Q2 2022 Hercules Capital Inc Earnings Call
The conference will begin shortly to raise your hand during Q&A you can dial star one one.
[music].
Okay.
Good day, ladies and gentlemen, and thank you for standing by walking to the Hercules capital second quarter 2022 earnings Conference call. At this time all participants are in a listen only mode. After the opening remarks. After the Speakers' remarks, there will be a question and answer session to ask a question. During the session you will need to press.
Star one one on your telephone.
At this time I would like to turn the conference over to your host Mr. Michael Hara Sir please begin.
Thank you Howard and good afternoon, everyone and welcome to Hercules Conference call for the second quarter of 2022.
With us on the call today from Hercules as Scott Bluestein, CEO and Chief investment Officer.
Meyer CFO Hercules second quarter 2022 financial results released just after today's market close.
To access for Hercules Investor Relations section of Investor Dot H D D C Dot com.
The webcast will be available on the Investor Relations webpage for at least 30 days following the conference call. During this call American Barak looking statements based on our own assumptions and our current expectations. These forward looking statements are not guarantees of future performance and should not be relied upon in making any.
Any investment decision.
<unk> 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 will turn the call over to Scott.
Thank you Michael and thank you all for joining us today.
Despite a more volatile and challenging economic and capital markets environment Hercules capital continued to deliver strong operating results in Q2 and took additional steps to further position the company for continued asset and earnings growth in the second half of 2022.
Our record originations performance in Q1 continued with record Q2 gross debt and equity commitments of over 1.04 billion.
The first time in our history that we have delivered over $1 billion of new commitments in a quarter.
Our gross fundings were also strong during the quarter with over $439 million.
For the first half of 2022, we delivered record gross debt and equity commitments of 166 billion and record gross fundings of over $790 million.
Similar to what we saw in Q1 early payoffs during Q2 remained low which resulted in strong sequential net debt investment portfolio growth of over $169 million during the second quarter and a record $360 million for the first half of 2022.
We anticipate that this record net debt investment portfolio growth from the first half of 2022, we will continue to drive our core income and NII per share higher during the second half of 2022.
This combined with the current rate environment has put us in a strong position to be able to raise our quarterly base distribution to <unk> 35 for Q2.
Our second base distribution increase in the last 12 months.
Our outlook on originations remains favorable and as a result, we executed on a series of capital markets transactions during Q2, which boosted our liquidity position to over $779 million and put us in a great position heading into the second half of 2022.
Let me recap some of the key highlights of our performance for Q2.
Our record Q2 originations activity was once again driven by both our technology and life Sciences teams delivering strong performance during the quarter.
Our commitments and funding activity demonstrated the balance between our two core verticals and our new commitments during the quarter were split nearly evenly between technology and life Sciences.
Having an investment team of over 50 individuals with domain expertise in a specific area that we focus on and the ability to consistently deliver originations in both the technology and life Sciences verticals continues to be a significant competitive advantage for us in the market.
We funded capital to 29 different companies in Q2.
Which 15, where new borrower relationships.
For the first half of 2022, we have added 25, new borrower relationships, which further expands our scale in the market.
In addition to strong funding activity for the for new portfolio of companies, we were able to expand our funding relationship once again with numerous portfolio companies that continued to show strength and achieved performance milestones during the quarter.
As a result of our recent focus on larger and later stage transactions as well as continued prudent and conservative underwriting our funding to commitment ratio at closing has declined slightly.
This combined with a record 264 billion of new debt and equity commitments that we delivered in 2021 should continue to drive strong funding activity from the existing portfolio over the next several quarters irrespective of the market for new loan originations.
In addition, approximately 48% or 237 million out of the currently available unfunded commitments of 489 million will expire in 2022, which we anticipate will drive further portfolio growth near term assuming that this capital is drawn prior to exploration.
Since the close of Q2 and as of July 26, 2022, our deal team has already closed over 250 million of new commitments and we have pending commitments of an additional $171 million in signed non binding term sheets.
Combined our year to date closed and pending new commitments currently exceeds $2 billion, which.
Which is the strongest start to any year that we have ever delivered through this period.
We expect this trend to continue in Q3, but moderate slightly a bit for seasonality given that Q3 is typically a slower quarter for new originations.
Our new deal pipeline remains very healthy and active and currently continues to exceed $1 billion of potential investments.
Volatility across the equity markets, particularly for growth stage companies accelerated in Q2.
As a result, we expect our pipeline to continue to be strong near to medium term as companies continue to look for creative and non dilutive structured capital solutions from debt providers that they trust.
In periods like this we believe that the benefits of scale and diversification helped drive sustained and continued outperformance.
In our asset class, having a strong balance sheet conservative leverage profile and an abundance of liquidity are essential and Hercules is incredibly well positioned in each of these areas.
Although the capital raising environment for many Bdcs and similar vehicles has become more challenging Hercules was able to successfully raise over $525 million of new capital during Q2, and maintain our cost of debt capital at 4% for the second quarter.
As we indicated on previous earnings calls, while the continued equity market volatility for certain growth stage companies may negatively impact net asset value short term as it did again in Q2, we expect it to be a long term net benefit to our business in terms of increased investment opportunities and net debt.
<unk> growth.
This is exactly what we have seen year to date.
Consistent with our historical approach to underwriting credit, we intend to remain patient and disciplined on new originations irrespective of market conditions, and we do not plan to chase yields for higher risk transactions.
Based on the current market volatility and increasingly challenging macro environment, we are being EBIT more selective than normal in terms of underwriting new credits with an increasing emphasis on later stage and more established companies, where we believe the risk adjusted profile is better at this time and we are avoiding certain industries and end market.
That are more susceptible to a potential downturn.
During Q2 portfolio company exits and liquidity events for the industry continued to reflect the ongoing pressure in the equity markets.
Year to date, we've had four companies complete their ipos, including two in Q2.
And five companies announced or completed M&A transactions.
In addition, we have two companies that have registered for their ipos or have entered into definitive agreements to go public be a merger or spec transaction.
As the IPO market remains uncertain and cautious we expect M&A to accelerate over the next several quarters across our addressable markets.
Early loan repayments were approximately $33 million well below our guidance of 150 million to $250 million and a significant decrease from $85 million in Q1 2022.
While the lower level of early loan prepayments reduced our Q2 NII per share. It resulted in strong net debt portfolio growth in the quarter, which positions us very well for strong earnings growth in the second half of 2022.
For Q3, 2022, we expect prepayments to remain low and be between $50 million and $150 million. Although this could change as we progress in the quarter.
In Q2, we generated total investment income of $72 1 million and net investment income of $40 1 million or <unk> 32 per share.
Assuming that the interest rate increases that took place during Q2 or in place at the beginning of the quarter. Our Q2 NII per share would have been approximately 35 cents.
Even with the lower level of prepayment activity during the quarter.
During Q2, our portfolio generated a record of over $70 million of core income, which excludes any benefit received from early payoffs.
Our expectation is that both core income and net investment income will further increase in Q3.
And that net investment income per share will fully cover the recently raised based distribution in the third quarter.
Our portfolio generated a GAAP effective yield of 11, 5% in Q2, and a core yield of 11, 3%, which was consistent with our guidance for the quarter.
With net regulatory leverage at a very conservative 92, 7% and continued robust liquidity across our platform our balance sheet remains very well positioned.
Credit quality of the debt investment portfolio remains strong and consistent with what we reported in Q1.
Our weighted average internal credit rating of 2.13 was slightly higher than the $2. One zero rating in Q1, our grade one and two credits decreased slightly to 74% compared to 73, 2% in Q1.
Grade three credits were also slightly higher at 29% in Q2 versus 26, 4%. In Q1 are rated four credits made up 0.5% and are rated five credits.
Represented 0.1% of the portfolio.
Capital raising across our portfolio remained strong in Q2 with our active portfolio companies once again, raising over $1 billion of equity and strategic capital during the quarter.
In Q2, the number of loans on nonaccrual increased by one with a total of two debt investments with an investment cost and fair value of approximately $19 7 million and $1 9 million, respectively, or 0.7% and 0.1% as a percentage of the company's total investment portfolio.
At cost and value respectively.
Since inception, Hercules has emphasized diversification and credit discipline as key cornerstones of our investment strategy and credit performance.
We believe that our diversified and defensive positioning should serve us well in this environment.
For our portfolio companies, having ample liquidity is just one important factor that we monitor.
As a result of the recent market volatility we wanted to provide a brief update on what we are seeing across our investment portfolio.
When looking at our entire outstanding debt investment portfolio, we estimate that approximately 74% of the portfolio. Currently has 12 plus months of liquidity with another 18% with six to 12 months of current liquidity on their balance sheets loans, which have three months or less of liquidity.
Make up approximately 2% of our outstanding debt portfolio.
During Q2 Hercules had net realized losses of $2 1 million. This was comprised of gross realized gains of $1 2 million offset by $2 million due to the write off of one public equity position and $1 3 million due to the write off of legacy equity and warrant positions.
Thanks to the tremendous and timely efforts of our broader finance team. We ended Q2 with strong liquidity of $780 million, which provides us with ample coverage of our available unfunded commitments of $489 million and the ability to fund our ongoing anticipated business activity.
The venture capital ecosystem continued its healthy pace for the first half of 2022 with fund raising activity at $121 billion and investment activity at 144 billion. According to data gathered by pitch book and the National venture Capital Association.
Fundraising activity continues on its record pace to exceed 2020 one's level of 139 billion with investment activity, while investment activity remained on par with Q1 2022.
We exited Q2 with undistributed earnings spillover of over $150 million or $1 18 per share the.
The undistributed earnings spillover continues to provide us with added flexibility with respect to our shareholder distributions going forward and the ability to continue to invest in our team and platform.
For Q2, we increased our base distribution to <unk> 35.
From 33.
And once again declared a supplemental distribution of <unk> 15 per share.
We will continue to evaluate the quarterly variable based distribution with a particular focus on the net debt portfolio growth and NII growth that we're expecting to materialize.
In closing our momentum has continued through the first half of 2022, and we remain well positioned from all aspects to take advantage of market conditions and grow our core income generating assets and as a result, the earnings power of the business.
We will remain steadfast with our core themes of maintaining a strong balance sheet and staying disciplined on new underwritings, while continuing to invest in our teams and platform.
We are thankful to the many companies management teams and investors that continue to make Hercules as their partner of choice.
I will now turn the call over to Seth.
Thank you Scott and good afternoon, ladies and gentlemen.
While the capital raising environment in broader markets deteriorated in Q2. This was a very busy and successful quarter for Hercules in terms of accessing the capital markets.
To support the record net debt portfolio growth that the investment team delivered in the first half of 2022 and with support of our financial institutional partners Hercules was able to leverage our recognized credit first culture and strong investment grade ratings to raise over $530 million.
<unk> equity debt financing and credit facility capacity in Q2.
With the addition of our fourth investment grade rating from Fitch in May we continue to benefit with a significant competitive advantage in terms of being able to raise institutional capital in a cost effective manner.
These steps have positioned us well for the continued uncertainty in the broad market broader market and compared to our competitive landscape.
Net investment income was $40 1 million or 12% quarter over quarter increase or <unk> 32 per share in Q2. This was achieved by delivering record core income despite a historically low volume of prepayments.
Overall impacted second quarter, NII, but is beneficial for the long term, especially in this rising interest rate environment.
With that in mind, let's review the following areas the income statement performance and highlights.
Unrealized and realized activity leverage and liquidity.
And the financial outlook.
Turning to the income statement performance and highlights as previously mentioned net investment income was $40 1 million or 12% quarter over quarter increase or 32 cents per share in Q2.
Total investment income was $72 1 million, an increase compared to the prior quarter driven by 16% growth in the debt portfolio year to date on strong new business lower prepayments and an increase in benchmark rates.
Our effective and core yields in the second quarter were 11, five and 11, 3% respectively.
Compared to 11, 5% 11, 1% in the first quarter.
The increase in the core yield was due to an increase in coupon interest as a result of base rate interest increases.
We expect this trend to continue throughout the remainder of the year with the full quarter impact of past fed policy interest rate changes as well as the recent decision.
Turning to expenses, our gross operating expenses for the quarter increased to $35 1 million compared to $30 8 million in the prior quarter.
Net of cost recharge to the RIAA, our operating expenses were $32 million.
Interest expenses and fees increased to $14 2 million from $13 5 million in the prior quarter due to the growth of the investment portfolio.
SG&A expenses increased to $20 9 million from $17 3 million in the prior quarter within my guidance.
Net of cost recharge to the hour I E. The SG&A expenses were $17 8 million.
Our weighted average cost of debt remained consistent at 4% with the prior quarter.
Our aro.
AE or NII over average equity increased 100 basis points to 12% for the second quarter and the R. O a a or NII over average total assets was five 9%.
Switching to the NAV unrealized and realized activity during the quarter, our NAV decreased 39 per share to $10 43 per share.
This represents a N a N a.
Per share decrease of three 6% quarter over quarter.
The main driver for the decrease.
Was the $48 $3 million of change in unrealized depreciation primarily related to the mark to market movement on our publicly traded equity positions.
Credit was stable during the quarter and was not a material contributor to the decline in NAV.
The net realized loss of $2 1 million comprised of $1 2 million of gains from the disposal of equity and warrant positions and investment fund distributions.
Offsetting by $3 3 million of realized loss related to the losses and write off of legacy equity and warrant positions.
Moving to leverage and liquidity.
Our GAAP and regulatory leverage were 114, 5% and 101, 3% respectively.
Which increased compared to the prior quarter due to the net growth in the investments.
As a result of our strong fundraising during the quarter, we held more cash than normal on the balance sheet throughout quarter end.
Netting out leverage with cash on the balance sheet, our GAAP, our net GAAP and regulatory leverage was 105, eight and 92, 7% respectively.
We ended the quarter with liquidity of $780 million as a reminder, this excludes capital raised by the funds managed by our wholly owned.
Subsidiary, we believe our strong liquidity position very positions us very well in the current rate environment and if the recent low prepayment trend continues.
As previously disclosed in June we completed two institutional.
Debt financings and expanded our capacity on both credit facilities to support the continued growth of the portfolio.
In total $470 million of additional debt financing and credit facility capacity was made available to Hercules derma.
Demonstrating our ability to raise significant amounts of capital at attractive rates and a period of significant volatility for the capital markets.
We continue to access the ATM market during the quarter and raised $62 million.
At an average price of one four.
Times to NAV.
<unk> and a 15% accretion to NAV.
Finally on the outlook points for the third quarter, we're increasing our core yield guidance range to 11, 5% to 12% as a reminder, approximately 95% of our debt portfolio is floating with a floor. So the recent interest rate hike and any.
Additional in 2022 will benefit our core yield going forward.
Although very difficult to predict as communicated by Scott, we expect $50 million to $150 million in prepayment activity in the third quarter, we expect our third quarter interest expense to increase compared to the prior quarter due to the balance sheet growth experienced in the second quarter.
For the third quarter, we expect SG&A expenses of $19 million to $20 million and a similar level of R&D expense allocation compared to the first quarter.
Based on a more normal level of funding and allocation for the quarter.
In closing we are positioned well to benefit from this market and are looking forward to continued growth of our core income.
I will now turn the call over to Howard to begin the Q&A portion of our call Howard over to you.
Ladies and gentlemen, once again, if you have a question or comment at this time. Please press star one one on your telephone keypad again press Star one one on your telephone keypad. Please.
Please standby, while we compile the Q&A roster.
Our first question or comment comes from the line of Christopher <unk> from Piper Sandler Your line is open.
Thank you and good afternoon. So first one I have is on credit quality. So.
I'm just curious if you can speak to your outlook for credit quality for the next several quarters. There is some some worries out there that the venture backed companies are burning cash at a quicker rate and then just some.
Confidence is deteriorating so I appreciate the liquidity numbers you provided earlier, but I'm just curious on how you're viewing the credit environment from your seat looking forward.
Sure. Thanks, Kristen we continue to feel good about the credit portfolio.
We have always maintained a very disciplined approach to underwriting and that really has not changed over the last few years.
There is no question that there has been an increasing amount of volatility in the equity markets, but we really have not seen a material impact yet with respect to our portfolio company's ability to raise capital in Q1. The markets were very choppy our portfolio companies raised over $1 billion of new equity.
In Q2, the volatility of the equity markets increased our portfolio companies. Once again raised over $1 billion of equity capital in the quarter. We have several companies right now that are in the middle of equity financings that we expect to get done. So we're obviously watching credit very closely but we have not yet seen.
Any material impact that would cause us to be concerned.
The other key things that we look at very closely weighted average credit rating across the portfolio historically that range for US was about $2 20 to $2 30 that was sort of the normal range for us on a weighted average portfolio basis, even with the slight uptick that we saw in Q2 from 210 to 213 still bill.
Although the low end of that range. We also watch our rated four and rated five credits very closely those continue to make up less than 0.6% of the entire portfolio at fair value and we have two small legacy loans that are on non accrual and we don't have any additional loans right now that we're watching for non accruals. So I think.
All in all we continue to feel positive about the credit environment. We're watching obviously the volatility of the equity markets. We have taken some additional steps to be a little bit more cautious in a little bit more prudent from a monitoring perspective, but we feel pretty good about what we're seeing right now.
Okay, great. Thank you for the color there Scott.
And then just one other one for me can you just remind me on the mechanics of the undistributed earnings spillover does the dollar 18 of spillover that you currently have does that need to be paid out over the next 12 months or is there another timeframe Im just curious what the details are on that spillover sure.
Absolutely Kristen so we've already distributed the majority of what needs to be distributed in the current year.
Related to the spillover related to last year. So we have to distribute about 90% of our earnings annually within the following year and so the distributions that we've made already in the year count towards that we have very little after we make the distribution in August that is required to.
Be distributed for last year.
Okay, great. Thank you I appreciate taking my questions.
Thank you.
Our next question or comment comes from the line of Kevin <unk> from JMP Securities. Your line is open Mr folds.
Hi, good afternoon, and thank you for taking my questions.
Could you talk a little bit about how the competitive environment has shifted over the past two quarters, given increased market uncertainty and how that's impacting documentation and deal pricing I'm just hoping you can quantify the change in pricing that you're seeing that market conditions have evolved.
Sure. Thanks, Kevin So a couple of things with respect to the competitive environment.
We are continuing to see I think a healthy competitive environment.
The one or two things that we have noticed particularly over the last quarter or so is that.
Several of our competitors appear to be pulling back a little bit given some leverage and liquidity constraints. That's why we went we went out of our way to emphasize our conservative leverage position and the abundance of liquidity that we have on the balance sheet. So we've seen a little bit of a pullback just kind of given liquidity and leverage across some of our competitor back.
She's.
The other thing that we've seen a little bit is that from a competitive perspective. Some funds are making the strategic choice to chase yields. So there have been several deals that had been done in the markets throughout the course of Q1 and Q2.
Our assessment of those deals is that they are higher risk deals and therefore lenders are able to generate some higher onboarding yields on those deals.
That's not the model that we've taken historically and thats not the model that we're taking into the current environment.
We're comfortable with the yields that we're getting on new originations, we have seen a little bit of an uptick in terms of onboarding originations just given the rate environment that we're currently in but it's not one for one and we made this comment on the Q1 call as well so if you assume.
Prime rate for US is up about 200 plus basis points over the last several quarters, we have not seen a 200 basis point increase in our ability to generate higher onboarding yields we've seen about a 25 to 50 basis points increase in onboarding yields. So there is some correlation but it's certainly not one to one we.
We did increase our core yield guidance for the portfolio that range last quarter was 11% to 11, 5% our new guidance for that as Seth indicated is 11, 5% to 12% part of that is obviously driven by the fact that 95% of the book is floating and the majority of our portfolio is now growing up from a rate perspective.
But the other part of that is also that we're onboarding deals at a slightly higher yield relative to where we were one or two quarters ago.
Okay. That's all really helpful. And then just a follow up modeling question around Sundays funds.
Plumbing is allocated to the private funds clearly that was elevated this quarter I was just curious if you expect the first private funds to be fully ramped by the time you launch the third funded what the timing is for launching our third fund as well.
Yes, so we're not going to provide any guidance in terms of timing for a potential third private fund I would tell you that the two private funds that we currently manage have continued to grow we did give some guidance with respect to sort of size at the end of the year and we're not going to update that now outside of the quarterly allocate.
The numbers that we're providing on a quarterly basis Q2 was very strong in terms of investments for us out of the two private vehicles that we manage we expect that number to sort of come down a little bit and probably revert back to what we saw throughout the course of last year for Q3 and Q4.
Yeah.
Okay, That's fair Scott I'll leave it there congratulations on the saltwater.
Thanks, Kevin.
Thank you. Our next question or comment comes from the line of Christopher Nolan from Ladenburg Thalmann. Mr. Nolan Your line is open.
Hey, guys.
Congratulations on a really solid quarter.
The interest rate sensitivity I noticed in the Q that you guys are not hedging your interest rate sensitivity what are your thoughts about that because.
Can you talk to different people in the outlook on those changes dramatically some people are.
Not quite so certain of the fed's going to be key.
To raise so little clarification in terms of what Youre thinking is along those lines, but yes.
Now historically, we have not hedged our interest rate exposure, mainly because as the our expectation for the fixed environment versus floating is that often the yield curves are way out of whack compared to what actually evolves and so what you end up doing is trying to pick the correct yield.
Curve.
Position.
So we're very comfortable with.
Choosing the right moment to fix our interest rate and when you look at Q2, we're very careful about choosing the duration and the amount.
Versus the amount that we decided to pick into the.
The credit facilities, so in allocation stratification, giving us optionality, but not a preference to swap into a floating rate environment, Scott, Yes, Chris the one thing that I would I would just add to that is we do have some built in protection given how we structure. These loans when we onboard a new loan.
Generally speaking they are floating with a floor in that contractual floor set at the base rate at origination so to the extent that we're originating deals right. Now there is no downside in those loans to the extent that the fed starts moving backwards over the course of the next year or so so.
I would just sort of add that back to what subset.
Great and as a follow up.
In your comments you mentioned the focus on larger companies.
Which seem to be new verbiage compared to more recent earnings calls does this imply that you are focusing on larger companies given your increased scale and if so does that mean, we should expect.
Higher operating expenses to scale up the operation further.
Yes, so no real change in Opex expectations outside of the guidance that <unk> gave in his prepared remarks, the comment that we made about the focus is consistent with what we said in Q1, given the volatility that we're seeing sort of across the venture growth stage landscape, we made the strategic decision.
Starting in Q4 of last year to begin to shift our underwriting screens a little bit more later stage more established companies takes away some of the inherent risk with earlier stage companies. That's not to say that every deal is going to fit that sort of a specific parameter, but thats really the focal point for us from an origination perspective. So these are <unk>.
Companies that have raised $3 to four rounds of institutional capital. These are companies that to the extent that they are public are generally trading at a $500 million to $1 billion plus market capitalization, even after significant pullbacks and on the technology side, just much more established better capitalized companies, which you may be down a little bit from a yield perspective, but we think.
It's the right decision from a credit perspective and at the end of the day, we are managers of credit and Thats always going to be our focal point.
Okay. Thank you guys.
Thanks, Chris.
Thank you.
Our next question or comment comes from the line.
Thanks, Lee from RBC capital markets. Mr. Lee Your line is open.
I'm sorry.
Uh huh.
Mr Lynch from K B W. Mr. Lewis Your line is open.
Hey, good afternoon.
I had a couple of questions. The first one.
Very interested by your comment regarding that your portfolio companies.
We're not having any increased difficulty raising additional capital I think you quoted that the numbers were very similar in Q1 and Q2 I'd Love. If you could just provide some more color on that because that seems very counterintuitive to what we're hearing in the market with fund raising being down and capital deployed.
On the venture equity side.
Coming under pressure recently, and we've seen all the memos from.
Sequoia is in that sort of stuff off of.
Tony founders that capital rates can be much harder tightened about so.
I guess I'm, a little bit surprised to hear that that fund raising really hasnt been an issue for any of our portfolio of companies. They just raising at at flat or down rounds are or what's going on that's kind of counterintuitive to what's going on in the broader markets.
So the comment that we made was not that we have not had any portfolio companies have trouble raising capital will be set what we said was that we have not seen any real material impact across the portfolio in terms of the ability to raise equity capital.
We monitor.
Our company's ability to raise capital on a quarterly basis as you as you mentioned in Q1 that number was over $1 billion across the portfolio in Q2 equity market volatility for our company's clearly increased and yet our portfolio companies. Yes, there was a little bit of growth, but our portfolio companies. Once again went up.
And raised over $1 billion of equity capital and that was spread across well over a dozen different names.
What we have seen is that it has taken a little bit longer to raise capital valuations are not what the board members investors management teams.
And initially wanted or expected, but we have not seen it yet turn into an inability to raise capital for good companies.
What youre seeing from a PC perspective is much more selectivity.
They are being much more focused in terms of their capital deployment.
But there should be no doubt that venture capital firms are continuing to invest meaningful amounts of capital.
If you look at the data that we have in Q1 venture capital firms invested over $70 billion of equity.
In Q2 venture capital firms invested once again over $70 billion of equity capital. So youre at over $140 billion of venture capital equity invested in the first half of this year. Despite the volatility that funding is going to fewer companies, but it is still flowing into companies that deserve to be fun.
And so given our historical emphasis on prudent and conservative underwriting so far we've seen the majority of our companies be able to go out and continue to raise equity capital.
Okay.
For clarification.
Then you obviously deployed a lot of capital this quarter had a had a.
Greater number of commitments in this quarter, which isn't surprising I mean, they need for venture capital need for venture debt is probably very desirable.
Marketplaces as people are looking for non dilutive capital.
I'm just curious.
Has your investment approach changed at all because I would think borrowers are looking for non dilutive rounds in.
In this environment, but.
You're going to want borrowers, who have abundant liquidity and I would think people arent going to be looking to raise capital in this environment right now if they don't have to.
And so how are you kind of.
<unk>.
Trading this marketplace, where you're probably getting approached by a lot of good companies, who are we'd rather do that capital, but in equity capital to extend liquidity.
Because if not dilutive. However, you probably I would think would also want to see companies with abundant liquidity and runway as you.
I'll provide some some really great SaaS and I do appreciate the liquidity stats you provided.
As far as run rate. So how are you navigating those two sort of forces.
It's a great. It's a great question and I'd say a couple of things so first.
For us we're following the same playbook that we have successfully followed for the last 17 plus years irrespective of market conditions, We think our first and utmost priority is to be disciplined managers of credit. So we think we take a very conservative and prudent view on underwriting new credit and that doesn't change.
Whether we're talking about 2000 22021 or 2022 in terms of the funding to commitment ratio that absolutely has come down and it's really a function of two things number one we are specifically targeting later stage more well capitalized companies those companies by definition.
<unk> are going to want to borrow less at closing.
The second part is we are using milestones more aggressively than we even have historically and this is a function of the current environment and just a more cautious approach on our side and so as we utilize more performance covenants as we utilize more capital raising covenants that funding to commitment ratio is naturally going to come down.
In Q2, it was below 50% so on a $1 billion of commitments, we funded $440 million really the first time that I can recall, where that number has been below 50%. We think the right way to think about it right now is really in that 50% to 60% range and Thats, where we expect it to sort of normalize into the.
The last point that I would make despite the record growth that we delivered in the first half of the year.
The net debt investment portfolio growth for Hercules was over $360 million in the first half which is a record for us.
Despite that we're not managing this business and running this business focused on growth. So what we have told our investment teams is to continue to make sure that we are doing the right deals not every deal. We are an internally managed BDC, we're not going to get paid more or less depending on what our asset base is and that really.
It gives us the ability to focus on making sure that we are doing the right deals with the right companies.
Okay.
That's helpful. I appreciate the time this afternoon I'll hop back in the queue.
Thanks, Brian .
Thank you.
Our next question or comment comes from Kenneth Lee from RBC capital markets.
Mr. Lee Your line is open.
Hi, Thanks for taking my question.
For your portfolio companies given potential changes to private company valuations, what's your best sense of how loan to value ratios have changed within your portfolio. Thanks.
Sure. Thanks, Ken So we track loan to value on a quarterly basis generally speaking if you look at our book historically.
Our ltvs on a weighted average basis per quarter has been in the 7% range up to $20 to 25% on the high end if.
If you look at where we were in the latter half of last year.
Our ltvs, we're down to sort of low teens, but 11%, 12%, 13% right now even with the significant pullbacks that we've seen from valuation perspective, our ltvs on a weighted average basis across the portfolio are in the 15% to 17% range. So we've certainly seen a little bit of movement up but it still continues to be a very conservative number.
<unk>, given what our Onboarding ltvs tend to be on these companies.
Gotcha Gotcha very helpful. There.
And one follow up if I may.
Have you been having conversations with the financial sponsors of the portfolio companies and if so.
How would you assess their willingness or their tone to provide additional capital if need be.
During the really volatile.
Market times thanks.
Sure. So I think a really important part of what we do and what our teams do on a daily basis is to have open communication with our management teams and with the board members and investors of all of our companies.
Those conversations take place in good markets those conversations take place in bad markets and so our teams are continuously talking to our companies. What we're continuing to hear is obviously concern about the broader market, we're seeing and we're hearing Vcs and board members pushed companies to reduce expenses.
<unk> to reduce burn to extend runway.
But at the same time, we are seeing the VC firms continue to fund the companies that they think deserve to be funded and Thats why we had again our companies raise over $1 billion of equity capital during the quarter. Some of that was on the private side. Some of that was on the public side. So I think.
Youre seeing sort of caution from the from the Investor community, but you are still seeing capital be deployed in the right opportunities.
Gotcha very helpful. There. Thanks again.
Thank you.
Our next question or comment comes from the line of Finian O'shea from Wells Fargo <unk> company.
Hi, guys Jordan.
Hi, Jordan on <unk> today.
Want to ask about.
Theres a handful of companies you guys have that.
Had planned to go public spat or do you expect.
Basically turned on.
Since the termination of that of their <unk>.
<unk> go public that way.
Just as a category could you maybe give us some color on how the.
How that process through the end of that process might be sector as potential and maybe.
A little some of your thoughts on whether or not youre underwriting.
Inside of that new paths to the public markets or M&A or exit might be.
Sure Jordan.
So we've seen sort of a mixed bag on the spec side, we've had some companies make the strategic decision to go through with spec transactions and execute successful spec transactions, we had one that got done.
In Q2, we've had other companies that have made the strategic decision that they did not want to pursue this back route and ended up terminating.
<unk> agreements.
Those are obviously still private companies. So we're not going to speak to anything that we shouldnt be speaking to in terms of their plans, but what we can tell you is that in each of these cases, we underwrite to the assumption that this back transactions are not going to get done so with respect to the deals that we specifically under O two that were.
In spec transactions, we continue to feel very comfortable with those companies and their ability to raise equity capital privately now that the spec transactions have been terminated.
Okay, great. Thank you so much is it for me.
Thanks Derek.
Thank you our next question or comment comes from the line of.
Casey Alexander from Compass point.
Mr. Alexander Your line is open.
Hi, good afternoon.
I have a couple of questions one is <unk>.
The volatility of the equity markets affects things in a lot of different ways.
The vintage of loans that you are writing now as you said, you're onboarding add a little bit higher yields.
But would it also be your expectation.
You are setting a basis point on the equity slices that you get from those at a lower level because of comps and would it be your expectation that you would be able to generate better ROE is on the loan vintage that youre originating right now.
Yes, so the answer to that Casey is yes, if you remember.
There are two components to serve the equity pieces that we generally get in transaction in certain cases will receive warrants most of the time those warrants will be priced at the better of last round or next round. So we will have next round protection to the extent that there is a down round in the future. We generally have protection and we.
Reset our pricing valuation so we so we have some.
Some inherent upside with respect to the warrant position.
The second equity component that we get in a number of our deals is the RTI, which has the right to invest that right to invest as a contractual right to invest in a subsequent equity round. So if those companies are going out and raising equity rounds, whether it's publicly or privately at more attractive valuations. This year to the extent that we think the equity investment makes sense and Reed.
Choose to exercise that RTI, we do think that there will be some again inherent upside in those equity positions on a go forward basis, just given that the valuations appear to be more attractive.
Okay. Thank you.
Secondly.
You guys did an outright sale of debt investments during the quarter of $73 million I'm curious why.
It's not something that you guys do on a regular basis.
How many loans were involved was it one or several loans and how did you go about it because generally.
That's not.
A super liquid market for just going out and selling loans.
Sure. So it is not something that we've done historically.
I would add one point to that that those loans were not sold in the general market. Those loans were sold to our two private funds. So just a little bit different than what we typically do which is when we assign those fundings at closing.
This quarter, given how strong our commitment numbers were and how strong our funding numbers were we made the decision to also do a sale of a couple of pieces of a handful of loans I think the number was about five or six loans. They were not the entire entirety of the loans. They were parts of specific loans and that was really done one just given the strength of the funding activity in.
Commitment activity that we saw during the quarter, but also as we sort of think about portfolio diversification as we think about concentrations as we think about ineligible assets. We obviously are watching those things very closely so in this quarter. There was an opportunity for us to sort of in addition to the assignments to the private funds sell down an additional 70 $374 million of law.
<unk> to the private funds, which remained very well capitalized and from our perspective and from a BDC perspective, given that those private funds are managed by the wholly owned RIAA the benefit of those loans ultimately accrete back to the shareholders regardless.
Alright, great. Thank you that that perfectly explains it and I appreciate youre, taking my questions.
Thanks Casey.
Yes.
Thank you I'm showing no additional questions in the queue at this time I would like to turn the conference back over to management for any closing remarks.
Thank you operator, and thanks to everyone for joining our call today, we look forward to reporting our progress on our next earnings call. Thanks, and have a great day.
Ladies and gentlemen, thank you for participating in today's conference. This concludes the program you may now disconnect everyone have a wonderful day.
Okay.
Yeah.
The conference will begin shortly to raise your hand during Q&A you can dial one one.
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Yes.
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