Q2 2023 Hercules Capital Inc Earnings Call

August 3, 2023

[music].

Yeah.

Okay.

Good day and thank you for standing by welcome to the Hercules Capital Second quarter 2023 earnings Conference call. At this time all participants are in a listen only mode. After the speaker's presentation. There will be a question and answer session to ask a question. During the session you will need to press star one.

On your telephone you will then hear an automated message advising you that your hand is raised to withdraw your question. Please press star one one again please be advised that today's conference is being recorded I would now like to hand, the conference over to your first speaker today, Michael Hara managing director of Investor Relations.

Michael you have the floor.

Thank you Stacy and good afternoon, everyone and welcome to Hercules Conference call for the second quarter 2023.

With us on the call today from Hercules are Scott Bluestein, CEO and Chief investment Officer.

Seth Meyer CFO .

These financial results were released just after today's market close and can be accessed from Hercules Investor Relations section at Investor Dot H T. G. 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 are 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.

Clothing, 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 the Hercules capital Q2, 2023 earnings call.

Our best in class venture and growth stage lending platform continued to deliver record earnings and operating performance in Q2, while maintaining the historical strong strong credit standards that we have come to expect.

Our record Q2 results were highlighted by many of the key themes that we have discussed over the last few quarters.

M&A exit activity in our portfolio remained robust which drove increased prepayments.

Capital raising across our portfolio accelerated doubling from the strong activity that we saw in Q1.

Rising rates combined with higher Onboarding yields and an increased weighted average portfolio balance drove total investment income core investment income and net investment income to record levels.

Credit remains strong and stable.

Deal activity combined with pipeline activity continued to show increasing quality and quantity.

As a result, we continue to be very optimistic about our positioning relative to others in the asset class and our ability to capture further market share over the coming quarters.

Our differentiated business model that is predicated on diversification fundamental credit underwriting and long standing relationships with over 1000 venture capital and private equity investors has continued to serve us well and allows us to outperform in a variety of macro environments.

During the second half of 2023, our focus will remain on prudent underwriting asset and liability diversification, maintaining an abundance of liquidity and an unwavering commitment to the venture and growth stage ecosystem that we service.

Our decision in Q2 to once again raise our quarterly base distribution to our shareholders is reflective of our strong outlook for the business over the coming quarters.

Let me recap some of the key highlights of our performance for Q2.

In Q2, we generated record total investment income of $116 2 million.

Up 61% year over year and record net investment income of $75 7 million up over 88% year over year, or <unk> 53 per share and providing 132% coverage of our newly increased base distribution of <unk> 40.

<unk> per share.

This is our third consecutive quarter of delivering record net investment income.

We also generated record return on equity in Q2 of over 20% for the first time in our long operating history.

Our portfolio generated a GAAP effective yield of 16% in Q2, and a core yield of 14, 1%, which is indicative of the recent rate increases and higher onboarding yields for certain new loans.

With net regulatory leverage at a very conservative 86, 4% and continued robust liquidity across our platform our balance sheet remains very well positioned.

As the market environment for new deals in our asset class continues to improve over the coming quarters, we believe that having a strong and diversified balance sheet with maximum liquidity will be a key differentiator for our platform and best positions Hercules to capitalize on the market opportunity that we believe is in front of us.

The focus for our origination efforts in Q2 was on diversification with an emphasis on later stage and scaled opportunities.

Our Q2 originations activity was once again driven by both our life Sciences and technology teams delivering healthy funding performance during the quarter.

Our funding activity demonstrated balanced between our two core verticals, which we believe helps drive consistent outperformance relative to our peer group.

We funded debt capital to 19 different companies in Q2 of which six were new borrower relationships.

Consistent with what we saw in Q1, we were again able to expand our funding relationship with numerous portfolio companies that continued to show strength and achieved performance milestones during the second quarter.

In addition, the strong level of fundings to existing companies also helped to lower our available unfunded commitments to $381 million, which was markedly down from $562 million in Q1.

Approximately 50% of our available unfunded commitments will expire by the end of the year driving higher expected follow on fundings in the second half of 2023.

As we guided to on our Q1 earnings call. Our funding activity in Q2 was backend weighted towards the end of the quarter with over $300 million of our quarterly fundings coming in the month of June .

Although Q3 is typically a seasonally slow quarter across the venture and growth stage lending markets. We expect our origination activity in Q3 to be robust.

Operating at scale being able to consistently deliver for our borrowers and their equity holders despite market conditions and not having to worry about being constrained by high leverage or low liquidity.

Is driving a strong start to Q3 for our business.

Since the close of Q2 and as of August <unk> 2023, our deal team has already closed $209 6 million of new commitments and funded $142 9 million.

We have pending commitments of an additional $305 5 million in signed non binding term sheets.

We continue to expect deal quality to remain high and continue to get better as the year plays out.

Although the portfolio company exits and liquidity events for the industry continue to be slow activity across our portfolio continues to be strong.

After having eight M&A transactions close in Q1 across our portfolio. We had another two M&A transactions closed in Q2, and we had another one closed shortly after the end of Q2.

In addition, we have two additional M&A events that had been recently announced that have not yet closed and in July our portfolio company and Jean announced a business combination agreement with four beyond acquisition to go public.

We now have three portfolio companies in the pipeline looking to go public.

Our portfolio activity continues to validate the great work and selective underwriting that our investment teams do.

As we anticipated early loan repayments increased further in Q2 to approximately $297 million.

Within our guidance of 225 million to 325 million and an increase from $202 million in Q1 2023.

For Q3, 2023, we expect prepayments to remain healthy but to decrease to 175 million to 250 million. Although this could change as we progress in the quarter.

Higher levels of prepayments over the last several quarters. Despite the market volatility 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.

Credit quality of the debt investment portfolio remains strong and stable.

Our weighted average internal credit rating of two to four improved from the 226 rating in Q1.

And remains at the lower end of our normal historical range.

Our grade one and two credits remained relatively flat at 59, 4% compared to 59, 8% in Q1.

Grade three credits were slightly higher at 38, 3% in Q2 versus 37, 1% in Q1.

Our rated four credits decreased slightly to two 3% and rated five credits were once again zero percent in Q2.

As of the end of Q2, we had one debt investment on non accrual with an investment cost and fair value of approximately $13 3 million and zero million, respectively, or 0.4% and 0.0% as a percentage of the company's total investment portfolio at cost and <unk>.

<unk> respectively.

As of our most recent reporting 100% of our debt portfolio companies are current on contractual payments to Hercules.

Despite increased selectivity and valuation sensitivity from venture capital investors capital raising across our portfolio remained strong in Q2 with 21 companies raising nearly $1 9 billion in new capital in Q2.

This was up over 100% from Q1 and was the strongest quarter of new capital raising in our portfolio over the last year and a half.

During Q2 Hercules had net realized gains of zero point $2 million.

This was comprised of net realized gains of $6 million due to the sale of equity and warrant investments.

And gains on foreign exchange offset by approximately $5 8 million due to the loss on two smaller debt investments.

Through Q2, we have generated $8 2 million of realized gains year to date.

Our net asset value per share in Q2 was $10 96.

An increase of one 3% from Q1 2023.

This was our fourth consecutive quarter of reporting and increased net asset value per share.

We ended Q2 with strong liquidity of over $670 million.

Inclusive of available liquidity in our private funds, we have approximately $1 billion of liquidity as of the end of Q2.

Venture capital ecosystem fundraising and investment activity continued to stay at muted levels relative to the historical highs that we witnessed in 2021 and 2022 with fundraising activity at $33 billion and investment activity at 86 billion for the firm.

Half of 2023, respectively.

According to data gathered by textbook NVCA.

In terms of VC investment activity Q2 was slightly lower than Q1 with $40 billion of investments relative to the $46 billion that was invested in Q1.

This pace puts the industry on track to meet or exceed pre pandemic VC equity investment levels for 2023.

We expect fundraising to stay at much lower levels than prior years and investment activity to continue to pick up as the year goes on.

With our record operating performance year to date, we exited Q2 with increased undistributed earnings spillover of over $148 million or $1 <unk> per ending shares outstanding.

For Q2, we increased our base distribution to <unk> 40.

And declared a supplemental distribution of <unk>.

For a total of 48 of shareholder distributions.

This represents the third base distribution increase in the last 12 months and as the 12th consecutive quarter of being able to pay out a supplemental distribution to our shareholders.

In closing.

Our scale institutionalized lending platform and our ability to capitalize on a rapidly changing competitive environment continues to drive our business forward and our operating performance to record levels.

In Q2 for the first time in our long operating history Hercules delivered over $100 million of quarterly core income, which excludes the benefit of prepayment fees or fee acceleration from early repayments.

This is another significant milestone for our business.

Our success is attributable to the tremendous dedication efforts and capabilities of our 100 plus employees.

And the trust that our venture capital and private equity partners placed with US every day.

We remain optimistic about our business opportunities given how well we are positioned to take advantage of market conditions and grow our core income generating assets and as a result, the earnings power of the business.

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, I'll now add some emphasis to some of the points that Scott has made.

Q2 marked another quarter of solid execution record financial performance and conservative balance sheet management for Hercules capital.

We are continuing to see the benefits from operating with a healthy spread between our lending and borrowing rates and a strong balance sheet with no near term material maturity.

In Q2, we had record investment total investment income of 116 million record net investment income of $75 7 million record net investment income per share of 53 per share and a record return on equity of more than 20%.

<unk>.

The investments that we've made in our platform and the scale at which we are now operating are helping to drive our record financial performance.

Our strong and defensive balance sheet positions us incredibly well to be able to take advantage of the attractive market opportunity for new investments that our team believes will continue to get better over the coming quarters.

With these points in mind, let's review the following areas the income statement performance and highlights.

Unrealized and realized activity leverage and liquidity and then finally the financial outlook.

Turning to income statement performance and highlights.

This was the third quarter in a row that total investment income exceeded $100 million at $116 2 million driven by the prior quarter growth in the debt portfolio on solid new business underwriting and an increase in benchmark rates. It was also the first quarter the core income.

non-GAAP measure exceed.

Exceeded $100 million at $102 5 million.

Our investment income excludes the benefit of income recognized as a result of loan prepayments. This is a true testament to the size of the portfolio now managed by the team.

Net investment income was another record at $75 7 million or 15, 6% quarter over quarter increase or a record 53 per share in Q2, NII margin has now been above 60% for three quarters.

In a row.

Our effective and core yields in the second quarter were 16% and 14, 1% respectively.

Impaired to 15, 1% in 2014.

14% in the prior quarter.

The increase in the core yield was due to an increase in coupon interest as a result of benchmark rate interest increases.

We continue to forecast a leveling of core yield hereafter due to minimal movement from the fed in the coming quarters. After the most recent rate increase.

Turning to expenses, our gross operating expenses for the quarter increased to $42 9 million compared to $42 3 million in the prior quarter.

Net of cost recharge to the RIAA, our operating expenses were $40 5 million inter.

Interest expense and fees increased modestly to $19 6 million from $19 million in the prior quarter due to the growth of the investment portfolio in the first half of the year and slightly.

Slightly higher weighted average cost of debt.

Strong funding activity to start Q3 will likely continue these trends.

SG&A expenses remained flat at $23 3 million slightly above my guidance of $23 million.

Net of cost recharge to the RIAA the SG&A expenses were $20 9 million.

Our weighted average cost of debt was a mere four 8% a tiny increase compared to the prior quarter, reflecting greater utilization of the credit facilities due to growth of the investment portfolio in the first half of the year.

R O AE or NII over average equity increased to 28% for the first quarter and our R. O a a or NII over average total assets was 10%.

Switching to NAV unrealized and realized activity during the quarter or any of the.

Increased for the fourth consecutive quarter by <unk> 14 per share to $10 96 per share.

This represents an <unk> <unk> per share increase of one 3% quarter over quarter.

The main drivers for the increase were the net change in unrealized depreciation of $18 9 million net of reversal of prior unrealized depreciation of $8 4 million, mainly due to investments disposals disposed of or written off.

Net investment income and accretion due to ATM sales offset by dividends paid in the quarter, including the supplemental distribution and the dilution from stock compensation.

Our 18.

Eight 9 million of unrealized depreciation was primarily driven by $16 million of appreciation to the public equity and warrant portfolio.

An additional $8 8 million of unrealized depreciation was related to the loan portfolio.

The reversal of prior unrealized depreciation resulted in a net realized gain of 200000 comprised of net realized gains of $6 million due to the sale of equity and warrant investments and gains on foreign exchange offset by $5 8 million due to the loss.

On two debt investments.

Moving to leverage and liquidity.

Our GAAP and regulatory leverage where 101, 3% and 93% respectively.

Which decreased compared to the prior quarter due to maintaining a more normal cash balance over the quarter end and reduction of the credit facility borrowings based on the high prepayments collected in the quarter net.

Netting out leverage with cash on the balance sheet, our net GAAP and regulatory leverage decreased to 97, 4% and 86, 4% respectively.

We ended the quarter with $671 million of available liquidity as a reminder, this excludes capital raised by the funds managed by our wholly owned.

A subsidiary inclusive of these amounts the Hercules platform has over 1 billion of available liquidity the.

The strong liquidity positions us very well to support our existing portfolio companies and source new opportunities.

We continue to have no near term debt maturities, giving us the ability to be opportunistic should we decide to raise additional capital to support the business growth that we anticipate in Q2, we opportunistically accessed the ATM market and raised $65 million, resulting in a seven cent per.

Share accretion to NAV.

On the outlook points for the remainder of 2023, we expect our core yield range to be at 13, 8% to 14, 2% 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 $175 million to $250 million and prepayment activity for the third quarter, we expect our third quarter interest expense to remain stable compared to the prior quarter.

For the third quarter, we expect SG&A expenses of $23 million to $24 million and RIAA expense allocation of approximately $2 5 million.

In closing our balance sheet remains strong to support our existing portfolio as well as opportunistically invest in the best opportunities.

I will now turn the call over to Stacy to begin the Q&A portion of the call Stacie over to you.

Thank you we will now conduct a question and answer session. As a reminder to ask questions. Please press star one one on your telephone and wait for your name to be announced to withdraw. Your question. Please press star one again, please stand by while we compile the Q&A roster.

Our first call is from John Hecht with Jefferies. John Go ahead with your question.

Hey, guys. Thanks, very much congratulations on another great quarter.

Making our lives easier here.

Maybe Scott first question.

Obviously, that's what's changed in the world.

As reported in the.

What are the major financing entities in your market SBB ahead of issues. When it was obviously sold to the first citizens, but I'm. Just wondering can you describe any are you seeing any kind of changes the overall framework of the industry.

That are worth noting.

Yes, So I think John in addition to what we talked about on our last call, which was post the SBB failure.

I think we've seen sort of a little bit of normalization across the market.

First citizens I think has done a great job at stabilizing that business, we've seen them in the market on a handful of deals we're actually working with them on a number of deals as well.

Outside of first citizens there are some commercial banks that have pulled back from the venture lending ecosystem.

I think as a net benefit for our business.

On the non bank side I think the two key themes that we're certainly seeing in the market is that a lot of our competitors are hamstrung by either high leverage or liquidity and that really puts them in a position where they're having to operate deal by deal.

Whereas we're sitting here with low leverage and abundance of liquidity and it allows our team to be consistently in the market essentially going after any and all of the deal that we think fit our tight underwriting and pricing parameters.

Okay.

Okay and then.

It sounds like you'd probably see moving favorable to you guys from a competitive perspective at anything like the venture capitalists behaviors changing in terms of.

Out of the way they process funding or is that pretty stable.

Yes, so look I think the VC ecosystem.

Continues to be somewhat volatile and in flux, but I would caveat that by saying when we look at the year to date data. We've now had two consecutive quarters, where U S venture capital investors have invested <unk>.

$40 billion or more of equity capital and that gets us to roughly the 86 billion that we mentioned through the first half of the year.

That is down materially from what we were seeing on a quarterly basis throughout the pandemic. So if you look at the 2021 numbers in the 2022 numbers.

VC investors, we're averaging almost 80% to $90 billion per quarter.

Of that $40 billion, while down from the pandemic levels.

Still up from where it was on a pre pandemic basis. So when we look at what we've seen year to date, it's down, but it's still healthy and it's still robust what we have noticed and we think this is a positive the venture capital investors are being much more selective in terms of the companies that they are investing too.

If you look at it on a on a numbers basis.

Approximately.

17, 18000 individual investments were done by the VC firms in 2021 2022.

It's down to about 6000 year to date, so we're seeing less deals get done and we're seeing much more of a focus on valuation.

We would be of the view that the venture capital ecosystem continues to be healthy continues to continues to be robust and then it's actually on pace to exceed pre pandemic levels.

Okay.

Alright, that's helpful. And then final question is I mean.

Talked about obviously spreads have been pretty healthy.

That's just a reflection of maybe your opportunity and market leadership.

But what about other things like coverage.

Things like that and anything worth, noting there in terms of changing trends when it when it comes to the deal structures.

In terms of pricing.

We're focused on increased yields that can come through a variety of different triggers that we have it can come from coupon. It can come from facility fee. It can come from warrants that can come from end of term fees. So outside of just a general emphasis on higher onboarding yields nothing specific that I can mention and then on the structuring side, what I would tell you is that.

Written by what I believe is the best team in the business and we view that that is something that will serve us incredibly well going forward.

Alright, thanks, very much guys.

John .

And by far our next question.

Our next question comes from Crispin Love with Piper Sandler Kristen go ahead with your question.

Thanks I appreciate you taking my questions just following up on the question on the market and FCB. Scott you made some comments earlier on the call about the potential for market share gains just given suvs exit to what level do you think you've already begun to benefit from Suvs absence by.

Greasing share in the last four or five months and you think the runway here will actually accelerate over the next few quarters and be available for for years ahead. Just curious if there's just any way for you to size the opportunities in front of you just given the changes in the competitive landscape.

Yeah. Thanks, Kristen, it's actually a great question.

We do think that over the last three or four months, we have begun to benefit from what happened with Silicon Valley Bank in March of this year.

But it is our strong view that the opportunity is going to continue to get better over the coming quarters and over the coming years Silicon Valley Bank was the largest player in the space over the last 40 years.

Obviously, they were acquired but that team that business will not be the same as it once was they are still in their new current sort of inclination.

Formidable player and we're certainly rooting for them to continue to do very well in the market, but we believe that over the next several quarters, we're going to continue to see a positive impact on the Hercules business tied to what happened in March of this year. These conversations that our deal teams have with these companies don't turn into <unk>.

Transactions in a week or two weeks or three weeks those conversations start in April and in May and they'll turn into deals. Some in Q2 more in Q3 more in Q4, and so we're very optimistic that that opportunity set continues to rise over the next several quarters.

Thanks Scott.

Very helpful color, there and then just one on <unk>.

On credit quality I am just curious if you can give any update on your credit outlook.

Your result, nonaccrual has actually decreased in the quarter, where others in the market or are seeing credit issues do you expect any normalization in credit over the near to intermediate term and are you. Just are you seeing any stress in your portfolio of companies as we sit here today, it's just because the results that you've put up so far just say otherwise.

So look I think our team has always led the industry in terms of credit performance and Thats something that we pride ourselves on.

This business was started in 2004 with an emphasis and a focus on both relationships and credit underwriting and that fundamental focus on credit underwriting is something that we've continued to expand upon and enhance over the course of the last 18 19 years.

When you have a three plus billion dollars portfolio at 120 debt positions of course, theres going to be a handful of credits on a quarterly basis that are in some type of I don't even want to call. It distressed, but some type of performance issues right now we have zero grade five credits and we have $67 million.

Great for credits I think that really speaks to the health and quality of the overall portfolio.

Things can change on a quarterly basis, we're not seeing anything Q3 quarter to date that tells us that there is going to be a material change either way you mentioned that our non accruals actually improve on a quarterly basis right. Now we have one legacy loan on nonaccrual that represents zero percent of our portfolio from a fair value.

<unk> perspective.

We did have the one loan which was to Kodiak biosciences that filed for bankruptcy at the very end of Q1 and was marked down in sorry and was marked down at the end of Q1.

We are up close to the finish line in terms of that work out and what I can tell you is to date, we have already received 100% of our fair value Mark in Q1, and we've recovered approximately 97% of that original principal amount in cash and I think that's an example of the great work that not only <unk>.

Our investment team, but that our credit team does and managing our portfolio.

Alright, well I appreciate you taking my question Scott Thanks sure. Thanks Kristen.

And for our next caller.

Our next question comes from Casey Alexander with Compass Point Research and trading Casey go ahead with your question.

Yes, good afternoon, I'm going to I'm going to try not to ask the same question.

The same question.

In a different way, but there seems to be a lot of interest around it.

And if I understand your comments.

A lot of your deal activity during the quarter came from your unfunded commitments.

But you are characterizing the deal quality is high and likely to get better. So so what's the catalyst that will get new deal activity going as opposed to just drawing out of the unfunded commitments.

Yeah, so casey to be clear.

30% of our fundings in the quarter were from unfunded commitments, 70% of our fundings in the quarter came from new commitments.

I would characterize the funding activity a little bit differently than how you characterized it in the question.

We think we've seen very healthy new deal volume. If you look at the companies that we work the new companies that we were able to add in Q1 and the new companies that we would add that we've added in Q2, which are now in the soi.

We think these are some of the best quality debt transactions that we've seen over the last 10 years. These are later stage mature scale businesses. We are very pleased by the quality and the quantity that we're seeing and when you look at our Q3 quarter to date activity, we have already closed over two <unk>.

$100 million of new commitments, and we have over $300 million of commitments that are signed and in the closing process.

Alright, great.

In reference to the comments relative to Silicon Valley Bank, and then being out of the market.

Having that sort of.

Signposts that everybody used to used to run around would you say that you had somewhat embedded.

Permanent higher cost of capital for venture debt borrowers because of that that lack of dominant competitor in this space.

So two things one I want to be clear, we did not say that Silicon Valley Bank is out of the market I actually specifically referenced that I think first citizens has done a really nice job post acquisition there in the market, we're seeing them on deals they've announced several transactions, we're actually working with them on a handful of transactions. So they are certainly not.

Out of the market that business has fundamentally changed with what happened to Silicon Valley Bank and its legacy form in March of this year with respect to the second part of the question. We believe the answer is absolutely yes.

Historically, SBB was able to essentially drive the market down from a yield perspective, and we think that has permanently changed.

Okay great.

Quite helpful Lastly, given where.

The leverage ratio is and you've got tremendous capacity.

Would it be likely that over the next few quarters, we might see the ATM returned to the levels that the company used to do a $1 million or 2 million shares a quarter from what has recently been a more elevated level.

I think it's I think it's tough to say Casey I think we were pretty clear in our public marks we are very focused on maintaining a pristine balance sheet with an abundance of liquidity. The concept that I think a lot of bdcs are struggling with is being forced to manage their business deal to deal.

Mike Your leverage ratio you have to raise equity to bring it down you're not in the market consistently you can't bid on the bigger deals we want to make sure that our team in conversations with companies and investors has the ability and has a balance sheet behind them that is pristine that is incredibly liquid and gives us the best opportunity to continue to take market share.

So I think that's something that we'll just continue to evaluate on a continuous basis based on what we're seeing in terms of pipeline and on the quality and quantity of new deals.

Fair enough. Thank you for taking my questions. Thanks Casey.

Standby for the next question.

Our next question comes.

From Christopher Nolan with Ladenburg Thalmann <unk> Company. Christopher go ahead with your question.

Hey, guys Casey just asked my question.

Scott quick question are you because of your dominant position in the market are you seeing that you have an advantage in terms and conditions and youre able to negotiate better prepayment fees and things like that.

I don't think it allows us to necessarily negotiate.

Better prepayment fees I think it allows us to win better quality deals.

We don't have to chase.

Some of the tougher deals that we've seen get done in the market.

Mentioned on this call that our pipeline continues to be incredibly strong and robust I would also mention that and I've said this before we track the number of deals that get done in the market that we ended up passing on and that continues to be at a very high level. So I think having.

A dominant position in the market allows us to essentially pick and choose the deals that we really want to do versus being forced to do some of the smaller tougher deal that we're seeing getting done in the market.

And my follow up question is given all the turmoil in venture debt and venture capital.

Are you guys rethinking in terms of how you are allocating your resources by industry.

So less life science more technology or.

I think the key for US really is on diversification right now we're managing our book at roughly 50 50, so approximately 50% of our asset base has invested in technology companies approximately 50% of our companies of our debt positions are in life Sciences companies.

We will toggle that percentage on a quarterly basis, depending on what our view of the macro environment is right now we're managing the book at roughly 50, 50, and Thats, what we intend to maintain certainly through the next quarter or so.

Okay nice.

Thank you thanks, Chris.

And by far our next question.

Our next question comes from Paul Johnson with K B W.

Paul go ahead with your question.

Yeah, Thanks, guys for taking my questions.

Lot of good ones have already behest.

And just a few from me I guess, but so I guess your prepayments this quarter were.

A little bit.

I think higher than maybe just a little bit higher than we were expecting but.

So I guess sort of counter to.

Some of the other venture Bdcs have reported just kind of wondering what's going on there with activity and why prepayments have been a little bit higher than you would expect in this environment.

Thanks, Paul two things first our prepayments were in line with our public guidance, our public guidance for Q2 was $225 million to $325 million. We ended up at about $297 million. So certainly within our public guidance and in terms of.

What's different and why other venture lenders are reporting different things all I can tell you is I think it speaks to the quality of our portfolio year to date, we've already had 11 closed M&A events, that's driving a significant spike in M&A across our portfolio, which obviously leads to prepayments.

And I think we will continue to have relatively higher prepayments relative to others in the space because of the quality of our portfolio.

Thanks, Scott It makes sense.

And then on the coal you mentioned emphasizing diversification this quarter.

Just curious.

Our finding any sort of.

Particular attracted more particularly attractive value at any specific kind of stage of growth are you seeing better opportunities and.

Expansion stage type of companies versus Stablish or is it pretty much at the best market you've seen in years.

So that's all good.

I think it's a really strong market Paul.

But we're not going to comment publicly on areas or industries or sectors or stages that we're focused on.

Obviously, that's something that we'll talk about after we finished the quarter.

But there are certainly parts of the market and certain stages that we are much more focused on now we're just not going to talk about that publicly.

Okay got it thanks, that's all for me thanks.

Thanks, graduations on a good quarter.

I'm showing no further questions at this time I would now like to turn the conference back over to Scott for closing remarks.

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

As a final note we will be participating in the K VW Midtown March on September 28 in New York.

You are interested in attending this event, please contact <unk> directly or Michael Hara, we look forward to reporting our progress on our Q3 2023 earnings call.

Thank you and have a great day.

Yeah.

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

Yeah.

[music].

Your telephone you will then hear an automated message advising you that your hand is raised to withdraw your question. Please press star one one again.

Be advised that today's conference is being recorded I would now like to hand, the conference over to your first speaker today, Michael Hara managing director of Investor Relations, Michael you have the floor.

Thank you Stacy and good afternoon, everyone and welcome to Hercules Conference call for the second quarter 2023.

With us on the call today from Hercules are Scott Bluestein, CEO and Chief investment Officer.

Seth Meyer CFO .

Hercules financial results released just after today's market close and can be accessed from Hercules Investor Relations section at Investor Dot H T. G C dot com.

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 are based on our own assumptions and current expectations. These forward looking statements are not guarantees of future performance and should not be relied upon in making any investment decision actual financial results may differ from the forward looking statements made during this call.

For a number of reasons.

Including but not limited to the risks identified in our annual report on Form 10-K.

And other filings that are publicly available on the SEC's website.

Any forward looking statements.

Made during this call are made only as of today's date and Hercules assumes no obligation to update any such statements in the future and with that I'll turn the call over to Scott.

Thank you Michael and thank you all for joining the Hercules capital Q2, 2023 earnings call.

Our record Q2 results were highlighted by many of the key themes that we have discussed over the last few quarters.

M&A exit activity in our portfolio remained robust which drove increased prepayments cap.

Capital raising across our portfolio accelerated doubling from the strong activity that we saw in Q1.

Credit remains strong and stable.

Deal activity combined with pipeline activity continued to show increasing quality and quantity.

As a result, we continue to be very optimistic about our positioning relative to others in the asset class and our ability to capture further market share over the coming quarters.

During the second half of 2023, our focus will remain on prudent underwriting.

<unk> and liability diversification, maintaining an abundance of liquidity and an unwavering commitment to the venture and growth stage ecosystem that we service.

Our decision in Q2 to once again raise our quarterly base distribution to our shareholders is reflective of our strong outlook for the business over the coming quarters.

Let me recap some of the key highlights of our performance for Q2.

In Q2, we generated record total investment income of $116 2 million up 61% year over year and record net investment income of $75 7 million up over 88% year over year or 53.

Sure and providing 132% coverage of our newly increased base distribution of <unk> 40 per share.

This is our third consecutive quarter of delivering record net investment income.

We also generated record return on equity in Q2 of over 20% for the first time in a long operating history.

Our portfolio generated a GAAP effective yield of 16% in Q2, and a core yield of 14, 1%, which is indicative of the recent rate increases and higher onboarding yields for certain new loans.

With net regulatory leverage at a very conservative 86, 4% and continued robust liquidity across our platform our balance sheet remains very well positioned.

The focus for our origination efforts in Q2 was on diversification with an emphasis on later stage and scaled opportunities.

Our Q2 originations activity was once again driven by both our life Sciences and technology teams delivering healthy funding performance during the quarter.

Our funding activity demonstrated balanced between our two core verticals, which we believe helps drive consistent outperformance relative to our peer group.

We funded debt capital to 19 different companies in Q2 of which six were new borrower relationships.

Consistent with what we saw in Q1, we were again able to expand our funding relationship with numerous portfolio companies that continue to show strength and achieved performance milestones during the second quarter.