Executive Summary / Key Takeaways

• Scale-Driven Selectivity Creates a Virtuous Cycle: Ares Capital's $22 billion portfolio and review of $650 billion in 2024 opportunities enable mid-single-digit selectivity, producing superior credit quality (1.8% non-accruals, low-40s loan-to-value) that attracts more high-quality borrowers and reinforces its market leadership.

• The Incumbent Borrower Moat: Over 70% of new commitments flow to existing borrowers, reducing underwriting risk while expanding wallet share in proven credits—this relationship depth is a structural advantage that smaller competitors cannot replicate.

• Dividend Sustainability Through Multiple Cycles: Core earnings of $0.50 per share in Q3 2025 comfortably cover the quarterly dividend, while $1.26 per share in spillover income and conservative 1.0x leverage (below the 1.25x target) provide substantial cushion against earnings volatility.

• Record Activity Meets Disciplined Underwriting: Despite originating $15 billion in 2024 and maintaining a record $3 billion backlog, ARCC's non-accrual rates remain below historical averages and peer levels, demonstrating that scale has not compromised credit discipline.

• Key Risk Asymmetry: While 98% of variable-rate loans have interest rate floors protecting downside, a prolonged low-rate environment could compress net interest margins by 5-10% unless management deploys its balance sheet flexibility and capitalizes on higher-yielding opportunities in its non-qualifying asset basket.

Setting the Scene: The Private Credit Leader in a Shifting Market

Ares Capital Corporation, founded in 2004 and externally managed by Ares Capital Management, has evolved from a startup BDC into the largest and highest-rated business development company in the market. The company makes money by originating debt and equity investments in middle-market companies, generating current income from interest and dividends while capturing capital appreciation from equity co-investments and successful exits. Its position in the industry structure is unique: ARCC operates as a lead arranger in most transactions, securing better terms and deeper relationships than participants in the broadly syndicated loan market.

The private credit landscape has fundamentally shifted. When the broadly syndicated market experiences volatility, institutional investors retreat, creating opportunities for direct lenders to capture market share. This dynamic played out in Q1 2025 and again during tariff-related uncertainty, as banks grew cautious and borrowers sought the certainty of capital that ARCC provides. The company's scale—evidenced by reviewing a record $875 billion in estimated transactions over the last twelve months—positions it as a preferred partner for private equity sponsors under pressure to deploy aging dry powder and return capital to investors.

ARCC's strategy centers on financing market-leading companies with high free cash flows in resilient, service-oriented industries. This focus on domestic service businesses naturally mitigates tariff exposure, with management estimating low single-digit percentage of high-risk names directly exposed to tariff impacts. The weighted average loan-to-value ratio in the low-40s range provides substantial downside protection, while 71% of investments bear interest at variable rates with 98% containing floors—creating a portfolio that performs well across rate cycles while protecting against downside.

Technology, Products, and Strategic Differentiation: The Incumbent Advantage

ARCC's core technology isn't software—it's a time-tested underwriting framework refined over two decades and nearly $53 billion in original cash invested. The company has generated approximately $68.6 billion in total proceeds from exited investments, achieving a 13% gross internal rate of return since inception. This track record has created a self-reinforcing ecosystem: successful borrowers return for larger facilities, bringing their private equity sponsors with them.

The incumbent borrower strategy is ARCC's most defensible moat. In 2024, over 70% of new commitments went to existing borrowers, and in Q2 2025, this figure reached 74%. The significance of this is that financing incumbent borrowers reduces due diligence costs, improves risk assessment accuracy, and allows ARCC to expand wallet share in its highest-quality relationships. As Kort Schnabel noted, across the ten largest transactions with incumbent borrowers in Q2 2025, ARCC more than doubled its previous lending commitments. This isn't just relationship banking—it's a data advantage built on years of monitoring performance through multiple cycles.

The company's AI expertise, gained through its acquisition of BootstrapLabs, informs credit decisions and quarterly risk assessments for software transactions. This expertise is crucial because ARCC's software portfolio, financed at an average 36% loan-to-value with zero non-accruals, faces minimal disruption risk from AI advancements. Rather than replacing mission-critical software, AI enhances these foundational systems by improving analytics and operational efficiencies. The in-house AI team provides a competitive edge in evaluating how technology impacts credit risk—a capability absent at most BDC peers.

Two key subsidiaries amplify ARCC's earnings power. Ivy Hill Asset Management (IHAM), a wholly-owned SEC-registered adviser with $13.5 billion in assets under management, generated $219 million in dividend income for ARCC in the first nine months of 2025. IHAM's 17.2% weighted average yield and $130 million in retained earnings demonstrate its sustainability as a earnings driver. The Senior Direct Lending Program (SDLP) joint venture with Varagon, which holds $4.5 billion in first lien loans, recently amended its documents to lower liability costs, boosting forward yields by 100 basis points. These strategic vehicles provide diversified income streams while leveraging ARCC's core underwriting capabilities.

Financial Performance & Segment Dynamics: Evidence of Strategy Working

Third-quarter 2025 results validate the scale-and-selectivity thesis. Core earnings of $0.50 per share exceeded the regular quarterly dividend, generating a 10% annualized return on equity. GAAP earnings of $0.57 per share increased nearly 10% sequentially, driven by $247 million in net realized gains—the second-highest quarterly gain in company history. This brought cumulative realized gains since inception to approximately $1.1 billion, net of losses.

The portfolio's underlying health is even more telling. Organic EBITDA growth across ARCC's companies reached 11% in Q4 2024 and over 10% in Q3 2025, more than double the broadly syndicated market's growth rate. Non-accruals at cost declined 20 basis points quarter-over-quarter to 1.8%, remaining below both ARCC's historical average and BDC peer group averages. Grade 1 and 2 investments (the lowest rating buckets) declined from 4.5% to 3.6% of the portfolio at fair value. These metrics collectively demonstrate that record origination volumes haven't diluted credit quality—scale has enabled selectivity, not compromised it.

The balance sheet provides substantial strategic flexibility. Leverage remains around 1.0x, well below the 1.25x target, creating capacity for $3-4 billion in additional investments that could boost earnings by 15-20% if deployed. Liquidity totals $6.2 billion, including available cash. In September 2025, ARCC issued $650 million of unsecured notes at 5.1%—inside the spread of its June issuance—demonstrating continued access to attractively priced capital. The 192% asset coverage ratio provides a substantial buffer above regulatory requirements.

Segment dynamics reveal a deliberate shift toward higher-quality first lien investments. New first lien commitments in Q3 2025 were completed at spreads of SOFR plus 560 basis points, 20 basis points higher than the prior 12-month average, while average borrower leverage remained conservative at 4.8x. The weighted average yield on first lien senior secured loans was 9.5% at amortized cost, with unitranche loans representing $11.2 billion of the portfolio. This indicates ARCC is maintaining pricing discipline even in a competitive environment, using its scale to lead transactions rather than chase yield.

Competitive Context: Scale and Relationships as Differentiators

ARCC's competitive positioning is defined by its scale and incumbent relationships. Main Street Capital (MAIN) operates with lower overhead due to internal management, achieving higher ROE (19.1% vs ARCC's 10.1%) and net margins (95.6% vs 45.2%). However, MAIN's smaller scale ($5.6 billion market cap vs ARCC's $14.9 billion) limits its ability to lead large transactions. ARCC's advantage lies in its ability to be a meaningful capital provider to larger borrowers in the $20-200 million range—a notable differentiator that MAIN cannot match.

Hercules Capital (HTGC) focuses on venture debt for technology and life sciences, achieving faster growth (10.3% revenue increase in Q3 2025) but with higher sector concentration risk. ARCC's diversified approach, with software representing just one segment of a broad portfolio, provides better risk-adjusted returns across cycles. While HTGC's specialized knowledge enables rapid due diligence in tech, ARCC's broader sponsor access and larger deal capacity position it better for M&A-driven opportunities.

Blue Owl Capital (OBDC) and Golub Capital (GBDC) compete more directly in first lien senior secured lending. OBDC's $14 billion in quarterly commitments demonstrates aggressive scale pursuit, but its adjusted NII of $0.36 per share in Q3 2025 trails ARCC's $0.50. GBDC's pristine credit quality (non-accruals under 1%) reflects conservative underwriting, but its limited equity exposure caps upside. ARCC's mezzanine and equity co-investment capabilities provide additional return streams—Q3 2025 saw $262 million in realized gains from the Potomac Energy Center exit and 2.5x multiples on three equity co-investments with gross IRRs exceeding 30%.

The key competitive advantage is ARCC's lead agent role in most transactions. This secures better economics, including capital structuring fees that increased year-over-year due to higher new investment commitments. When the broadly syndicated market becomes choppy, ARCC's ability to provide certainty of capital allows it to take market share, as management explicitly stated. The company's scale and sector specialization provide a real-time view of relative value, enabling it to remain highly selective while deploying over $1.3 billion net in Q3 2025—more than double the prior quarter.

Risks and Asymmetries: Where the Thesis Can Break

The most material risk is interest rate compression. While 98% of variable-rate investments have floors that protect against downside, a prolonged low-rate environment could compress the spread between asset yields and funding costs. Management acknowledges this headwind but points to multiple levers: balance sheet flexibility to increase leverage toward the 1.25x target, potential for higher-yielding investments in the non-qualifying asset basket, and increased capital structuring fees from a more active M&A environment. The $1.26 per share in spillover income provides a cushion for temporary earnings shortfalls, but sustained margin compression of 5-10% would pressure dividend coverage.

Competitive pressure on spreads represents another risk. While ARCC's Q3 2025 spreads were 20 basis points above the prior 12-month average, OBDC's aggressive $14 billion quarterly commitments could pressure pricing in the senior loan market. However, ARCC's incumbent borrower focus and lead agent role provide some insulation—relationship-based lending is less price-sensitive than auction-driven syndicated markets. The risk is moderate, as ARCC's scale allows it to pass on commoditized deals while capturing higher-yielding opportunities with proven borrowers.

Execution risk under new leadership is a consideration. Kort Schnabel assumed the CEO role on April 30, 2025, after serving as a founding member of Ares' US direct lending strategy since 2004. While his deep experience mitigates transition risk, any strategic shift away from the incumbent borrower model or loosening of underwriting standards would compromise the core thesis. The early evidence is positive: Q3 2025 results maintained credit discipline while achieving record deployment.

Tariff and AI disruption risks are well-contained. Management estimates low single-digit percentage exposure to high-risk tariff names, down from mid-single digits previously. The software portfolio's 36% average loan-to-value and zero non-accruals demonstrate conservative underwriting that minimizes AI disruption risk. These factors highlight how ARCC's portfolio is constructed to withstand specific macro shocks that could harm less-diversified competitors.

Valuation Context: Reasonable Pricing for Quality

At $20.87 per share, ARCC trades at 1.04 times book value of $20.00 and 10.59 times trailing earnings. The dividend yield of 9.13% is supported by a 96.5% payout ratio that, while high, is cushioned by substantial spillover income. These multiples are reasonable for a business that has generated over $1.1 billion in cumulative realized gains since inception and maintained stable or increasing dividends for over 40 consecutive quarters.

Peer comparisons provide context. MAIN trades at 1.90 times book value and 10.42 times earnings, but its higher valuation reflects internal management and superior ROE (19.1% vs 10.1%). HTGC trades at 1.55 times book with a 9.87% dividend yield, but its tech concentration carries higher risk. OBDC trades at 0.88 times book value, a discount that may reflect integration challenges from rapid growth. ARCC's 1.04x book multiple fairly reflects its scale advantages and consistent execution.

The enterprise value of $29.44 billion represents 19.19 times revenue, though this metric is less indicative for a BDC than for an operating company. More relevant is the balance sheet strength: debt-to-equity of 1.09x is conservative, and the 4.78% return on assets, while modest, reflects the low-risk nature of the portfolio. The 0.62 beta indicates lower volatility than the broader market, consistent with ARCC's focus on senior secured lending.

Conclusion: Scale and Relationships as Sustainable Advantages

Ares Capital has built a self-reinforcing ecosystem where scale enables selectivity, selectivity produces superior credit performance, and strong performance attracts more high-quality borrowers. The Q3 2025 results—record deployment, stable credit metrics, and substantial realized gains—demonstrate that this model continues to deliver despite competitive pressures and macro uncertainty. The incumbent borrower moat, with over 70% of commitments flowing to existing relationships, provides a durable advantage that smaller competitors cannot replicate.

The investment thesis hinges on two factors: management's ability to maintain underwriting discipline while deploying excess liquidity, and the sustainability of dividend coverage if interest rates compress further. The evidence suggests ARCC is well-positioned on both fronts. Balance sheet flexibility provides earnings upside through prudent leverage increases, while the $1.26 per share in spillover income and conservative payout ratio support the dividend through temporary earnings volatility.

For long-term investors, ARCC offers a rare combination of scale-driven competitive advantages, reasonable valuation near book value, and a 9.13% dividend yield backed by two decades of consistent performance. The critical variables to monitor are spread compression in competitive markets and any deviation from the incumbent borrower strategy that has defined ARCC's success. If management continues to execute, ARCC will likely maintain its position as the highest-quality BDC in the market, capturing disproportionate share as private credit continues its secular growth.