Ares Capital (ARCC) reported quarterly earnings down sharply from 58 cents to 42 cents. But that is misleading. Core earnings of 42 cents a share were less than last year’s by only 1 cent, and it followed a record 4th quarter, notes Adrian Day, editor of Global Analyst.

The first quarter of the year is typically slow, and this year was further hurt by the war in Ukraine and the Federal Reserve starting to tighten, affecting a small business lender. The result was that transaction activity slowed, pressuring interest and fee income.

However, the quarter was strong in many ways: net asset value was up 9% on a year ago, to a new record of $19.03; and credit quality remains strong. The portfolio continues to perform well, with non-accruals (at cost) below the 10-year average.

The company has strong liquidity, having raised additional capital and extended its debt maturities. It increased its long-term debt by $615 million in the quarter, locking in low rates.

Although its debt is largely fixed-rate, most of its loans are floating rate, meaning that an increase in interest rates would increase its earnings run rate, at least in the near term. It has undistributed taxable income equivalent to $1.32 per share, which is more than three quarters of regular dividends. Although earnings cover the dividend, the spillover income provides a cushion.

The company also announced it had purchased the $2.4 billion direct lending portfolio of Annaly Capital (NLY), which is exiting that business. The portfolio consists of senior secured loans to over 40 companies, with the portfolio being split between Ares and its wholly owned Ivy Hill unit. Being senior secured loans, the package improves Ares’s overall credit quality, yet the return is in line with the existing portfolio.

A weak economy could hurt some companies in the portfolio, but Ares has a history of supporting its portfolio companies through difficult patches. A weak economy would also see Ares, which has the deepest origination platform in the industry, be competitive in generating new business.

With a dividend yield of 8.3%, plus special dividends, a payout covered by earnings and the stock trading barely over book, it is a buy for investors looking for solid income.

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