5. INVESTMENTS

Under the Investment Company Act, we are required to separately identify non-controlled investments where we own more than 5% of a portfolio company’s outstanding voting securities as “affiliated companies.” In addition, under the Investment Company Act, we are required to separately identify investments where we own more than 25% of a portfolio company’s outstanding voting securities as “control affiliated companies.”  We had no existing control relationship with any of the portfolio companies identified as “affiliated companies” or “control affiliated companies” prior to making the indicated investment.

For the three months ended June 30, 2009, the Company funded $63.0 million aggregate principal amount of senior term debt and $6.5 million of investments in equity securities.

In addition, for the three months ended June 30, 2009, $53.4 million aggregate principal amount of senior term debt was redeemed. Additionally, $29.2 million aggregate principal amount of senior term debt and $4.0 million of senior subordinated debt were sold.

As of June 30, 2009, investments and cash and cash equivalents consisted of the following:

As of December 31, 2008, investments and cash and cash equivalents consisted of the following:

The amortized cost represents the original cost adjusted for the accretion of discounts and amortization of premiums on debt using the effective interest method.

The industrial and geographic compositions of our portfolio at fair value at June 30, 2009 and December 31, 2008 were as follows:

6. COMMITMENTS AND CONTINGENCIES

As of June 30, 2009 and December 31, 2008, the Company had the following commitments to fund various revolving senior secured and subordinated loans:

Of the total commitments as of June 30, 2009, $160,400 extend beyond the maturity date of our Revolving Credit Facility (as defined in Note 7). Additionally, $109,000 of the total commitments, or $34,000 of the net adjusted unfunded commitments, are scheduled to expire in 2009. Included within the total commitments as of June 30, 2009 are commitments to issue up to $15,600 in standby letters of credit through a financial intermediary on behalf of certain portfolio companies.

Under these arrangements, the Company would be required to make payments to third parties if the portfolio companies were to default on their related payment obligations. As of June 30, 2009, the Company had $10,300 in standby letters of credit issued and outstanding on behalf of the portfolio companies, of which no amounts were recorded as a liability.  Of these letters of credit, $4,900 expire on September 30, 2009, $300 expire on January 31, 2010, $200 expire on February 28, 2010, $1,500 expire on March 31, 2010 and $3,400 expire on July 31, 2010.  These letters of credit may be extended under

substantially similar terms for additional one-year terms at the Company’s option until the Revolving Credit Facility, under which the letters of credit were issued, matures on December 28, 2010.

As of June 30, 2009 and December 31, 2008, the Company was subject to subscription agreements to fund equity investments in private equity investment partnerships, substantially all at the discretion of the Company, as follows:

7. BORROWINGS

In accordance with the Investment Company Act, with certain limited exceptions, we are only allowed to borrow amounts such that our asset coverage, as defined in the Investment Company Act, is at least 200% after such borrowing. As of June 30, 2009, our asset coverage for borrowed amounts was 224%.

Our debt obligations consisted of the following as of June 30, 2009 and December 31, 2008:

(1) Subject to borrowing base and leverage restrictions.

The weighted average interest rate of all our debt obligations as of June 30, 2009 and December 31, 2008 was 1.98% and 3.03%, respectively.

CP Funding Facility

In October 2004, we formed Ares Capital CP Funding LLC (“Ares Capital CP”), a wholly owned subsidiary of the Company, through which we established a revolving facility, referred to as the “CP Funding Facility,” that, as amended, allowed Ares Capital CP to issue up to $350,000 of variable funding certificates (“VFC”). On May 7, 2009, the Company and Ares Capital CP entered into an amendment that, among other things, converted the CP Funding Facility from a revolving facility to an amortizing facility, extended the maturity from July 21, 2009 to May 7, 2012, reduced the availability from $350,000 to $225,000 (with a reduction in the outstanding balance required by each of December 31, 2010 and December 31, 2011)and decreased the advance rates applicable to certain types of eligible loans.  In addition, the interest rate charged on the CP Funding Facility was increased from the commercial paper rate plus 2.50% to the commercial paper, Eurodollar or adjusted Eurodollar rate, as applicable, plus 3.50% and the commitment fee requirement was removed.  The Company also paid a renewal fee of 1.25% of the total facility amount, or $2,813. As of June 30, 2009, there was $225,000 outstanding under the CP Funding Facility and the Company continues to be in compliance with all of the limitations and requirements of the CP Funding Facility. As of December 31, 2008, there was $114,300 outstanding under the CP Funding Facility.

The CP Funding Facility is secured by all of the assets held by Ares Capital CP, which as of June 30, 2009 consisted of 43 investments.

The interest charged on the VFC is payable quarterly and as of June 30, 2009, the rate in effect was one month LIBOR, which was 0.31%. As of December 31, 2008, the rate in effect was the commercial paper rate which was 2.3271%. For the three and six months ended June 30, 2009, the average interest rates (i.e. rate in effect plus the spread) were 3.70% and 3.66%, respectively. For the three and six months ended June 30, 2009, the average outstanding balances were $177,932 and $135,495, respectively. For the three and six months ended June 30, 2008, the average interest rates (i.e. rate in effect plus the spread) were 3.77% and 4.33%, respectively. For the three and six months ended June 30, 2008, the average outstanding balances were $27,315 and $69,815, respectively.

For the three and six months ended June 30, 2009, the interest expense incurred on the CP Funding Facility was $1,648 and $2,480, respectively. For the three and six months ended June 30, 2008, the interest expense incurred on the CP Funding Facility was $271 and $1,324, respectively. Cash paid for interest expense during the six months ended June 30, 2009 and 2008 was $2,701 and $2,391, respectively.

Prior to May 7, 2009, the Company was required to pay a commitment fee for any unused portion of the CP Funding Facility equal to 0.5% per annum for any unused portion of the CP Funding Facility.  Prior to July 22, 2008, the commitment fee was 0.125% per annum calculated based on an amount equal to $200,000 less the borrowings outstanding under the CP Funding Facility. For the three and six months ended June 30, 2009, the commitment fees incurred on the CP Funding Facility were $122 and $443, respectively. For the three and six months ended June 30, 2008, the commitment fees incurred on the CP Funding Facility were $55 and $91, respectively.

Prior to May 7, 2009, the Company was required to pay a commitment fee for any unused portion of the CP Funding Facility equal to 0.5% per annum for any unused portion of the CP Funding Facility.  Prior to July 22, 2008, the commitment fee was 0.125% per annum calculated based on an amount equal to $200,000 less the borrowings outstanding under the CP Funding Facility. For the three and six months ended June 30, 2009, the commitment fees incurred on the CP Funding Facility were $122 and $443, respectively. For the three and six months ended June 30, 2008, the commitment fees incurred on the CP Funding Facility were $55 and $91, respectively.

Revolving Credit Facility

In December 2005, we entered into a senior secured revolving credit facility referred to as “Revolving Credit Facility”, under which, as amended, the lenders have agreed to extend credit to the Company in an aggregate principal amount not exceeding $525,000 at any one time outstanding. The Revolving Credit Facility expires on December 28, 2010 and with certain exceptions is secured by substantially all of the assets in our portfolio (other than investments held by Ares Capital CP under the CP Funding Facility and those held as a part of the Debt Securitization, discussed below) which as of June 30, 2009 consisted of 177 investments.

The Revolving Credit Facility also includes an “accordion” feature that allows us to increase the size of the Revolving Credit Facility to a maximum of $765,000 under certain circumstances. The Revolving Credit Facility also includes usual and customary events of default for senior secured revolving credit facilities of this nature. As of June 30, 2009, there was $375,045 outstanding under the Revolving Credit Facility and the Company continues to be in compliance with all of the limitations and requirements of the Revolving Credit Facility. As of December 31, 2008, there was $480,486 outstanding under the Revolving Credit Facility.

The interest charged under the Revolving Credit Facility is generally based on LIBOR (one, two, three or six month) plus 1.00%. As of June 30, 2009, the one, two, three and six month LIBOR (all good here)  were 0.31%, 0.41%, 0.60% and 1.11%, respectively. As of December 31, 2008, the one, two, three and six month LIBOR were 0.44%, 1.10%, 1.43% and 1.75%, respectively. For the three and six months ended June 30, 2009, the average interest rate was 1.83% and 2.19%, respectively, the average outstanding balance was $423,069 and $457,590, respectively, and the interest expense incurred was $1,939 and $5,012, respectively. For the three and six months ended June 30, 2008, the average interest rate was 4.11% and 4.68%, respectively, the average outstanding balance was $402,063 and $371,597, respectively, and the interest expense incurred was $4,117 and $8,677, respectively. Cash paid for interest expense during the six months ended June 30, 2009 and 2008 was $6,311 and $9,518, respectively. The Company is also required to pay a commitment fee of 0.20% for any unused portion of the Revolving Credit Facility. For the three and six months ended June 30, 2009, the commitment fee incurred was $101 and $202, respectively. For the three and six months ended June 30, 2008, the commitment fee incurred was $185 and $257, respectively.

The amount available for borrowing under the Revolving Credit Facility is reduced by any standby letters of credit issued through the Revolving Credit Facility. As of June 30, 2009 and December 31, 2008, the Company had $21,600 and $16,700, respectively, in standby letters of credit issued through the Revolving Credit Facility.

As of June 30, 2009, the Company had a non-U.S. borrowing on the Revolving Credit Facility denominated in Canadian dollars. As of June 30, 2009 and December 31, 2008, unrealized appreciation on this borrowing was $2,805 and $3,365, respectively.

Debt Securitization

In July 2006, through our wholly owned subsidiary, ARCC CLO 2006 LLC (“ARCC CLO”), we completed a $400,000 debt securitization (the “Debt Securitization”) and issued approximately $314,000 principal amount of asset-backed notes (including $50,000 of revolving notes, all of which were drawn down as of June 30, 2009) (the “CLO Notes”) to third parties that were secured by a pool of middle market loans that have been purchased or originated by the Company. The CLO Notes are included in the June 30, 2009 consolidated balance sheet. We retained approximately $86,000 of aggregate principal amount of certain BBB and non-rated securities in the Debt Securitization (the “Retained Notes”). During the six months ended June 30, 2009, we repurchased, in several open market transactions, $34,790 of CLO Notes consisting of $14,000 of the Class B and $20,790 of the Class C notes for a total purchase price of $8,247.   As a result of these purchases, we recognized a $26,543 gain on the extinguishment of debt and as of June 30, 2009, we held an aggregate principal amount of $120,790 of CLO Notes, in total. (smart) The CLO Notes mature on December 20, 2019, and, as of June 30, 2009, there is $279,210 outstanding under the Debt Securitization (excluding the Retained Notes). The blended pricing of the CLO Notes, excluding fees, is approximately 3-month LIBOR plus 27 basis points. (all low rates-I am scared of intrest rate risk if we have big inflation, their debt is assinged in libor and their income is based on libor so not to bad)

The classes, amounts, ratings and interest rates (expressed as a spread to 3-month LIBOR) of the CLO Notes are as follows: (only 279k not significat but looks good.)

(1) Revolving class, all of which was drawn as of June 30, 2009.

As of June 30, 2009, there were 69 investments securing the notes. The interest charged under the Debt Securitization is based on 3-month LIBOR, which as of June 30, 2009 was 0.60% and as of December 31, 2008 was 1.43%. For the three and six months ended June 30, 2009, the effective average interest rate was 1.59% and 1.63%, respectively, the average outstanding balance was $279,210 and $289,638, respectively, and the interest expense incurred was $1,107 and $2,356, respectively. For the three and six months ended June 30, 2008, the effective average interest rate was 2.93% and 4.00%, respectively, and the interest expense incurred was $2,295 and $6,265, respectively. Cash paid for interest expense during the six months ended June 30, 2009 and 2008 was $2,629 and $6,492, respectively. The Company is also required to pay a commitment fee of 0.175% for any unused portion of the Class A-1A VFN Notes. There were no commitment fees incurred for the three and six months ended June 30, 2009 and 2008 on these notes.

8. FAIR VALUE OF FINANCIAL INSTRUMENTS

Effective January 1, 2008, the company adopted SFAS No. 159, the Fair Value Option for Financial Assets and Liabilities (“SFAS 159”), which provides companies the option to report selected financial assets and liabilities at fair value. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities and to more easily understand the effect of the company’s choice to use fair value on its earnings. SFAS 159 also requires entities to display the fair value of the selected assets and liabilities on the face of the balance sheet.  The Company has not elected the SFAS 159 option to report selected financial assets and liabilities at fair value. As a result, with the exception of the line items entitled “other assets” and “debt,” which are reported at cost, all assets and liabilities approximate fair value on the balance sheet.  The carrying value of the line items entitled “interest receivable,” “receivable for open trades,” “payable for open trades,” “accounts payable and accrued expenses,” “management and incentive fees payable” and “interest and facility fees payable” approximate fair value due to their short maturity.

Effective January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements (“SFAS 157”), which expands the application of fair value accounting. SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosure of fair value measurements. SFAS 157 determines fair value to be the price that would be received for an investment in a current sale, which assumes an orderly transaction between market participants on the measurement date. SFAS 157 requires the Company to assume that the portfolio investment is sold in a principal market to market participants, or in the absence of a principal market, the most advantageous market, which may be a hypothetical market. Market participants are defined as buyers and sellers in the principal or most advantageous market that are independent, knowledgeable, and willing and able to transact. In accordance with SFAS 157, the Company has considered its principal market as the market in which the Company exits its portfolio investments with the greatest volume and level of activity. SFAS 157 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. In accordance with SFAS 157, these inputs are summarized in the three broad levels listed below:

· Level 1 — Valuations based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.

· Level 2 — Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.

· Level 3 — Valuations based on inputs that are unobservable and significant to the overall fair value measurement.

In addition to using the above inputs in investment valuations, we continue to employ the valuation policy approved by our board of directors that is consistent with SFAS 157 (see Note 2).  Consistent with our valuation policy, we evaluate the source of inputs, including any markets in which our investments are trading (or any markets in which securities with similar attributes are trading), in determining fair value. Our valuation policy considers the fact that because there is not a readily available market value for most of the investments in our portfolio, the fair value of the investments must typically be determined using unobservable inputs.

Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments may fluctuate from period to period. Additionally, the fair value of our investments may differ significantly from the values that would have been used had a ready market existed for such investments and may differ materially from the values that we may ultimately realize.   Further, such investments are generally subject to legal and other restrictions on resale or otherwise are less liquid than publicly traded securities. If we were required to liquidate a portfolio investment in a forced or liquidation sale, we may realize significantly less than the value at which we have recorded it. (all normal)

In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the valuations currently assigned.

The following table presents fair value measurements of cash and cash equivalents and investments as of June 30, 2009: (remember LOW liquidity on in investments it is intrinsic to trade below NAV)

The following tables present changes in investments that use Level 3 inputs for the three and six months ended June 30, 2009:

As of June 30, 2009, the net unrealized loss on the investments that use Level 3 inputs was $301,383.

Following are the carrying and fair values of our debt instruments as of June 30, 2009 and December 31, 2008. Fair value is estimated by discounting remaining payment using applicable current market rates which take into account changes in the Company’s marketplace credit ratings.

9. RELATED PARTY TRANSACTIONS

In accordance with the investment advisory and management agreement, we bear all costs and expenses of the operation of the Company and reimburse the investment adviser for all such costs and expenses incurred in the operation of the Company. For the three and six months ended June 30, 2009, the investment adviser incurred such expenses totaling $527 and $944, (not significant)

IVY HILL FUNDS

On November 19, 2007, we established a middle market credit fund, Ivy Hill Middle Market Credit Fund, Ltd. (“Ivy Hill I”), which is managed by our affiliate, Ivy Hill Asset Management, L.P. (“IHAM”). IHAM receives a 0.50% management fee on the average total assets of Ivy Hill I as compensation for managing this fund. As of June 30, 2009, the total assets of Ivy Hill I were approximately $370,000.  For the three and six months ended June 30, 2009, the Company earned $395 and $883, respectively, in management fees. For the three and six months ended June 30, 2008, the Company earned $384 and $581, respectively, in management fees. Ivy Hill I primarily invests in first and second lien bank debt of middle market companies. Ivy Hill I was initially funded with $404,000 of capital, including a $56,000 investment by the Company consisting of $40,000 of Class B notes and $16,000 of subordinated notes. For the three and six months ended June 30, 2009, the Company earned $1,369 and $3,022, respectively, from its investments in Ivy Hill I. For the three and six months ended June 30, 2008, the Company earned $1,581 and $2,593, respectively, from its investments in Ivy Hill I. (take advantage of banking problems - and build a track record) - BDC Private Equity - why create a sub and add a .50 management fee, who gets that?

Ivy Hill I purchased investments from the Company of $3,980 and $12,980 during the three and six months ended June 30, 2009, respectively, and may from time to time buy additional investments from the Company. There was a loss of $20 recognized by the Company on these transactions.

On November 5, 2008, the Company established a second middle market credit fund, Ivy Hill Middle Market Credit Fund II, Ltd. (“Ivy Hill II”), which is also managed by IHAM. IHAM receives a 0.50% management fee on the average total assets of Ivy Hill II as compensation for managing this fund. Ivy Hill II primarily invests in second lien and subordinated bank debt of middle market companies. Ivy Hill II was established with an initial commitment of $250,000 of subordinated notes, of which $125,000 has been funded, and may grow over time with leverage. Ivy Hill II purchased $27,500 of investments from the Company during the six months ended June 30, 2009. The Company recorded a loss of $1,388 on these transactions. As of June 30, 2009, the total assets of Ivy Hill II were approximately $123,000. For the three and six months ended June 30, 2009, the Company earned $274 and $353, respectively, in management fees.

Our affiliate, IHAM, is party to a separate services agreement, referred to herein as the “services agreement,” with Ares Capital Management. Pursuant to the services agreement, Ares Capital Management provides IHAM with office facilities, equipment, clerical, bookkeeping and record keeping services, services of investment professionals and others to perform investment advisory, research and related services, services of, and oversight of, custodians, depositories, accountants, attorneys, underwriters and such other persons in any other capacity deemed to be necessary. Under the services agreement, IHAM will reimburse Ares Capital Management for all of the costs associated with such services, including Ares Capital Management’s allocable portion of overhead and the cost of its officers and respective staff in performing its obligations under the services agreement. The services agreement may be terminated by either party without penalty upon 60-days’ written notice to the other party. For the three and six months ended June 30, 2009, IHAM incurred such expenses payable to the investment adviser of $282 and $538, respectively. No such expenses were payable for the three and six months ended June 30, 2008.

During the three months ended June 30, 2009, because of a shift in activity from being primarily a manager with no dedicated employees and of funds in which the Company has invested debt and equity, to a manager with individuals dedicated to managing an increasing number of third party funds for which the Company has limited or no investment, we have concluded that GAAP requires the financial results of IHAM to be reported as a portfolio company in our schedule of investments rather than as a consolidated subsidiary in the Company’s financial results.  For the three months ended June 30, 2009, the Company made an initial equity investment of $3,816 into IHAM and also recognized an unrealized gain of $8,000. (same for here)