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Drop in Asset Coverage Ratio to Aid Ares Capital Financials?

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Ares Capital Corporation’s (ARCC - Free Report) board of directors approved to lower the minimum asset coverage ratio to 150% from 200%, as per the amendment in the Investment Company Act of 1940 by the Small Business Credit Availability Act. The amendment is subject to certain approval, timing and disclosure requirements. The effective date, from which the ratio will be lowered, is Jun 21, 2019.

Notably, the debt/equity ratio ceiling of 1.0x will be pushed to 2.0x on the successful application of this amendment. Ares Capital is likely to use increased leverage while maintaining the quality of its investment portfolio. The company plans to stick to its old investment philosophy and keep the mix of assets same.

The company will be deploying additional funds over the next 12-36 months, after the effective date. It is also going to continue operating in a manner so that its investment grade rating is not lost. However, it will work toward generating additional earnings per share of up to 20%.

Base management fees will be brought down to 1% from 1.5% on the assets, which will be funded with the leverage of over 1.0x debt to equity. Further, the company plans to maintain debt/equity ratio in the range of 0.90-1.25.

Usage of additional leverage will permit Business Development Companies like Ares Capital to reduce their portfolio risk by allowing those to invest in higher capital structures, without having to forego their current returns. It will give extra funding flexibility to the companies, providing additional growth opportunities.

Co-chairman of Ares Capital and chief executive officer and president of Ares Management, L.P, Michael Arougheti informed, “We plan to operate with an increased cushion to the new regulatory threshold, which we believe significantly de-risks ARCC. In addition, the flexibility of the SBCAA allows us to further diversify our portfolio and broadens our opportunity set.”

Shares of this Zacks Rank #3 (Hold) company have outperformed the industry in the past six months. Its shares have rallied 5.3%, against the industry’s increase of 1.5%.

Stocks to Consider

A few better-ranked stocks from the same space are WhiteHorse Finance, Inc. (WHF - Free Report) , CM Finance Inc (CMFN - Free Report) and Solar Capital Ltd. (SLRC - Free Report) . All the three stocks carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The Zacks Consensus Estimate for current-year earnings of WhiteHorse Finance has been revised 7.1% upward in the last 60 days. Also, its share price has risen 17.1% over the past three months.

CM Finance’s earnings estimates for 2018 have been revised 14.4% upward over the last 60 days. In the past three months, the company’s shares have gained 9.8%.

The Zacks Consensus Estimate for Solar Capital’s current-year earnings has been revised upward by 2.2% in the last 60 days. Its share price has appreciated 1.9% in the past three months.

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