Good day and thank you for standing by. Welcome to the Hercules Capital Q3 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to introduce your host for today's call, Michael Hara, Managing Director of Investor Relations. Please go ahead.

Thank you, Justin. Good afternoon, everyone, and welcome to Hercules conference call for the third quarter 2023. 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 webpage for at least 30 days following the 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 Q3 2023 earnings call. Our best-in-class venture and growth stage lending platform continued to deliver record earnings and operating performance in Q3 as well as delivering record year-to-date gross fundings of $1.29 billion, which represents an increase of over 17% year-over-year. We were able to achieve record Q3 results despite continued volatility in both the equity and credit markets as well as across the broader global macro landscape. While we are pleased with our continued record operating performance in Q3 and remain optimistic about our positioning in the asset class and our ability to capture further market share over the coming quarters, we continue to take steps to manage our business defensively while maintaining the ability to play offense as the market improves. This includes enhancing our liquidity position, maintaining very low leverage, tightening our credit screens for new underwritings and driving our first lien exposure up to over 87%, our highest level since Q1 2017. During Q3, we experienced many of the same themes that we have been discussing over the last several quarters with one notable exception capital raising across our portfolio remains strong, exceeding the level of activity that we saw in Q2. Rising rates combined with higher onboarding yields and an increased weighted average portfolio balance drove total investment income, core investment income, and net investment income to record levels. M&A activity and interest continues to be strong across our portfolio and we expect several additional M&A exits over the coming quarters. Our differentiated business model, which is predicated on asset and liability diversification, fundamental credit underwriting, and longstanding relationships with over a thousand venture capital and private equity investors has continued to serve us well and allows us to outperform in a variety…

Thank you, Scott, and good afternoon ladies and gentlemen. Q3 marked another quarter of records for Hercules Capital. Total investment income was a record of $117 million. We had record net investment income of $77 million and core income of $0.46 per share. To support the $195 million of portfolio growth, we proactively strengthened our balance sheet and liquidity position with the equity offering in August. We also received a green light letter from the SBA for an additional SBIC license, which upon final licensing will provide us with additional attractive financing. With these points in mind, let's review the following areas, the income statement performance and highlights, NAV, unrealized and realized activity, leverage and liquidity, and finally, the financial outlook. Turning first to the income statement performance and highlights. Total investment income exceeded $100 million, again at $116.7 million, driven by the year-to-date growth in the debt portfolio on consistent business underwriting and a small increase in benchmark rates. Core investment income a non-GAAP measure, again exceeded a $100 million at $107.4 million. Core investment income excludes the benefits of income recognized as a result of loan prepayments. Net investment income was another record of $76.8 million, a 1.4% quarter-over-quarter increase, or $0.52 per share in Q3. NII margin was 65.8% for Q3 and has increased every quarter since Q1 2022. Our effective in core yields in the third quarter were 15.5% and 14.2% respectively compared to 16% and 14.1% in the prior quarter. The decrease in the effective yield was due to lower prepayments consistent with our guidance versus the prior quarter. The increase in the core yield was due to an increase in coupon interest as a result of benchmark interest rates. We continue to forecast a leveling of core yield hereafter due to minimal movement from…

And thank you. [Operator Instructions] And our first question comes from Crispin Love from Piper Sandler. Your line is now open.

Thanks. Good afternoon everyone. Scott, you’ve made some comments on being weighted more towards life sciences in the quarter. Just curious if you can dig a little deeper there. Was that due to credit expectations, demand from borrowers or just anything else worth calling out and would you expect to be more weighted towards life sciences over the near term?

Sure. Thanks, Crispin. So it was an intentional move. I think we’re one of the few private credit direct lenders in the market that have the ability to sort of toggle back and forth between technology lending and life sciences lending. And as we’ve said consistently over the course of the years, depending on what our macro assessment is, we will go back and forth in terms of waiting between those two sectors on a quarterly basis. Over the course of Q3, and we would expect this to sort of remain this way in Q4 as well, given the macro volatility that we’re seeing, given some of the turmoil that we’re seeing on kind of a global perspective our view was that the life sciences sector represented a better credit opportunity for us in terms of short-term underwritings, and that was our focus in Q. We expect that to continue to be our focus in Q4. I want to emphasize however, that we will continue to very actively pursue both technology and life sciences transactions. I mentioned the numbers in my prepared remarks, but it was not a 100% life science, and 0% technology. It was essentially a 60/40 allocation in the quarter, and we think we’ll be pretty consistent for the remainder of the year in terms of those numbers.

Okay, great, Scott, that’s helpful. And then just, just on leverage here did remains very well contained. But looking a little further out, can you talk about where you’d be willing to increase leverage to if opportunities pick up just from the changing competitive landscape out there, and I’m thinking over say the next several quarters to a year if the environment improves?

Sure. Thanks, Crispin. So, we, our guidance has always been a 125 [ph] GAAP leverage ceiling, and we’re going to stay a fair distance away from that just for mark-to-market volatility at the end of quarters and things of that nature. While we are working through a leading up to a recessionary environment, we’re going to be pretty careful and stay around a 1.1 level. We have taken it up in 2022, and at certain quarters to about the 1.15 level historically twice. So, I would see that as our ceiling, but I would see us operating in the 1.1 to 1.10 range in the foreseeable future as a result of the recessionary environment and wanting to maintain sufficient liquidity.

And Crispin, I would just add to that from a positioning perspective right now we think two critical items from a platform perspective are high liquidity and low leverage, and the reason for that is really not credit related. Its new business related based on the conversations that our investment teams are having with venture capital firms, private equity firms and prospective companies. We are actually very optimistic about what the new business environment will look like, particularly in the first half of next year. And we think being able to aggressively move to win those opportunities will be a key point of differentiation. And by maximizing liquidity and keeping leverage low, we’ll be able to react very quickly to take advantage of that market opportunity when the time arises.

All right. I appreciate you taking my questions.

Thanks Crispin.

And thank you. And one moment for our next question. And our next question comes from Christopher Nolan from Ladenburg Thalmann. Your line is now open.

Hey guys. Seth, based on your effective yield – core yield guidance, should we assume that the flow through of the rate increases is just about done?

Yes. I would agree with that, Chris. I think that what we see is probably the ceiling absent any additional rate increases from the Fed. As we’ve said, we’re going with later stage companies that comes with tighter spreads and we’ve benefited certainly from the increase of spreads as the Fed has raised. And a lot of these loans, remember, were originated at times when rates were much lower. We continue to see a strong prepayment volume on the higher rates. And so we’re just trying to manage the expectations that the new originations largely will come in or just below the level that we’re at as far as spreads because they’re later stage companies. And that as the larger spreads pay off, we expect that this is likely our ceiling in the rates that we see. And again, absent any changes from the Fed. If they decide that they need continue to increase rates to stem inflation, then all bets are off as to what our ceiling is.

And then I guess strategically given the increase in first lien and being more selective, focusing on later stage, should we assume that we’re not going to see any sort of yield expansion from just attractive market opportunities, you’re more likely to see real yield compression in coming quarters?

Sure. Thanks, Chris. I don’t think we’re going to see yield compression and we’re really not forecasting any significant yield compression of note. We think despite the fact that we’re moving upstream, despite the fact that we’re positioning into more of a first lien book exposure. We’ll be able to maintain the core yields in that sort of high 13s, low 14s range. So we’re not expecting any contraction and we feel pretty comfortable despite the move upstream that we’ll be able to maintain core yields roughly where they are today.

Great. Thanks guys.

Thanks, Chris.

And thank you. And one moment for our next question. And our next question comes from Ryan Lynch from KBW. Your line is now open.

Hey, good afternoon. My first question was, could you just provide a little context of what drove the – approximately 30 million of unrealized depreciation on your debt portfolio this quarter?

Yes, sure, absolutely Ryan. So it was a number of things offsetting each other. The most significant is the loss on Convoy, which is about 50 million write down on the BDC. And contrasting that though was the appreciation on the remainder of the portfolio where the benchmark rates that we use to really model out what our market value should be for the existing portfolio had a compression in the yields. Whereas we did not see that in our originations and we felt that our portfolio was still coming along pretty strong with the exception of Convoy. So we had a slight uptick in the value of our portfolio of 20 million, and those two things were the offsetting amounts that were most material.

Okay. That makes sense. And then my other question is kind of a two-part question. I think you mentioned you had 23 companies raised new capital in the third quarter, which was the strongest quarter you've had in the last 1.5 years. And so kind of a two-part question on that is, number one, you've talked about having a very strong portfolio for a long period of time. Why do you think was there any sort of driver behind why this quarter was so strong from a capital raising standpoint in your portfolio of companies? And then the second part of that was, maybe this correlation doesn't make sense but natural to me if there's a lot of your portfolio companies that are raising new capital this quarter, you would have seen an increase in prepayment activity. Now, prepayment activity actually got cut in half this quarter from about $300 million to about $150 million. And so it was interesting that, that correlation didn't stand. I'm not sure if historically that's been a good correlation or not, but I naturally would have thought that would have occurred. So why didn't that happen? And are those things normally correlated or not?

Sure. Thanks Ryan. I'll take the second part first. So there actually is not typically correlation between those two items for us. The vast majority of our prepayments historically come from either M&A exits or traditional re-financings when the companies are able to secure cheaper, more bank like facilities. Very rarely will one of our portfolio companies go out and raise an equity round and then use the proceeds to retire the debt. And so there historically has not been correlation. So I really wouldn't look into that too much. On the first point a couple of comments; number one, Q3 was our strongest quarter in terms of Portfolio Company fundraising in the last 18 months as I mentioned in the remarks. It was up slightly from Q2. In Q2 we had 21 companies raise $1.9 billion. In Q3 we had 23 companies raise $2 billion. The biggest driver this quarter was actually continued outperformance on the life sciences side. We had several fairly large public biotech companies achieve very meaningful milestones during the quarter, and they used those milestones to go out and raise additional financing. It wasn't just public biotech that drove that number. If you kind of think about it in terms of public versus private mix of the 23 companies that raised capital in the quarter, twelve were private, eleven were public. So a nice mix between public and private, but definitely some of the bigger ones that helped drive that $2 billion were on the public biotech life sciences side.

Okay. That's really helpful detail and background on that. That's all for me today. I appreciate the time.

Thanks Ryan.

And thank you. [Operator Instructions] And our next question comes from Finian O'Shea with Wells Fargo. Your line is now open.

Hey, everyone. Good afternoon, Scott, first high level question. I think at times not very often but opportunistically Hercules would invest in equity in the past and seeing how you feel that opportunity is today and what your appetite for it might be?

Sure. Thanks, Finn. Right now we're focused on credit. We're focused on underwriting and allocating our capital to new investment opportunities that we think generate the best risk adjusted returns for our investors. And the vast majority of those opportunities we believe right now will come on the secured credit side. We have and we will continue to opportunistically invest in equity. Over the course of Q3, we did make a couple of equity investments in some of our portfolio companies by exercising the RTI, which gives us the right to invest in subsequent rounds of financing. We still think valuations have some room to go down further. And so we're certainly not allocating any significant amount of capital to equity at the current time. And we're going to remain focused on credit underwriting over the near term, yes.

Awesome. Thank you. And just a, a follow up, are you able to remind us on the RIA, AUM and maybe what you targeted or hope or expect for 2024 fundraising?

Sure. We continue to be very excited about the private platform that we have underneath the RIA. We do not disclose separate AUM numbers for the private funds, but we do disclose an aggregate number, which is a little bit over $4 billion in our press release. And that's obviously inclusive of the public and private fund business. You can back into the private fund business AUM by just subtracting what the AUM is in the public BDC from a growth perspective. Right now we still have significant liquidity in the private funds to put to work. We're very excited about the investment opportunities that we think will be in front of us over the next several quarters. And fundraising for next year is, TBD in terms of when we'll go back to market, but we continue to believe that private fund business will be a key driver of returns for our public company investors.

Thanks so much.

Thanks Fin.

And thank you. And I'm showing no further questions. I would now like to turn the call back over to Scott Bluestein for closing remarks.

Thank you Justin, and thanks to everyone for joining our call today.

And Pardon me, Scott, I apologize. We have one more question. Okay. One moment please. And our next question comes from Craig Bellinger [ph] from City National Bank. Your line is now open.

Hi. Thank you. And sorry I was slow to press the buzzer. You know, congratulations on the, on the record results and you know, I appreciate the comments on con convoy and particularly some of the reserves that you've taken. I wonder if there's any other color on that in terms of kind of the go forward position on that particular outlier.

Yes, appreciate the question. We're not going to make any further public comment outside of what I said in the prepared remarks. It remains an active workout situation. We are working with the company to maximize our recovery and based on our efforts to date, as I mentioned in my remarks, we expect that our net recovery will meet or exceed our Q3 fair value mark.

Okay, thank you.

And thank you. Now I would like to turn the call back over to Scott Bluestein for closing remarks.

Thank you Justin, and thanks to everyone for joining our call today. As a final note, we will be participating in the Jefferies Eighth Annual BDC Summit on November 15th in New York City, the JMP Virtual BDC Direct Lending Day on November 30th, and the SMBC Virtual Annual BDC fixed income investor event on December 1st. If you are interested in attending any of these events, please contact Jefferies, JMP or SMBC directly, or Michael Hara. We look forward to reporting our progress on our Q4 and year end 2023 earnings call. Thanks everyone and have a great day.

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