companies where we have control or could gain control through an
option or warrant security, and to determine if
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there is credit impairment for debt investments. If debt investments are credit
impaired, an EV analysis may be used to value such debt investments; however, in
addition to the methods outlined above, other methods such as a liquidation or
wind-down analysis may be utilized to estimate enterprise value. The second
valuation technique is a yield analysis, which is typically performed for
non-credit impaired debt investments in portfolio companies where the we do not
own a controlling equity position. To determine fair value using a yield
analysis, a current price is imputed for the investment based upon an assessment
of the expected market yield for a similarly structured investment with a
similar level of risk. In the yield analysis, we consider the current
contractual interest rate, the maturity and other terms of the investment
relative to the risk of the company and the specific investment. A key
determinant of risk, among other things, is the leverage through the investment
relative to the enterprise value of the portfolio company. As debt investments
held by us are substantially illiquid with no active transaction market, we
depend on primary market data, including newly funded transactions, as well as
secondary market data with respect to high yield debt instruments and syndicated
loans, as inputs in determining the appropriate market yield, as applicable.
For other portfolio investments such as investments in the SDLP Certificates,
discounted cash flow analysis is the primary technique utilized to determine
fair value. Expected future cash flows associated with the investment are
discounted to determine a present value using a discount rate that reflects
estimated market return requirements.
See Note 8 to our consolidated financial statements for the year ended
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