Executive Summary / Key Takeaways

• Market Leadership and Robust Performance: Ares Capital Corporation ($ARCC) is a market-leading Business Development Company (BDC) with a diversified portfolio of $28.7 billion across 587 companies. It reported strong Q3 2025 results, with core earnings of $0.50 per share, exceeding its regular quarterly dividend, and GAAP earnings of $0.57 per share, reflecting a 10% sequential increase driven by significant net realized gains.
• Differentiated Origination and Credit Quality: ARCC's unmatched origination scale, evidenced by reviewing over $875 billion in estimated transactions in the last 12 months, enables high selectivity and strong credit performance. Non-accruals remain low at 1.8% at cost and 1% at fair value, well below historical and industry averages, supported by a focus on domestic, service-oriented businesses and a robust software portfolio strategy.
• Strategic Financial Flexibility: The company maintains a conservative balance sheet with a debt-to-equity ratio of 1.02x, significantly below its 1.25x target, providing ample dry powder ($6.2 billion liquidity) for opportunistic growth. Recent credit rating upgrades to the highest-rated BDC and optimized funding facilities underscore its efficient capital structure.
• Sustainable Dividend Outlook: ARCC is confident in maintaining its $0.48 per share quarterly dividend, backed by consistent core earnings coverage, a historically sustainable return on equity (9-10%), and a substantial $1.26 per share in spillover income, equivalent to over two quarters of dividends.
• Leveraging Technology for Investment Edge: ARCC integrates AI expertise through its acquisition of BootstrapLabs, enhancing its underwriting and risk assessment, particularly in its software portfolio. This strategic use of technology strengthens its competitive moat and supports resilient investment outcomes.

The Enduring Strength of Direct Lending's Titan

Ares Capital Corporation ($ARCC) stands as a titan in the direct lending landscape, operating as a specialty finance company with a core objective to generate both current income and capital appreciation through a diversified mix of debt and equity investments. Since its initial public offering in October 2004, ARCC has consistently focused on providing flexible financing solutions to U.S. middle-market companies, a segment often underserved by traditional banks. This foundational strategy, honed over two decades and through periods of significant economic stress like the Great Financial Crisis and the COVID-19 pandemic, has shaped ARCC into a market leader known for its resilience and disciplined approach.

ARCC's competitive positioning is formidable, rooted in its unparalleled scale and broad market coverage. The company distinguishes itself by actively participating across the lower, core, and upper middle markets, a comprehensive reach that few direct lenders can match. This expansive presence, coupled with its ability to act as an agent or lead in transactions, fosters stronger relationships with portfolio companies and provides a competitive edge in deal execution and relationship building. ARCC's robust origination platform, supported by over 200 U.S. direct lending professionals and 50 portfolio management specialists, allows for exceptional selectivity, enabling the company to bypass transactions with unfavorable terms and focus on high-quality credits. This strategic advantage is particularly evident in the lower middle market, where ARCC can secure 25 to 50 basis points of enhanced spread with lower leverage levels and stronger documentation compared to some upper middle market transactions.

Technological Acumen in Investment Strategy

ARCC's technological differentiation is not in developing proprietary software for sale, but in its sophisticated approach to investing in technology companies and its internal integration of advanced analytical capabilities. The company leverages its acquisition of BootstrapLabs, an AI-focused venture platform, to enhance its underwriting processes, improve risk assessment, and streamline operations. This internal AI expertise provides a critical lens for evaluating its software portfolio, which is a significant component of its investments.

ARCC's software investment strategy is meticulously crafted to mitigate risks associated with technological disruption, particularly from artificial intelligence. The company focuses on financing large, market-leading, and well-capitalized software companies that operate business-to-business (B2B) platforms. These companies typically serve highly regulated industries, leverage proprietary data, or deliver repeatable, consistent results essential to business operations. This approach ensures that ARCC's software loans are deeply embedded within customer operations and benefit from high switching costs, providing additional layers of durability and resilience against potential AI disruption. Quantifiable benefits of this strategy include conservative leverage levels, with an average loan-to-value (LTV) ratio of only 36% for its software loans, and a pristine credit record, as none of these loans are currently on nonaccrual. Furthermore, these software portfolio companies exhibit strong growth prospects, with a weighted average EBITDA exceeding $350 million and consistent double-digit EBITDA growth over the last 12 months. ARCC views AI as a complementary tool that can enhance these foundational systems by improving analytics, user experience, and operational efficiencies, rather than a disruptive threat to its core software borrowers. This technological acumen contributes directly to ARCC's competitive moat, supporting superior credit quality and long-term value creation for investors.

Financial Strength and Operational Excellence

ARCC's financial performance in the third quarter of 2025 underscored its operational effectiveness and disciplined strategy. The company reported core earnings of $0.50 per share, consistently exceeding its regular quarterly dividend, and GAAP earnings of $0.57 per share, marking a nearly 10% sequential increase. This robust performance was supported by significant net realized gains of $247 million on investments, including a notable $262 million gain from the successful restructuring and exit of Potomac Energy Center. Additionally, ARCC realized gains from three equity co-investments, generating over $30 million in proceeds and achieving an impressive 2.5x multiple on original invested capital with an average gross Internal Rate of Return (IRR) exceeding 30%.

The company's total investment income for Q3 2025 was $782 million, slightly above analyst estimates, driven by higher capital structuring service fees and other income. While interest income from investments saw a modest decrease due to declining base rates, this was partially offset by an increase in the average size of ARCC's portfolio. Recurring dividend income also experienced a slight dip due to a decrease in yielding preferred equity investments. Despite an increase in stated interest expense due to a larger average principal amount of outstanding debt, ARCC's core earnings remained stable. The company's net asset value (NAV) per share reached a record $20.01, marking the ninth increase in the past ten quarters and reflecting its consistent value creation.

ARCC's credit quality remains a cornerstone of its financial health. As of September 30, 2025, loans on non-accrual status stood at a low 1.8% of total investments at amortized cost and 1% at fair value, significantly below its historical average of 2.8% since the Great Financial Crisis and the broader BDC industry average of 3.8%. This strong credit performance is further evidenced by a decline in Grade 1 and 2 investments (lowest risk ratings) from 4.5% to 3.6% of the portfolio at fair value. The underlying portfolio companies continue to exhibit strength, with a weighted average organic LTM EBITDA growth rate exceeding 10% in Q3 2025, more than double that of the broadly syndicated market. Borrower leverage levels are below ARCC's five-year average, and the portfolio's average loan-to-value (LTV) remains in the low 40% range, providing robust downside protection.

Capital Structure and Strategic Outlook

ARCC's capital structure is designed for flexibility and efficiency, positioning it to capitalize on market opportunities. The company maintains a conservative balance sheet with a debt-to-equity ratio, net of available cash, of 1.02x as of Q3 2025, well below its target range upper end of 1.25x. This conservative leverage, coupled with a strong liquidity position of nearly $6.2 billion (including available cash), provides ARCC with substantial dry powder for new investments.

The company has actively optimized its funding, securing credit rating upgrades from S&P (to BBB from BBB-) and Moody's (to Baa2 from Baa3) in late 2024, establishing ARCC as the highest credit-rated BDC among the three major rating agencies. This translates into best-in-class funding costs. Recent financing activities include the issuance of $650 million of unsecured notes at 5.1% due January 2031, priced at a spread inside previous issuances, and the upsizing and spread reduction of its credit facilities.

Looking ahead, ARCC anticipates an accelerating M&A environment in 2025, driven by a healthy economy, increasing pressure on private equity sponsors to seek liquidity, and growing executive confidence. The company's origination platform is poised to capture this momentum, having reviewed a record $875 billion in estimated transactions over the last 12 months. Its investment backlog reached a new record of $3 billion as of October 23, 2025, signaling robust activity. ARCC's strategic investment vehicles, Ivy Hill Asset Management (IHAM) and the Senior Direct Lending Program (SDLP), are expected to contribute to growth, with recent amendments to the SDLP joint venture resulting in a 100 basis point increase in its yield.

ARCC's management expresses strong confidence in maintaining its current $0.48 per share quarterly dividend for the foreseeable future. This confidence is underpinned by consistent core earnings coverage, a historically sustainable return on equity (9-10%), and a significant $1.26 per share in spillover income available for distribution in 2025. This spillover income acts as a substantial cushion, equivalent to over two quarters of current dividends, providing further visibility and stability for investors.

Risks and Competitive Dynamics

Despite its strengths, ARCC operates within a competitive and dynamic market. The investment management and specialty finance sector is intensely competitive, with ARCC facing rivals such as other BDCs (e.g., BlackRock TCP Capital Corp. (TCPC), Main Street Capital Corporation (MAIN), FS KKR Capital Corp. (FSK), and Hercules Capital, Inc. (HTGC)), private equity firms, hedge funds, and traditional financial institutions. Increased competition could lead to lower investment yields and decreased profitability. ARCC's competitive advantages, including its scale and diversified financing structures, help it to counter the resource advantages of larger firms and the specialized focus of niche players. However, it must continuously innovate and offer attractive terms to maintain market share.

Interest rate sensitivity remains a key financial risk. While a significant portion of ARCC's portfolio bears interest at variable rates, higher rates can pressure borrowers, potentially leading to defaults. Conversely, a prolonged low interest rate environment could compress net interest income. ARCC mitigates this through hedging strategies and a portfolio largely composed of floating-rate loans, with 98% of its variable rate investments containing interest rate floors. Investment valuation risk is inherent due to the illiquid nature of many middle-market investments, requiring fair value determinations based on unobservable inputs. ARCC's rigorous valuation process, supported by independent third-party valuation providers, aims to manage this uncertainty.

Tariff exposure, particularly from changes in government policies, is another area of vigilance. While ARCC's portfolio is strategically focused on domestic, service-oriented businesses, which generally mitigates direct risks, the company proactively assesses and engages with the small number of borrowers (mid-single-digit share of the portfolio) that may have direct exposure. These companies are believed to be in a strong financial position and possess mitigation strategies, such as adjusting pricing or transitioning supply chains. ARCC also acknowledges the potential for broader macroeconomic impacts, such as inflation dampening consumer demand or a recession, and continually underwrites new deals with conservative downside cases.

Conclusion

Ares Capital Corporation's investment thesis is compelling, built upon a foundation of unmatched scale, a resilient investment strategy, and a proven track record of consistent performance. The company's ability to generate strong core earnings, deliver consistent NAV growth, and realize significant gains from its diversified portfolio underscores its operational excellence. ARCC's strategic competitive advantages, including its broad market presence, highly selective origination, and sophisticated technological investment strategy, position it favorably against a dynamic competitive landscape.

With a conservative balance sheet, ample liquidity, and a substantial spillover income reserve, ARCC is well-equipped to capitalize on an accelerating M&A environment and maintain its attractive dividend for the foreseeable future. While market volatility, interest rate fluctuations, and competitive pressures present ongoing risks, ARCC's disciplined risk management, experienced leadership, and strategic adaptability provide a robust framework for sustained value creation. For discerning investors seeking a high-quality income-generating asset with a demonstrated capacity for long-term growth and stability, ARCC remains a compelling consideration.