Hercules Capital, Inc. (HTGC) Q3 2026 Earnings Report, Transcript and Summary

Good afternoon. My name is Leslie, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Hercules Capital Third Quarter 2026 Financial Results Conference Call. [Operator Instructions] Please be advised that today's conference may be recorded. [Operator Instructions] I will now turn the call over to Michael Hara, Managing Director of Investor Relations.

Thank you, Leslie. Good afternoon, everyone, and welcome to Hercules Conference Call for the Third Quarter 2026. With us on the call today from Hercules are Scott Bluestein, CEO and Chief Investment Officer; Seth Meyer, President; and Andrew Olson, CFO. Hercules financial results 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 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 Q3 2026 Earnings Call. In the third quarter of 2026, Hercules delivered another strong quarter of operating performance, platform growth, strong seasonal originations and stable credit. Our focus in Q3 remained consistent with what guided us during the first half of 2026. Disciplined and conservative new underwriting, maintaining a strong and flexible balance sheet and being proactive in terms of managing credit. We were also able to further accelerate our efforts to expand the broader Hercules platform. Hercules Adviser LLC, our wholly owned registered investment adviser, surpassed $2.3 billion in investable capital during Q3. The milestone follows the closing of new commitments across several vehicles from a wide range of sophisticated global institutional investors, including insurance companies, pensions, asset managers, foundations and endowments, and family offices. As of the end of Q3, our balance sheet and liquidity position is strong. Our asset base is diversified. Our credit performance remains stable, and our investment portfolio continued to generate net investment income in Q3 that comfortably covered our base shareholder distribution by 118%. Coming off a record-breaking first half for originations, our platform experienced healthy seasonal deal flow in Q3. For the first 3 quarters of 2026, we delivered record originations of $3.44 billion, an increase of 20% year-over-year, and record fundings of $1.93 billion, an increase of 9.9% year-over-year. The combined business activity in the first three quarters helped to deliver new records for total investment income and net investment income for the first three quarters of the year. Driven by the continued growth of both the public BDC and our private credit funds business, Hercules Capital is now managing approximately $6.5 billion of assets, an increase of 17.7% from a year ago. We continue to manage our business and balance sheet conservatively while maintaining the flexibility to take advantage of market opportunities as they arise. This includes continuing to enhance our liquidity position as we did both during the quarter and subsequent to quarter end, remaining disciplined on new underwritings, staying focused on asset diversification and maintaining our higher-than-normal first lien exposure, which was approximately 89% in Q3. Let me now recap some of the key highlights of our performance for Q3. In Q3, we originated total new debt and equity commitments of $701 million and gross fundings of over $572 million. The focus of our origination efforts in Q3 was on maintaining a disciplined approach to capital deployment while emphasizing diversification across the asset base. Our Q3 new commitment activity was weighted slightly towards life sciences companies, while our fundings were weighted more towards our tech portfolio. In Q3, approximately 54% of our commitments and 48% of our fundings were to life sciences companies, while approximately 46% of our commitments and 52% of our fundings were to tech companies. We funded debt capital to 32 different companies in Q3, of which seven were new borrower relationships. During the quarter, we were able to opportunistically increase our commitments and fundings to several portfolio companies that have continued to demonstrate strong performance. Being able to continue to support our portfolio companies as they scale and expand their businesses is an important part of our model and a differentiator of our expanded platform capabilities. Our available unfunded commitments decreased to $397.6 million from $408.2 million in Q2, still maintaining a more defensive positioning of the portfolio. Early loan repayments in Q3 were $148.3 million, which came in below the lower range of our guidance for the quarter. Approximately 44% of the repayments during the quarter came from M&A or balance sheet cash, which we believe speaks to the continued strength of our broader investment portfolio. Despite the market volatility this year, year-to-date through September 30, 2026, we have had over $946 million of early loan repayments, and we expect 2026 to be our strongest year on record for early loan repayments across the debt portfolio. For Q4 2026, we expect prepayments to normalize and be in the range of $200 million to $300 million, although this could change as we progress in the quarter. Our expectation is that both total investment income and net investment income will increase in Q4, driven partly because of the expected normalization of prepayment activity during the current quarter. We anticipate strong originations in Q4, and we expect the originations to be more back-end weighted. Since the close of Q3 and as of October 26, 2026, our investment team has closed $219.6 million of new commitments and funded $89.2 million. We have pending commitments of an additional $571.7 million in signed nonbinding term sheets, and we expect this number to continue to grow as we progress in Q4. Based on our performance to date and the current pipeline activity, 2026 is on pace to be another record year for the company in terms of both new commitments and new fundings, exceeding the previous records that we achieved in 2025. In the current environment where cost of capital is higher than it has been in several years, capital is more difficult to raise and originations are larger and more complex. Scale, experience and platform strength matter more than ever. Hercules is benefiting from this dynamic. Across our existing portfolio, we are still seeing an abundance of attractive opportunities to provide new capital to existing portfolio companies that are meeting or exceeding expectations, and we expect this to again be a driver of our Q4 investment activity. We are also continuing to observe that a handful of lenders, both bank and non-bank remain aggressive in terms of deal structure and pricing for new opportunities. We will remain disciplined and not chase the market in cases where we do not believe it makes sense for our shareholders. This strategy has always served us well. Let me now provide an update on our portfolio and credit performance for Q3. Our asset base remains intentionally diversified with approximately 50% of our assets in our life sciences vertical and approximately 50% of our assets in our technology vertical. No single subsector makes up more than 25% of our total investment portfolio, and our debt investments are spread across 137 different companies with a combined fair value of $4.65 billion. In addition, we have warrants in 114 companies and equity investments in 73 companies. Combined, our warrant and equity investments make up approximately 4% of our investment portfolio. Approximately 98% of our debt investments are floating rate investments with a floor. And as of the end of Q3, nearly 60% of our prime-based loans are at their contractual rate floor. The decrease in the percentage of loans at their contractual floor was driven by the most recent Fed rate increase, which will be accretive to total investment income. Consistent with our historical experience, as of the end of Q3, the average loan duration across our debt portfolio was approximately 22 months. There has been a recent focus on loan vintages across the private credit space. So we wanted to provide some additional color on how that looks at Hercules. Approximately 60% of our active loan book was funded between 2025 and 2026. Approximately 82% of our active loan book was funded between 2024 and 2026. That number rises to 90% if you include 2023 originations. In other words, the vast majority of our portfolio was underwritten and funded after the 2021, 2022 peak in market valuations. In Q3, PIK continued to decline as a percentage of total revenue, falling to approximately 7.5% from 8.3% in Q2. Approximately 85% of our Q3 PIK income came from PIK that was part of the original underwriting or PIK by design. More than 83% of our Q3 PIK income came from loans that were rated 1, 2 or 3. We collected approximately $18.5 million in cash payments on accrued PIK during Q3. Year-to-date, as of September 30, 2026, we have collected $45.8 million in cash payments on accrued PIK income. Credit quality of the debt investment portfolio was stable quarter-over-quarter. Our weighted average internal credit rating in Q3 improved to 2.12 compared to the 2.17 rating in Q2 and remains well within our normal historical range. Our Grade 1 and 2 credits increased to 68.6% compared to 65.4% in Q2. Grade 3 credits decreased to 30% in Q3 versus 32.7% in Q2. Our rated 4 credits decreased to 1.1% from 1.8% in Q2, and our rated 5 credits were at 0.3% versus 0.1% in Q2. Our rated 5 -- rated 4 and 5 credits continue to make up less than 2% of the portfolio fair value. In Q3, the number of companies with loans on nonaccrual remained the same with two loans on nonaccrual with an investment cost and fair value of approximately $18.8 million and $13.2 million, respectively, or 0.4% and 0.3% as a percentage of our total investment portfolio at cost and value, respectively. As of the most recent reporting that we have, 100% of our debt investments that were on accrual are current with respect to the payment of scheduled principal and interest. With respect to our broader credit book and outlook, we generally remain pleased by what we are seeing on a portfolio level, but our portfolio monitoring remains enhanced given the continued volatility in the capital markets. While the exit activity that we saw in our portfolio remained strong during the quarter and through the first half of the year, we are continuing to see that in certain parts of the market, M&A valuation and process timing remain less certain. This is something that we will continue to monitor over the coming quarters. In Q3, we had 3 portfolio companies announce an M&A event. Year-to-date, we've had 13 M&A events and 2 IPOs in our portfolio. Additionally, we currently have 5 debt portfolio companies that are under LOI to be acquired, and our teams are monitoring those transactions closely. Venture capital investment activity in Q3 continued to demonstrate robust levels of investing. Investment activity came in at $98.4 billion for the third quarter, according to data gathered by PitchBook and NVCA. The VC market in the first 3 quarters of 2026 reached unprecedented levels with $515.8 billion deployed, already exceeding the entire 2025 full year figure by nearly 61%. AI continues to define the venture landscape, capturing 83% of the first 3 quarters of 2026 deal value. Fundraising for the first 3 quarters of 2026 totaled $108.5 billion, already surpassing 2025 levels at $78.3 billion. The capital was heavily concentrated among a few established managers. The first 3 quarters of 2026 M&A exit activity remained strong with exit value at $465.3 billion compared to $128.5 billion for all of 2025. Consistent with the aggregate data for the ecosystem, during Q3, capital raising across our portfolio continued to be strong with 25 companies raising over $2 billion in new capital. Year-to-date, as of Q3 2026, our portfolio companies have raised a total of $11.3 billion in new capital, surpassing all of 2025 by a wide margin. We remain confident in the strength and stability of the Hercules platform and our ability to continue to generate strong operating results irrespective of the market backdrop. Our Q3 net investment income covered our base distribution by 118%. This is our 25th consecutive quarter of being able to provide our shareholders with a supplemental distribution in addition to our regular quarterly base distribution. With the expansion of our platform capabilities over the last several years, and our expectation for continued market volatility, we continue to expect a robust new business environment for the remainder of 2026. Our platform scale, balance sheet and liquidity allow us to play offense during market volatility, which should position us to see a robust pipeline of high-quality companies throughout the year. I will now turn the call over to Andrew.

Thank you, Scott, and good afternoon, ladies and gentlemen. Q3 2026 was another solid quarter for Hercules Capital, contributing to record year-to-date results through the first 9 months of the year with total investment income of $430.8 million and net investment income of $268.4 million. During the quarter, we delivered total investment income of $140.1 million and net investment income of $87.3 million. Strong investment activity, coupled with lower prepayments drove net debt investment portfolio growth of $252.9 million during the quarter, with year-to-date net debt investment portfolio growth totaling $380.7 million. Despite the robust net portfolio growth, we continue to maintain a prudent leverage profile, conservative balance sheet and ample liquidity given the pipeline momentum that we carried into the fourth quarter. During the third quarter, we raised $325 million of 5-year institutional 6.3% unsecured notes and repaid $325 million of unsecured notes that matured in September 2026. Further, subsequent to quarter end, we raised an additional $400 million of 6.7% notes due in 2029. Lastly, solid contributions from both the BDC and our wholly owned RIA managed private credit fund business continue to provide us with significant capital flexibility and investment capacity. Hercules Adviser delivered another quarterly dividend of $2.1 million to HTGC, which, when combined with the expense reimbursement of approximately $4.7 million, resulted in $6.8 million in NII contribution to the BDC for the quarter, an 11% increase from a year ago. Year-to-date through Q3, the BDC has received nearly $21 million in total NII contributions from Hercules Adviser, a 22% increase from a year ago. Inclusive of the adviser funds, Hercules had approximately $6.5 billion of assets under management as of quarter end, an increase of 17.7% year-over-year. All in all, it was another productive quarter for the Hercules platform. With that as a backdrop, let me take you through our results in greater detail across four key areas: the income statement, changes in net asset value, balance sheet, leverage and liquidity; and finally, our financial outlook. Beginning with the income statement. Total investment income in Q3 was $140.1 million, an increase of 1.5% year-over-year and a decrease quarter-over-quarter, reflecting a moderated level of unscheduled early principal repayments of $148.3 million, down from the record $572.1 million in Q2. Core investment income, a non-GAAP measure, which excludes the benefits of accelerated prepayment revenue, was a recorded $135.7 million compared to $134.4 million in Q2 and up 6.1% on a year-over-year basis. Net investment income was $87.3 million, or $0.47 per share, in Q3, resulting in 118% coverage of our quarterly base cash distribution and 100% coverage of our total base plus supplemental distribution. With an anticipated increase in prepayment activity during the fourth quarter, we expect an increase in total investment income and net investment income in Q4 relative to Q3 levels. Our undistributed earnings spillover was $167.8 million, or $0.88 per share, providing continued support for our shareholder distribution. Our GAAP effective yield and core yields were 12.3% and 11.9%, respectively, compared to 13.4% and 12% in the prior quarter. The decrease in effective yield was driven by the lower prepayment-related revenue during the quarter and core yield for the quarter was within our guided range, reflecting continued portfolio turnover, which we expect to maintain in the fourth quarter. Third quarter gross operating expenses were $57.5 million compared to $61.1 million in the prior quarter. Net of costs we charged to the RIA, our net operating expenses were $52.8 million. The decrease in operating expenses was largely driven by lower variable compensation expense and excise tax, partially offset by higher interest expense. Interest expense and fees increased to $33.2 million compared to $31.1 million in Q2, reflecting higher borrowings to fund the net portfolio growth and higher cost of debt. Our weighted average cost of debt increased to 5.4% compared to 5.2% in Q2, primarily reflecting the refinancing of our maturing lower coupon notes with new issuances. As we continue to refinance legacy fixed rate debt in the current rate environment and manage our overall cost of capital and liability mix, as of now, we do not have any maturing liabilities in the next 18 months outside of the January notes, which we intend to repay with some of the recent $400 million raise completed in October. SG&A decreased to $24.3 million, primarily due to lower compensation expense and excise tax. Net of costs we charge to the RIA, the SG&A expense was $19.6 million. Our ROAE, or NII over average equity, was 15.4% for the third quarter compared to 16.8% in Q2, and ROAA, or NII over average total assets, was 7.4% compared to 8.3% in Q2, driven primarily by a reduction in the outsized prepayment income we experienced in the prior quarter. Now let's switch the focus to change in our net asset value along with unrealized and realized activity. During the quarter, our NAV per share increased by $0.11 to $12.26 per share, or nearly 1% quarter-over-quarter, driven primarily by net unrealized appreciation of investments and ATM accretion. Our $8.2 million of net unrealized appreciation during the quarter was driven by approximately $9.8 million of net appreciation on debt investments, $8.1 million on FX-related appreciation, $2.6 million of net reversals due to realizations and $0.8 million on warrants, partially offset by approximately $13.1 million of depreciation on publicly and privately held equity and investment funds. Hercules had net realized losses of $1.9 million in Q3, comprised of $8 million of gains on equity and warrant investments, offset by $7.9 million of realized foreign currency losses and $2 million of losses on debt investments. The realized foreign currency loss was related to the repayment of our euro-denominated credit facility, which had a minimal impact on net asset value during the quarter as it represented previously recorded unrealized depreciation. The loss was driven by a paydown of the facility, which was converted into a forward contract to hedge the currency exposure related to euro-denominated debt investments. Those investments continue to carry unrealized appreciation from foreign currency movements and the net impact of the transaction was accretive. Moving on to discuss our capital position. While funding strong net portfolio growth, we maintained a conservative and liquid balance sheet. GAAP and regulatory leverage increased to 111.1% and 96.1%, respectively, compared to 103.9% and 88.5% in the prior quarter as net portfolio growth was funded with borrowings given lower prepayment activity. Netting out leverage with cash on the balance sheet, our net GAAP and regulatory leverage was 109% and 94%, respectively. We ended the quarter with $506.6 million of available liquidity in the BDC, subject to existing terms and covenants. Inclusive of capital raised by funds managed by our RIA subsidiary, the Hercules platform had more than $1 billion of available liquidity as of quarter end. The strong liquidity, together with our conservative leverage positions us very well to support our existing portfolio companies and source new opportunities. As previously mentioned, subsequent to quarter end, Hercules Capital issued $400 million of 3-year institutional 6.7% unsecured notes due in 2029. Also during the quarter, we raised $39.2 million via the ATM, selling 2.3 million shares to support our net debt portfolio growth while maintaining a prudent leverage profile. Our intent is to remain disciplined and thoughtful about how and when we use the ATM, given our long-term focus on maximizing shareholder value and the numerous non-dilutive capital sources that we have access to. Overall, the current market continues to offer a very favorable capital deployment environment for Hercules, and we want to ensure that we are well positioned to opportunistically take advantage of that for the long-term benefit of our shareholders. We will continue to maintain a nimble capital structure, allowing us to compete aggressively on quality transactions, which we believe is prudent in the current environment. Lastly, let's look ahead to the fourth quarter. For the fourth quarter, we expect our core yield to be in the range of 11.8% to 12%, including the recent change in benchmark interest rates and portfolio turnover. As a reminder, 98% of our debt portfolio is floating with a floor. Although very difficult to predict and following the $148.3 million of prepayment activity in the third quarter, we expect prepayment activity to normalize to a range of $200 million to $300 million in the fourth quarter. We expect our fourth quarter interest expense to increase given recent offerings. For the fourth quarter, we expect gross SG&A expenses of $27.5 million to $28.5 million and expense allocation of approximately $4.5 million. Finally, we expect a quarterly dividend from the RIA of approximately $2 million to $2.5 million per quarter. In closing, Hercules delivered another strong quarter in Q3 2026, marked by record core investment income and net debt portfolio growth. Our balance sheet, liquidity position and credit discipline continue to position us well to scale our platform and capitalize on opportunities as we close out the year. I will now turn the call over to the operator. Operator, over to you.

[Operator Instructions] We will take our first question from Finian O'Shea with Wells Fargo.

So on core yields, you gave a lot of color in the call. It sounded like toward the end, a little bit more compression adjusted for base rates. Correct me if I'm wrong there. But sort of what are the drivers of the headwind at this point? Is it the capital market, you going upmarket? And what it would kind of -- what sort of change would allow this to stabilize?

So our guidance for core yield in Q4 was 11.8% to 12%. Our core yield in Q3 was 11.9%, so right in the midpoint of that range. And based on everything that we are seeing through today, we have a high degree of confidence that our core yields will be that 11.8% to 12% range. So really not seeing or expecting any further compression with respect to core yield. And I think at this point, just based on our outlook, our pipeline, I think we also feel fairly confident that we actually don't expect to see any more material degradation with respect to core yield over the coming quarters.

Okay. And then just a small follow-up, forgive me if you hit on this, the G&A comp expense was a pretty good tailwind this quarter. Is that more one-off? Or were the recent couple of quarters more on the high end of kind of what we should model on that side?

Yes. I think the current quarter was slightly lower than what you've seen in prior quarters. That was mostly just driven by some adjustments to the overall originator compensation throughout the year and excise tax. So I would expect it to kind of normalize back to what you've seen kind of an average of the prior couple of quarters.

Our next question is from Merrill Ross with Compass Point Research & Trading.

So far, looking at the trend in the expenses allocated to the RIA, it seems to run counter to the fact that you talk about growth in AUM. And so I'm just wondering what is the driver kind of the quarterly step down in that allocation if the assets are growing in the RIA.

Yes. I think there's kind of two factors. So the RIA AUM is growing overall, though it does take time for deployments to kind of ramp up. So there's an investment that's made in the funds as we're initially launching them. So although AUM is growing, we're kind of still continuing to invest in those vehicles. I think the second point is the kind of the allocation overall will somewhat move in line with what you see in the G&A on the BDC side, mostly because a portion of that is driven by originator compensation. So variable compensation on the originator side as we allocate deals, we'll also allocate a portion of the variable compensation and tax expense. So they're a little bit correlated, although we'd expect future quarters as that business continues to mature for there to be more of a meaningful allocation of expenses and ultimately dividends coming from the private side.

Our next question is from John Hecht with Jefferies.

You guys made comments on the core yields. But I'm wondering like on the current deal flow, has there been any changes with respect to spreads, the prepayment fees or the other fee components? And I'm thinking like over the last 6 months, has there been any change on that?

Yes, John, nothing that's material. Prepayment economics remain largely consistent with what we've seen historically. End of term economics remain largely consistent. I would say over the last 18 to 24 months, as we've noted, there has been competitive pressure across the ecosystem that has taken onboarding yields down. But based on the current pipeline and based on everything that we're seeing in our business today, we feel very confident that the core yields are going to stabilize in that sort of 11.8% to 12% range. And we're not seeing anything in terms of the new deals that we're looking at that would lead us to a different conclusion.

Okay. That's very helpful. And then I mean, obviously, one of the key themes in tech are AI innovation, but also the build-out of AI infrastructure. How do you think about that? How do you kind of position Hercules for that intermediate-term type of explosive activity?

Sure. So I think we're approaching the space broadly the same way that we've been approaching the space now for several quarters. We're not investing in what we would consider to be sort of pure-play AI-related companies. We're not participating in any direct GPU financing facilities. What we are looking to do is to essentially invest in companies, in sectors, in verticals that we think are going to be drivers of AI adoption. So power, energy, networking and communications. We're also looking to invest heavily in sectors that we think will benefit from increased AI capabilities, defense tech and space tech. And that's why if you look at our SOI, you've seen some pretty significant movements in a couple of key areas. And I think that's really indicative of how we're looking to approach the space, broadly speaking.

Our next question is from Crispin Love with Piper Sandler.

This is Ben Graham in for Crispin Love. You obviously mentioned credit quality continues to be solid. And I'm just wondering if you could discuss a little deeper your outlook there, specifically sort of the forward indicators that you're watching most and how they're behaving.

Sure. So I think we gave some commentary on that in the prepared remarks. Based on everything that we're seeing as of today, our credit outlook remains stable. 100% of our debt portfolio companies that are on accrual status are current with respect to contractual payments of principal and interest. We're not really seeing a slowdown with respect to capital raising across our portfolio. And a lot of the key metrics that we use in terms of funded debt to paid in capital or invested capital ratios, our LTV ratios are very consistent this quarter from what we saw in Q1 and in Q2. And obviously, too early to speak to Q4 because we haven't run those numbers yet, but we're not seeing anything in the data that we have that would tell us that our credit outlook is not going to be consistent with what we just discussed on the call today for Q3.

Awesome. I appreciate the color there. And then quickly, I'm just wondering if you could also share a little bit about where you're most interested in putting incremental capital today, at least broadly, if you're leaning more towards life sciences and tech or how large could life sciences get versus tech here?

Sure. So Ben, I appreciate the question. We're not going to give any guidance with respect to particular sectors that are our focus points for us because obviously, we want to do that, and then we'll talk about it after we've done it. What I would say to you is our focus on the asset side continues to be centered around asset level diversification. We want the asset book at Hercules to be as diversified as possible because we think that allows us to outperform irrespective of the market environment. Right now, we're running our book with a target asset allocation of 50-50. So we want 50% of our exposure to be in life sciences. We want approximately 50% of our exposure to be in technology. Within each of those 2 core verticals, we also want a significant sector diversification. So if you look at our SOI, there's a tremendous amount of sector granularity. We manage and monitor our top 5 and our top 10 companies as a percentage of the portfolio pretty closely. So our emphasis and our priority is on diversification, not necessarily with respect to any specific sector or not.

Our next question is from Christopher Nolan with Ladenburg Thalmann.

Scott, in your comments on the broader VC market, you talked about scarcity of capital on the call. Is that more for credit or equity venture?

Yes. So that was more of a reference to just private credit, so not a reference to the VC market. To the contrary, we're continuing to see tremendous strength in terms of capital raising across the venture capital ecosystem. And I touched on a couple of these data points in the prepared remarks, but just to sort of double back on them. Year-to-date through Q3, venture capital firms have already invested over $500 billion of capital. That is the strongest year on record, and that is obviously excluding Q4. We're also seeing some pretty strong momentum and a rebound in terms of fundraising across the venture capital ecosystem. And that data is consistent with what we're seeing in our own portfolio, where through Q3, our companies have already raised over $11 billion of capital. The comment about capital being more expensive and a little bit more difficult to raise was a reference to private credit broadly, not a reference with respect to the venture capital ecosystem.

Great. And as a follow-up on that broader industry, the turmoil in Europe, how is that affecting the innovation space? Are you seeing companies start to migrate out of Europe as a result of that? Or any observations?

Yes. So we haven't seen any impact to date. What I would tell you is a lot of what's happening in Europe is fairly recent. So it's something that we are watching closely. I would tell you that Europe and the international markets broadly continue to be a focal point for us, but it continues to be a relatively small part of our business. 90-plus percent of our business is centered around the U.S. There are a couple of core geographies that we do focus on in the international markets, and we've been very successful in that regard. So I think we're going to continue to invest in certain international geographies, but it will be limited to those geographies where we feel comfortable and confident in the long-term outlooks for those specific areas.

Our next question is from Chris Muller with Citizens Capital Markets.

Congrats on a nice quarter here. So ROEs have come down understandably over the last couple of years, but we're now in a rising rate environment. So is it fair to think that ROEs are either at or near a trough, especially if the forward curve plays out with another couple of hikes?

Yes. I think when we look at the modeling that we're doing internally, just based on the rebound that we expect in prepayments, as an example, in Q4, we would expect ROE to start to head north. And I think generally speaking, our outlook tells us that ROEs have probably reached a floor.

Got it. And that's a good dovetail into my follow-up. So early repayment fees, looking at that versus NII last quarter, I guess how much of the $0.03 decline in NII was due to the elevated repayment fees last quarter?

It was nearly all of it. I mean we had net portfolio growth during this quarter. And so -- and some of the origination activity that occurred last quarter was back weighted. So I would say it was nearly all of the net degradation was prepayment related.

Yes. And I would just point out, Chris, if you look at Q3 prepayment activity and associated non-core income, it was one of the slowest quarters we've had in several years. So as Andrew said, almost the entirety of that decline was attributable to the fact that prepayments went from $572.1 million to $148.3 million quarter-over-quarter.

Got it. So that normalizing will be a nice tailwind to earnings, too.

Our next question is from Paul Johnson with KBW.

What was the write-down driven by in the equity portfolio? Is that just like a single investment driving that? Or were there multiple companies, I guess, behind the equity write-down this quarter?

It was a little bit broad-based. There was a conversion of debt to equity that we transferred over a portion of unrealized that was not net new unrealized depreciation. So it's just more of a conversion from debt to equity. But the rest of it was all just kind of broad market. So there wasn't any one individual position that made up a material portion.

Got it. Okay. And then in terms of like the capital raise in the portfolio this quarter, what would you say that you've seen so far in terms of like the venture capital support for the software companies in your portfolio? I guess, did any of that capital raising include any of the software companies? And what has kind of been your observation there in terms of the support?

So I can't speak to the Q3 data specifically because I actually don't have that breakout in front of me. But I can tell you, year-to-date, we have absolutely seen capital inflows to our software portfolio. That does not mean that every software company is able to raise money because that would be inaccurate. But we are not seeing venture capital firms, at least in our portfolio companies turn away from software broadly. I would also point out that if you look at our M&A activity year-to-date, we've now had 13 exits. More than a handful of those exits have come from our software portfolio and our two biggest exits year-to-date have come from our software portfolio as well. So continuing to see activity across the software portfolio. There are a handful of companies that we continue to monitor aggressively with enhanced monitoring, just given some of the disruption that we've seen across the ecosystem. But I would not say that we have seen a general pullback, at least in our portfolio from venture capital interest in software companies.

Got it. Okay. That's very helpful. And then in terms of -- my last question, just in terms of the LOIs, I think you mentioned there are five companies under LOI this quarter. I'm just curious how many of those like historically, those typically convert into like a payoff or a realization event for the BDC?

Yes. I would tell you, historically, the majority of our companies that end up under an LOI, those transactions end up closing. I can't tell you though when they will close. So could be Q4 events, could be Q1, could be Q2. We've had LOIs that get signed. You have a 90-day process, you sign definitive documentation and then there's HSR or regulatory approval and it can take 6 to 9 months from there. So we would expect a high degree -- a high percentage of those five companies to end up closing transactions, but when they'll happen is very much up in the air.

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

Thank you, Leslie, and thanks to everyone for joining the call today. We will be attending the Citizens Financial Services Conference in New York on November 17. If you would like to meet with us at the conference, please contact Citizens or Michael Hara. We look forward to reporting our progress on our Q4 and full year 2026 earnings call. Our scale, institutionalized lending platform and our ability to capitalize on a rapidly changing competitive and macro environment continues to drive our business forward and our operating performance to record levels. Our continued success is attributable to the tremendous dedication, efforts and capability of our 120-plus employees and the trust that our venture capital and private equity partners place with us every day. We're thankful to the many companies, management teams and investors that continue to make Hercules their partner of choice. Thanks, everyone, and have a great rest of the day.

This does conclude today's Hercules Capital Third Quarter 2026 Financial Results Conference Call. You may now disconnect your line, and have a wonderful day.