Hercules Capital, Inc. (HTGC) Q3 2016 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen, and welcome to the Hercules Capital Q3 2016 Earnings Conference Call. At this time, participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Mr. Michael Hara, Senior Director of Investor Relations. Please go ahead.

Thank you, Heidi. Good afternoon, everyone, and welcome to Hercules conference call for the third quarter of 2016. With us on the call today from Hercules are Manuel Henriquez, Founder, Chairman and CEO; and Mark Harris, Chief Financial Officer. Hercules third quarter 2016 financial results released just after today’s market close and can be accessed from Hercules’ Investor Relations section at www.htgc.com. We’ve arranged for a replay of the call at Hercules’ webpage or by using the telephone number and passcode provided in today’s earnings release. During this call, we may make forward-looking statements based on current expectations. Actual financial results filed with the Securities and Exchange Commission may differ from those contained herein due to timing delays between the date of this release and then the confirmation of the final audit results. In addition, statements contained in this release that are not purely historical are forward-looking statements. These forward-looking statements are not guarantees of future performance and are subject to uncertainties and other factors that could cause actual results to differ materially from those expressed in the forward-looking statements, including, without limitation, the risks and uncertainties, including the uncertainties surrounding the current market turbulence and other factors we identified from time to time in our filings with the Securities and Exchange Commission. Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions can prove to be inaccurate, and, as a result, the forward-looking statements based on those assumptions also can be incorrect. You should not place undue reliance on these forward-looking statements. The forward-looking statements contained in this release are made as of the date thereof. And Hercules assumes no obligation to update the forward-looking statements for subsequent events. To obtain copies of related SEC filings, please visit sec.gov or visit our website, htgc.com. For today’s agenda, Manuel will begin with a brief overview of our third quarter business highlights, followed by an overview of the competitive environment and venture capital markets, and our perspective and outlook for the fourth quarter of 2016. Mark will follow with a summary of our financial performance results for the third quarter of 2016. And following the conclusion of our prepared remarks, we will open up the call for question-and-answers. With that, I will turn the call over the Manuel Henriquez, Hercules Chairman and Chief Executive Officer.

Thank you, Michael, and good afternoon, everyone, and thanks for joining us today, for the Hercules Capital third quarter 2016 earnings call. First and foremost, I am very pleased and proud to announce another outstanding and very robust third quarter of activities for Hercules Capital, which culminated in delivering another strong performance with $0.32 in net investment income, which is our second consecutive quarter in which NII has exceeded our dividend distribution of $0.31. Our third quarter 2016 results reflected our solid performance across our three specialized lending industry groups: our life sciences, our technology and our sustainable and renewable group. These groups all perform extremely well thus far throughout the year and exhibited very strong performance in the third quarter that led with high effective yields, stable credit outlook and continued ongoing deal flows and transactions from those three respective groups. I like to remind everybody, Hercules is not a generalist. We do not operate as a generalist. We have three distinct origination groups that are specialized lending practices, associate each one of those groups for the proprietary deal flow that we receive from our venture capital partners. Hercules’ access to the debt and equity capital markets remains a critical advantage over many of our direct and indirect competitors, thereby allowing Hercules Capital to continue to grow and access the debt and equity capital markets to facilitate and ensure continuation of portfolio expansion and earnings growth. This has afforded us the ability to access in multiple source of growth capital on a just-in-time basis using two of our differentiated ATM programs which Mark will cover in greater details in his presentation or his remarks. As we stated in our second quarter 2016 earnings call, Hercules Capital is quickly approaching a critical inflection point with its debt invested portfolio as we ended the quarter with approximately $1.276 billion on a cost basis, quickly approaching the $1.3 billion mark that we have been advocating now for well over a year. By the end of 2013 – by the end of Q3 2016 with a $1.276 billion portfolio, we now find ourselves just $25 billion to $75 billion away from our desired debt investment portfolio target of the $1.3 billion or the $1.35 billion and what we referred to as our optimal portfolio inflection point. Once we achieve our targeted portfolio inflection point of $1.3 billion, and assuming we maintain our effective yield levels above 13.5%, which by the way are currently operating at 14.6%, as well assuming that we maintain net investment interest margin or NII margins above 52%, which currently are at 52.7%, we anticipate that our debt portfolio at this level will generate sufficient net investment income at or above our existing dividend distribution policy of $0.31 per share, said differently, we remain optimistic as we put our capital to work that we’ll be continuing to be able to grow our dividend entering into 2017 and beyond with just the liquidity that we have on-hand today. In addition to our strong liquidity position and our ability to continue to grow our debt investment portfolio above the $1.35 billion, we also find ourselves with a very advantageous position of having substantial and growing amount of potential undistributed taxable income or earnings spillover rolling into 2017. Assuming, of course, no adverse changes in the broader capital markets or any material changes in our outlook for our credit book entering into the fourth quarter of the year. Although it is still too early to determine the final year-end balance, as of the end of the third quarter of 2016, the estimated potential earnings spillover is currently standing at approximately $0.15 to $0.20 in NII spillover at this point. However, I’d like to remind everybody, this final amount is in fact subject to final end of the year tax true up and any additional realized gains and losses that we may have in the fourth quarter, may also impact that final number that we will be reporting at the end of our Q4 earnings call. This is a growing and important spillover and serves various purposes for our shareholders. First, it serves its ability to have special one-time dividend distributions. Two, it serves to retain and grow our net assets from long-term realized capital gains, which allows to grow net assets for the benefit of our shareholders. Or three, allows us to continue to make strategic investment in our business and continue to grow our platform without having to worry about generating ample sufficient NII income to cover dividend with a growing spillover currently standing at $0.15 and $0.20. This is a very important achievement and I remind you we had similar fallback position in 2015 where we actually had earnings spillover while we were not earning our dividend at the time and yet we never bothered to cut the dividend because our confidence in our platform and having the extra additional earnings spillover to cover that. As we surpass this critical inflection point of $1.35 billion and we continue to focus on our growing debt investor portfolio to the next stage of growth or target, meaning $1.5 billion later on in 2017, we expect to revisit our dividend distribution policy by mid to late 2017 and at that point making determination, evaluates and as to whether not to raise the dividend or simply make a onetime distribution on behalf of our shareholders. That will be revisited most likely in the second quarter of 2017. In other words, if we continue to grow our debt investment portfolio as planned with or without the benefit of unscheduled early or headwind, we anticipate achieving this targeted investment portfolio and growth and dividend and earnings growth later on in Q4 or late Q4 I should say and certainly by the early first quarter of 2017 subject of course to I said earlier, marketing conditions and of course let’s not forget the current elections coming unfavorably to the capital markets as well. We were still offering under a wait-and-see attitude before continuing to make any meaningful new investments and accelerating any new loan portfolio growth. We want to wait for the outcome of the election, because they could have adverse effect in the different industries and segments for the industry that we’ve choose to invest in. So, definitely, we are holding back liquidity until we have clarity in which direction of the capital markets may continue to progress, and we’ve seen as of late fairly unexpected volatility in the equity and the debt capital market as of late. As I turn my attention to growth, I’m encouraged by many factors that I see in the market and our prospect for growth at a time when many of our competitors are experiencing growth and growing challenges both on credit, credit losses, inability to access the equity or debt capital markets, trace significantly below book and finding themselves in a continuation of talent leaving their organizations. Because of this, we are finding many of our competitors unable to continue to originate assets, and we find ourselves in a market that’s allowing us to experience nice, attractive, new originations at very attractive yields, and, unlike our competitors, we find ourselves an abundance of liquidity and access the equity and debt capital markets for growth. Hercules Capital is extremely well positioned entering into Q4 and early 2017, and we like the prospect that we’re seeing, subject, of course, to the elections that I mentioned earlier. I’d like to remind everybody, in early 2015, we made the conscious decision to invest in our organization and our infrastructure to ensure that our platform is capable of handling the current growth and future growth projections leading into 2017 and beyond, as we continue to turn our attention to long-term growth and long-term managing the growth to a $2 billion, $2.5 billion loan portfolio over the next few years. I’d like to remind everybody that we are anticipating achieving a $1.5 billion loan portfolio late in 2017 as we continue to convert our existing liquidity. As you can see, our decision to invest in our future has begun to generate the expected benefits and return our shareholders have expected and as we had planned, as evidenced by our increase in earnings growth and our increase in earnings velocity over the last five quarters. Many forget that just a few quarters ago in Q1 2015, we had net investment income or NII of only $0.20 per share. In contrast, today, we are generating net investment income or NII earnings of approximately $0.32 per share, representing a 60% increase in our earnings growth in just under five quarters. We’re also broadening our source of liquidity, while also growing our investment and loan portfolio for the benefit of our shareholders. We remained committed to our strategy of slow and steady and we committed to continue to originate our loan investment – loan portfolio growth. However, we will only do that if and when we believe that credit quality is there and the underlying assets make sense. Today, we find ourselves at a very advantageous position on many fronts as we turn our attention to the fourth quarter and early 2017. We expect to continue to grow our debt portfolio to the $1.35 billion and beyond. We expect to achieve that late in the fourth quarter or early in Q1 2017 subject to when we decide to start redeploying capital post the election outcome. Thanks to our wonderful shareholders and their continued faith in Hercules Capital coupled with our focus on generating consistent, strong and healthy ROAs and ROEs, Hercules Capital continues to enjoy and trade a significant premiums and asset value, which has afforded us ample access to the both debt and equity capital market at extremely attractive and accretive cost of capital and funding levels for the benefit of our shareholders to allow us to continue to both grow our investment loan portfolio, as well as our earnings for the half of our shareholders. This is very important as Hercules may be the only BDC that I’m aware of that currently has and is capable and is effectively initiating a dual strategy on using two strategic ATM, at-the-market, just-in-time programs. We have effectively been using an ATM program for equity issuance and we’re now proud to say that we are one, if not the only BDC aware of, using also an active ATM program for bonds at the same time as an effective ATM program for equity issuance. Those ATM programs allows us to have access to the debt and equity capital markets on adjusted time basis, meaning raising capital in small bites, just a time when we needed and only when they needed without having to access the broader debt or equity capital markets in any disruptive manners where stock or our bonds that are highly accretive to net asset value and high cost effective on the bond offering to our shareholders today and bondholders today. Being able to access the debt and equity capital markets and using our ATM program has proven an invaluable and extremely cost-effective method of ensuring control portfolio growth will also allowing us to effectively use that as a management tool to regulate our regulatory leverage, which currently stands at 62.7%, which has supporting us plenty of headroom for additional growth. I would like to remind you because our ability to access the ATM equity program, we have been effectively been able to manage down our overall leverage or regulatory leverage exposure down to now the 62% level that I mentioned just a few seconds ago. And finally, as we entered Q4 2016, we have an extremely strong and liquid balance sheet. With on-hand access to capital without having to tap the equity or debt capital markets of approximately $260 million currently available on hand for additional growth. This capital forces the ability to continue to grow our debt investment portfolio without having to generate or access any new equity or capital markets transaction. However, we are not looking to not pursue those strategies, but we will pursue as only needed for additional growth and grow the portfolio, maintain leverage levels that we feel appropriate for the time. That said, I do not expect to abandon our effective slow and steady growth strategy, which has served us well over the years as we approach year end. We anticipate growing our loan portfolio during the fourth quarter by approximately $75 million to $100 million net total growth representing approximately a year-end portfolio balance of approximately $1.35 billion to $1.375 billion exceeding our initial expectations over that inflection point of $1.35 billion. With the transactions already in house today, we’re well on our way on making that goal a reality. Assuming a favorable post election and favorable capital markets activities, and venture capital investment environment after the elections, we expect to continue to deploy our capital, and existing liquidity to grow our loan portfolio at or above the $1.35 billion level. We will continue, as I said earlier, to rely upon our ATM program on adjusted time, just as needed basis to continue to access additional debt and equity capital to maintain leverage ratios that we feel appropriate for the continuation of growth and access to our continuation of portfolio growth to now, our new target of $1.5 billion, sometime late in 2017, again, assuming favorable market conditions. By converting our additional liquidity to that $1.5 billion in loan portfolio growth, we expect that could translate into continuation of earnings growth leading into 2017. We expect earnings growth to begin to exceed our current dividend levels in the second half of 2017. And we are being conservative in the first few quarters of 2017, not knowing what may happen post the election, and that is why we could continue in our strategy of slow and steady rolling into 2017. However, even though this is an important goal to achieve, we remain steadfast in our stated mission of growing slow and steady and patiently growing our debt investment portfolio. As many of you have witnessed over the years and our long-term shareholders who have seen, we are less interested and still growing a portfolio to grow the portfolio since we have no incentive for assets under management or additional fees. We will not compromise credit quality, we will not compromise earnings, and we will not reach down the capital structure to try and achieve higher yields and compromise credit for the sake of earnings and earnings growth. We remain steadfast in our principles, and belief on our growth strategy of slow and steady and consistent has been a proven and true strategy for us, leading us to now having earnings of $0.32 per share, and we expect that to grow later on in the year. That slow and steady strategy and that hand on the tiller has allowed us to have a very strong and liquid balance sheet of $260 million and a stock that trades currently today at 1.4 times book. This serves as a testament of our Company’s ability, a testament to origination teams and a debt and experience of origination team by having specialized lending practices and not generalists in what we do. This continued access to high quality deal flow, access to deal to the capital markets and debt capital markets, we believe has positioned us well for continuation for shareholder growth in earnings and continuation in dividend distribution growth for our shareholders. Now, let me share with you some additional highlights of the many achievements we accomplished in the third quarter of 2016. Hercules new origination activities were quite strong. Even though, seasonally, the quarters typically slowest. We originated $178 million of new commitments. For the first three months of the year, three quarters of the year, excuse me, origination team has been quite busy. Proud to say they have now accomplished over $600 million of new originations in the first three quarters of the year, putting us on pace to potentially exceed our already outstanding performance in 2015 of $745 million of new commitments in 2015. We’re actually on page right now to exceed that in the fourth quarter. Thanks in no small part to our venture capital partners and our strong relationships that our deal teams have with the venture capital community and the entrepreneurs and their skills at originating and identifying the right companies to invest in. That selection process has also manifested itself with an outstanding and continuation of the strong credit performance that Hercules has delivered for our investors over 12 years, one of which we do not feel nor close to ever compromising our continued belief and our discipline as credit underwriters. There are a few BDCs capable of sustaining the growth and actions to deal flow to which Hercules Capital has let alone the ability to underwrite growth and maintain the credit discipline that we have maintained over the last 12 years. I am very grateful to the strong brand recognition, the strong reputation and awareness within the venture capital industry and the great confidence that our venture capital and entrepreneurs have placed upon Hercules as one of their capital partners and to help them continue on growth as a company themselves. The innovative and entrepreneur and disruptive community to which we provide capital to is thriving and doing just fine. On the funding front, equally impressive showing of our team and our investment professionals. We achieved an impressive $462 million of gross fundings and net realized portfolio growth of $124 million for the first three quarters of 2016, representing approximately 10% growth year-over-year for the same period. This is culminating the debt portfolio as I said earlier $1.276 billion, very, very happy and proud of achievement on behalf of our team. This achievement, notwithstanding the higher level – this will achieve notwithstanding the higher level of unscheduled early payouts in Q3. We had indicated early payout activities of $50 million to $75 million. However, we came in slightly above that at $84 million. That headwind allowed us not to grow the portfolio as much as we anticipated, but certainly helped us with accelerations of early payoff income and fees, driving our portfolio earnings to the $0.32 a share that we talked about just now. As an indication of current yields and future yields, for the benefit of our shareholders or analysts out there. We are beginning to see solid evidence of our core yields stabilizing in the upper end of our targeted range of 12.5% to 13.5% with Q3 2016 core yield stabilizing at 13.2%. However, we anticipate core yields to stabilize at 13.2% plus or minus 25 basis points. During the quarter, we also witnessed a slight increase on our effective yields to 14.6%, up from the 14.4% in the prior quarter driven obviously by a higher than anticipated early payoff activities representing $84 million. Now, turning my attention to deal flow. We are in a great position entering Q4 2016. However, as I said, we are purposely holding back closing on some transaction until we have greater understanding and perspective of the election in the equity and debt capital markets post the election process. That said, as you’ll see in our press release, we are sitting on signed term sheets of $150 million and have already closed almost $40 million of transaction thus far and funded $50 million of transactions. So, we’re well on our way to achieving our end point target of $1.35 billion without having to do much efforts for the rest of the year. However, we are not stopping once we have visibility on the elections. However, because of the position to hold back capital until such time as the election has been cleared up, we are anticipating that most of our earnings growth in the fourth quarter of 2016 will be back-end loaded. And I mean by that is because we are holding back the majority of our growth in our portfolio, we’ll be post election earnings attributed – earnings balances will not occur until after the election, and therefore a shorter stub period in the fourth quarter. You’ll see that manifest itself in a strong end-of-year portfolio balance, which will lead you in a well position for portfolio growth and earnings growth into the first quarter of 2017. We have a very strong pipeline. I am proud to say, consistently with our history, we have over $1 billion of potential transactions in our pipeline today, well positioned to enter in the last quarter of the year and certainly into the first quarter of 2017. We remained highly selective in our underwriting and we’re not going to compromise underwriting as we do that. As further evidence of our confidence and steady growth in our loan portfolio and outlook for Q4 2016 and 2017, I will call your attention as I’ve said few minutes ago into our Q3 earnings release. At the last few pages of earnings release, you will see that we are entering the fourth quarter with the first month in the first quarter, October, with already $40 million of close transaction of which we funded $51 million between our unfunded commitments and new transactions closed thus far in the quarter. We also have as I said a few seconds ago $150 million already at in-house signed term sheets positioning us well within reach of $1.35 billion or even higher if we choose convert all those signed term sheets for growth. Unlike many of our competitors, we are highly liquid and we’re well positioned for continuation of earnings growth with an extremely strong credit book as we entering into the 2017 time period. Now, no call is complete of Hercules Capital without speaking to the venture capital community and developments in the venture capital community. Much has been written about the so called decline in venture capital dollars. However, I will call your attention to – when I said over the last three or four quarters, we’ve only expected that venture capital activities for 2016 to only be $50 billion, well below the $25 billion [ph] done in 2015. We made a prognosis based on the analogy of 2015 which included many, many high large transaction into many unicorns. When you adjust for that, the venture capital community actually is doing quite fine. Last time I check, $50 billion in fundings for the year is a quite healthy year when the sustain rates is typically more in a $35 billion level. So unlike many others out there, I find the venture capital investment activities to be quite strong and we’re quite happy in its trajectory. As evidence of that confidence and belief, just look to the intention of the venture capital fundraising activities. Venture capitals had an exceptionally strong fundraising environment thus far. They have had an extremely healthy ability to raise capital. Venture capital firms through the third quarter 2016 have raised $34 billion of capital, already eclipsing the capital raise in 2015 and in 2014, which raised approximately $35 billion in 2015 and $34 billion in all of 2014. It is on pace to exceed those two years and certainly exceed the venture capital fund-raising level not seen in the past eight years. Last time I check, that’s a pretty healthy environment and I remain equally bullish on the outlook for venture capital investments. This is highlighted in the fund-raising activities. I’d like to remind everybody, as venture capital raise money, that money eventually has to find a home in new investments. Those new investments become new candidates for a good capital to make new investments. We also anticipate the strong fund raising activity not to pull back. We don’t see any evidence or any significant pullback going on that market. Now investments, as the fund raising capitals begin to be deployed, we expect the investment activities to also remain fairly strong. As evidence of that in the Q3 2016, the venture capitals invested $11.7 billion during the quarter, representing a total for the year-to-date for the third quarter of $41 billion already. Just normalizing that, we believe strongly the venture capital should hit or exceed our expectation of $50 billion which we indicated at the beginning of 2016 as evidence of the transcript that we spoke about this earlier in the year. We see investments remain strong, venture capital confidence in investment activities also remain strong. However, as I said just a few seconds ago, it is in fact the pull back from the peak of 2015, all of which we expected driven by the unicorns and highlighted by the overfunding of some these unicorn companies. Quickly turn to stage of investments. Venture capital dollars continue to flow and right into our wheelhouse squarely in where Hercules target segment of the market is late stage venture growth stage companies. That is what we do, contrary to what many believe what we do or say that we do. We do not do early stage investment. So, let me point – a point on that. Hercules is primarily a growth stage, later stage venture capital investment where 60% of venture capital dollars of load right where we wanted to be. This is why we’re experiencing very healthy and strong pipeline of transactions in the marketplace. We do not do early stage companies and I want to emphasize that very strongly. Venture capital exits. Well, we all know have heard ad nauseum how anemic the IPO market is. I actually believe the IPO market is quite anemic and I don’t see any quick signs of improvement and any time in the near future. However, IPO exits for the venture capital industry represents generally less than 10% of the exits that venture capitalist pursue, so insignificant. That said, we’ve seen 12 IPOs completed thus far in the third quarter. One of which probably is a Hercules portfolio company called TPI Composites. IPOs for the first three quarters of the year have represented an anemic 28 companies have gone public raising a mere $2 billion in capital, well off the 2015 and 2014 base of 67 and a 108 companies for the year. Lastly, we have four companies of Hercules currently in IPO registration. We do not see that number materially changing at anytime in the near future. However, we continue to see a quite robust M&A activities in our portfolio with seven companies experiencing – excuse me, M&A events in the quarter so far – sorry, seven have completed M&A events year-to-date so far in a year, apologize for that folks. In closing, outlook for the fourth quarter in 2017, as I stated earlier, we are reaching a critical inflection point in our debt investment portfolio of delivering sustained earnings that cover if not exceed our existing dividends of $0.31 per share. We believe confidently that we should achieve the $1.35 billion in our targeted debt investment portfolio or inflection in our debt investment portfolio, which puts us in extremely well position as we continue to add to that portfolio growth entering into 2017. Core is sustained effective yields of 13.5%, and maintaining healthy margins above 52%, positioned us well for continuation of earnings coverage or above our dividend rate is not exceeding that. Once again, I’m only expecting to see net portfolio growth of being conservative, net portfolio growth of only $75 million to $100 million. This is going to be materially influenced by the outcome of the election. If the elections in equity capital markets remained very favorable, we may start approaching the upper end of that $75 million to $100 million of net growth. However, for modeling and growth purposes, $75 million to $100 million, we believe is a perfectly appropriate number of growth given what we see in the market and giving us plenty of headroom of liquidity on use to continue growth portfolio above and beyond that point today. Because of our current wait and see position, rolling into Q4, we do not expect early sale activities to be significant or material. This is a quiet of a difference we see in the first three quarters of 2016. However, it is in line with exactly what we saw occur in Q1 and Q2 of 2015. We are expecting extremely modest early payout activities. I’d like to remind everybody, early payout activities for us typically get only 30 to 45 days out. In power with that knowledge and insight, we are only forecasting $15 million to $25 million only of early payout activities, hence leading to a $75 million, $100 million net portfolio growth. However, I caution, that number is difficult for us to hold on to and it can wiggle around anywhere between $10 million to $20 million, unforeseen by us especially with an election that’s unpredictable as it may be that may leave other companies to payout early or not payout early. Because of that, we anticipate our core yields in Q4 to converge and match the effective yields no dissimilar that we saw occur in Q1 and Q2 of 2015, meaning our core and effective yields should equate approximately 13.2%, 13.4% and having very little contribution attributed to effective early payout into our effective yields. It’s a very important statement that I want folks to understand. That said, we are extremely well positioned as I said earlier, highly liquid balance sheet, access to debt and equity capital markets or ATM program, and we have a fairly healthy and positive outlook at the venture capital community. With that, I’ll turn the call over to Mark Harris, our CFO. Thank you. Mark?

Thank you, Manuel. And good afternoon and evening, ladies and gentlemen. I’m excited and proud to report our third quarter and year-to-date financial results as our best-in-class venture lending platform continues to deliver outstanding financial performance on virtual every meaningful metric as well as exceptional total shareholder return of approximately 46.4% over the trailing 12 months at quarter end along with strong return on equity performance of 12.9% in the third quarter both of which are amongst the highest like a distinguished blue flame in the BDCindustry. In addition, we’re pleased to declare our 45th consecutive dividend since going public in 2005, of $0.31 per share that will be paid on November 21 as approved by our Board of Directors with a record date of November 14. Today, I’d like to focus on six key financial items that drove our success in the third quarter. First, our managed and purposeful loan growth with our credit outlook; second, our stabilized yields; third, our increase in NII and NIM; fourth, our net realized gains and unrealized appreciation; fifth, our strong NAV performance, and I’ll follow that with last, our strategic treasury and liquidity management designed for the future growth. We had a strong total investment fundings of $130.7 million in the third quarter including the addition of five new portfolio companies that accounted for 73% of our originations. We were able to grow our loan book by $20 million in the third quarter at cost even with the headwinds of $84.2 million from unscheduled early payoffs and $32.4 million from scheduled amortization. This resulted in our debt investment portfolio increasing to $1.276 billion at the end of the third quarter on a cost basis, or up approximately 11% from the beginning of 2016. In the fourth quarter, we expect to add $75 million to $100 million of net portfolio growth with $15 million to $25 million of unscheduled early payments in the fourth quarter. Despite the strong expected growth in the fourth quarter, we do not anticipate the growth will have a meaningful impact to NII in the fourth quarter as we believe originations will be back-ended, but this will set as up nicely in 2017. In the third quarter, our weighted average credit rating moved to 2.32 from 2.11 in the second quarter. The increase was primarily driven by the net addition of six new companies, two are Grade 3 risk rating category, primarily due to our conservative long-standing policy of generally downgrading credits to a Grade 3 as the companies approach a capital raise or performance milestone. Traditionally, our portfolio companies will need to raise capital every 9 months to 14 months. Thus it is our expectation that our portfolio companies will migrate to a three-rating at some point in their normal lifecycle at Hercules. Given our consistent and significant funding activities over the last several quarters, the increase in rated-three credits is consistent with a natural maturation of our loan book. Our credit four and five-rated companies, which are a primary focus were 5.3% in the third quarter, up from 4.4% in the second quarter of total debt investments at value, primarily related to the addition of one portfolio company. Furthermore, we have seen positive developments in our four and five-rated credits after quarter end and could potentially see further improvements due to recent pending M&A and capital raising activity with some of the larger portfolio companies in this bucket. Turning to non-accruals, our non-accrual loans increased by $11.7 million in the quarter due to the addition of one company to non-accrual status. This increased our non-accrual loans as a percentage of total investments at cost to 3.3% from 2.5% in the second quarter. Since quarter end, we have seen a significant improvement in the status of our non-accrual loans as we have already had one of our non-accrual loans pay us off in full and we’re expecting another company to pay as off later in the fourth quarter. Assuming this happens, our non-accrual loans as a percentage of total investment at cost would reduce to 2.3% on a pro forma basis, which is consistent with our historical levels. Turning to our yields, our unscheduled early payoffs and pay downs drove our effective yields to 14.6% in the third quarter, which was up from the 14.4% in the second quarter. Given the comments that Manuel made earlier that we expect to see $15 million to $25 million of unscheduled early payoffs in the fourth quarter of 2016, this would drive our effective yields to the lower end of our historical range of 13.5% to 14.5%, and thus converging with our core yields. Looking at our core yields, which exclude the effect of prepayment penalty and accelerations from early payoffs, this is 3.2% in the third quarter compared to that of 13.4% in the second quarter. That’s our core yield continue to maintain around that 3.2%, 3.25%, plus or minus 20 basis points. Turning our attention to our NII and NIM. Our net investment income closed at $23.8 million in the third quarter or $0.32 per share, more than covering our dividend of $0.31 for the second consecutive quarter. This was driven by the increase in our total investment income by nearly 4% to $45.1 million in the third quarter from $43.5 million in the second quarter. The increase is attributable to both the growth of our debt investment portfolio where we saw an increase of 2.2% in our weighted average loan outstanding balances between the second and third quarters and one-time accelerations from early unscheduled payoffs. Given the reduction in anticipated early payoffs in the comments that were made earlier, we expect our aggregate fourth quarter revenue to be consistent with that of the third quarter revenue as it will be primarily driven by the recurring revenue from our core portfolio. In the third quarter we saw an increase in our interest and fee expense to $10.1 million from $8.9 million in the second quarter. This increase was anticipated due to the $141.9 million 2024 notes that we issued in the latter half of the second quarter 2016 as I commented on in our last earnings call. Our net interest margin continues to expand at $35 million in the third quarter, up from $34.7 million in the second quarter due to our strong investment growth. Further, our net investment margin as a percentage of yielding assets increased to 11.1% in the third quarter as we are generating more income over our growing yielding asset base while effectively managing our cost of capital. This leads to our potential spillover. As we’ve discussed and we've commented on, our NII coverage of dividend is 103% coupled with our earnings spillover from 2015, our net realized gains through Q3 2016 of $3.4 million, and the potential to harvest equity and portfolio gains in the future will provide us with sufficient ability to cover our dividends and the potential to distribute excess earnings in the future as Manuel discussed. Our NII margins came in at 52.7% in the third quarter, which is slightly higher than the 51% to 52.5% range we discussed last quarter. We expect our NII margins to maintain in this range into the fourth quarter. Last, we keep an eye on the Federal Reserve's Federal Open Market Committee reports as potential rate hikes are always monitored closely, which we believe is highly probable in the month of December. As we have commented on in the past, we do have a very well-positioned asset sensitive balance sheet in the event of future interest rate increases. 93% of our loans are variable interest rate loans with floors, that's a 25 basis point increase in the prime rate which most of our loan agreements are based and 100% of our debt outstanding was fixed interest rate debt at the end of the third quarter, would be accretive to our income and NII by approximately $1.8 million on an annualized basis or $0.02 NII per share. Turning to realized gains and unrealized appreciation. We had strong net realized gain activity in the third quarter with net realized gains of $7.9 million or $3.4 million for the nine months ended September 30, 2016. This mainly was attributable to both full and partial disposals of our investments in Box, ReachLocal, and TouchCommerce in the third quarter. Further at the end of the third quarter, we had an additional $5.4 million of potential unharvested Box gains, which would have added another $0.07 to our spillover in 2016 although we have seen some retraction since quarter-end. Q3 net realized gains further decreased our cumulative net losses since inception, which is now $3.4 million on approximately $6.3 billion of commitments made since inception making our losses negligible since inception. An outstanding achievement and a testament to our proactive investment management culture here at Hercules. We had a net change in unrealized appreciation of $800,000 on our investment portfolio consisting of both debt investment portfolio, which had net unrealized appreciation of $7.6 million and our equity and warrant portfolio, which had a net change in unrealized appreciation of $6.6 million. The depreciation in our debt investment portfolio primarily consisted of a net increase in collateral based impairments partially offset by mark-to-market appreciation. The appreciation in our equity and warrant portfolio was made up of approximately $5.6 million from our public company portfolio, an increase of approximately 13% quarter-on-quarter and $7.8 million of appreciation from our private portfolio, an increase of approximately 19% quarter-on-quarter. Both of which were offset by reversal of unrealized appreciation of $6.7 million due to realizations. This is consistent with the performance of the many indexes that we track. For example the Russell 2000 biotech index was up 24% and the Russell 2000 index was up 18% in the third quarter along with Box, which was up 52%. This led to strong NAV performance. Our net assets grew to $753.6 million in the third quarter from $771.8 million in the second quarter or 5% growth. This increased our NAV per share in the third quarter to $9.86 from $9.66 in the second quarter. This increase was primarily due to our NII outperforming our dividend, the $7.9 million of net realized gains in the third quarter and the equity ATM issuances significantly above NAV. We expect our NAV to continue to grow with further equity ATM issuances, NII performance and for potential future realized gains. For illustrative purposes, today we’re sitting on 138 different warrant positions with a nominal exercise value of $101 million, which we believe may hold the potential to generate future realized gains of approximately $1 to $2 NAV per share. With this, I would like to close and say in closing that we’re very pleased with our third quarter performance achievement and believe that we have positioned ourselves nicely for the fourth quarter and into 2017 for sustainable and accretive growth. We believe strongly that our long-term focused approach will enable us to deliver solid results for the foreseeable future and this is evident by our performance on key ratios, our stock price trading at a premium to book and trading of our debt at a premium all pointing to the market affirming the same. With that, I will now turn the call over to the operator to begin the Q&A part of our call. Operator, over to you, please.

Certainly. [Operator Instructions] Your first question comes from the line of Jonathan Bock with Wells Fargo Securities. Your line is open.

Good afternoon or evening, and thank you for taking my questions. Manuel, maybe a broader question to start off. We've noticed that certainly within the venture lending asset class there have been a few folks that have endured some significant losses to themselves, right? To a point where it can at times introduce some uncertainty about the asset class itself as to whether or not the returns of the asset class are going to fall and maybe perhaps a few folks that are reporting significant losses are the effective canaries in the coal mines, can you walk us through the real differentiating factor? We have yet to see losses in your book, but walk us through the true differentiating factor that we can look at to say that those can be more idiosyncratic than global as it relates to the venture lending landscape.

Sure. How does that old expression go? As the tide goes out, we see those who have bridges and those who don't have bridges. I think the tide's going out and we are perfectly well-dressed and suited. I think that it really goes down to a critical differentiation in the market and that is venture lending does not lend itself to being a generalist and I cannot emphasize the importance of that. We are not generalists. We have four unique origination teams and groups that specialize in the verticals that they operate under and they know those verticals very deeply. I think that the venture industry is beginning to show the shake out that I have been expecting to see now for quite some time and those are the players who know what they’re doing and those players who don’t know what they’re doing in the asset class itself. It’s a very complicated and very difficult asset class. It has significant barriers to entry and it also requires you to have a very broad and deep balance sheet and access to the equity and debt capital markets to do that. Small portfolios have becomes just that smaller. It’s very difficult when you have losses to recover from those losses when they’re only growing in the marketplace. It’s unfortunate I don’t wish ill will unlike to some of our competitors in the marketplace because it only serves to ask question that you’re asking me on the comp set. So, no, it’s not a systemic issue in the marketplace whatsoever. I just indicated and shared with the callers – the listeners that venture capital activity is robust, fundraising by venture capital is robust, capital deployment of the venture capitals will be at extremely high level at $50 billion. So, all of those indications are quite strong. M&A event remained quite strong. So, therefore the only thing left to reconcile is that maybe some of these players are not very good underwriters.

That's fair and clearly it's certainly evidenced in performance. Then maybe to tack on, you mentioned about robust activity. If that's the case, then why guide repayments down to what I would believe to be an extremely low level at around let's just say $15 million? It would signal to me that we would likely see more activity in your portfolio if that were the case?

Well. Let me kind of give you the three or four key items that relate to early payoff. One is competitors. We're seeing a dramatic decrease in competition therefore we're not seeing people quote unquote picking off our portfolio or trying to chase investors off our portfolio. So, that's one of the reasons. Number two, a lack of an IPO market. You're not seeing a catalyst by which a company goes public and it pays off our debt. So, that's not causing it. Number three, I think that you're seeing although M&A remains continued events, we're not seeing as many as M&A driven early payoff events meaning our companies are being acquired and therefore paying off our debt. So, that's not necessarily concerning to that. And four, to be honest is I think that the market like we are is simply holding back liquidity and I think people want to have a good directional understanding where the market's going and then make balances in our portfolio accordingly. And I think that until these elections are over, I don't think you're going to see a significant pick-up in early payoff. And because we have visibility 30 to 45 days out at this point, that's all the number we have right now. And so, I would call your attention to similar patterns that happened in Q1 and Q2 of 2015. We had fairly de minimis early payoff activities and I think we're back right in that same wheelhouse.

And then maybe turning to the balance sheet for a moment. So, you do have an attractive opportunity via the bond issuance program. I was curious, Mark, what type of yields you're going to be effectively pulling off on those issues?

In regards to the debt ATM program.

Yes, the debt ATM. Sorry, the debt ATM, sorry.

Okay.

Okay. Yes. So look on the debt ATM, that's obviously attached to our 2024 6.25% notes. We issued those at a premium.

Yes.

So, the way to think about that is effectively mathematically that would reduce the 6.25% whatever premium we offset obviously against our coup, but we also have issuance costs put on top of that. So, the way to think of it's almost like a natural 6.25% with no or relatively small issuance cost because we get to issue it at the market at a premium.

The effective yields are 5.8%, 5.9% depends on what day you look at it. So, it can hover in effective yield 5.8% to 6% overall. However, the ATM is being utilized for a very critical strategic reason. Those bonds basically have eight month non-call or seven month non-call provisions left on them at which point the bonds are freely callable and I'm able then to aggregate and pursue a larger index or index eligible institutional offering later on when rates stabilize in the marketplace.

Got it, got it, okay. So then thinking about just the way you've always been so smart in terms of building of the balance sheet from a risk profile, the question we'd ask is why would we still leave SBA or SBIC debentures effectively below the 225 threshold? And then two, why are we not again exploring the securitization financing option just given the size and scale that you have already? Granted, don't get me wrong, the issuance is attractive; I'm wondering why we wouldn't be considering these other two either.

Who said that we're not? So, I only have so much time on an earnings call so let me be clear and address the issue. Hercules prides itself on multiple access to a wide array of liquidity options in the marketplace. That includes bank lines, that includes SBA program, that includes access to ATM both debt and equity, it includes issuance of securitization, it includes convertible debt instruments, baby bonds, and institutional debt offerings; all of which are readily and easily available to us. We are extremely yield sensitive in what we want to do. Every one of those layers of capital has a significant purpose in the balance sheet and we pride ourselves and want to have a widely distributed source of funding that have latter maturities at different cost to capital, but serve different purposes in our balance sheet. But Mark and his team has a highly comprehensive treasury function that oversees our continuation of monitoring our cost of funds, but all those instruments are absolutely in process and are available. We are actively engaged on the securitization right now. We are benign at whether not we do it in 2016 or early 2016. It just doesn't really matter to us, but we are accessing all of those forms of capital for growth.

Great, great. Thank you for taking my questions.

Thanks, Jonathan.

Next question comes from the line of John Hecht with Jefferies. Your line is open.

Thanks, guys. A quick question, Manuel, you mentioned you're waiting for the outcome of the election. I wondered just if you could tell us depending on the outcome, which I guess subsets or sub-industries you're more focused on and sort of what we should kind of expect on the outside of it depending on who wins?

Look at, I mean, broadly speaking, I think the equity capital markets are speaking for themselves right now. You’re seeing that on a Trump administration, the capital markets a little more jittery. And the Trump administration as he openly advocated that ACA or the Obamacare Act – Affordable Care Act, excuse me, I just blended two different concepts. The Affordable Care Act is probably going to be assaulted and removed, which could have impact on a healthcare services company. You also now seeing the generic pharmaceutical companies being sued by the DoJ today on generic manufacturing. So the biotech, life science in the industry maybe a bit under assault, which you’re seeing that the index is down 24% year-to-date so today. So, frankly, both of these potential candidates have impacts in our portfolio, but we can manage that. We just need to know which direction it’s going to occur and we can make adjustments in our portfolio and underwriting standards to then mitigate that unexpected risks that we’re seeing in the marketplace. I also like to remind everybody, their loans are short-term, amortizing loans, so we can change the construct of our portfolio within 18 months and completely change the risk profile of our portfolio proactively.

Great, okay. Thanks. And then, I guess a little bit of follow-up on Jonathan's question. You mentioned some kind of asset weaknesses in some end market participants. To me that tells me that there is a potential that some of your competitors got punched to some degree. How would you describe the competitive environment at this point in time?

It's self-evident for anybody who listens to these earnings calls lately that a lot of our competitors are experiencing credit challenges and also size limitations and trading below book, all of which impair and impact our ability to grow. However, I don’t want people to realize or believe that we’re not saying we don’t have any competition. That will be silly. I think that we still have very formidable players as a competitors, I think that the venture banks continues to be a competitor. I don’t see that materially changing. But I think that the competitor environment has become a little bit more balance, if you will. We’re not seeing this craziness in structure. I think we are seeing some new entrants trying to backfill the void that’s been created by some of these players who are struggling in the marketplace. And I will – I warned them and I warned everybody else, venture lending doesn’t lend itself to easy asset generation. It is a very difficult and expensive and challenging market to build to achieve penetration with the venture community. And most importantly having a knowledge of the technology and life sciences trends. We have highly skilled investment professionals that have been doing this for a very long time. We’ve pride ourselves and our team and our team and itself and our credit capabilities really differentiate ourselves. And we’ve proven that now over 12 years that serves as significant barrier to entry. It is very hard what we do and new players come and go. I’ve been doing this for 30 years and we’ll see new players come and go all along. It’s a matter of staying true to what we do and not getting caught up on a competitive environment in compromising credit and yields. I’m happy to miss earnings if credit quality is not there because reaching down the balance sheet or taking risk for credit makes no sense.

Okay. And then last question. Clearly your earnings or your NOI's in an upward trajectory and you're talking about continuing to grow the balance sheet and continue to secure the infrastructure. So as you get to mid-2017, I think you mentioned some inflection point of assets that you're about to cross and that you'll re-evaluate things in 2017. What are you going to look at to determine if you should potentially consider a special dividend versus a dividend increase?

Well. That’s not in my control. That is in the control of our independent Board members, and I am sure that we as the upper management will provide insights. But to answer your question, it has to do with sustainability of a portfolio and earnings levels that I think exceeds consistently, exceeds our current dividend of $0.31 a share for a few quarters. If that were the case, might spillover that we currently have at $0.15, $0.20 is probably going to be, I don’t know, I would say speculating $0.25, $0.30 maybe that give us a good buffer. It could be a little lower than that. I don’t know yet until we end up Q4. But I think that to answer your question, I would encourage our board to look at a dividend increase or special dividend only after we have a few quarters of sustained earnings above our dividend and at that point, I think we revisit the whole dividend policy at that point.

Okay. Great, thanks, guys.

Next question comes from the line of Ryan Lynch with KBW. Your line is open.

Good afternoon. You guys had some strong equity and warrants appreciations in the quarter. Obviously, Box was a big contributing factor towards that. But even outside of Box, you all had some big gains in some of your level 3 equity and warrant positions, I believe that was about $8 million. So, what was driving these gains? Was there any particular sector that was really performing well or were these just specific portfolio of companies that had some strength?

Sure. Hello, Ryan. If you look at our schedule of investment or SOI, you’ll see that markets above $5 million is directly correlated to public holdings that we have in appreciation.

$5.6 million. That’s right.

So, Ryan, $5.6 million of that appreciation is directly correlated when you look at our public holdings in our SOI, schedule of investments, relating to those positions increasing. We then had approximately $7 million or so. What was the final?

$7.8 million.

$7.8 million. Thank you, Mark. $7.8 million in appreciation directly correlated to our private holdings which obviously indexed off of the public holdings and/or the last round of capitals that they raised for themselves. So those are the two major drivers in that area.

Okay. And then you mentioned a $1.5 billion portfolio in late 2017 as kind of your goal or target hopefully. Is that something you all think you can achieve that type of portfolio growth and portfolio size with your current team and current set of investment professionals or is that contingent on you guys being able to grow your team to meet that portfolio size?

In all fairness, I think and to be conservative, I think it’s a little bit of both. I don’t think we need to add 10 headcounts, for example to do that. I think that we will always hire strong athletes when we see them. I think we have a very strong and growing bench of highly skilled and talented rising investment professionals that have been with us for a year or two, that are also showing their ability to kind of mature into a managing director level. So, it’s a function of both growing organically as well as promoting from within and then hiring selectively as we’ve recently done, we’ve made some critical new hires from some of our competitors as of late that has been very accretive to us. And so, the answer the second part of your question, it’s very simple math. We’re at $1.275 billion, $1.275 billion, we have over $260 million liquidity on hand today. Without doing anything, we can easily get to $1.35 billion, $1.4 billion loan portfolio just with the liquidity on hand. And I think as we turn to our attention to Q1, once we have an outlook of the election, I think that you can see us add another $100 million or so in growth in Q1.

Okay. Great. Thanks for taking my questions.

Thank you, Ryan.

Your next question comes from the line of Chris York with JMP Securities. Your line is open.

Good afternoon, guys. And thanks for taking my questions. So, my first question here combines a couple of the topics we already discussed. We've talked about a couple venture debt portfolios at both banks and BDCs that have had credit issues. So, I'm curious to learn how you're thinking about acquiring loan portfolios and/or teams when situations like this occur?

Great question. I don’t wish any ill will in any of our competitors, because I need them as comps to show that the asset classes is resilient. But I can’t help on how they underwrite certain loans. So, that’s a different issue. When it looks like buying a a loan portfolio, and you place it through the Hercules stream, I think that our marks will be probably much more draconian than they’re probably doing today. And I think that because of that the ability to effectuate or complete, I should say a purchase of loan portfolio becomes a bit more challenging because I don’t think that some of the marks that I’m seeing in the marketplace today are necessarily reflective of what we believe those quality of the assets should be marked at. And so, that makes it a bit more challenging. But as I said and I said this over and over in many calls, we remain very open. We do evaluate portfolios from time to time. We just evaluated another portfolio recently. We chose to pass because we couldn’t get there on what we considered to be an appropriate mark to transact on behalf of ourselves and our shareholders. And to the defense of the seller, they marked – or they could accept that would be at the levels that they wouldn’t have to take another hit. So that becomes the problem. And so we remain open and more than willing to look at portfolios and teams to acquire. But they have to meet our credit screens and go through our credit process in order to be justified.

Makes lot of sense, and then maybe when there is a bid-ask spread there for maybe some of the smaller portfolios, is the preferred route to potentially look at acquiring people as that fund or bank might have less origination abilities going forward?

It varies. One of these are [indiscernible] you don’t grab a red and white – a red hot poker or blue flame poker, you got to be careful with that because it can be dangerous. So, you got to be very, very careful on how you evaluate those teams and portfolios that the guys and gals maybe highly confident, but are they confident in the credit parameters and underwriting standards that we apply to Hercules. So, what we find is, when we are looking at talent to bring onboard, first it has to fit in our team and fit our culture. Number two, they have to be willing to – I don’t mean this majority, but somewhat relearn how to do venture credit underwriting. Because we’re quite unique in how we do things as evidenced in our credit performance. And so that takes a bit of training, so when you hire new talent it could take six months to a year before that talent becomes accretive and contributing to meaningful asset growth as it goes through that learning process of how we would like credit to be underwritten inside our organization.

Yes. Again, makes sense and we talk about that. Can you remind us how many employees exist currently at Hercules?

I think we have a total of 67 or 70. We are growing, we keep on hiring because we have a lot of growth in front of us and we are actively interviewing in hiring folks at all levels in the organization from accounting to IT to finance to legal to credit, everywhere, origination. So, we are constantly looking, but we hire like we invest. We’re slow, we’re methodical about it, we go through a fairly lengthy process, and we fully accept that not all hires, they work out for example. That’s unfortunate, but we also need to make sure that we don’t compromise who we are in our credit standards.

Got it. And then so if we think about growth, is there any area of focus between your three lending specialties that you would prefer to grow more than any other?

They are cyclical. In doing this for 30 years, really the technology flow at the same time as biotechnology or life sciences flow. They tend to ebb and flow slightly differently and that's why we maintain a fairly balanced portfolio. We’re about 50%, or so, life sciences, 35% or so technology and 15% or so percent in the kind of renewals category. And that would move around quite a bit, plus or minus 10% any one of those verticals. We have a highly field members of both of those – three of those teams, and it really depends of what we’re seeing the market and what the capital markets are doing. And life science is quite attractive. We may go deeper in that area. If we find life science is pulling back, we may hold back or change the structure of the investment activities that were doing there. Well, were quite happy with what our team does and the insight of our team in managing the credit book throughout our history here. And currently what we were doing today in balance in the credit book. So, were quite – we’re actually happy with what’s going on.

That's helpful. And then last one here, I know Jonathan touched on SBA, could you give us an update, maybe on the potential likelihood for filing an application this year? And then maybe for Manuel, is that included, any funds there included in your $1.5 billion target…

No, no. Not at all. Look, the SBA has been a fantastic. It’s in great partner for us for years. I like to remind everybody that I think our first license we got in 2006 or 2007. Those are typically 10-year licenses. So, I think that my first license here is probably be going to be into maturing here soon. And so, we’re going to be looking at refinancing that license and putting a new one in place. But as I keep on reminding everybody, the SBA team and staff has been fantastic. But the political appointees in the SBA is way direction for the new administration. And as such, I don’t think they’re granting a lot of licenses right now. We’ve been in dialogue with them and we expect to file our property, or paperwork here right after the election and probably get a license – if everything lines up, maybe end of Q1, early Q2. But I want to yield to the SBA staff until they decide what political direction they’re being chartered to go forward on. But we intend to file a license. We just haven’t because we haven’t needed it right now.

Sure, it makes sense. That’s it from me. Thanks for taking my questions.

Thank you.

Next question comes from the line of Aaron Deer with Sandler O’Neill. Your line is open.

Hey. Good afternoon, everyone.

Hey, Aaron.

Manuel, you've painted somewhat of a binary picture with respect to the election. It sounds, if I understand you correctly, that under one scenario you can achieve this $75 million to $100 million in net growth in the fourth quarter, but if there is an adverse outcome to the election, then it will be something below that. Am I understanding that correctly and can you give us more specifics on how you view the negative side of that?

Well, it’s not binary, because binary means zero or plus or plus or one. This is 1 or 1.5 or half, I should say. The issue has to do with directional what the capital market is going to do. The capital market is going to a tailspin, and guess what I’m going to do. I’m going to hold back liquidity and choose not to grow because to grow to growth’s sake is a silly thing to do when the capital markets are melting, for example. So, we’re not going to grow. And I think the prudent thing to do at that point is to hold on to liquidity and protect your downside and your balance sheet and your investment portfolio. And if the capital markets deemed that the candidate that wins is favorable, and has a good outlook, then I think that we’re sailing into nice sunshine and calm waters in doing that. So, I’m not picking candidates nor do I really care which candidate wins or lose. I’m not really favorable on either of these candidates. But I have to do – I’ve been prudent in deploying capital and looking at the broader market activities and make sure that we’re not simply growing to grow and compromising credit quality to do so. So, that is one of the factors I think will contribute to how we decide what we want to do in our growth strategy.

Okay. And then on the credit it looks like it was a single credit – it sounded like it was a single credit that caused most of the uptick in the non-performers and the increase in the Grade 5 migration. But it sounds like there has been some resolution to that here or you expect a resolution to that. Can you give some color behind what industry that's in and what gives you confidence that that's going to get resolved this quarter?

Well, one – just to be clear, one actually did resolve this morning, so that was done. So that’s my confidence on that one. Money is in our account, so that’s a pretty good outcome resolution there. The second one – or just the one you refer to, you’re absolutely right, Aaron, it’s the largest one. That company is actively engaged in an M&A transaction. I personally have just been debriefed and met with the management team and some of the equity holders on that transaction or have spoken to equity holders as of late. And at this point, everything seems to be at go. But we all know that until M&A deal closes, I don’t count the deal or how’s the expression go; I don’t count the chickens until they come home. So, everything is pointing in the right direction on that. I know the acquirer himself. The company itself is waiting for an outlook on the U.S. economy in the election. And I would tell you unequivocally, I know for a fact that, that transaction is being held up until after the elections. So they feel confident that U.S. consumers will continue to be buying services and products. And at that point, they’ll feel comfortable that the forecast that the portfolio company has provided that company is what is realistic and achievable and that's a gaining item. And that – I think the transaction from everything I have been told is expected to close within – it will close in Q4.

Okay, that's great. And then very quickly, Mark, the average issuance of the ATM, the price in the quarter and your expectation to continue that at a similar price going forward?

Look, it will be a function obviously in terms of where our stock price is. We obviously look at where we are and what kind of performance we want. As of the end of last quarter, our performance of our stock was doing exceptionally well and we talked about the fact that we issue on – for additional approximately $27.5 million of liquidity, about 2.1 million shares in the third quarter. Do I expect that to continue in the fourth quarter? It’s very difficult to make that this time. You got two things kind of working against – there’s possibly three. One, the presidential election; two, Thanksgiving; three, Christmas. We have some pretty big holidays. And then of course, the performance of our stock has to be there for us to really use it. And of course, the pipeline, et cetera to making sure that we’re matching it with the pipeline for just in time financing.

Okay. Good stuff. Thanks for taking my questions.

Thank you, Aaron.

Your next question comes from the line of Merrill Ross with Wunderlich. Your line is open.

Thank you. My question really isn't specific to you, it's a broader question about the industry. Given the fact that IPO activity and M&A activity has been somewhat depressed, are you seeing evidence that there are sponsors who are for wavering in their commitments to their portfolio companies?

So, Merrill, that's a good question and good insightful question. I think the answer is yes for early-stage companies. Really early stage would see the investment capital is definitely suffering from venture capital support and co-generation support, which is what we don't do. We were not seeing any evidence of that in our later stage companies. Do I believe that fundraising is taking potentially longer than the historically lows? Sure, I think venture capital community itself is also waiting directionally, to see which way the economy is going to go and what's in favor and what's not in favor. And so, I think that there is a bit of a wait and see attitude. But I don't see any evidence of systemic pullback on venture capital follow-on investments to portfolio companies. I do see that certainly manifesting itself towards earlier stage C companies, if you will. I think those are definitely experiencing a much more challenged capital raising environment. But again, that's not what we do.

Thank you. That’s sort of reassuring.

Thank you, Merrill.

Your next question comes from the line of Robert Dodd with Raymond James. Your line is open.

Hi guys. Most of mine have been asked already, but just one on – given that the disruptions and the credit issue we've seen across various areas of the industry, are you seeing any effort to tighten up on covenants and tests and things like that from other lenders and that giving you an opportunity – particularly obviously the first-lien lenders you compete with rather than other tiers. Is that the kind of thing that's feeding into the stability or helping feed into the stability of the yield as well in terms of your covenant package or your requirements there is less push back on pricing because that's becoming more uniform or shifting kind of in your favor. Is that the kind of theme that's going on?

Look, if anybody answer that question yes, I think they're lying and it's silly. I think that is very difficult to extrapolate after one quarter or maybe two that we've had a game-changing event taking place or use the California term, a tectonic event has occurred that suddenly we were in this [indiscernible] of being able to price a structured deal. If anybody says yes to that, shot the stock. That makes absolutely no sense. I think that we are certainly seeing evidence of stabilization. I think that we're seeing some weaker venture lenders struggling and because of that lack of liquidity, I think we're seeing, I would call it stabilization of pricing pressure, but I don't think that necessarily terms and covenants have materially weakened and I don't think that they have realistically strengthened materially in just the last two quarters. I think that I am encouraged by what I'm seeing. I like what we're seeing. I like our balance sheet and access to liquidity, while others do not have that. But I'm not going to sit here and dismiss the venture lenders, the banks out there to suddenly say that they're not eager to continue to also grab market share as we are in the market opportunity right now. And so you have to be very leery on underwriting and keep your screens up and not get jade. And just because there is opportunities out there, you don't go after them. You don't compromise credit in this environment because that's how you get hurt. So we're not seeing demonstrable improvement on terms as you would like me to answer your question, but we're seeing a certain stabilizing of terms that we like. But I think it's too early to call that the trend is going on in our favor on covenants and other things coming to our wheelhouse.

Perfect. Thank you.

You’re welcome.

I am showing no further question at this time. I would now like to turn the conference back to Manuel Henriquez for closing remarks.

Thank you, Heidi. And thank you for everyone for joining us today. I like to remind everybody that we have a fairly busy agenda between now and year end. We’re going to be doing a European tour along with other – select the ample of other BDCs with Jefferies on the Jefferies European Investor BDC Summit. That is extremely important as we are beginning to see investors coming from Europe. We’re also going to be attending the FBR Investor Conference, as well as the incredibly important and industry-wide Wells Fargo Conference on the BDC’s aluminum market which is a highly respected conference in November and December timeframe. If anyone is interested in meeting with Hercules, please contact Jefferies, FBR or Wells Fargo or, of course, our own Michael Hara, on Investor Relations. Thank you very much and have a good evening.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. Have a wonderful day. You may all now disconnect.