Q4 2022 Hercules Capital Inc Earnings Call
Okay.
Good day and thank you for standing by welcome to the Hercules Capital fourth quarter 2022 earnings Conference call. At this time all participants are in a listen only mode. After the speaker's presentation there'll be a question and answer session to ask a question during the session you will need to.
Press Star one one on your telephone you will then hear an automated message advising your hand is raised to withdraw your question. Please press star. One again, please be advised that today's conference is being recorded I would now like to hand, the conference over to your speaker today, Michael Hara managing director of Investor Relations.
Thank you, Josh and good afternoon, everyone and welcome to Hercules Conference call for the fourth quarter.
Full year 2022.
On the call today from Hercules are Scott Bluestein, CEO , and Chief investment Officer, and Seth Meyer CFO .
Hercules financial results released just after today's market close and can be accessed from Hercules Investor Relations section at Investor Dawn H T J C Dot com.
An archived webcast replay will be available on the Investor Relations webpage for at least 30 days following the conference call.
During this call we may make forward looking statements based on our own assumptions and current expectations. These forward looking statements are not guarantees of future performance and should not be relied upon in making any investment decision.
Actual financial results may differ from the forward looking statements made during this call for a number of reasons.
Including but not limited to the risks identified in our annual report on Form 10-K.
Other filings that are publicly available on the SEC's website.
Any forward looking statements made during this call are made only as of today's date and Hercules assumes no obligation to update any such statements in the future.
And with that I'll turn the call over to Scott.
Thank you Michael and thank you all for joining the Hercules capital Q4, 2022 earnings call.
Following our record operating performance in 2021 Hercules capital raised the bar higher and once again delivered record performance in 2022.
2022 was a historic year for Hercules capital and I am incredibly proud of what our talented and growing team accomplished.
Our record setting performance in 2022 culminated with the strongest total and net investment income quarter in the company's history.
And the recent declaration of an increased quarterly base distribution and a new supplemental distribution program for our shareholders.
Hercules capital delivered another strong year of record originations performance our record financial results and continued strong credit performance.
Our performance in 2022 reflects the benefits of being able to achieve and operate upscale maintain robust liquidity and a strong balance sheet.
And working with the best in class team that is highly experienced in this asset class.
Thanks to the growth of both the BDC and our private credit funds business Hercules capital was now managing an excess of $3 6 billion of assets an increase of over 38% from where we were at the end of 2021.
Despite continued market and macro volatility.
Continued strength in expansion of our originations platform robust liquidity position and strong balance sheet put us in position to deliver achievements on multiple fronts in 2022, including <unk>.
Our record total gross debt and equity commitments of $3, one 2 billion up 18% year over year and the first time in our 18 year history, where we haven't been able to deliver over $3 billion of new commitments in a year.
Record debt investment portfolio growth of nearly $600 million.
A record total investment income of $322 million up 14% year over year.
Record net investment income of 188 million up 25% year over year.
Increased our base distribution three times in 2022 with our most recent increased to 39 per share in Q4.
Record cash distributions of $1 96 declared for 2022 and.
An 18% increase year over year.
Three consecutive years of delivering supplemental distributions to our shareholders and finally over $330 million of investments assigned two <unk> funded directly out of the advisor funds that we manage through our wholly owned <unk>.
2000, 22022 was also another year of investment in the company, where we took additional steps to strengthen our platform originations capabilities and back office functionality and sophistication.
These investments provide us with continuing optimism and confidence in the trajectory of our business heading into 2023.
Our results in Q4 can be summarized by record earnings strong portfolio growth and momentum improving yields and stable credit.
Let me recap some of the key highlights of our performance for Q4.
Our record originations performance in the first three quarters of 2022 continued with strong Q4 gross debt and equity commitments of $645 million.
Our gross fundings continued to be strong during the quarter with over $367 million.
This led to strong net debt investment portfolio growth of over $133 million during the fourth quarter and a record $598 5 million for 2022.
The net debt investment portfolio growth that we achieved in 2022 combined with the current yield environment puts us in a strong position to be able to deliver strong net investment income growth in fiscal year 2023.
Our Q4 originations activity was driven by both our technology and life Sciences teams delivering strong performance during the fourth quarter.
Our commitments and funding activity demonstrated balanced between our two core verticals and this continues to provide us with a unique ability to actively target both vehicles, depending on where we are seeing better opportunities and risk adjusted returns.
We funded capital to 25 different companies in Q4.
Of which nine were new borrower relationships.
For 2022, we added 52, new borrower relationships, which further expands our scale in the market and reputation as a lender of choice for growth stage companies looking for a long term and stable financing partner that has been active in the market through several cycles.
Consistent with what we saw throughout the first three quarters of 2022, we were again able to expand our funding relationship with numerous portfolio companies that continue to show strength and achieved performance milestones during the fourth quarter.
With over 3 billion of new commitments in 2022, and a lower than typical funding to commitment ratio driven by conservative credit underwriting. We expect this trend of increased follow on fundings to existing portfolio companies to continue in 2023.
The momentum that we saw throughout 2022 has carried into 2023 and we are pleased by our performance on originations quarter to date.
Since the close of Q4 and as of February 13th 2023 R.
Our deal team has already closed $189 million of new commitments and funded over $192 million.
We have pending commitments of an additional $263 million in signed non binding term sheets.
Volatility across the equity markets, particularly for growth stage companies continued to stabilize in Q4.
Valuations for both public and private companies remain under pressure in the capital markets have stayed more selective on the equity side.
This is continuing to drive strong demand for our capital and why we expect our pipeline to continue to be healthy near to medium term.
We believe that Hercules is best positioned in the asset class for continued and sustained success.
Consistent with our historical approach to underwriting credit we are remaining patient and disciplined on new originations and we will prioritize credit quality over chasing higher risk transactions with a yield premium.
We believe that we are incredibly well positioned in the current market and that our scale and portfolio in D. C diversification afford us the ability to say no on new credits that do not meet our underwriting parameters.
This is particularly important in today's market with a number of growth stage companies looking for structured debt has increased dramatically.
Hercules has always maintained a credit first culture and we expect this to continue to serve us well, particularly in periods of volatility.
During Q4 portfolio company exits and liquidity events for the industry continued to reflect the ongoing pressure in the equity markets as well as the trends and M&A that we anticipated on our Q3 earnings call.
For 2022, we had 19 total exits comprised of five Ipos and 14 companies announced or complete M&A transactions.
Although the exit environment in 2022 was suppressed relative to 2021.
Our 19 exits were consistent with our historical average.
As the IPO market remains uncertain, we continue to expect to see an acceleration of M&A transactions over the next several quarters.
Since our last earnings call on November 2nd we have had nine portfolio companies announced or completed M&A transactions.
This includes.
I will start announcing the merger with Bella Dine in Q4 and completing it in Q1.
And ever note announcing its acquisition by bending spoons also in Q4.
During Q1 quarter to date, we have had seven additional portfolio companies announced or completed M&A transactions.
This includes fungible being acquired by Microsoft.
Eldorado pharma being acquired by Gibson.
Aggravated or being acquired by notice.
Concert pharmaceuticals being acquired by Sun pharma.
Logic works being required by Cox communications.
They are being acquired by LG Chem.
And Oak streets recent announcement that it is being acquired by Cvs.
This reflects the quality of our loan portfolio as well as our team's ability to continue to identify and target. The most promising growth stage companies in the market.
Early loan repayments were approximately $131 million in Q4 close to the midpoint of our guidance of $100 million to $150 million.
And a modest increase from $125 million in Q3 2022.
For Q1 2023, driven in large part by M&A, we expect prepayments to be between $150 million and 200 million.
Though this could change as we progress in the quarter.
In Q4, we generated a record total investment income of $102 million.
And record net investment income of $62 1 million or 47 per share providing 121% coverage of our recently increased base distribution of 39 per share.
Our portfolio generated a GAAP effective yield of 14, 7% in Q4, and a core yield of 13, 8%, which exceeded our guidance for the quarter and is indicative of the recent rate increases and higher onboarding yields for certain new loans.
With net regulatory leverage at a very conservative, 101% and continued robust liquidity across our platform our balance sheet remains very well positioned.
Additionally, we have no long term debt maturing in 2023, which affords us the ability to be opportunistic and selective on raising new capital.
Credit quality on the debt investment portfolio remains strong and stable.
Our weighted average internal credit rating of two point Q3 was slightly higher than the 220 rating in Q3.
But it remains at the low end of our normal historical range.
Our grade one and two credits decreased to 61, 5% compared to 67, 4% in Q3.
<unk> three credits were higher at 36, 3% in Q4 versus 31, 1% in Q3.
Our a rated four credits made up two 1% of the portfolio and rated five credits were 0.1% in Q4.
As of our most recent reporting 100% of our debt portfolio companies are current with respect to contractual payments of principal and interest.
As of the end of Q4, we had only two debt investments on nonaccrual with an investment cost and fair value of approximately $18 million and $1 7 million respectively.
Or 0.6% and 0.1% as a percentage of the company's total investment portfolio at cost and value respectively.
We ended Q4 with strong liquidity of over $606 million.
Subsequent to year end, we signed a new letter of credit agreement with <unk>, which provides for a letter of credit facility of up to $100 million.
In addition, we amended and extended our <unk> led facility.
The venture capital ecosystem finished 2022 with fund raising activity at a record 163 billion.
And investment activity at $238 billion. According to data gathered by pitch book and the National venture Capital Association.
With the amount of available capital to invest at historic highs, we remain optimistic that venture capital activity will accelerate in 2023.
Despite more selectivity and valuation sensitivity from venture capital investors capital raising across our portfolio remained strong throughout 2022, with 58 companies or more than half of our portfolio companies raising over five 6 billion.
New capital.
In Q4 alone we had 20 different companies raise over one $6 billion of new capital.
We exited Q4 with undistributed earnings spillover of nearly $125 million or 94 per share.
The undistributed earnings spillover continues to provide us with the added flexibility with respect to our shareholder distributions going forward.
And the ability to continue to invest in our team and platform.
For Q4, we increased our base distribution to <unk> 39.
From 36.
And declared a new annual supplemental distribution of 32.
Which will be paid equally over the next four quarters beginning in March 2023.
This was our third increase to our quarterly base distribution in 2022.
And our third consecutive year of being able to payout supplemental distributions to our shareholders.
We will continue to evaluate the quarterly variable base distribution with a particular focus on the debt portfolio growth and NII growth that we are expecting to materialize.
In closing.
Our momentum remained strong throughout 2022, and we remain well positioned in 2023 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.
Our core themes for 2023 will largely remain consistent with 2022.
And they reflect maintaining a strong balance sheet and liquidity position and staying disciplined on new underwritings, while continuing to invest in our investment teams and platform.
We are thankful to the many companies management teams and investors that continue to make Hercules their partner of choice I will now turn the call over to Seth.
Thank you Scott and good afternoon, ladies and gentlemen.
As Scott mentioned this was another record quarter for Hercules capital capping off a record breaking 2022.
In addition to record investment activity in 2022, we continued to strengthen our team expand and enhance our balance sheet and ensure our cost of leverage was optimized in a rising interest rate environment.
Throughout the year, we were able to further validate the benefits of operating at scale by demonstrating meaningful operating leverage as we grew AUM to record levels. This allowed us to deliver an NII margin of 62% in Q4, the highest that we've achieved since 2007.
Yeah.
During 2022, our weighted average cost of debt remained below four 6%, putting us in a very strong position relative to others in our asset class. We are able to do this by refinancing more expensive legacy instruments in 2021 and into early 2022, then focusing.
Iron balance sheet flexibility once the markets became more challenging from a rate perspective.
As a recap 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 capital.
Demonstrating our ability to raise significant amounts of capital at attractive rates and a period of significant volatility for the capital markets.
We've started 2023 with the same success.
Lending in renewing early our largest credit facility led by <unk> and putting in place a new letter of credit.
Facility with S. NBC to cover a $100 million of our available unfunded commitment and a more cost effective manner. The consequence of these steps is greater flexibility lower financing costs and consistently strong liquidity to support our business and portfolio companies.
We will continue to focus on these themes in 2023 as well as focus on other operational efficiencies and scale of the platform.
With that in mind, let's review the following areas number one income statement performance and highlights number two.
Unrealized and realized activity number three leverage and liquidity and then finally number four the financial outlook.
Focusing first on the income statement performance and highlights.
Total investment income was another record at $100 2 million driven by 27% growth in the debt portfolio over the year on strong new business underwriting combined with lower prepayments and an increase in benchmark rates.
Net investment income was a record $62 1 million or 24% quarter over quarter increase or a record of 47 per share in Q4.
Our effective and core yields in the fourth quarter were 14, 7% and 13, 8% respectively.
Compared to 12, 9% and 12, 4% in the third quarter the.
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 in the first quarter with the the full quarterly impact of the fourth quarter fed policy interest rate changes.
And the partial impact of the most recent rate change we are forecasting a leveling of core yield thereafter, due to expected loan onboarding yields and less movement from the fed.
Turning to expenses, our gross operating expenses for the quarter increased to $40 million compared to $36 1 million in the prior quarter.
Net of cost recharge to the R. I E. Our operating expenses were $38 million.
Interest expense and fees increased to 18 million from $16 7 million in the prior quarter due to the growth of the investment portfolio and slightly higher weighted average cost of debt.
SG&A expenses increased to 22 million from $19 4 million in the.
Prior quarter.
My guidance on higher funding for the quarter versus our forecast now.
Net of cost recharge to the I R. R. I E. The SG&A expenses at we're at $20 1 million.
Our weighted average cost of debt was $4 six a slight percent incur.
The increase compared to the prior quarter, reflecting greater utilization of the credit facilities due to growth of the investment portfolio.
R. R O AE or NII over average equity increased another 350 basis points to 18, 2% for the fourth quarter and our O a a or NII over average total assets was eight 8%.
Switching to NAV unrealized.
And realized activity during the quarter, our NAV increased <unk> <unk> per share to $10 53 per share. This represented an NAV per.
Per share increase of <unk>, 6% quarter over quarter.
Net investment income accretion due to modest use of the ATM was offset by the dividends paid in the quarter, including the 15 cents per share spillover distributions of 2021 earnings.
Net realized loss.
<unk> of $1 7 million.
Related to the write off of the legacy equity and warrant positions.
Moving on to leverage and liquidity, our GAAP and regulatory leverage were 113, 7% and 101, 3% respectively.
Which slightly increased compared to the prior quarter due to the net growth of the investments offset by the modest use of the ATM net.
Netting out.
Leverage with cash on the balance sheet, our GAAP and regulatory leverage was 112, 6% and 100.1% respectively.
We ended the quarter with more than $600 million of available liquidity. As a reminder, this excludes capital raised by the funds managed by our wholly owned <unk>.
Subsidiary.
We believe our strong and flexible liquidity positions us very well in the current rate environment.
With the renewal of the <unk> credit facility.
And the addition of the S. M. B C letter of credit facility, we have no near term debt maturities, giving us the ability to be opportunistic should we decide to raise additional capital to support the business with.
We continued to opportunity to mystically access the ATM market during the quarter and raised approximately $40 million, resulting in an <unk> <unk> per share accretion to NAV.
For the year, we raised approximately $230 million from the ATM program.
Finally on the outlook points for the first quarter, we're increasing our core yield guidance range to 13, 5% to 14%, excluding any future benchmark interest changes.
As a reminder, approximately 95% of our debt portfolio is floating with a floor. So the recent interest rate hike and any additional in 2023 will benefit our core yield going forward, although very.
Difficult to predict as communicated by Scott, we expect $150 million to $200 million and prepayment activity activity for the first quarter.
Expect our first quarter interest expense to increase compared to the prior quarter due to the balance sheet growth experienced in the fourth quarter and anticipated in the first quarter.
For the first quarter, we expect gross SG&A expenses of $21 million to $22 million.
In a similar lever level of or a expense allocation compared to the fourth quarter.
As a reminder, the first quarter always has higher payroll taxes and.
And benefit costs.
In closing as we reflect on the achievements of 2022, and our ability to deliver both record AUM and record NII per share we remain optimistic about 2023, and our ability to continue to drive growth across the platform while remaining focused on <unk>.
Levering best in class total shareholder returns I will now turn over the call to Josh to begin the Q&A portion of our call Josh over to you.
Thank you as a reminder to ask a question. Please press star one on your telephone and wait for your name to be announced to withdraw your question. Please press star one again.
Our first question comes from Crispin Love with Piper Sandler You May proceed.
Thanks, Good afternoon.
In the prepared remarks, you talked about.
Some of your companies.
Portfolio companies raised equity capital in 2020 team for I think you said about $5 6 billion and that's with the industry activity fell off.
So can you just speak to what.
Why do you believe that your portfolio companies, where we are in a position to raise significant capital while the industry as a whole was unable to.
Sure. Thanks, Kristen I think a lot of it really has to be attributable to the quality of our team. We have we have over 55 professionals on the investment team. This.
This is an incredibly experienced investment team the average industry experienced across that investment team is approximately 10 plus years and they have a long track record of working successfully together to identify and then winning transactions with some of the best quality companies in the market. So I think a lot of the credit has to go to the <unk>.
The second thing that I would point out is that at least from what we're seeing.
There has certainly been some pressure in terms of valuation, but the companies that remain strong companies are able to raise new equity capital and Thats really what we saw across our portfolio in 2022 and those numbers that you cited where exactly where they came out for us in Q4, we had 20 different.
Companies raise over one $6 billion of new capital and for the year. We had approximately 58 companies raised approximately $5 $6 billion of new capital.
It just got hung about $5 6 billion compared to 2021.
I don't have the data for you for 2021, so I'd have to get back to you on that.
Okay.
Not a problem and then Scott you also mentioned during the prepared remarks about.
Being patient and disciplined on new.
Originations are you able to drill into that a little bit deeper and what that might mean for your expectations for new debt fundings or debt fundings growth in 2023 or at least what you are seeing over the near term.
Sure. So as a firm we are incredibly optimistic about what the environment will look like for us in 2023, we're off to a great start in Q1 and I provided some.
To date closed commitments and quarter to date pending commitment numbers and we're off to a great start in regards to both of those numbers.
The team is continuing to look at and evaluate a record number of transactions. So when we look at our pipeline activity is as large as it's been in a long time.
Having said that and this was also part of the prepared remarks because of the turbulence that we're seeing in the equity markets, both public and private we're seeing a tremendous increase in the number of companies that are looking for venture debt or growth stage debt funding solutions.
And as you know having followed this business for a long period of time, you simply can't hit the bid for every company that's looking for debt financing. So our team is being.
Very thorough in terms of our screening very diligent with respect to the number of companies that we are progressing along in our pipeline activity and we believe that we are closing transactions with the best qualified companies that we are seeing on a quarterly basis I would also reference last year, we did $3 billion of.
When you look at our funding to commitment ratio last year was approximately 55% to 60%. So there are a lot of fundings that we anticipate taking place from the existing portfolio over the course of the next six to 12 months.
Thanks, Scott I appreciate the color.
Sure. Thanks Kristen.
Thank you.
Our next question comes from Kevin <unk> with JMP Securities You May proceed.
Hi, good afternoon, and congratulations on a great year.
Clearly the portfolio credit quality is in excellent shape I'm just curious if you've seen an increase in requests at all and if you could discuss your expectations that potentially pick up in the near term.
Sure. Thanks, Kevin.
We have not and we actually we just looked at as we look at it every quarter, but over the course of Q4.
It really did not see any uptick in amendment requests broadly.
And specifically, we did not see any amendment requests that were related to stress or liquidity related situations. So I think overall, we're continuing to see a stable and strong credit environment across our portfolio.
We have two loans on non accrual it makes up less than 0.1% of the portfolio from a fair value perspective, we're certainly increasing our monitoring work, we're tightening our underwriting screens given the volatility that we have seen over the course of the last several quarters that we expect to see on a go forward basis, but overall, we have not seen.
<unk> any uptick with respect to amendment requests from our portfolio companies.
Okay, that's great to hear and I guess to continue on that line of questioning you mentioned non accrual. It's obviously in great shape with only two investments on non accrual.
Curious if you could provide some high level color on the one new investment that was added this quarter.
Sure. It's a small loan it's about a $5 million loan to a small tech company that is private.
That company remains current with respect to its contractual payments to Hercules, but it does have stressed liquidity theyre currently exploring a variety of options and we're working closely with the team. We did make the decision in Q4 out of an abundance of caution to put that put that loan on non accrual and we did take a fair value of.
Adjustments on that position as well, but it's a very small position relative to obviously a $3 billion portfolio.
Understood.
Thanks for taking my questions I'll leave it there.
Sure. Thanks, Kevin.
Thank you.
Our next question comes from Christopher Nolan with Ladenburg Thalmann, you May proceed.
Hey, guys.
Scott unfunded commitments for 645 million, 20% of the portfolio down slightly quarter over quarter are you given the volatility of the broader environment are you seeing companies, having a tougher time meeting their milestones to tap those commitments.
We're not we've actually had a tremendous run of success with respect to companies of being able to unlock unfunded commitments.
It's hard to sort of see the quarter over quarter movements, because they are sort of a combination of two things number one in any given quarter. We're funding a large portion of those available unfunded commitments and then new unfunded commitments are being unlocked. So what you essentially saw in Q4 was we were able to fund a lot of capital to existing port.
Bolio companies, but on top of that we had several of our larger later stage companies. Both on the tech side and life Sciences side achieved specific performance milestones during the quarter, which unlocked new tranches from from an availability perspective.
And my follow up question is in your prepared remarks, you mentioned if I heard.
<unk> correctly, three 6 billion.
Assets the balance sheet has $3 billion at costs should we assume that the incremental $600 million.
Assets in the RIAA.
Yes.
And then what.
How do you I know service side, but do you see the <unk> B may even a faster growth vehicle than the publicly traded BDC.
'twenty three.
It's hard to say.
We think that both vehicles are obviously growth oriented vehicles, and we demonstrated and we delivered very strong growth in the public BDC and in the private credit fund business last year, we expect that to continue to be the case based on what we're seeing right now for 2023, I would point out that because of the unique structure that we've deployed.
Floyd here, where the RIAA business is operated as a wholly owned subsidiary of the public BDC. The more successful that private credit fund business is the better it is for the shareholders and stakeholders of <unk>.
Okay. That's it for me. Thank you for taking my questions.
Thanks, Chris.
Thank you.
Our next question comes from Casey Alexander with Compass point, you May proceed.
Yeah.
Good afternoon.
So I'm trying to wrap my head a little bit around the cadence of.
The way things look like Theyre going to flow here in the first quarter.
And you discussed $150 million to $200 million of repayments.
As your instrument I understand that.
You had commitments in the first quarter already of 190 million, but you've already funded $193 million I am assuming that that is some of those loans that are coming off of the unfunded.
Commitment schedule.
Okay.
It would suggest especially given that most of the time.
Fundings are back ended that you would be looking at a fairly robust.
Quarter in terms of net originations and would that in part explain why you've already sold two 6 million shares under the equity ATM program this quarter.
Sure. Thanks, Casey So first with respect with respect to Q1 as you know we do not provide a gross funding projections with respect to what we expect to do we did provide the commitment numbers I think the way you are looking at it though is it.
The right way to think about it the reason why the funding numbers, so far quarter to date exceed the commitment numbers as we've been able to fund a lot of capital to existing portfolio companies, who hit performance milestones in the second half of last year and those tranches were either expiring or the company has made the decision to draw that capital.
And in the case that.
What we typically see happening where the companies are achieving those milestones and we're obviously happy to fund that additional capital to borrowers where we already have the relationships.
We're also seeing strong demand from a new business perspective, and thats evidenced by the new commitment number and the pending commitment number.
So we're confident and we're optimistic with respect to what that Q1 funding number is going to is going to look like and that does lead to a why we have been not aggressive but why we have been active on the ATM quarter to date and I would also tell you that that should serve as a pretty strong signal about how we feel about portfolio grew.
Over the course of the first half of this year.
Okay. Thank you for that my other question is.
Yes.
What's different.
And precipitate the usage of a letter of credit as opposed to a credit facility is there something different about that is it is it securitized debt allows for it to be cheaper capital or why go in that direction I'm not sure I ever remember a BDC actually using a letter of credit as opposed to a credit facility.
<unk> yeah.
Thanks, KC I sat here, we think it's a pretty Smart addition to our toolbox based on the fact that.
It's a lot cheaper facility to put in place, we're very grateful for SMB see working with us to put in place. What we think is probably the first.
And an unrelated letter of credit Thats been put in place and it covers the tail end of the exposure on the available unfunded commitment that portion, which is unlikely in any single quarter ever to be drawn down.
Historically, the range has been 5% to 15% of the prior quarters available unfunded commitment is drawn down so covering all of it with a higher cost credit facility doesn't seem smart to us in the long term.
Okay, I think I get it.
Alright. Thanks I appreciate your taking my questions.
Thanks Casey.
Thank you.
Our next question comes from John Hecht with Jefferies. You May proceed.
Hey, guys congratulations on a good year and a good quarter and.
I appreciate you taking my questions.
First one is I mean, it's very clear that the public markets have gone from a kind of heartland and softer landing kind of valuation and there was an expectation that I'm wondering Scott you maybe.
How does the deal in the venture capital World.
Terms of their viewpoint on the climate.
And what does that mean for <unk>.
Kind of the demand for your product and the opportunity set.
Sure. Thanks, John .
We're seeing across the ecosystem is I would say caution but also optimism.
The VC firms have record amounts of liquidity available to invest when you look at the investment activity numbers for 2022, you can look at it one of two ways you can look at it relative to 2021, which was the best year on record and you can say that it was down year over year, which is absolutely factual, but you can also look.
At it and say that the 2022 investment numbers.
It represented the second strongest year in the history of venture capital activity and so we chose to sort of look at it somewhere in the middle We think the fund raising activity that was a record level. In 2022 is a very strong signal of what we expect to be an acceleration of VC investment investment.
Activity over the next 12 months to 24 months. We're also continuing to see the same trends that we saw throughout 2022.
Good companies are able to raise money.
But deals are still getting done for the companies that deserve to be funded and whether it's on the equity side or the debt side. There have always been and there will continue to be a handful of companies that probably should not be getting financed and until all of that sort of works its way through the system and that will take some time youre going to continue to have this sort of.
Volatility that we're seeing both in the public markets and in the private markets as well.
Okay. That's great color. Thank you and then the second question is look I mean, you have a history of extraordinarily low losses and obviously here.
Current credit book is still really strong I know you have regulatory restrictions on leverage.
But given your kind of loss content in your credit book.
Yes.
Or is there any potential appetite to kind of move towards the higher end of your leverage target over time or how do we just think about the application of leverage.
You're giving here.
Again, that's terribly low loss ratio over time.
Thanks, John for the question two things one and we've talked about this publicly before in the venture lending or growth stage lending asset class drew.
Driving leverage up.
He is really challenging and the reason for that is the duration of our assets.
Throughout 2022 on a quarterly basis, our average duration was somewhere between 12 and 16 months right now our average duration is roughly 15 months.
And so when your portfolio is turning that rapidly, it's very difficult to drive leverage up on a consistent and sustained basis.
As of the end of Q4, we were operating at roughly 113, 7% from a GAAP leverage perspective.
Our guidance or our ceiling has publicly indicated is about 125%. So there is some room for us to drive that up and if the portfolio growth is as strong as we expect it to be in 2023, it would not surprise us if that number gets driven up slightly but we're not a firm that has traditionally or will want.
On a go forward basis pushed the envelope with respect to leverage because even though it might help generate some additional return.
I think in our asset class, it's the most prudent thing to do.
Okay.
Good thank you very much.
John .
Thank you and as a reminder to ask a question you will need to press star one on your telephone.
Our next question comes from Ryan Lynch with <unk> you May proceed.
Hey, good afternoon.
First question I had was I think you've kind of touched on it earlier, but.
Can you just explain why you are.
While both your debt and your equity and warrant portfolio valuation.
Held up so well this quarter kind of kicked in the face kind of a challenging.
The venture capital marketplace.
Yes, so thanks, a lot Ryan.
I think.
When you dig into the detail of our movement Youll see that the public equity.
Positions moved up so and that's just driven by the public markets, where they landed at 12 31, whereas the private positions move down by almost an equal amount that was obviously a coincidence.
Different quantum's of those positions and.
And what we've always seen is that the private positions typically trail about a quarter behind the public positions and so it's not uncommon that we have those move in.
Different directions, or deferring quantum's because of that delay of the impact to the private markets.
And Ryan I would just add as Jeff mentioned, the biggest driver on the upside was the public equity position and if you just look at some of our larger public equity positions quarter over quarter from where they started Q4 to where they ended up the vast majority of those larger positions were up and that's that was the largest driver of the overall move.
<unk> and unrealized appreciation.
Okay.
Helpful.
And then <unk>.
Going back to just the overall environment.
You guys talked around the call Theres been a lot of venture capital fund raising.
2022, I think it was a record year.
But if you look at the venture capital investment while it was healthy in 2022, there was a pretty sharp decline throughout 2022.
Yes.
Starting with the fourth quarter, I think of like $36 million 36 billion.
And then also when you look at venture capital activities. They have really kind of dropped off a cliff and I think they were down to about 5 billion in the fourth quarter and so my question is while there's been a lot of capital raised.
And venture capital firms in 2022.
How do you feel.
How active do you feel they'll be it exits and theyre not receiving their money back actually stay kind of at these very low levels.
Sure. Thanks for the question Ryan So a couple of things and I had mentioned this in a response to one of the earlier questions. You can look at the 2022 investment data one of two ways. We chose to look at it as very strong and healthy $238 billion invested by VC firms.
The course of 2022 down year over year from a record in 2021, but the second strongest year on record and for US. Despite the fact that it's down year over year.
That's still reflects what we saw in our own portfolio in 2022 with respect to funds raised that was a record number of about $163 billion raised by venture capital firms in 2022, when VC firms make investments, they're not anticipating an exit in three months six months or 12.
<unk>.
These tend to be longer term investments, we are very optimistic about the future of the venture capital ecosystem and based on the conversations that we're having with our portfolio companies with the venture capital firms that back our portfolio companies. We believe that 2023 will represent an uptick with respect to VC investment activity.
<unk> across the ecosystem.
I guess my question was more on the trends that we're seeing because.
While there was a record number of capital raised in 2022, the trend from investing on a quarterly basis.
The accelerated.
Significantly throughout 2022.
Fourth quarter was very weak and then when you look at the exit activity.
That really drop throughout the year significantly. So my question is really <unk>.
Do you expect these trends to.
The turnaround or to continue in 2023, and what does that mean.
For your business, even even kind of forgetting about 2021, but I know those were kind of years.
Now it may be.
Somewhat exacerbated by by kind of the frothiness of the interest rates, but.
Do you see these trends sort of turning around that we saw in the second half of 2022, and if not what does that mean for the venture capital landscape.
So Q Q4, both with respect to funds raised and dollars invested was down.
If you look at it relative to Q3, we do expect that to turnaround I am not going to predict whether that happens in Q1 or Q2, we look at things on a six to 12 month basis and based on everything that we're seeing conversations that we're having we believe that you will see an uptick over the course of 2023.
With respect to exit activity, which was another comment that you made in terms of trends again, I would sort of distinguish between some of the overall industry data and just the empirical evidence that we see in our own portfolio.
To date, we've had seven companies out of 105 companies announced or closed M&A transactions.
We certainly are not seeing any uptick.
With respect to IPO activity, but as we've been indicating public over the course of the last several quarters, we expect and we are seeing a tremendous uptick in M&A activity and again based on conversations we're having across the portfolio. We actually expect that trend to continue to accelerate into the first half of 2023.
Okay understood.
Understood I appreciate the time this afternoon.
Sure. Thanks, Brian .
Thank you. This concludes the Q&A session I would now like to turn the call back over to Scott for any closing remarks.
Thank you, Josh and thanks to everyone for joining our call today.
As a final note we will be participating in the RBC 2023 financial institutions Conference in New York on March 7th.
If you would like to arrange a meeting with the Hercules management team. Please contact RBC or Michael Hara, we look forward to reporting our progress on our Q1 2023 earnings call.
Uh huh.
Thank you. This concludes today's conference call. Thank you for participating you may now disconnect.
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The conference will begin shortly two reasons lower Johan during Q&A, you can dial one one.
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The conference will begin shortly to raise and lower Johan during Q&A you can dial one one.
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