Ares Capital's 10% Yield Masks Risk From 34% Non-Cash Income

Ares Capital (ARCC), the market’s largest business development company, is facing scrutiny over the quality of its earnings and the sustainability of its 10 percent dividend, as a recent analysis showed over one-third of its investment income in 2025 came from non-cash sources.

"It is something to be concerned about," Robert Willens, a veteran accounting analyst, said of the BDC's reliance on non-cash income. "While collections are robust, it’s not something to be worried about, but when collections are not…"

The core of the issue lies with Payments-in-Kind (PIK), a form of non-cash interest that is added to a loan's principal instead of being paid in cash. A Barron's report from 2026 revealed that PIK interest and dividends constituted $490 million, or 34 percent, of Ares Capital’s net investment income in 2025, up from just 8 percent a decade prior. This practice helped ARCC cover its $1.26 billion in dividend payouts last year, which exceeded the $1.1 billion in cash net investment income it generated, according to an analysis of its financial statements. The fund's portfolio structure also differs from peers, with 60 percent in first-lien senior secured loans, below the 80 percent BDC average and the 98 percent held by Blackstone Secured Lending (BXSL).

This reliance on non-cash income to bridge the dividend gap could pose a risk if the lending environment deteriorates, making the fund more dependent on investment gains and loan repayments to satisfy its dividend obligations. While Ares has delivered a 12 percent annualized return since 2004 and maintained its dividend for 17 years, its valuation trades just 1 percent below its book value, while peers with high PIK levels trade at steeper discounts.

Ares' Defense and Dividend Buffer

Ares management contends that its dividend is secure. The company stated its dividends for the past five years were "fully covered" by cash from interest, dividends, and investment gains. On a recent earnings call, CEO Kort Schnabel said, "We continue to believe that ARCC’s current dividend approximates the long-run underlying earnings power of our business." The company argues that when a loan is paid off, the deferred PIK interest is collected in cash, and these collections should be counted toward dividend coverage. In 2025, Ares collected about $280 million from prior-period PIK interest and dividends.

Further supporting the dividend is a substantial spillover buffer. According to a Seeking Alpha report, Ares holds $1.38 per share in spillover income, totaling approximately $988 million. This amount alone covers nearly three-quarters of the BDC's annual dividend, providing a significant cushion against any short-term earnings shortfalls. The firm also notes its selective approach to equity co-investments has generated returns "well in excess" of the S&P 500's total return over the last decade.

BDC Sector Under Pressure

The focus on ARCC's accounting comes as the entire BDC sector navigates a more challenging environment. Competitor Golub Capital BDC (GBDC), for example, recently recorded a small 1 percent loss of net asset value, driven primarily by mark-to-market write-downs as credit spreads widened. While GBDC’s management believes these marks are temporary, it highlights the pressure on valuations across the industry.

However, credit quality remains a key differentiator. GBDC reported that non-accruals, or loans that are not generating income, remained low at 1.4 percent of its portfolio's fair value. Ares Capital has similarly reported few bad loans and has a long history of successfully managing PIK investments. Both firms have also proactively assessed portfolio risk from artificial intelligence, with an independent review of ARCC's software holdings finding 85 percent have low AI risk. The stability of underlying credit performance across top-tier BDCs suggests that while accounting methods may differ, portfolio health remains the ultimate driver of long-term returns.

This article is for informational purposes only and does not constitute investment advice.