Good day, and thank you for standing by. Welcome to the Hercules Capital Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions]. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Michael Hara, Managing Director of Investor Relations.

Thank you, Josh. Good afternoon, everyone, and welcome to Hercules Conference Call for the Fourth Quarter and Full Year 2022. With us on the call today from Hercules are Scott Bluestein, CEO and Chief Investment Officer; and Seth Meyer, CFO. Hercules' financial results were released just after today's market close and can be accessed from Hercules Investor Relations section at investor.htgc.com. An archived webcast replay will be available on the Investor Relations web page for at least 30 days following the conference call. During this call, we may make forward-looking statements based on our own assumptions and current expectations. These forward-looking statements are not guarantees of future performance and should not be relied upon in making any investment decision. Actual financial results may differ from the forward-looking statements made during this call for a number of reasons, including, but not limited to, the risks identified in our annual report on Form 10-K and other filings that are publicly available on the SEC's website. Any forward-looking statements made during this call are made only as of today's date, and Hercules assumes no obligation to update any such statements in the future. And with that, I'll turn the call over to Scott.

Thank you, Michael, and thank you all for joining the Hercules Capital Q4 2022 Earnings Call. Following our record operating performance in 2021, Hercules Capital raised the bar higher and once again delivered record performance in 2022. 2022 was a historic year for Hercules Capital. And I am incredibly proud of what our talented and growing team accomplished. Our record-setting performance in 2022 culminated with the strongest total and net investment income quarter in the company's history. And the recent declaration of an increased quarterly base distribution and a new supplemental distribution program for our shareholders. Hercules Capital delivered another strong year of record originations performance, record financial results and continued strong credit performance. Our performance in 2022 reflects the benefits of being able to achieve and operate at scale, maintain robust liquidity and a strong balance sheet and working with the best-in-class team that is highly experienced in this asset class. Thanks to the growth of both the BDC and our private credit funds business, Hercules Capital is now managing in excess of $3.6 billion of assets, an increase of over 38% from where we were at the end of 2021. Despite continued market and macro volatility, the continued strength and expansion of our originations platform, robust liquidity position and strong balance sheet put us in a position to deliver achievements on multiple fronts in 2022, including record total gross debt and equity commitments of $3.12 billion, up 18% year-over-year and the first time in our 18-year history where we have been able to deliver over $3 billion of new commitments in a year. Record debt investment portfolio growth of nearly $600 million; record total investment income of $322 million, up 14% year-over-year; record net investment income of $188 million, up 25% year-over-year; increased our base distribution 3x in…

Thank you, Scott, and good afternoon, ladies and gentlemen. As Scott mentioned, this was another record quarter for Hercules Capital, capping off a record-breaking 2022. In addition to record investment activity in 2022, we continue to strengthen our team, expand and enhance our balance sheet and ensure our cost of leverage was optimized in a rising interest rate environment. Throughout the year, we were able to further validate the benefits of operating at scale by demonstrating meaningful operating leverage as we grew AUM to record levels. This allowed us to deliver an NII margin of 62% in Q4, the highest that we have achieved since 2007. During 2022, our weighted average cost of debt remained below 4.6%, putting us in a very strong position relative to others in our asset class. We were able to do this by refinancing more expensive legacy instruments in 2021 and into early 2022. And then focusing our balance sheet flexibility once the markets became more challenging from a rate perspective. As a recap, in June, we completed 2 institutional debt financings and expanded our capacity on both credit facilities to support the continued growth of the portfolio. In total, $470 million of additional debt financing and credit facility capacity was made available to Hercules Capital, demonstrating our ability to raise significant amounts of capital at attractive rates in a period of significant volatility for the capital markets. We've started 2023 with the same success, amending and renewing early, our largest credit facility led by MUFG and putting in place a new letter of credit facility with SMBC to cover $100 million of our available, unfunded commitment in a more cost-effective manner. The consequence of these steps is greater flexibility, lower financing costs and consistently strong liquidity to support our business and portfolio companies. We…

[Operator Instructions]. Our first question comes from Crispin Love with Piper Sandler.

In your prepared remarks, you talked about how half of your companies -- portfolio companies raise equity capital in 2022 for, I think, you said about $5.6 billion and that's with -- as the industry activity fell off meaningfully. So can you just speak to why you believe that your portfolio companies were in a position to raise significant capital while the industry as a whole wasn't able to?

Sure. Thanks, Crispin. I think a lot of it really has to be attributable to the quality of our team. We have over 55 professionals on the investment team. This is an incredibly experienced investment team. The average industry experience across that investment team is approximately 10-plus years, and they have a long track record of working successfully together to identify and then win transactions with some of the best quality companies in the market. So I think a lot of the credit has to go to the team. The second thing that I would point out is that at least from what we're seeing, there has certainly been some pressure in terms of valuation. But the companies that remain strong companies are able to raise new equity capital, and that's really what we saw across our portfolio in 2022. And those numbers that you cited were exactly where they came out for us. In Q4, we had 20 different companies raised over $1.6 billion of new capital. And for the year, we had approximately 58 companies raised approximately $5.6 billion of new capital.

And Scott, how does that $5.6 billion compared to 2021? .

I don't have the data for you for 2021. So I'd have to get back to you on that. .

Okay. Not a problem. And then, Scott, you also mentioned during the prepared remarks about being patient and disciplined on new originations. Are you able to drill into that a little bit deeper and what that might mean for your expectations for new debt fundings or debt fundings growth in 2023 or at least what you're seeing over the near term?

Sure. So as a firm, we are incredibly optimistic about what the environment will look like for us in 2023. We're off to a great start in Q1, and I provided some quarter-to-date closed commitments and quarter-to-date pending commitment numbers, and we're off to a great start in regards to both of those numbers. The team is continuing to look at and evaluate a record number of transactions. So when we look at our pipeline activity, it is as large as it's been in a long time. Having said that, and this was also part of the prepared remarks, because of the turbulence that we're seeing in the equity markets, both public and private, we're seeing a tremendous increase in the number of companies that are looking for venture debt or growth-stage debt funding solutions. And as you know, having followed this business for a long period of time, you simply can't hit the bid for every company that's looking for debt financing. So our team is being very thorough in terms of our screening, very diligent with respect to the number of companies that we are progressing along in our pipeline activity. And we believe that we are closing transactions with the best qualified companies that we are seeing on a quarterly basis. I would also reference, last year, we did $3 billion of commitments. When you look at our funding-to-commitment ratio, last year was approximately 55% to 60%. So there are a lot of funding that we anticipate taking place from the existing portfolio over the course of the next 6 to 12 months.

Our next question comes from Kevin Fultz with JMP Securities.

Congratulations on a great year. Clearly, the portfolio credit quality is in excellent shape. I'm just curious if you've seen an increase in amendment requests at all. And if you could discuss your expectations that potentially pick up in the near term.

Sure. Thanks, Kevin. We have not -- and we actually -- we just looked at this -- we look at it every quarter. But over the course of Q4, we really did not see any uptick in amendment requests broadly. And specifically, we did not see any amendment requests that were related to stress or liquidity-related situations. So I think overall, we're continuing to see a stable and strong credit environment across our portfolio. We have 2 loans on nonaccrual. It makes up less than 0.1% of the portfolio from a fair value perspective. We're certainly increasing our monitoring. We're tightening our underwriting screens given the volatility that we have seen over the course of the last several quarters and that we expect to see on a go-forward basis. But overall, we have not seen any uptick with respect to amendment requests from our portfolio companies.

Okay. That's great to hear. And I guess just to continue on that line of question. You mentioned nonaccruals obviously in great shape, with only 2 investments on nonaccrual. I was just curious if you could provide some high-level color on the one new investment that was added this quarter. .

Sure. It's a small loan. It's about a $5 million loan to a small tech company that is private. That company remains current with respect to its contractual payments to Hercules, but it does have stressed liquidity. They're currently exploring a variety of options, and we're working closely with the team. We did make the decision in Q4 out of an abundance of caution to put that loan on nonaccrual and we did take a fair value adjustment on that position as well. But it's a very small position relative to, obviously, a $3 billion portfolio. .

Our next question comes from Christopher Nolan with Ladenburg Thalmann.

Scott, unfunded commitments for $645 million, 20% of the portfolio, down slightly quarter-over-quarter. Are you -- given the volatility of the broader environment, are you seeing companies having a tougher time meeting their milestones to tap those commitments? .

We're not. We've actually had a tremendous run of success with respect to companies of being able to unlock unfunded commitments. If you -- it's hard to sort of see the quarter-over-quarter movements because there's sort of a combination of 2 things. Number one, in any given quarter, we're funding a large portion of those available, unfunded commitments and then new unfunded commitments are being unlocked. So what you essentially saw in Q4 was we were able to fund a lot of capital to existing portfolio companies. But on top of that, we had several of our sort of larger, later-stage companies, both on the tech side and life sciences side achieve specific performance milestones during the quarter, which unlocked new tranches from an availability perspective.

And my follow-up question is, in your prepared remarks, you mentioned, if I heard correctly, $3.6 billion in investment assets. The balance sheet has $3 billion at cost. Should we assume that, that incremental $600 million is assets in the RIA?

Yes.

And what -- how do you -- I know it's , but do you see the RIAs being even a faster growth vehicle than the publicly traded BDC for 2023?

It's hard to say. We think that both vehicles are obviously growth-oriented vehicles, and we demonstrated and we delivered very strong growth in the public BDC and in the private credit fund business last year. We expect that to continue to be the case based on what we're seeing right now for 2023. I would point out that because of the unique structure that we've deployed here where the RIA business is operated as a wholly-owned subsidiary of the public BDC, the more successful that private credit fund business is, the better it is for the shareholders and stakeholders of HTGC.

Our next question comes from Casey Alexander with Compass Point.

Yes. I'm trying to wrap my head a little bit around the cadence of the way things look like they're going to flow here in the first quarter. And you discussed the $150 million to $200 million of repayments as your estimate. I understand that. you had commitments in the first quarter already of $190 million, but you've already funded $193 million. I'm assuming that, that is some of those loans that are coming off of the unfunded commitment schedule. It would suggest, especially given that most of the time, fundings are back-ended that you would be looking at a fairly robust quarter in terms of net originations. And would that, in part, explain why you've already sold 2.6 million shares under the equity ATM program this quarter.

Sure. Thanks, Casey. So first, with respect to Q1, as you know, we do not provide a gross funding projection with respect to what we expect to do. We did provide the commitment numbers. I think the way you're looking at it, though, is the right way to think about it. The reason why the funding numbers so far quarter-to-date exceed the commitment numbers is, we've been able to fund a lot of capital to existing portfolio companies who hit performance milestones in the second half of last year. And those tranches were either expiring or the company has made the decision to draw that capital. I mean in the case that what we typically see happen with the companies are achieving those milestones, we're obviously happy to fund that additional capital to borrowers where we already have the relationships. We're also seeing strong demand from a new business perspective, and that's evidenced by the new commitment number and the pending commitment number. So we're confident and we're optimistic with respect to what that Q1 funding number is going to look like. And that does lead to, a, why we've been not aggressive, but why we've been active on the ATM quarter-to-date. And I would also tell you that, that should serve as a pretty strong signal about how we feel about portfolio growth over the course of the first half of this year.

Okay. My other question is what's different and precipitates the usage of a letter of credit as opposed to a credit facility? Is there something different about that? Is it securitized that allows for it to be cheaper capital? Or why go in that direction? I'm not sure I ever remember a BDC actually using a letter of credit as opposed to a credit facility.

Yes. Thanks, Casey. It's Seth here. We think it's a pretty smart addition to our toolbox based on the fact that it's a lot cheaper facility to put in place. We're very grateful for SMBC working with us to put in place what we think is probably the first, unrelated letter of credit that's been put in place. And it covers the tail end of the exposure on the available unfunded commitment. That portion, which is unlikely in any single quarter ever to be drawn down. Historically, the range has been 5% to 15% of the prior quarter's available unfunded commitment is drawn down. So covering all of it with a higher cost credit facility doesn't seem smart to us in the long term.

Okay. I think I get it. .

Our next question comes from John Hecht with Jefferies.

Congratulations on a good year and a good quarter, and I appreciate you taking my questions. First 1 is, I mean, it's very clear that the public markets have gone from a kind of hard landing to softer landing kind of valuation and narrative and expectation that I'm wondering, Scott, maybe how does the feel in the venture capital world in terms of their viewpoint on the climate. And what does that mean for kind of the demand for your product and the opportunity set?

Sure. Thanks, John. What we're seeing across the ecosystem is, I would say, caution, but also optimism. The VC firms have record amounts of liquidity available to invest. When you look at the investment activity numbers for 2022, you can look at it 1 of 2 ways. You can look at it relative to 2021, which was the best year on record, and you can say that it was down year-over-year, which is absolutely factual. But you can also look at it and say that the 2022 investment numbers represented the second strongest year in the history of venture capital activity. And so we chose to sort of look at it somewhere in the middle. We think the fundraising activity that was a record level in 2022 is a very strong signal of what we expect to be an acceleration of VC investment activity over the next 12 to 24 months. We're also continuing to see the same trends that we saw throughout 2022. Good companies are able to raise money. The valuation discussions are a little bit more difficult. The VC firms are more valuation sensitive. But deals are still getting done for the companies that deserve to be funded. And whether it's on the equity side or the debt side, there have always been and there will continue to be a handful of companies that probably should not be getting financed. And until all of that sort of works its way through the system, and that will take some time, you're going to continue to have this sort of volatility that we're seeing both in the public markets and in the private markets as well.

Okay. That's great color. And then the second question is, look, I mean, you've had a history of extraordinarily low losses. And obviously, your current credit book is still really strong. I know you have regulatory restrictions on leverage. But given your kind of loss content and your credit book, is there any potential appetite to kind of move towards the higher end of your leverage target over time? Or how do we just think about the application of leverage you've -- given your -- again, that terribly low loss ratio over time?

Thanks, John, for the question. Two things. One, and we've talked about this publicly before. In the venture lending or growth-stage lending asset class, driving leverage up is really challenging. And the reason for that is the duration of our assets. Throughout 2022 on a quarterly basis, our average duration was somewhere between 12 and 16 months. Right now, our average duration is roughly 15 months. And so when your portfolio is turning that rapidly, it's very difficult to drive leverage up on a consistent and sustained basis. As of the end of Q4, we were operating at roughly 113.7% from a GAAP leverage perspective. Our guidance or our ceiling as publicly indicated is about 125%. So there is some room for us to drive that up. And if the portfolio growth is as strong as we expect it to be in 2023, it would not surprise us if that number gets driven up slightly, but we're not a firm that has traditionally or will, on a go-forward basis, push the envelope with respect to leverage because even though it might help generate some additional return. We don't think in our asset class, it's the most prudent thing to do.

[Operator Instructions]. Our next question comes from Ryan Lynch with KBW.

First question I had was, I think you kind of sort of touched on it earlier. But can you just explain why your -- why both your debt and your equity warrant portfolio valuation held up so well this quarter, kind of just in the face of kind of a challenging venture capital marketplace.

Yes. So thanks a lot, Ryan. I think that when you dig into the detail of our movement, you'll see that the public equity positions moved up. So that's just driven by the public markets where they landed at 12/31 whereas the private positions move down by almost an equal amount. That was obviously a coincidence. There's different quantums of those positions. And what we've always seen is that the private positions typically trail about a quarter behind the public positions. And so it's not uncommon that we have those move in different directions or differing quantums because of that delay of the impact to the private markets.

And Ryan, I would just add, as Seth mentioned, the biggest driver on the upside was the public equity position. And if you just look at some of our larger public equity positions quarter-over-quarter from where they started Q4 to where they ended, the vast majority of those larger positions were up, and that was the largest driver of the overall movement in unrealized depreciation.

Okay. That's helpful. And then going back to just the overall environment. You guys talked about on the call, there's been a lot of venture capital fundraising in 2022. I think it was a record year. But if you look at the venture capital investment, while it was healthy in 2022, there was a pretty sharp decline throughout 2022, bottoming with the fourth quarter, I think, of like $36 billion. And then also, when you look at venture capital exits, they have really kind of dropped off a cliff, and I think they were down to about $5 billion in the fourth quarter. And so my question is, while there's been a lot of capital raised in venture capital firms in 2022. How do you feel -- how active do you feel they'll be if exits and they're not receiving their money back if exits stay kind of at these very low levels.

Sure. Thanks for the question, Ryan. So a couple of things. And I had mentioned this in response to one of the earlier questions. You can look at the 2022 investment data one of two ways. We chose to look at it as very strong and healthy, $238 billion invested by VC firms throughout the course of 2022, down year-over-year from the record in 2021 but the second strongest year on record. And for us, despite the fact that it's down year-over-year, that still reflects what we saw in our own portfolio in 2022. With respect to funds raised, that was a record number, about $163 billion raised by venture capital firms in 2022. When VC firms make investments, they're not anticipating an exit in 3 months, 6 months or 12 months. These tend to be longer-term investments. We are very optimistic about the future of the venture capital ecosystem. And based on the conversations that we're having with our portfolio companies, with the venture capital firms that back our portfolio companies, we believe that 2023 will represent an uptick with respect to VC investment activity across the ecosystem.

Well, I guess my question was more on the trends that we're seeing because while there was a record number of capital raised in 2022, the trend from investing on a quarterly basis decelerated significantly throughout 2022. Fourth quarter was very weak. And then when you look at the exit activity, that really dropped throughout the year significantly. So my question is really, do you expect these trends to turn around or to continue in 2023? And what does that mean for your business, even kind of forgetting about 2021, but I know those were kind of years or maybe somewhat exacerbated by kind of the frothy mix of the interest rates. But do you see these trends sort of turning around that we saw in the second half of 2022? And if not, what does that mean for the venture capital landscape?

Sure. So Q4, both with respect to funds raised and dollars invested was down if you look at it relative to Q3. We do expect that to turn around. I'm not going to predict whether that happens in Q1 or Q2. We look at things on a 6- to 12-month basis. And based on everything that we're seeing, conversations that we're having, we believe that you will see an uptick over the course of 2023. With respect to exit activity, which was another comment that you made in terms of trends, again, I would sort of distinguish between some of the overall industry data and just the empirical evidence that we see in our own portfolio. Quarter-to-date, we've had 7 companies out of 105 companies announced or closed M&A transactions. We certainly are not seeing any uptick with respect to IPO activity. But as we've been indicating publicly over the course of the last several quarters, we expect and we are seeing a tremendous uptick in M&A activity. And again, based on conversations we're having across the portfolio, we actually expect that trend to continue to accelerate into the first half of 2023.

Thank you. This concludes the Q&A session. I'd now like to turn the call back over to Scott for any closing remarks.

Thank you, Josh, and thanks to everyone for joining our call today. As a final note, we will be participating in the RBC 2023 Financial Institutions Conference in New York on March 7. If you would like to arrange a meeting with the Hercules management team, please contact RBC or Michael Hara. We look forward to reporting our progress on our Q1 2023 earnings call. Thank you. .

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.