For two straight quarters, Ares Capital has earned a penny less than it pays. Core earnings of $0.47 per share in each of the last two reports trailed the $0.48 regular dividend, while net asset value slipped and non-accruals crept higher. Spillover income of $1.38 per share means the payout is not in danger, but the market wants to know whether the earnings plateau is a pause or the start of a longer slide. The third-quarter report, due before the open on October 27, is the first real test of management's argument that better deal terms and cheaper funding can offset a softer credit backdrop.
The Street is leaning toward a modest recovery. Consensus calls for EPS of $0.48, a penny above last quarter but about 4% below the $0.50 earned a year ago. Revenue is expected at $780.3 million, essentially flat against the year-ago $782.0 million but up from $768.0 million last quarter. Management has offered no formal outlook, so the dividend effectively serves as the benchmark. Matching it would suggest the earnings decline has bottomed. Another $0.47 would make a third quarter of under-earning hard to dismiss as noise.
The bull case built on last quarter's call depends on activity converting into income. Management said transactions under review rose more than 25% sequentially, with June among the strongest months in two years, and described the upper middle market as a better hunting ground as retail-funded rivals pull back. New senior loan spreads were 20 basis points wider and upfront fees 50 basis points higher than late last year. Yet gross originations fell to $2.6 billion from $3.2 billion and $3.9 billion in the two prior quarters, and the closing ratio ran below its historical average. A rebound in originations, along with stronger fee income, would support the busier back half management described. Another drop would suggest the pipeline is not turning into closed deals.
Credit is the bigger swing factor. Non-accruals at cost have risen in successive readings to 2.4%, with four new names added last quarter and continued weakness in Cornerstone and Sinclair Software, two credits tied to the same sponsor. Management has framed this as normalization toward historical averages, and it attributed much of the NAV erosion to wider market spreads rather than permanent impairment. If that view is right, NAV should stabilize near last quarter's $19.35 per share and non-accrual additions should slow. A third straight NAV decline or a move well above 2.4% would undercut the claim that the markdowns are temporary. Portfolio company EBITDA growth, which cooled from low double digits to about 8%, is a useful early indicator of whether borrower fundamentals are holding.
The funding initiatives could help margins too. Ares launched the first commercial paper program among business development companies, a $1 billion facility with potential savings of 50 to 100 basis points, and it repriced its main revolver and first securitization. Early signs of a lower cost of debt would show that management can defend earnings even if asset yields stay under pressure. The newly expanded SDLP joint venture, which grew from 28 to 72 borrowers, is another source of potential income.
The market has not given much credit for any of this. Shares are down 2% since the last report while the S&P 500 gained 3.2%, and at $18.72 the stock sits below its 200-day moving average of $19.12, near the low end of its post-earnings range of $18.30 to $20.23. Sentiment remains bearish, though less so than heading into last quarter. Expectations are therefore restrained, but not low enough to make a repeat of last quarter acceptable. The central question is simple: can Ares earn its dividend again while holding NAV and credit steady? A yes would support management's view that this is normalization, not deterioration.