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Ares Capital’s First Lien Investing Rises in 2Q16

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First lien investing

Ares Capital (ARCC) has consistently increased its exposure to second lien secured debt over the past several quarters. However, in the second quarter, second lien debt made up only 24% of its new commitments. It also represents 31% of the company’s total portfolio. First lien senior secured loans represent 29%, in line with the previous quarter.

The exposure to first lien loans has decreased over the past few quarters, from 34% in 1Q15 to 29% in 1Q16. The company is targeting a minimum yield that is 400 basis points higher on its second lien debt offerings than what it generates on first lien senior loans.

Risk profile

This strategic change should help Ares Capital boost the average yield on its overall portfolio. The overall risk profile has deteriorated marginally, but it remains strong. Ares Capital’s management believes that the careful selection of companies can help it eliminate the risk from the selection of a second lien over a first lien.

Ares Capital has generated returns of 7.2% on its book equity. Below is a look at how some of the firm’s peers in investment management have fared in terms of return on equity:

  • Prospect Capital (PSEC): 9.3%
  • BlackRock Capital Investment (BKCC): 5.0%
  • KKR (KKR): 5.0%
  • Blackstone Group (BX): 10.7%

Together, these companies form 6.3% of the PowerShares Global Listed Private Equity ETF (PSP).

New investments and opportunities

In July 2016, Ares Capital made new investment commitments of approximately $469 million, of which $343 million were funded. Of these new commitments, 46% were in investments in SDLP (Senior Direct Lending Program) certificates. About 21% were in first lien senior secured loans, 19% were in senior subordinated loans, 13% were in second lien senior secured loans, and 1% were in other equity securities. The weighted average yield of debt and other income-producing securities funded during the period at amortized cost was 11.7%.

The company also exited ~$752 million of investment commitments in July. Included in these exited commitments were $529 million of investment commitments sold to SDLP. The weighted average yield of debt and other income-producing securities exited or repaid during the period at amortized cost was 8.1%.

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