Q1 2021 Hercules Capital Inc Earnings Call
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Ladies and gentlemen, and good for standby and welcome to the Hercules Capital Q1, 2021 earnings conference call. At this time all participants are in listen only mode. Later, we will conduct a question and answer session and instructions will follow at that time, if and when should you export assistance during the conference. Please.
Press the Star then zero on your Tech Zone telephone as a reminder, this conference call is being recorded I would now like to turn the call rich and Mr. Michael Hara managing director of Investor Relations. Please go ahead Sir.
Thanks, Charlie.
Thank you to everyone and welcome to Hercules Capital Conference call for the first quarter of 2021.
With us on the call today from Hercules, and Scott, boosting CEO and Chief investment Officer and.
Seth Meyer CFO.
And he is first quarter of 2021 and financial results were released just after today's market close and it.
Can be accessed from Hercules Investor Relations section at <unk> Dot com.
Range for a replay of the call at Hercules webpage or by using the telephone number and pass code provided in todays earnings release.
This call we may make forward looking statements based on current expectations actual financial results filed with the Securities and Exchange Commission may differ from those contained herein due to timing delays between the date of this release and in the confirmation and final audit results and.
In addition, the statements contained in this release and are not purely historical are forward looking statements. These forward looking statements are not guarantees of future performance and are.
Subject to uncertainties and other factors that could cause actual results to differ materially from those expressed in the forward looking statements and including without.
Patient the risks and uncertainties, including the uncertainties surrounding the current market turbulence caused by the COVID-19 pandemic and other factors, we identified from time to time and our filings with the SEC.
Although we believe that the assumptions on which these forward looking statements are reasonable and any of those assumptions can prove to be inaccurate and as a result, the forward looking statements based on those assumptions and also can be incorrect.
You should not place undue reliance on these forward looking statements are forward looking statements contained in this release are made as of the date hereof and Hercules assumes no obligation to update the forward looking statements or subsequent events.
To obtain copies of related SEC filings, please visit our website and when.
That I will turn the call over to Scott.
Thank you Michael and thank you all for joining US today, we hope that everyone is staying safe and healthy.
Q1, 2021 was another strong quarter for Hercules capital, we delivered solid operating results strengthened and expanded our investment platform and continue to emphasize credit discipline across our investment portfolio.
Our investment team hit the ground running in 2021 with record Q1 performance for both gross new debt and equity commitments and fundings.
Even as the population continues to progress with vaccinations more states announced plans for reopening and the broader markets continued to show strength, we continue to conservatively manage the business by maximizing liquidity staying disciplined on new underwritings, ensuring a strong balance sheet and maintaining substantial.
<unk> operational flexibility.
The public and private equity markets continued to perform exceptionally well and an abundance of liquidity across our core markets requires us to prioritize prudent underwriting and investment discipline more than ever.
Let me recap some of the key highlights of our performance for Q1.
We originated nearly $531 million of gross new debt and equity commitments and delivered gross fundings of over $355 million.
Our debt and equity commitments and fundings in Q1 were weighted towards new portfolio company relationships and we're balanced nearly evenly between our core technology and life Sciences verticals.
We saw strength across each of our areas of focus during the quarter.
As we saw throughout 2020, many of our portfolio companies continue to achieve certain performance and capital raise milestones during Q1, which allowed us to once again expand our lending relationships with several companies and our existing portfolio.
Even though our new business originations were strong in Q1, we chose to stay disciplined and focused on strong underwriting parameters as an abundance of equity capital and loosely structured debt has continued to create certain challenges in terms of prudent new business origination.
Our platform scales and brand reputation and continue to give us exposure to an active pipeline that currently exceeds $1 billion and potential investments.
The quality of the companies and our pipeline is the best that we have seen and some time, but we will continue to evaluate each opportunity with a focus on staying true to what has made us successful on a sustained basis over the last 16 years.
Since the close of Q1 and as of April 27, 2021, Hercules has already close to $135 million of new commitments and we have pending commitments of an additional $152 9 million and signed non binding term sheets.
We expect the majority of our Q2 funding activity to be weighted towards the back end of the quarter.
Through April 27, 2021, our closed and pending commitments total $818 8 million, which puts us on pace to comfortably exceed over $1 billion of total new commitments for the fourth consecutive year.
During Q1, we continued to see strength in terms of portfolio company exits and portfolio company liquidity events.
This combined with continued very strong performance across our portfolio again drove high levels of early payoffs.
Early loan repayments were at the high end of our guidance of $150 million to $200 million at over $191 million, but decreased from $282 million in Q4.
For Q2, we again expect prepayments to be between $150 million and $200 million. Although this could change materially as we progress in the quarter.
Even with the continued elevated levels of early payoffs are strong fundings during the quarter produced net debt investment portfolio growth of over $82 million after allocating over $47 million of new fundings to the private fund that we now manage through our wholly own registered investment advisor.
In Q1, we generated total investment income of $68 8 million and net investment income of $34 6 million or <unk> 30 per share.
The decline in both total investment income and net investment income was consistent with our guidance and due to the lower debt portfolio balance attributable to the record Q4 payoffs and lower fee income as a result of a lower level of prepayments during the first quarter.
Our portfolio generated a GAAP effective yield of 13, 2% and Q1 and a core yield of 11, 6%, which was above the midpoint of our previous guidance for 2021.
With net regulatory leverage at a very conservative 83, 5% and continued robust liquidity across our platform, we remain very well positioned.
Credit quality on the debt investment portfolio again improved in Q1 with a weighted average internal credit rating of 2.01 as compared to $2 one six in Q4.
This was our strongest internal credit ratings since 2011 and.
And it speaks to the strength that we're seeing and our core markets.
Overall, our grade one and grade two credits increased to 79, 6% in Q1 versus 68, 7% in Q4.
<unk> three credits decreased to 19, 5% in Q1 versus 29, 7% in Q4.
Our rated four and five credits made up 0.9% of the entire debt portfolio fair value.
In Q1, we had four debt investments on non accrual with a cumulative investment cost and fair value of approximately $24 1 million and $8 million, respectively, or 1% and 0.3% as a percentage of the company's total investment portfolio at.
Cost and value respectively.
As a result of continued strong performance across our portfolio the exceptionally strong equity capital markets and robust exit and IPO activity. Our Q1 net asset value per share increased by nearly 1% to $11 and 36.
We ended Q1 with strong liquidity of $550 million, which provides us with substantial coverage of our available unfunded commitments of $258 million and the ability to fund our ongoing anticipated business activity.
Overall, we believe that our balance sheet is exceptionally strong and well positioned.
The venture capital ecosystem continued to exhibit strength in Q1 after a record year in 2020.
For Q1 venture capital funds raised a total of $32 7 billion and invested over 69 billion in the U S. According to data gathered by pitch book and the NVCA.
The overall vibrancy of the VC ecosystem has continued to positively impact our portfolio.
As of the most recent data that we have we estimate that approximately 80% of our portfolio continues to have at least 12 plus months of current liquidity and since just our last earnings call. We've had an additional 12 of our debt portfolio companies raised new capital totaling over $655 million.
<unk>.
Year to date, we have had four new M&A events, two of which have closed and seven companies that have either filed registrations for their initial public offerings or have agreed to stock transactions.
In addition, several of our companies are currently working on either new capital raises or strategic transactions, and we expect M&A and IPO spec activity to remain strong over the next few quarters.
I would also like to discuss our supplemental shareholder distribution program for fiscal year 2021.
In addition to our ninth consecutive quarterly cash distribution of 32 per share. We are also declaring a supplemental distribution of <unk> 28 per share for fiscal 2021, which will be distributed equally at seven <unk> per quarter for the next four quarters beginning with the first.
Quarter distribution payable in May 2021.
As of Q1 2021, we have generated undistributed earnings spillover of approximately $109 1 million or <unk> 94 per share subject to final tax filings.
This provides us with additional flexibility with respect to our variable base distribution going forward.
And the ability to continue to invest in our team and platform.
Finally, I would like to briefly touch on the progress that we made and the first quarter in terms of strengthening and expanding our investment platform.
And after establishing Hercules advisor as a wholly own registered investment adviser and 2020. We are very pleased to have raised and closed our first institutional private credit fund.
Having this first fund and potentially future funds gives us the opportunity to expand and diversify our investment platform, while enhancing our level of service and service and capabilities to our current and future of venture growth stage companies.
While we anticipate that it will take time to ramp up our activities under our RIAA. We do expect that over the short term Hercules capital will benefit from being able to share certain expenses with Hercules adviser and having a more diverse platform for the funding of new investments.
Longer term and subject to the ultimate performance and size of the funds managed by Hercules adviser, we expect Hercules capital to potentially benefit from distributions from the adviser as that business ramps up.
In closing.
Our employees have continued to work tirelessly to ensure that Hercules capital remains the premier provider of growth capital to venture and growth stage companies.
And I'm grateful and thankful to each of them for their work effort and commitment.
I would also like to thank each of our 100 plus portfolio companies and their institutional investors that have chosen to make Hercules capital their preferred financing partner.
I will now turn the call over to Seth.
Thank you Scott and good afternoon, ladies and gentlemen, and Scott mentioned the investment team gave us a great start to 2021. This was another very strong commitment and funding quarter for Hercules, we were able to grow the loan book by $82 5 million and it costs during the quarter, which allowed us to replace the <unk>.
Portion of the portfolio declined from Q4, which was the result of elevated prepayments during the prior quarter.
We delivered total investment income of $68 8 million and once again.
<unk> and <unk> appreciation per share triggered by the strength of our portfolio and the broader market.
Our early payoff levels reduced to $191 5 million, which was again elevated but within the guidance range.
During Q1, we successfully closed our first private fund and as a result, we allocated a portion of certain commitments and fundings to the initial private fund.
This also allowed us to allocate certain expenses to Hercules advisor or a a managing the private fund during the quarter.
Net of allocations to this day initial fund the healthy loan growth helped our total investments grow by $88 4 million to $2 4 billion at cost.
As usual I'll focus on the following areas Inc.
<unk> statement performance and highlights and.
Unrealized and realized activity.
Leverage and liquidity and then finally to the outlook.
With that let's turn our attention to the income statement performance and highlights.
Net investment income was $34 6 million or <unk> 30 per share and Q1, a decrease compared to the prior quarter attributable to the elevated early repayments in Q4 of 2020.
Total investment income was $68 8 million a decrease compared to the prior quarter. The main driver for the decrease.
Two the total investment income was lower interest and fee income as a result of the higher payoffs and related portfolio decline experienced in Q4.
Our effective and core yields and the first quarter were 13, 2% and 11, 6%, respectively compared to 13, 3% and 11, 8% and the fourth quarter.
The quarter yields were largely in line with the prior quarter with a slight decline and the core yield due to a modest decrease in income from expired unfunded commitments.
Turning to expenses, our gross operating expenses for the quarter increased to $35 1 million compared to $33 2 million and the prior quarter.
Net of cost recharge to the RIAA, our operating expenses were $34 2 million.
Interest expense and fees increased slightly to $17 5 million from $17 2 million and the prior quarter due mainly to the acceleration of fee recognition for the partial pay down of the SBA debentures and securitization due to the reinvestment period ending for those instruments.
SG&A expenses increased to $17 6 million from $16 million and the prior quarter.
The increase was driven by higher compensation expenses related to the increase and fundings and first quarter payroll taxes, which normally run higher and the first quarter.
Net of cost recharge to the RIAA the SG&A expenses were $16 7 million.
Our weighted average cost of debt was five 5%.
Which represented a small increase compared to the prior quarter driven by additional fees associated with early debt retirements from both our Securitizations and SBA debit share and loan repayments. The adjusted cost of debt excluding fee acceleration was consistent with the prior quarter at five.
And 1%.
Let's now switch to NAV.
Unrealized and realized activity.
During the.
Our NAV increased by <unk> 10 per share share to $11 36 per share this represents and NAV per share increase of 9% quarter over quarter.
The main driver for the increase was the net change in unrealized depreciation of $21 9 million after reversal of prior unrealized depreciation of $7 million, mainly due to investments disposed or written off.
Our $21 nine.
And 9 million of net change in unrealized depreciation was primarily driven by the mark to market of our equity and warrant portfolio, which contributed $13 $8 million a day movement.
Our debt portfolio also benefited from declines and the market yields contributing $8 1 million of appreciation.
The net realized gains and the quarter of $7 8 million comprised of $8 8 million of net gains from the disposal of equity positions.
<unk> by $1 million of realized loss pertaining to one loan position.
Moving on to discuss leverage.
Our GAAP and regulatory leverage was $94 six.
Per cent, and 89, 2%, respectively, which decreased compared to the prior quarter due to the partial repayment of the two securitization, which are now and runoff netting out leverage with the cash on the balance sheet, our GAAP and regulatory leverage was 88, 9%.
And 83, 5%, respectively, putting us in a very strong position heading into the next quarter.
Our leverage includes the March issuance of $50 million five year notes and a private placement with a fixed coupon of 455%.
This was the second tranche of the arrangement announced in November 2020, totaling up $100 million and private placement financing.
In addition, we have started to utilize our third SBA license, drawing down 37, and $5 million of debit yours, and I and attractive annual interest rate of seven and 7%.
As a result, we ended the quarter with strong liquidity of 550 million. This excludes the additional amounts available via our new SBA license as well as capital raised by the <unk>.
As a reminder, our liquidity continues to be enhanced by our normal course monthly principal and interest collections as well as early repayments.
And finally on the outlook points, our core yield guidance of 11% to 12% continues to apply for Q2 2021.
For the second quarter, we expect SG&A expenses of $16 million to $17 million slightly.
Below the prior quarter as Q1 always has higher employer payroll taxes.
We expect our second quarter borrowing costs to decrease modestly this is dependent on weather early repayments.
Our heavily weighted two portfolio companies assigned to the two securitizations, which are now and natural runoff and trigger and increased capitalized fee recognition, we have assumed a normal weighted allocation to the securitization.
Although very difficult to predict as communicated by Scott, we expect $150 million to $200 million and prepayment activity and the second quarter.
Now that the IRI is operational and managing outside capital, we anticipate being able to allocate expenses to the <unk> on a go forward basis for the second quarter, we expect a similar level of expense allocation.
What we saw in Q1.
In closing we are pleased with the start of 2021.
And look forward to building on this success of the quarter. We continued to focus on the things that we believe will position us best given the current operating environment.
And I'll now turn the call over to Charlie to begin the Q&A portion of our call Charlie over to you.
Thank you, Sir ladies and gentlemen, if you have a question at this time. Please press Star then the number one key on your Touchtone telephone. If your question has been answered or you wish to remove yourself from the queue press accounts. Please limit your question to one and one follow up.
Your first question comes from the line and Finian O'shea with Wells Fargo Skews Your line standard.
Hi, everyone. Good afternoon.
First question on the RIAA, Scott I saw there were some dropdowns into that.
Vehicle over the quarter.
Can you provide some color on.
And if that was just us.
Start up type.
Transaction or if that will be ongoing and and then for that matter.
How different will the strategy of the private funds or at least this one.
B versus Hercules BDC.
Sure. Thanks, Ben we're only going to speak to this fund because thats. The one that has been raised and is currently being invested out of what you saw in Q1 was essentially and allocation of certain of the <unk> commitments and fundings to the private fund we would anticipate that you will continue to see.
That to a varying degree on a go forward basis on a quarterly basis.
Our reasons and the drivers for that can vary on a quarterly basis. It could be diversification it could be the size of the deal it could be industry your concentration issues, but we would anticipate that.
Parts of certain deals will continue to be allocated to the private fund on a go forward basis, and we would also anticipate at the same time that the private fund will do certain transactions on its own that will not be originally originated were funded from the <unk> business.
Okay, and just just to be clear those were.
And those were new origination co invests rather than.
Existing.
The issue of Dropdowns.
Correct those renew those were new commitments and new fundings in Q1 that were allocated to the private fund.
Okay. Thank you and then just.
The second on expenses I think you said there was a.
Payroll taxes were up is that was that most of the.
The driver.
Versus.
Can you kind of break that down between larger and the U S.
And.
Market costs and general and what.
If we can we expect any change and the expense rate going forward overall.
Opposition and such yeah.
Yeah, and so the expenses were mainly related to the increase of the fundings fan.
So that was a pretty significant jump quarter on quarter.
<unk> role taxes will run off as they regularly do Q1 is always a higher employer payroll tax quarter than the rest.
And for the guidance going forward really we can only say 16 to 17 million for Q2 and beyond that we'll give guidance as we get closer.
Okay, Great. That's all from me thanks, so much.
Your next question comes from the line Kristen lumped with Piper Sandler Your line is now open.
Firstly can you give a little more color on the credit quality trends that you've been seeing the 2.01 grade from the portfolios and the best quarterly metric, but I think I have on record and my model. So what did you see that drove it significantly lower during the quarter and I guess.
Just what has changed versus recent quarters.
Sure. Thanks, Chris I think it's two things number one it is just the overall strength from a portfolio perspective that we're seeing most of which is attributable to liquidity.
We've kind of highlighted on the last several earnings calls, we've had more and more companies raise larger and larger rounds of financings.
Several of our companies continue to have right now record liquidity and so if you look at the migration that we share of shelf show on a quarterly basis. When we started Q Q1 of 2020, which is sort of the first quarter of the COVID-19 pandemic, we had a weighted average credit rating of roughly 234, and then we've had now four consecutive quarters.
The improvement in Q1, we were down to 2.01, the two biggest drivers worrying increase and the rated one credits those are the companies that are either abundantly capitalized or performing well above our expectations and the second driver was a reduction in the rated three credits those are the companies that are.
<unk> or are about to raise equity capital and then our general philosophy is once those companies raise capital we upgrade them either to a rated two or rated one. So those were the two biggest drivers and I think it just speaks to the tremendous job that our team has done in terms of identifying the right opportunities to invest and and the strength that we're seeing across the portfolio.
Okay. Great. Thanks, that's helpful. One more from me can you just talk about some of your recent investments I think you said that they were geared towards new relationships I.
And I'm curious about what caused that that its more for a new relationship and have to do with recovery and reopening and changing the way that your diligence process is going or is it just more comfortable with kind of the diligence process that you've had for the last several months during the pandemic.
I think the credit really goes to our investment team.
We've just seen tremendous performance from both our technology team and our life Sciences team and we're seeing it across the venture and the growth stage parts of our markets.
Our team has done a great job in terms of building and expanding our pipeline and I made the comment that our pipeline right now is over $1 billion and from a from a quality perspective, we think it's the strongest pipeline that we've seen from a quality perspective, and some time, both on the technology and on the life Sciences side.
And I think the team has been very aggressive in terms of trying to pick the ones that we want and we want to go after and then finding creative and flexible solutions that allow us to get deals done with those companies and Thats. What you saw in Q1.
We had strong funding and commitment performance, both with respect to new portfolio investments and existing portfolio investments, but as we mentioned and the call of the numbers more weighted more towards new investments in Q1.
Your next question concerns the lineup and Devin Ryan with JMP. Your line is open.
Good evening everyone.
Evening.
Okay.
So most of my questions have been asked maybe.
Just on the spec market.
Okay.
And to hit a little bit of indigestion and.
And some maybe additional FTC scrutiny. So I'm just kind of curious how that maybe affecting things at all.
Some of the companies kind of in process and mature that slows things down or are there any other considerations.
Things that you guys have a plan for just with some of the developments and the stock market.
Her picture kind of expectations going forward.
Sure, we're certainly monitoring the spec market pretty closely and I think it's fair to say that there has been a little bit of a slowdown here over the last 30 to 60 days.
And Theres a backup in terms of filings there as a backup in terms of SEC review the FCC is raising some new issues now primarily around.
Accounting related to legacy warrant positions that is is creating some issues for certain companies I would tell you that within our portfolio. We have not seen much of a slowdown at all right. Now we have five companies that have announced spec transactions that are in process of all of those remain and process as.
Of the current date and we're aware of several other additional portfolio companies that are in active conversations force back transactions. So we're monitoring it and we are aware of a broader slowdown in that market, but we have not seen that impact our portfolio yet.
Okay terrific and just a quick follow up on institutional private credit fund, obviously, congratulations on that and.
And if you get what is the size of that and interest expected kind of investment cadence any other color you can give on that would be helpful.
Sure.
Non registered institutional private credit fund, we're not going to disclose the size of the fund at this time.
At least for the initial fund.
And that fund ramps up we will make disclosure around what level of AUM. The RIAA is managing.
I think the bigger picture comment that I would make is that this initial fund and gives us several hundred million dollars of additional dry powder to invest with we expect the private fund the first one and potential future farmers to be very accretive to the Hercules platform.
It should give us the ability to go after larger transactions it should give us the ability to go after select smaller transactions. It should give us the ability to offer some differentiated structures and differentiated pricing models and it should also over time and give us the ability to explore some new verticals to potentially expand into as well. So it's something that we have.
And working on for a number of years and it's something that we're very excited about in terms of diversifying and expanding the <unk> investment business.
Okay, great well congratulations and.
And taking my questions.
Sure.
Your next question comes from the line of Ryan Lynch with <unk>. Your line is now open.
Hey, good afternoon guys.
First one I just had another one on the private fund raised.
Can you just talk about what is that strategy compare it to the strategy at Ht GC and what I'm getting at is.
Does it does if the strategy is somewhat different.
In what ways and and what sort of new deal opportunities will that open up or is it basically the same strategy that you guys. Currently run at <unk> that will just allow you to take down larger commitment sizes to your potential borrowers.
Sure Ryan I think the answer is it's both initially it's more ancillary and complementary to the existing investment strategy.
You know from having covered us for a number of years there are certain restrictions that we have to deal with being an internally managed BDC.
Having this private credit fund will allow us to manage and potentially mitigate some of those challenges and historical issues that we've had in terms of diversifying and growing and expanding the platform.
Over time, we would expect the private credit fund business to allow us to potentially go into new asset classes, new verticals, but at least initially I think what youre going to see is that the investment strategy is very ancillary and very complementary to what we're doing and it will allow us to just take advantage of opportunities that we may otherwise not be able to do because of the.
<unk> managed BDC structure.
Okay understood.
You mentioned, a really strong pipeline billion billion plus of deals and you also said these are very high quality companies and that pipeline I guess.
What are what are the characteristics that you guys use net debt determining what sort of company or potential deal could go into your pipeline and are these are strong companies that could use debt financing are these conversations you're already having just because with.
And with the amount of capital that's been raised and the venture.
And the venture ecosystem as well as the valuations and that space and it seems like equity financing.
And could be a very big competitor to the two.
And the venture debt side and so when we were just talking about a big pipeline and a pipeline of really high quality companies.
The chance that that you know a good deal of those companies go to the equity route versus debenture that route and get them it would be if the backdrop.
And it's a great question, Ryan and look there's no question and we've said this now for the last two or three calls that our biggest competitor right now and the market is the equity markets both from a public perspective and from a private round of financing perspective.
I would also say and we've seen this over the years. The companies that we are investing in and are continuing to burn and capital. They are continuing to invest and growth and they have a voracious need for capital. So yes, we are competing with equity right now at a pretty aggressive state yes, a lot of these.
Companies are continuing to raise meaningful rounds of capital, but in many cases the company still choose to supplement that equity with structured debt as long as it can be structured and priced appropriately and.
And that's what our team is spending the majority of their time doing looking at these quality opportunities that are well capitalized that may have raised equity capital recently and trying to find creative flexible custom tailored solutions that that work for both sides and I think that that's what you're going to continue to see from us in terms of what we include in that pipeline and we are and.
Internal system that we use to sort of track opportunities and the companies that we include in that pipeline number are companies that are in markets or sectors that we are interested in pursuing companies that are backed by institutional investors that we are comfortable working with companies that are looking to raise that capital.
<unk> and companies that we have had at least one conversation with where we believe it is a viable opportunity.
Okay.
That's really helpful color.
Thats all from me I appreciate the time this afternoon sure. Thanks, Brian.
Your next question comes from the line its targets <unk> with B Riley Securities Your line standard.
Good afternoon, and thanks for taking my question here.
Just wanted to touch on origination activity for the second quarter do you think thats going to be in line with first quarter levels and how do you expect the cadence of originations to play out as we think about that $1 billion of pipeline you mentioned throughout fiscal 'twenty one.
Sure. So we're not going to provide any Q2 guidance in terms of fundings or commitments and.
And the subsequent events disclosure, we obviously highlighted the fact that we've already closed excuse me, we've already closed $135 million of commitments quarter to date through April 27th we have another $153 million that are signed non binding term sheets that gets us to approximately $819 million of Clos.
<unk> and pending through April 27th.
And with our pipeline, we feel pretty optimistic that Q2 will be another strong quarter from our fundings and commitments perspective, but where we end up in the spectrum of numbers I think is still to be determined our focus is on quality. Our focus is on making sure that the documentation is appropriately structured and documented and sometimes things.
Quarter over quarter. So I think we don't manage the business on quarterly fundings or quarterly commitments, but I think that pipeline gives us tremendous confidence in terms of our ability to have a very strong year in terms of commitments.
Oh, great. Thanks for that and just wanted to have a follow up here on the advisor maybe if you can speak to the planned and economic contribution to the BDC and in terms of maybe fee income generation and what.
Point or at what scale would you feel comfortable providing us with more and metrics along those thoughts. Thank you.
Sure. So initially we expect that the main contribution will be the cost sharing like you saw in Q1 was about 900000, so just under $1 million, we would expect and Q2 are similar.
Allocation of costs.
And maybe towards.
The next.
Midpoint of 2022, we would hope based on the amount of funds that we raise based on the performance of the fund that we might see some dividends start accruing to the BDC, but it'll take time to generate enough fee income to cover the costs that are being allocated and then eventually.
Chile, a dividend stream to the BDC, but thats the way I would think about it initially as a cost reimbursement and cost sharing that's going to happen and then eventually a dividend stream.
Great. Thank you.
Your next question comes from the line of Casey Alexander with Compass point Your line standard open.
And.
Good morning, Yeah, the best lot of my questions.
But I do have two here one is that the RIAA is showing a.
A value of $9 $8 million with no cost basis, and the schedule of investment. So I'm just curious how that value was arrived at.
Yeah sure.
We went through a discounted cash flow analysis based on the way that we see the fund developing as originations occur and allocations occur.
And really going back to the prior question Casey of when we expect dividend flows to occur and so we did a discounted cash flow analysis based on the first fund that we've raised.
And that was the result of it and then we did a comparison of other raw valuations and.
And that are publicly available that we can compare it to and made sure that it made sense.
Okay. So this is done with a DCF based upon your sort of expectation of filling out the portfolio and the fees that will eventually be generated so we shouldn't look for a great variation to that number until there are other funds that are being managed by the Ara and <unk>.
Correct.
Thats precisely right Casey and Thats a good analysis.
Okay, Great. My second question is.
Given that the net originations after the prepayments for the quarter were about $157 million.
So about 30% of the net originations went into the external bonds.
Which seems like a large amount, but I don't know how large the fund is.
Capital that is committed to the fund relative to the size of the Hercules portfolio. So I'm curious what the allocation policy is because.
When you have a co investment vehicle my understanding is that you need to have some sort of a stated allocation policy.
Sure Casey So we've adopted a fairly conservative equal footing allocation policy deals will be allocated primarily based on available liquidity, but we do have the flexibility and the ability to change that depending on diversification sector and overall investment strategy and focus I.
I would also just point out I think youre, 30% number is just it's certainly higher than the way, we think about it and the way we're looking at it we look at the new fundings in the quarter of roughly $350 million about $47 million of the fundings were allocated so you are about 10% to 15% versus.
30% that you were you were speaking to and your comments.
Right, but the new fund doesn't have any.
Prepayments coming back to it.
Okay. So so.
In essence.
And I understand its getting only 15% of the new fundings.
But it is drawing.
Investments away from the BDC itself.
It is on and initial basis as it ramps up potentially taking some investments away with the to caveat that we mentioned before the number one there are a lot of deals that we're now able to do at the BDC level that we probably could not otherwise have done if we didn't have the private vehicle to be investing alongside us and then.
This is not an externally managed private com. This is a private fund that's managed by a wholly owned RIAA. So a 100% of the benefit from the activities of crews and accretive to the shareholders of the public BDC.
Okay, Great Alright, I appreciate you taking my questions. Thank you.
Your next question concern the line and Christopher Nolan with Ladenburg Thalmann. Your line is now open.
Hi, quick question on the rig and how much leverage you're going to run them.
Entity with.
So we're going to target a leverage ratio of one to one over the life of the fund.
Gotcha.
And wanted to clear the full supplemental dividend and the first quarter.
And it's something that we've talked about on the last couple of calls and I think we stated pretty clearly on the Q4 call that one of our goals was to establish a policy for 2021 that provided a little bit more clarity and continuity to our shareholders with respect to that base distribution.
We thought that the 28.
As an appropriate number given two things number one we are still sitting on a record level of spillover at 94 and.
And number two our confidence and the trajectory of the business for the course of 2021 and based on those two things we thought that it was more appropriate for us to.
Declared a <unk> 28 and give our shareholders.
<unk> and comfort that it would be seven per quarter versus what we've done for the last two years, which is and six of the eight quarters declares a supplemental distributions on a quarterly basis. This just provides a little bit more visibility and a little bit more clarity to our shareholders, which we think is an important thing to do.
Finally.
But by the administration has discussed.
And increasing the capital gains tax.
And if what the.
They outlined were to become law.
And what would you think that would be the impact on the venture debt market and also and HTC specifically.
And I don't think Youll see much of an impact honestly with respect to HTC and I think there could be a little bit of and impact from a negative perspective on sort of not just the venture debt market, but I think the broader kind of.
Gross market.
It's still very early these things change a lot and has to go through a process and and I think it's still very much TBD in terms of how it will play out from an overall tax reform perspective, it's something that we're watching and we don't think it has a material impact on our business or our markets and we'll just watch it closely over the next couple of quarters. Okay. Thanks Scott.
Sure.
Your next question comes from the line of John Hecht with Jefferies. Your line standard Okay.
Yes. The last question was similar to what I was going to ask one thing and I'll ask me.
And given kind of and I guess, what we've observed over the last year and moving through the pandemic Scott is there any kind of <unk>.
Change and what you think your opportunity set is for focusing on within and the portfolio and investing versus biotech versus other.
Are there other channels and technology or do you think it's pretty going be pretty consistent going forward.
I think it's pretty consistent the way we built this business and it's with a focus on diversification and I think that's what's made US successful we have the ability to focus on life Sciences, we have the ability to focus on venture technology, we have the ability to focus on the later stage sponsor backed technology transactions.
Having the ability to do all three of those things is a tremendous competitive advantage and we're going to continue to sort of focus on making sure. The business is broadly diversified and we have the ability to outperform irrespective of what's going on from a macro perspective.
Perfect. Thanks very much.
Sure. Thanks, John.
Yes.
Once again, if you would like to ask a question. Please press star one on your telephone Keypad. Your next question comes from the line of thing and O'shea with Wells Fargo. Your line is now open.
Hi, guys just a follow up.
On your dialogue with the KC and moments ago.
On the allocation policy and the Alright, I think you said it would be based on.
Liquidity.
My understanding is that the.
The convention is.
Co investment is based on the allocable capital.
And that's leveraged rather than.
Cash available.
At any given fund and newer fund might be advantaged. So it's.
Is that the case is that why.
And the new fund got so much allocation or.
Or is it.
Normalized as described.
It was again I think it was it was fairly normal it was about 10% to 15% of the gross fundings of the business.
It was not every deal being allocated it was done pursuant to our board approved allocation policy were the primary driver is our available liquidity.
Cross both of the vehicles and again.
I wouldn't look at it as it's deals being taken away right. In most cases. These are deals that the BDC would have issues or challenges with doing on its own and now that we have the vehicle we're able to do these things that otherwise we likely could not have done.
Okay. That's helpful. Thank you.
Sure makes sense.
Once again, if you would like to ask a question. Please press star one on your telephone keypad.
Yeah.
And we had no free good question at this time presenters. Please continue.
Thank you operator, and thanks to everyone for joining our call today, we look forward to reporting our progress on our next Q2 2021 earnings call.
Thank you.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.
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Yes.
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