Hercules Capital, Inc. (HTGC) Q1 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Hercules Capital Q1 2017 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today’s conference, Michael Hara, Senior Director of Investor Relations. You may begin, sir.

Thank you, Nora. Good afternoon, everyone and welcome to Hercules conference call for the first quarter 2017. With us on the call today from Hercules are Manuel Henriquez, Founder, Chairman and CEO and Mark Harris, Chief Financial Officer. Hercules first quarter 2017 financial results were released just after today’s market close, and can be accessed from Hercules Investor Relations section at htgc.com. We have 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 SEC may differ from those contained herein due to timing delays between the date of this release and in the confirmation and final audit results. In addition, the statements that 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 and without limitation the risks and uncertainties, including the uncertainties surrounding the current market turbulence and/or 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 hereof and Hercules assumes no obligation to update the forward-looking statements or subsequent events. To obtain copies of related SEC filings, please visit sec.gov or our website htgc.com. With that, I will turn the call over to Manuel Henriquez, Hercules Chairman and Chief Executive Officer.

Well, thank you, Michael and good afternoon, everybody and thank you for joining us today for the Hercules first quarter 2017 earnings call. I will be providing a brief overview of our key highlights and accomplishments, followed by a summary of the venture capital industry activities and conclude with a brief outlook for Q2 and the second half of 2017 and then turn the call over to Mark Harris, our CFO for a more detailed overview of our financial results and financial accomplishments in Q1 2017. I will then conclude with a Q&A session related to our Q1 earnings and then of course specifically addressing the questions that maybe related to our recent press release regarding our externalization announcement that we issued yesterday to discuss with our shareholders. I also intend to explain and deeply elaborate why and personally my belief as to the externalization process is in the best interest of our stockholders – or shareholders, I should say and the strategic reasoning behind pursuing the externalization and why it makes sense. Clearly, there has been a lot of confusion related to the announcement. And I will spend as much time on today’s call and later on meeting with investors over the next 3 to 5 weeks to elaborate and expand upon the externalization and explain the merits of why we are doing this for the benefit of our shareholders long-term. Now, for some key highlights and achievements of our accomplishments for Q1 2017. In an environment where growth has become challenging for many of our peers given the tightening credit market and higher levels of prepayment activity seen throughout the industry, Hercules Capital direct private lending platform continues to prove its resiliency in strong brand recognition as Hercules turned another solid quarter to start 2017 with strong new origination activities of $191 million in new commitments and $153 million in fundings overcoming our own high level of unscheduled or repayment activities of $100 million and achieving net investment debt loan portfolio growth of approximately $14 million on a cost basis. In addition, we delivered another year-on-year strong results for our shareholders. Looking at the first quarter of 2017 versus the same period last year, we saw solid growth across many key indicators. For example, we grew total assets by 19%, to $1.59 billion. We also grew total debt investment portfolio on a cost basis, up by 13% year-over-year to $1.4 billion. We also grew total investment income by 19% to $46.4 billion and of course, we also grew aggregate total net investment income, or NII, up by 13% to $22.7 million in the quarter. If you actually exclude the impact of the one-time financing event or retirement of our $110 million retail baby note, the 2019 notes, you would have seen that our NII income in aggregate would have grown by 23% year-over-year. As a reminder, our NII for the first quarter was impacted and Mark will elaborate further in this discussions, but was impacted by approximately $0.03 in NII related to the retirement of this $110 million bond and the announcement of that retirement embedded with the additional interest expense attributed to the 30-day overlap regarded in notice period of redemption to our bondholders in the marketplace. Adjusting for that, our NII during the quarter would have been $0.31 per share when adjusted for the one-time non-reoccurring events related to the retirement of our bonds. In terms of generating total shareholder returns for our shareholders, Hercules Capital delivered another strong result for the periods ending 1 year, 3 year and 5 years. And in fact, our 1-year total shareholder return, which is defined as stock appreciation plus dividends distributed, for the last 12 months was 33.7% and for a cumulative 3-year period of time was 31.8% and of course for the 5-year cumulative period of time was 77.4% total shareholder return for our shareholders. And finally, we further enhanced our liquidity position and balance sheet in Q1. We successfully raised $230 million in convertible bonds at a coupon rate of 4 3/8% and allowing us to retire $110 million of our 7% 2019 retail notes that I referred to earlier in the conversation. Coupled with this capital raise and the retirement of those bonds, we ended the quarter with over $343 million of dry powder liquidity to continue to make new investments in the portfolio and continue to grow our investments for the benefit of our shareholders as we continue to deploy additional capital and liquidity and continue to grow earnings and our assets for the benefits of our shareholders. As to our key market focus and developments in the venture capital marketplace venture capital activities remains actually strong. We are surprised by the level of resiliency that we witnessed in the first quarter by the venture capital and a sustained pace of new investment activities that occurred during the first quarter. The venture capitalists invested an impressive $14.5 billion of capital into new companies during the quarter, putting it on pace of the same level as we witnessed in 2016. And this of course is according to the Q1 2017 Dow Jones VentureSource report. I remain deeply grateful to our shareholders, our venture capital partners and many of our wonderful innovative entrepreneurs who continue to select and have the confidence in Hercules Capital’s brand and our reputation as a long-term capital partner. Hercules Capital is widely recognized as the largest BDC focused on the venture lending community and targeting and working almost exclusively with the venture capital marketplace as evidenced by yet another very strong year or quarter of origination activities in Q1 with over $191 million of commitments completed during the quarter. This could not have been achieved with not the support and the backing and belief of our venture capital partners and of course our entrepreneurs and innovative entrepreneurs that run many of these wonderful companies that we invest in. Because of this, we continue to see a steady and progressive growth in our venture capital relationships, which has led us to continue to grow our venture-backed investment portfolio. Our total assets finished at $1.59 billion and it continues to grow as we expect to continue to deploy our liquidity of over $343 million of existing liquidity. I would like to once again extend out a thank you to our shareholders and our employees and of course our innovative entrepreneurs who continue to support and select Hercules and have the confidence in what we are doing. I will promise you at the end of this call, I will spend an inordinate amount of time elaborating on the externalization and the benefits as to why we are doing and hopefully convince all of our shareholders to see the same vision that we are seeing as to why we are embarking on this very important transformation in our business model. That said, as we enter the second quarter of 2017, we are extremely well positioned. I expect to continue our very effective slow and steady growth strategy which has led to a solid performance over the years for Hercules, which I expect to continue both currently and post externalization to continue to deliver the strong performance our shareholders expect of this management team. We know what we have to look, we know what we have to accomplish and we know what we are coming from and I will assure you we will continue to work as hard as we work today even as an external manager and with the new fee structures that we are putting forward. We are directly and still remain very aligned with our shareholders and I will work to convince you of that benefits of what we are doing and why this makes sense. As I continue to focus on directionally where we are going, I have to honestly admit that we are continuously faced with challenging issues in the broader economy. We still do not have directional clarity as to where we are going as a U.S. economy. We do not have directional clarity on tax reform. And we do not have clarity on legislative reform. I am happy to say that today Congress in fact finally passed a reform of the ACA and actually put forward a program that goes before the Senate to evaluate. However, with all the many uncertainties associated with a repeal and replace of the ACA, our own outlook of investing in life sciences company remains a bit opaque, but we continue to make investments where we think it’s prudent. And we have structured around issues related to ACA as much as we can with what we know today. We are encouraged by the steps that Congress has taken and we remain very encouraged to see tax reform takes shape and bring back GDP growth in this economy. Obviously, any GDP growth that we see will be greatly beneficial for that of Hercules and further translating to additional earnings growth on behalf of our shareholders that should lead to higher dividend growth for our shareholders. Because of our continued discipline, we continue to project having overall net portfolio growth on a cost basis in the first half of the year of between $50 million and $75 million. We have brought this number down by about $25 million only because of the increase in early payoff activities that we have seen. That said, we currently have a debt investment portfolio of approximately $1.4 billion which puts us well underway to where our target price or I should say target size of that investment portfolio that we are projecting by the end of the year, which I will elaborate shortly. We are expecting early repayment activities in the second quarter of 2017 of approximately $50 million to $75 million of early payment activities. This is in contrast to the $100 million of early payment activities we saw in Q1, of the nearly $150 million to $175 million of anticipated early activities in the first half of the year. Let me say that differently. In the first quarter, we had $100 million and we are now forecasting another $50 million to $75 million of early payoff activities, which means that in the first half of the year we are anticipating early payoffs of approximately $150 million to $175 million. Notwithstanding the $150 million to $175 million in early repayment activities during the first half of the year, Hercules Capital does in fact anticipate entering new commitments during the same first half of the year of nearly $350 million to $375 million of new commitments. We remain very active and we continue to deploy capital and we are able to successfully absorb the early payoff activities and still focus on growing the portfolio, no thanks to our high brand recognition in marketplace and the strong commitment and focus of our origination team. Already in the first quarter, we completed $191 million of funding and we are well on the way to achieving that $350 million to $375 million of funding in the first half of the 2017. Offsetting this elevated early repayment activities is this increase in our portfolio. As I indicated, we believe that the portfolio will probably grow in the first half of the year between $50 million to $75 million of growth in the first half of the year, $14 million of which has been realized so far in the first quarter. As a reminder, predicting early repayment activities remains highly difficult and challenging to specifically know which companies and which states and if and when they will actually complete the anticipated early payoff activities. We do not have control of early payment activities and generally we only notify between 30 days to 60 days out from early payoff activities and we do the best that we can to try to manage for unanticipated early payment activities. That said, I think that the $50 million to $75 million of early payoff activities in Q2 at this point feels an appropriate number from what we know today. However, I will preface it by saying it is subject to change and subject to market conditions that could impact any activities going on to drive those early repayments such as IPO or M&A activities, all of which are currently actively going on in our portfolio today. Overall, our business performance remains quite well and quite strong. We do not take lightly the change of externalization, given how strong and how vibrant the business is, if not for the fact that we believe in our hearts that this is the right thing to do for our shareholders and continue to expand the platform and to ensure that we have the best of breed BDC platform in the marketplace today. Our opportunity entry in second quarter 2017 remains robust. We have over $1.3 billion of transaction activities that we are purposefully and cautiously evaluating as we make new investments, especially with a focus of originating $350 million to $375 million of new commitments during that period of time. However, we remain cautious in our capital deployment and will continue to be very judicious as we have done and sustain our longstanding credit performance that we have done as the manager that you have come to entrust and believe in. Finally, as we turn our benefits to the rising rate environment, clearly the Fed’s announcement earlier this week that they do not anticipate near-term rate increases is good news for everything that we do in our companies. We have witnessed the benefits of two rate increases so far this year and you will see those benefits translate into higher earnings in the remainder of 2017. The increase in the prime rate in December, the increase in the prime rate in Q1, have all now been digested in our investment portfolio and you should start to see the benefits of that income begin to materialize throughout 2017, as we continue to deploy capital. We do expect to see another rate increase in the second half of the year and primarily in our expectations in the fourth quarter of 2017. We are not expecting to see two additional rate hikes in 2017, but we are expecting at least one rate hike in 2017 in the fourth quarter, especially on the eve of the tax reform bill passing and stimulating economic growth in the current economy. Without the tax reform occurring, we do not anticipate an increase in the prime rate later on this year. Now, turning my attention to venture capital marketplace, as a reminder, our data comes from Dow Jones VentureSource. Venture capital fundraising started off the year with $8 billion of new capital raising activities by venture capitalists, a similar pace seen in 2015 and investments starting off on a stronger than expected pace of $14.5 billion to over 1,000 companies receiving capital from the venture capital. This certainly lays the foundation for an encouraging year. However, one quarter does not make much of a trend. So given all the noise in the economy, giving everything that’s going on currently, I think I am hesitant to judge that we can expect 2017 to be greater than the venture capital activities that we witnessed in 2016. 2016 was a very vibrant year with over $50 billion of capital invested. And at this juncture, we believe that 2017 will emulate very much the same performance of venture capital deployment as we saw in 2016. Following the highly anticipated $25 billion Snap IPO, we have seen a number of positive successful technology IPOs so far occurring this year, including Presidio, Mulesoft and Cloudera, among others, including Alteryx and Akka that have gone public so far this year. Seven companies have successfully completed IPOs in 2017. Albeit the number still remains anemic, it is encouraging. And the fact of the matter is that we are seeing some evidence of unicorns being able to monetize themselves through an IPO and seeing high level of investor receptivity seeking high growth stocks in the marketplace today. We are encouraged by this sign, but we need to continue to see sustained pace of IPO activities in the second quarter and the second half of 2017. That has not yet occurred and we remain encouraged to see it happening. M&A activity on the other hand remains quite strong. And we are encouraged by the M&A activity that we are seeing within the industry itself and certainly in our portfolio and certainly the activities that we are expecting to see in the second quarter of 2017 in the Hercules portfolio. I would like to inform you that Hercules finished the first quarter with approximately 6 companies currently in IPO registration, which is encouraging against the backdrop of those 7 companies that had completed IPOs in the first quarter in the industry itself. For additional information on the venture capital industry, stage of investments continues to be in the core wheelhouse or focus of Hercules Capital’s targeted stage of investing. VC investments primarily consisting of late stage or expansion stage companies as we call venture growth stage, remains the earmark of over 50% of the capital invested by the venture capital in the marketplace today. That is exactly our area of focus and where we anticipate with the depth and strength of our balance sheet to be able to continuously participate in larger venture capital transactions with those larger deals and the later stage companies. We are extremely well-positioned to take advantage of that growing market opportunity. But as I said, we remain selective and judicious in identifying prospective candidates to which we deem to be viable solutions for new investment activities in the marketplace today. We expect to maintain a high illiquid balance sheet throughout 2017 as a purposeful issue until we get clarity understanding of the economy and the broader economy direction will be going itself. I would like to remind everyone Hercules Capital does not generally make investments in early stage companies nor do we make investments in C stage companies. That is not what we do and it is not our focus. Venture capital exits. As I alluded to earlier in my comments, 7 companies completed IPO activities in the first quarter of 2017, an encouraging trend, but still not where it needs to be. However, an encouraging trend that did emerge is the tightening of time between the first initial venture capital dollars to that of an exit. We are historically running at level of 7.2 years. And I am happy to report that in Q1 2017, we saw significant tightening of time between first venture capital dollars and exits to only 6 years. We saw compression of 1.2 years, which means that we should expect to see a higher velocity of portfolio liquidity pursuing IPO events that are occurring sooner than later for the first stage of investment. This is actually an encouraging sign for those who actually follow the venture capital industry. Again M&A. Although M&A activity started off slightly at a slower pace in the first half of the year – in the first quarter of the year, excuse me, I remain, nonetheless, encouraged by the number of transactions that took place meaning 154 transactions completing M&A activities in the first quarter, representing transaction values of over $23.3 billion, which puts us a little bit slightly below the 2016 pace of over 800 companies that occurred during that period of time. Nonetheless, I am encouraged by also the time contraction from the first venture capital dollars in to an M&A event of 4.9 years, compressing to 4.6 years in Q1. Now in closing, Q1 was a solid start for 2017 for Hercules Capital. We remain very bullish on the outlook of our company and we have abundance of liquidity and access to the debt and equity capital markets. Unlike many of our competitors, we are exceptionally well positioned to continue to convert this excess liquidity into additional earning assets for the benefit of our shareholders. We will continue to make investments in our infrastructure and investments in our business to overall ensure the continuation of our long-term success and make critical investments in our infrastructure and our management team and throughout our organization to ensure that we are well-positioned for sustained growth. That means that we will make investments that may not be deemed initially favorable by investors on how we make investment decisions to ensure that the platform continues to have sustainability on a long-term basis. Many of you have been with me may recall that we made similar strategies and similar moves in 2015 where we actually took down earnings from $0.31 a share in Q4 2014 to only $0.20 in Q1 2015. I assure you that the same strategies that we are embarking now on externalization, is much of the same strategy that I am embarking on now to ensure that our platform has the wherewithal to continue sustainability of our continued long-term success. Embedded with that, I would like to remind everybody that we finished the year with over $34.2 million of projected earnings spillover, which at last share count, representing $0.42 of undistributed earnings, allowing us ample room and ample flexibility to make critical investments that may actually dip in our NII without having to cut dividend and having the assurances and the wherewithal that we have a very strong, sustainable and definable dividend position that we have and not to mention a very strong balance sheet and good credit performance and credit record that we have today. In wrapping up my comments, as I said, we are still waiting for directional understanding of the new policies of the new administration, regulatory and legislative changes in the new administration and any impact that may have, especially with a repeal and replace of the ACA that may or may not occur in our biotech and pharma companies today. Because of that and because we are prudent credit managers, we will continue to pursue a slow and steady strategy of deploying capital in a very methodical way as we have done throughout our history and continue to enhance and ensure sustainability of our credit performance and earnings sustainability of our shareholders in order to continue to grow our dividend as we expect to do. Even after externalization, I do not anticipate any dividend adjustments on the downward side. And if anything I expect to see dividend increases upon externalization for the benefit of our shareholders. I want everybody to understand that we remain optimistically, but guardedly bullish in our outlook for the second half and the second quarter of 2017. We will continue to deploy capital and will make over $350 million to $375 million of new capital commitments during the first half of 2017. We are not idly waiting by. We are actively managing and reinvesting our portfolio and sustaining a level of invested asset income generation to absorb any early repayment activities. We are well positioned with $1.3 billion of transactional deal pipeline to evaluate and ensure that we achieve those levels. We continue to increase our hiring across all levels. And most of you have seen the press release that we recently issued with the additional 5 additional invested professionals, two of which expands our credit team with Lee Merkle-Raymond and Charlie Vandis both joining our credit team to expand our wherewithal and sustainability of our credit performance. We remain optimistic throughout the rest of the year and we still have anticipated portfolio growth target of $1.5 billion to $1.6 billion by the end of the year subject of course to market conditions remaining favorable. With that, I will turn the call over to Mark Harris to review our first quarter financial results. And then Mark and I will more than happily answer any specific questions anybody would like to have regarding externalization and your support of that. Thank you very much. Mark?

Thank you, Manuel and good afternoon or evening ladies and gentlemen. Today I am going to make comments on our core numbers, which means I will be speaking to some numbers and ratios on an adjusted basis that is without the one-time non-recurring expense of $2.1 million, which consists of the acceleration of unamortized fees of the redemption of our $110 million 7% 2019 notes of approximately $1.5 million and the one-time interest expense overlap of approximately $600,000 pertaining to both 2019 notes and the new convertible bond outstanding during the 30-day required redemption notification period. In doing this, it will give you a better sense of the true underlying business performance and better demonstrate our expected performance in the following quarters. I am pleased to report our strong first quarter results of our premium venture lending platform continues to deliver strong financial performance on virtually every meaningful metric. All of this is possible for the growth of our balance sheet, where we achieved another record high investment portfolio of $1.525 billion at cost or growth of approximately 1% over the last quarter. In the first quarter, we raised over $277 million, $46.9 million of net equity issuances at a blended price-to-book multiple of 1.47 under our equity ATM program and the issuance of $230 million 4 3/8% convertible bonds. Hercules further saved $0.03 of NII per share annually on a cost of fund basis and lowered our forward weighted average cost of debt to approximately 5.7% starting in Q2 2017 through the full redemption of our 7.5% 2019 notes. As Manuel commented, we are pleased to report our final 2016 earnings spillover of $34.2 million or approximately $0.42 per share. Board and management will review this spillover within the next couple of quarters and make the appropriate decisions if there needs to be change in our dividend policy accordingly. Today, I would like to focus on six key financial items that drove our first quarter results. First, we had strong investment fundings of $153.3 million in the first quarter, which include the addition of 8 new portfolio companies that accounted for 81% of our originations in the quarter. On a cost basis, we are able to grow our loan book by $14.4 million in the first quarter even with headwinds of $137.8 million stemming from $100.3 million from unscheduled early payoffs and $37.5 million from scheduled amortization. This resulted on our net debt investment portfolio increasing to $1.399 billion at the end of the first quarter on a cost basis or of approximately 12.7% from the first quarter of 2016. In the first half of 2017, we do expect to see growth in our loan portfolio of approximately $50 million to $75 million, even with the expected unscheduled early payoffs in the second quarter of $50 million to $75 million. Our core yields were 12.2%, down from 12.9% in the previous quarter, primarily due to one position that was placed on non-accrual during the quarter, but then has subsequently been converted into an equity position in the second quarter. After that conversion, we anticipate our core yields to normalize back between the 12.25% and 13.25% going forward. Our net investment income was $22.7 million. However, on an adjustment basis, our NII closed at $24.8 million in the first quarter or $0.31 a share, which is an increase of 23.3% over the first quarter of 2016. This was driven by our total investment income kind of increasing 19.1% to $46.4 million in the first quarter from $38.9 million in the first quarter of 2016. This increase was attributable to both the growth of our debt investment portfolio where we saw an increase of approximately 17% of our weighted average loans outstanding between the first quarter of ‘17 and the first quarter of ‘16 and an increase in one-time accelerations from early unscheduled payoffs. Our interest and fee expense was $12.4 million in the first quarter. This was due to a non-cash charge on the acceleration of the 7% 2019 notes of 1.5 and the one-time interest overlap of $600,000. Adjusting for those one-time events, we would expect our second quarter and beyond to maintain the cadence of $10.5 million to $11 million per quarter in terms of interest and fee expense. Our net interest margin continues to expand to $33.9 million or adjusted $36 million in the first quarter of ‘17, up 16.5% from the $30.9 million in the first quarter of ‘16, due to the strong investment income growth. Further, our net interest margin as a percentage of average yielding assets was 10.8% on an adjusted basis in the first quarter of ‘17, up from 10.1% in the first quarter of 2016, as we generated more income over our growing yielding asset base. Last, we always keep an eye on Federal Reserve Open Market Committee reports. As we have commented in the past, we have a very well positioned portfolio with a highly asset sensitive balance sheet in the event of future interest rate movements. 93% of our loans were variable interest rate loans with floors. And nearly 100% of our outstanding debt was fixed interest rate debt. A 25 basis points increase in benchmark interest rates at the end of the first quarter would be accretive to income and NI by approximately $2.4 million or on annualized basis $0.03 of NII per share annually. Turning to credit, in the first quarter our weighted average credit rating adjusted slightly to 2.43% from 2.41% in the fourth quarter of ‘16. During the same period our watch list grades 3 through 5, slightly increased from 37.6 to 39.4 on a cost basis, primarily from our grade 3s increasing from 23.8 to 25.4 on a cost basis. Most movements within the portfolio are consistent with our longstanding policy of generally downgrading credits to a grade 3 as the company approaches capital raise or clinical milestones. Traditionally, our portfolio companies will need to raise capital every 9 months to 14 months, thus it’s our expectation that our portfolio companies will migrate to a credit rating 3 at some point in their normal lifecycle with Hercules and in an ordinary course of business. Our credit 4s and 5 rated companies, which are primary of focus remained relatively flat on a cost basis from Q4 to Q1 ‘17. Our non-accruals in the first quarter primarily due to adding one position to non-accrual status increased to 7.0% from 2.9% in the previous quarter on investments on a cost basis. However, after completion of one conversion again from debt into an equity position in the second quarter, our non-accrual balance has adjusted down to approximately 3.1% in the second quarter. Looking at realized gains and unrealized [ph] depreciation, we had net realized activity in the first quarter with net realized gains of $3.2 million, which was the result of our full disposal of our investment in Box in the quarter. This allowed us to continue to reduce our cumulative net realized loss since inception to actually a positive cumulative gain position of $900,000 on approximately $6.7 billion of commitments. We had a net unrealized depreciation of approximately $31.2 million on our investment portfolio during the quarter consisting of both our debt investment portfolio which had a net change in unrealized depreciation of $31.2 million and our equity and warrant portfolio which had negligible net change. The depreciation on our debt investment portfolio primarily consisted of one company having an impairment of $32.8 million and all other net collateral based impairments in the period of about $7 million. These were offset by $8.6 million of reversal and mark to market appreciation in the quarter. The depreciation in our equity portfolio was made up of an appreciation of approximately $1.2 million from our public company portfolio, then appreciation about $700,000 from our private portfolio, which was offset by $4.7 million of reversal primarily relating to our disposal. Our warrant portfolio saw gross unrealized depreciation about $2.8 million, consisting of unrealized depreciation of both our public and our private holdings. These movements outside of reversals were entirely consistent with public market benchmark performance in the same period. Our first quarter strength was achieved in our solid shareholders, which can be seen through our return on average equity which increased from 10.9% in Q1 2016 to an adjusted rate of 13% in Q1 ‘17. This achievement was done while operating at a modest leverage levels with our net regulatory leverage of 54.7%. That’s not stressing our balance sheet to make this achievement and providing us plenty of headroom for further growth to drive our key ratios, such as our return on equity. Last, I would like to comment on our treasury and our liquidity, our net regulatory leverage, excluding SBA debentures as we have an exemptive relief from the SEC, declined to 54.7% at the end of the first quarter. This was 58.9% at the end of the fourth quarter. Our net GAAP leverage also declined to 78.2% in the first quarter from the 83.1% at the end of the fourth quarter. With our cash position at the end of the quarter and our self imposed 1 to 1 to 1.1 to 1 GAAP leverage would enable us to grow our debt investment portfolio to between $1.58 billion to $1.66 billion without raising additional equity. This demonstrates the importance of our liquidity and why it’s the foundation for our success. At the end of the first quarter, we finished with $343 million of liquidity. Our liquidity consisted of $148.1 million of unrestricted cash and $195 million of un-drawn availability under our revolving credit facilities which are subject to our borrowing base leverage and other restrictions. Thus, in closing, we’re very pleased with the current position at the end of the first quarter. Our liquidity position allows us to grow our book opportunistically and prudently, while long-term focus approach will enable us to deliver solid results for the foreseeable future. With that report, I now turn the call over to the operator to begin our Q&A part of our call. Operator, over to you.

Thank you. [Operator Instructions] Our first question comes from Jonathan Bock of Wells Fargo Securities. Your line is open.

Good afternoon and thank you for taking my questions. And look unfortunately, I don’t want to really – I have a couple follow-ups and my hope is you will give me at least three, because given you didn’t mention the reasoning behind externalization in your prepared remarks, I don’t want to waste a question asking why, so Manuel, Mark, can you tell us why you are doing this and the three major reasons? And then I will start my questions after that.

Sure. Let me take that, because I am the one who is embracing this and strongly encouraging this move. When you look at the business itself, after 14 successful years we are doing, the market has evolved. And the market has evolved where these larger externally managed BDC funds have access to ample tools of capital that we do not have, giving us a disadvantage on the ability to originate different loans with different yields and different product categories that, what I believe in my opinion, would be a detriment in doing so at the existing fund. For example, if we were to be doing significant levels of asset based lending activities at the main fund of Hercules to which I would like to remind shareholders that we did in fact do that in the second quarter of 2011 and 2012 when we started working on ABL to validate this business model and business concept, we have proved that we actually have an ability to do that. However, because of the 1 to 1 BDC yields will leverage, doing so on originating assets that have a significant lower yield spread than we realized today in the market and by commingling those investments in our current core fund today would only dampen our investment performance and lower our overall ROE. By having a related fund by externalizing, we are able to strategically have access to pools of capital, whether they are additional SMA accounts, whether they are senior floating funds or other initiatives that many of the other external managers have, we are then able to better defend and enhance the value that we are realizing for our shareholders by being able to originate lower margin loans that will be complementary and support of our existing term loans at Hercules Capital without having to compromise our return on ROE and our margins that we are realizing in Hercules by being able to originate lower margin loans in these related funds for the benefit of sustaining our term loans outstanding. Number two is the critical need to ensure that we have a platform that we are able to continue to attract and retain key management talent by enabling them to be able to see continuation of growth and continuation of our own maturation as a company and continuing to grow our assets. However, the ability to continue to grow assets and without diluting the critical brand that we have of Hercules Capital in the venture industry starts becoming affected over certain size that we have and I do not – and do not believe we should ever compromise the value and the brand that Hercules has as a venture lender and not be able to leverage that expertise and being able to deploy capital in new funds for the benefit of attracting and retaining additional talent is a critical issue for us to continue to pursue. Number three is the reason to looking at externalization is to ensure that our shareholders continue to see and realize a very competitive solution that we do not anticipate seeing a cut in dividends under the new incentive fee income that we are putting forward. And in fact, I will go to great length to defend that we are putting forward an incentive fee income that is one of the best in the industries. To help people understand this context, today, the vast majority of the BDCs have a hurdle rate of 7.5% to 8%, after which point they receive a 20% participation of the profits. Under the proposed incentive fee that we are putting forward, which we have gone to great length and great pangs to ensure that is no different on an expense basis or relatively tightly similar to what we are seeing today with this new fee structure that are putting forward, at that same 7.5%, 8% hurdle rate that the industry would normally see today, 20% participation, under the Hercules proposal of the new externalized fee structure, we would only see 5% of the incentive fee income. So which means that the fee structure we are putting forward goes at great lengths to try to emulate the same financial results and performances that we would otherwise have seen as an internally managed, but now but now being done as an external managed with a greater alignment as an external adviser with a fee structure that’s best-in-class in the industry today.

Okay, I appreciate that. And so now I have two questions. The first is Manuel is it’s the competitive disadvantage of not having funds to originate lower yielding loans or effectively grow your platform with different bucks. This can be done through, a), forming joint ventures with partners and using off balance sheet leverage or external funds in that regard, or b) forming an external manager within the BDC, ala, American Capital or another example, Main, to go out and push that endeavor, why not go that route? And then I have one more question.

So I think those are viable solution among others. But I would not call ACAS the pinnacle of the greatest success story of managing that type of initiative and that type of effort as they culminate in the sale to Ares Capital who took advantage of that dislocation and inefficiency in the structures to eventually be able to acquire the assets of ACAS led by Elliott Management. So, I don’t think that ended very well. As to the Main Street, Main Street is always a one sole player that has that. We have looked at that initiative. We are not convinced that is the most viable solution out there and I think creates a lot of confusion by pursuing it that way with having a POCO of an asset manager inside of a BDC. And I would tell you that I am not sure the SEC is 100% necessarily behind such of those initiatives. And so we looked at that. But we still believe that one of the best models to look at out there, believe it or not, is actually Solar Capital. I think Solar Capital – and I am more than happy to compliment good BDC operators out there. I think Solar Capital certainly has a very good business model that I think is one that merits some replication of in terms of the structure. But I think that you wanted my honest opinion, I think it’s in the best interest as I engage as many institutional shareholders to allow the institutional shareholders their ability to select what pools of capital they want to invest in and not simply have the asset manager do the asset diversification on their behalf. And what I have learned from speaking to many institutional investors has been, that at Hercules, a 155 to book or 160 to book has been very attractive, but they question the additional level of growth that you can originate or I should say make an investment at the externalized level – excuse me, at the Hercules level and get returns. However, if we as an asset manager were able to launch new funds, as an example, those institutional investors will be able to buy the same manager they have believed in for the last 14 years or whatever period of time they have held and be able to buy into asset classes at par and be able to benefit from that asset manager’s execution into new asset classes that, that shareholder may not want Hercules Capital to be involved in, because they want Hercules Capital to remain, for example, pure-play venture platform.

I appreciate that. I guess the small rebuttal would be, well, ACAS got a lot of things wrong passing on the benefit of earnings via management or external management of their REITs to shareholders created a lot of value too. Solar actually utilizes the JV platforms to provide the increased economics to their SLRC shareholders, but really it culminates with this question. If we look at the REIT space or even the BDC space, well, looking at REITs in terms of internalization. When a REIT internalizes, the owner of the external manager receives a payment, right or some form of value. Also, if we think about some BDC external managers that have traded over the past, let’s say, 12 months, there is a significant amount of value created for the owner of that external manager there. So in this context, Manuel, can you explain why a shareholder, if the external manager has value, should hand over an external manager to the owners of Hamilton Advisors for free?

Well, I appreciate the question. But last time I checked, Abe Lincoln abolishes indentured slavery. So I am not sure that anybody at the internal adviser – internal manager is subject to having to do what you just advocated. I think that employees and high value employees have the ability to change position and pursue economic issues. This effort is there to hopefully retain and encourage those valuable employees to continue to remain at the asset manager and continue to develop value for our shareholders. But I want to correct the couple things that you said. Number one there has been three BDCs who have externalized as internal BDC managers. Number two, there has been, most recently, [indiscernible], a REIT that converted from internal to external managers, did not do any of the things that you just advocated in consideration on shareholders. So, there are so many multiple different ways of looking at equations and looking at remunerations. But at the end of the day, this is something that the shareholders have the choice. They can vote. They can vote affirmatively on June 29 for or against it and they can decide what they want to do in the judgment of that decision on the impact on the management team and retention of key critical managers who are out there. But it’s their company and they are entitled to that vote. And if they don’t want to do it, they don’t have to vote for it. And whatever happens at that point happens. But I think it’s in the best interest of us to move this forward. I believe very strongly as one of the largest shareholders in this company that this is the right thing to do, but shareholders are entitled to vote as they deem. And this is why I believe very proactively in the democracy process of having shareholders vote their shares whichever which way that they want. I will allocate the next 4 to 5 weeks to spend as much time with analysts and institutional shareholders to address their questions and get into any specifics they like over the next 4 to 5 weeks.

Much appreciate. And you are correct it is a choice and thank you for allowing the investors to make it. That’s all my questions.

Thank you. Our next question comes from John Hecht of Jefferies. Your line is open.

Afternoon, guys. Thanks very much. First of all, the – and I apologize if you referred to this and I have not had a chance to look at the Q yet, but there was some depreciation in the debt portfolio. Did you mention the company or companies that, that was isolated to and do you know what’s the – what’s your, I guess strategy to work those situations through?

Sure. Well, I am happy to report that with continued Hercules performance as a quality asset manager that we have been and are that we continue to execute on behalf of our shareholders and we will intend to continue to do that in the future as well. Specific to your question, that the company you are referring to is Sungevity in our portfolio. Sungevity successfully went through a bankruptcy process to which we were one of the credit bidders along with Northern Pacific Group, which ended up being the winners of the process. At the culmination of that bankruptcy process, Northern Pacific Group or NPG and Hercules Capital become now the equity holders of that new entity that was formed upon exiting of the bankruptcy. The company successfully have retained new talent of management and is recapitalizing itself. And we are encouraged on the hopes and ability over the next 12 months to 24 months to start seeing some recovery of significant portion of our original investment that we wrote down to about $13.5 million carrying value at the end of Q1. We expect to see throughout the fiscal 2017 and 2018 as the new management team and the new capital partner continue to make progress in the turning around of that situation and enhancing the company’s performance to start seeing recoverability of principal from that investment.

Okay. And then well, you have had a lot – well, a reasonable amount of experience of dealing with these situations and I believe a pretty good record of recovery, is there any stats around that like what are typical recovery rates in this type of situation?

When it comes to companies that go through bankruptcy and new management team being injected into the business and new capital being injected into the business, obviously the answer is more encouraging than the sure thing of liquidation. We would not have credit bid, we have joint partnered with Northern, NPG if we didn’t believe that it made a lot of sense for our shareholders. So as we have done in the past in our successful track record that Mark alluded to, that since inception we have done $6.7 billion of capital and over $5 billion of fundings, that our cumulative net losses are positive that almost $1 million throughout our 14-year history. So I think that our track record and our tenacity in working with restructuring companies with both the venture capital sponsor and the new sponsors that are coming in has certainly been encouraging with our history. So I can’t handicap and say that I am going to have full recovery and when. I believe that the expectations for this new co-emerging out of bankruptcy, that we credit bid and having us have a greater probability than not of recovering principal is certainly encouraging at this point. But it’s too early to say because we have only been almost only 45 days or so out of the bankruptcy process with the new management team. So in fairness to them, I got to give them some time to get their sea legs and really get their arms around the situation.

Okay, that’s good color. Thanks. You gave a lot of good stats throughout the VC markets, you guys have had a pretty active – I know repayments are pretty high, but you have had a couple quarters of good deployment activity, can you give us some color around what industries you are focused on, what you might be looking for over the next two or three quarters, based on changes in the market?

We continue to see very strong investment interest in big data, strong investment interest in personalized medicine, immunotherapy, obviously life sciences companies remains a very hallmark of our focus and our interest. I think that we are – I will speak for myself now, not on Hercules. But I will speak on my behalf now. I am actually encouraged by net neutrality being rescinded. I think that that will encourage strong investments and communications. I think it will allow networking companies and telecom companies to start making capital investments in developing their network infrastructures. Everybody knows, unless you have been living under a rock, that cloud computing has become very, very important part of the equation. And in order to have effective cloud computing, you need to have fast networks where you have proprietary traffic, can move quickly. And if you are doing all your applications being hosted on cloud, you want to make sure that your service provider has a network and bandwidth that can give you the performance that you are looking for. Network neutrality certainly gives you that strong ability to ensure that your customers are able to get that premium traffic and throughput. So I am actually maybe a minority in this view, but I actually believe network neutrality is a very positive economic growth engine for this country. And I am encouraged by it.

Alright guys. Thanks very much for the color.

Thank you.

Thank you. Our next question comes from Ryan Lynch of KBW. Your line is open.

Hey, good afternoon and thanks for taking my questions. First one just has to do with quarter-to-date activity, so it looks like so far you guys have a pretty healthy pipeline of pending commitments through the quarter, about $140 million, but quarter-to-date, it looks like closed commitments are only about $1 million, so can you just talk about what is I guess keeping commitments, quarter-to-date, actually made so far so low?

Yes. I think that I mean to be honest, it’s just our slow and steady strategy. I think that we are probably taking a little longer on diligence, probably taking a little longer on ensuring legal documents. We are waiting for clarity on ACA and other aspects of the new administration. But that said, as I indicated in my opening remarks, I am expecting the first half of 2017 to have about $350 million, $375 million. And if you look at Page 12 of our press release, we are well on our way. We are at $332 million of identified commitment in-house that we are processing of that $350 million. So I am $20 million short of hitting my lower mark. So I am quite encouraged about what we are doing and where we are at right now. Am I a little slower on funding than I would like, sure, I am not going to deny that. But I think that was consciously done on our part, awaiting for a better clarity on economic direction. But it does not mean that we are anywhere off the pace that we expected to be for the first half of the year, $350 million of commitments, to $375 million.

Okay. And then can you just talked about, you guys have been accessing the ATM market to grow equity and eventually grow your portfolio, it looks like there was only about $10 million or so, about 750,000 in shares remaining on your ATM program, can you just give any sort of outlook on what you guys are expecting as far as issuing the remainder of that ATM and as far as raising capital going forward to fund your growth?

Sure. As we indicated, with only $340 million of liquidity on balance sheet, the short answer is that in the near-term there is no necessarily a need to rely on the ATM right now. Mark will give you a response as to the remaining shares of the ATM program. But before I get there, the reliance on the ATM right now remains a strategically important product for us. We don’t anticipate, unless we see a lot better clarity on regulatory policy or legislative policy that’s quite favorable and we see GDP growth better than it was in Q1 actually pick up in Q2, I don’t think that you are going to see us materially step on the gas for ATM activities in the second quarter. And we will probably reserve issuance of the ATM program for Q3. And I will let Mark elaborate on the first part of your question.

Yes, absolutely. So you probably missed it, but what we did do is we got approval to up the share count, that is to create a new kind of shares under the ATM program. If you go to Page 6 of our press release, we talk about as of March 31, we have approximately 751,000 shares remaining available for issuance and sale under the equity program, which is just north of $10 million, $11 million worth of shares available under the program.

Right. But the answer is that once we exhaust that, are there other shares and the answer is yes. Yes Ryan, we have other shares that we have authorized. And we will be – we haven’t put the new ATM in place, because we haven’t needed to. But you can see sometime in Q3, probably the new shelf for the ATM program being put forward.

Okay. And then I do have one on the externalization, I mean one question that I have that a lot of investors that I have been talking with have is, basically what happens to expenses and what happens to ROEs under the externally managed structure, I mean if I look at the proxy that you guys put out, you guys generated about a 12.5% roughly, ROE in 2016. And the proxy shows that expenses under the external management agreement would be about 1% higher, expense ratios would be, which would roughly equate to 1% lower ROE. Now, if I look going forward in 2018, most people have your estimates at around a 14% ROE. Now, your incentive fee is beneficial. But as you guys generate a higher pre-incentive fee, that incentive fee increases to a 30% on that incremental income. It remains effective rates lower than 30%, but that incremental is 30%. So to the extent that you guys are generating a 14% type return in 2018 or so, it seems that, that annual expense ratio could increase even higher than what you guys outlined in the proxy of about 1% in 2016, which would mean ROEs would be much lower than that 1% rate. So lot of investors are worried about what if you externalize, what’s going to happen to expense ratio and similarly, what could happen to ROEs?

Well listen, first and foremost, I don’t want shareholders to be concerned about that. And rightfully so, there is not a lot of information that we have put out in the market yet today, because we only have a preliminary proxy. I can assure you and I can assure our shareholders that the intent that what we are doing is not to see elevated expenses. There is certainly no question in everything I have looked at and everything that we have modeled that the intent is to see disproportionately higher expenses. I would not do that if that’s the case. Because I like to remind everybody, not only am I the Founder, I also own 2 million shares outright, plus. And I too suffered a dramatic loss in net worth today. It is not my intent nor is it my interest to see our expenses go up at the cost of our shareholders. I spent 14 years advocating for and arguing for the benefits of an internal manager. I am a strong believer in the internal management structure. However, shareholders who know me and understand this need to hear this very clearly, it is not my intent to see dividends being cut. It is not my intent to see higher operating expenses. It is certainly my intent to ensure that our platform for the benefit of our shareholders, to which I am a large shareholder, continues to see that our platform continues to grow and develop and generate the ROEs that are commensurate of that of emulating an internal BDC structure. I have gone through great lengths with Mark on modeling and analyzing this and we have spent nearly 4 years working on this project that culminated into this proxy. And I can assure you that everything I have seen that I do not see any evidence of any material decrease in our ROEs related to externalization. And if that is the case and if there is, in fact, evidence that we have missed that lead to a dramatic decline in ROE, then I will be the first one to say don’t externalize. That is not my intent. My intent is to externalize to ensure that our shareholders continue to see the benefits of our platform and give us the competitive advantage that I feel that we do not have today in order to compete with external advisers who have multiple pools of capital and who can access multiple different cost of capital for different investment vehicles to help ensure value to the main fund. It is my intent and I will be spending as much time with every shareholder that I can and every analyst over the next 4 or 5 weeks, including taking the most difficult, painful question, because my job is to make sure that everyone understands this, so when they vote, they have a good understanding. But I will go to great lengths to do whatever I can to show financial models, whatever I can from the SEC that I do not believe from everything that I have evidence in my possession that the externalization will lead to any material degradation in the performance of Hercules let alone in our returns. There is clear evidence that there maybe some smaller declines in ROE, but not to the levels that you are advocating. I would not have put forward the fee structure that I believe in my heart emulates the internal manager and truly, truly does what I fundamentally believe in my heart, which is I am a big advocate of internal BDC structure and I went out of my way in designing a fee structure that I believe emulates our performance and replicates the ROE performance that allow Hercules even as an external adviser to be the best-in-class external BDC advisors with one of the best external management fee. We are not enriching ourselves with this management fee at all. And in fact, if you look at the mathematical computation of the fees that we are proposing, we are not seeing any disproportionate change for the benefit of the manager ourselves. I also like to remind everybody, the entire management team of Hercules is moving into Hamilton Advisors if and when it’s approved. And we are not changing that. And if anything, we are doing this to ensure that Hercules fund the external BDC pool of capital, continues to generate the returns that I believe that we are capable of doing and more importantly, have the defensive tools of accessing new pool of capital to ensure that our shareholders continue to enjoy the disproportionately higher ROE returns that we see as an internal BDC that has an external with a new fee structure.

Okay. Thank you for that commentary. And just to add on to that, I would say, to the extent that the SEC allows as much information I think as you can put out as far as future expense ratios and ROEs, I think that would be very helpful to see how they compare and so that investors can get a good idea of what are the impacts. So to the extent you can do that? That’s great.

I absolutely agree with you. And I could assure you, I have been working on investor decks with my team that when we file with the SEC, w e are going to be working very proactively with the SEC on this issue, because I believe very strongly, as I have for 14 years and I am a strong advocate of our institutional shareholders and our shareholders as abroad that I believe that having full transparency, so they can make an educated decision is critical. And if our shareholders have feedback for me on suggestions on tweaks to the proposal that we are doing, I, too, as a manager, will encourage you to provide that to me. It is a company that we have worked together to build and I have no interest whatsoever in disenfranchising our shareholders. And I will say it again I believe I put forward a fee structure that aligns what we have done as an internal manager with an external managed BDC that aligns management and our shareholders as if we were internally managed as an external manager. And if our shareholders feel differently and mathematically have a different computation, I am open to that criticism and having those discussions. I am not going to be a deaf ear to those issues. And I want all of our shareholders to reach out to me and our team to talk about it, because I encourage feedback.

Okay. Those are all the questions for me.

Thank you. Our next question comes from Christopher Nolan of FBR & Company. Your line is open.

FBR & Company. Hey, guys. So, I joined the call late. So please excuse me if whether or not this is answered. Manuel, the look back is only 12 months and it’s only 12 calendar months. So it resets every December 31, if I understand it correctly. Why did you choose that since some of the other externally managed BDCs have a 3-year look back or even back to the IPO?

I am sorry. So the question is why do we not have a total return look-back? Is that your question?

Yes, exactly, for your part two incentive compensation schedule.

Sure. So one of the things that was shocking to me when I analyzed it, I looked at Goldman Sachs, TPG, Golub Capital, Gladstone, TCP, Fidus, Ares, Solar Capital, among many others. As most of you know, there is approximately 55 or so externally managed BDCs in the marketplace. To my surprise, overwhelmingly, very few actually have total return look-backs associated with them. For example, Goldman Sachs is a 3-year, while TPG has none. Golub Capital has an infinite look-back, while Gladstone does not. TCP does and etcetera. And so the answer is and I am looking at the way we structured our mindset of incentive fee compensation, because we don’t participate at the 20% level until we see 22% hurdle rate. So, let me make sure people understand this. This is a very, very critical point. But I am happy to add it if we need to. But I don’t think it’s necessary, because my hurdle rate before I experienced a 20% participation is up to the 23% level. While the vast majority of BDCs in the marketplace today receive an incentive fee participation as low as 7.5% to 8% hurdle rate, which then they get the 20% and they can apply the look-back for those who have it from a total return. So, what that means is, when you look at it mathematically, although I don’t have a total return, and I am happy to add it. Is that’s something that shareholders want us to add, I’m open to that. I am not opposed to it. But because our fee structure it doesn’t really get into the 20% participation level until such a high level of a hurdle rate, the need for that so called total return look-back, I believe and maybe I am wrong, but I believe is embedded in how we derive the incentive fee compensation. And maybe that was just me being too clever, if you will, with our fee structure that most people have lost on it. And so maybe I did a horrible job on explaining it in that press release and the proxy statement. But in essence, to answer your question forthright to me, we didn’t include it because the way the incentive fee works, by the time we get to 20%, we are operating at such a high level of functionality for the benefit of our shareholders, that you don’t need it.

Thank you. My follow-up question, assuming shareholders pass the external management resolution as is, how does this change Hercules, HTGC specifically, let’s say 3 years from now, what do you envision the company to be, I mean what’s the vision here?

Well, what’s the most important thing as the founder of this firm and as one of the largest shareholders and one of the things that I cared about that I believe has established our brand over the 14 years, is to sustain the purity of being that venture lender that is known to be and being the largest venture lender in the asset class. I believe that if Hercules were to embark in new asset classes, I think that it clouds and confuses what we do as a core. And from my conversation with the institutional investors, it is very clear to me that the reason why they have owned Hercules is that they want that pure play. If they want a low to middle market allocation, they can go buy another BDC in the lower middle market area. But if they want a pure venture play, they can buy Hercules Capital as a best-in-class pure venture play. So doing other asset classes with inside the confines of that Hercules Capital umbrella, I believe dilutes the brand and dilutes what the investors have come to believe and expect from this management to execute. However, this management team has the capability and has the depth and breadth to be able to do new asset classes and do new asset classes that can complement what we are doing at Hercules. But I believe strongly in my heart and I could be wrong on this, because I am being very humble here. But I believe that if the investors’ choice for them to decide who want to be in the vehicle. And so what I believe in, that Hercules will be the best-in-class venture lending platform. They have that and they will continue to have that even after externalization. It will remain core to its competence and core to its focus. And if they want for example, to have Hercules senior lending fund or Hercules ABL fund, which could be a lower margin product and it could have a lower management fee structure, they could invest potentially in a future fund that we do, to do that, or any other subsequent pools of capital that they want to invest in that has maybe the Hercules oversight. So what I believe in my heart, that I want to create a platform by which I allow the shareholders to decide the risk profile that they want to be investing in and have the shareholders decide which different asset classes that they want to be in. If they want to be in pure venture, then they stay with Hercules today. We are not changing anything that we are doing, even upon externalization. That’s going to remain in our core competency, in our core wheelhouse and continued to execute and deliver the performance we have done over the years. And so there is a lot of confusion that the new asset classes that we may or may not embark on will now be done at Hercules. And Hercules remains core. I do not expect any dividend cuts. I hope to see dividend growth. I expect the same exact quality dimension [ph] that we have today remains focused on building and developing Hercules Capital further, as the HTGC entities exist today. And all that we are doing is eventually creating new pools of capital that will help complement and support the core fund with complimentary asset based lending and other investment assets that will help the Hercules portfolio sustain its performance that it’s done over the past.

Final question, do you anticipate this to improve or impact your debt to borrowing cost?

I am sorry, cost of debt overall; is that the question?

Yes. Well, external management, do you think that will affect your cost of capital?

I don’t believe it will, because there are 55 examples of external managers out there. I don’t believe, despite some of these questions, that obviously, we have to do a much better job of articulating and hopefully working with the SEC, putting forward examples of what these pro formas expectations ROEs would look like or at least in arrears, to show that we, with everything that we know, we do not expect, nor anticipate any material degradation or changes in a overall historic ROEs on a prospective basis upon externalization. And the reason why I say that, with that level of conviction and confidence is that we have gone to great lengths to have an incentive fee that is relatively low and almost generates the expenses that we have today at Hercules without taking any income away from our shareholders to ensure that we have a sustained ROE that we have done historically on a go-forward basis. So embedded with that and with the financial models that we have run, I don’t believe that I will see any degradation in our cost of funds that we will get upon externalization. And I actually believe that upon externalization, we may see a benefit to our existing shareholders and potentially a benefit on ROE because we will actually see greater duration, meaning less turnover of our term loans by being able to have complementary senior based loans, asset based loans that are able to keep our term loans outstanding longer, therefore reduce our churn and have assets on the books longer, generating greater interest income and having a lower cost of capital of acquisition of new loans which manifests itself into greater returns for our shareholders. And I truly mean that. That is the main reason why we are doing this.

Great. Thanks for taking my questions.

Thank you.

Thank you. This concludes the Q&A session. I would like to turn the call back over to management for closing remarks. Thank you, operator. And as I said, shareholders and analysts and investors out there, we strongly encourage you and we will actively be seeking out your feedback and conversations regarding externalization. It is your company. It’s your voice. Your vote. It is our responsibility to make sure that we provide you with the necessary information to make an educated decision. If you have suggestions and if you think that we need to make changes and tweaks I encourage you to come forward and provide that information and feedback. We want to do this collaboratively with you and we believe that this is the right decision. With that, Mark and I will be on the road for the next five weeks, meeting with shareholders throughout the country. We will be participating at the JMP Financial Conference and the Real Estate Conference in New York and the Super Return Conference and the Creditflux Conference in Boston. We expect to be doing non-deal road shows regarding externalization. And I will go to great lengths and pangs to meet with as many investors as possibly can. I will encourage you to please come forward with any comments or questions. But please give us the benefit of the doubt in hearing us out and justifying the business model as to why we believe it’s the right thing to do. After which point, if it’s not the right thing to do, please vote the way you consciously then should. But it’s not our interest to see destruction in value in Hercules. And we believe that this is the right thing for long-term sustainability and value for our shareholders. With that, thank you very much. And I greatly appreciate and thank you for your support.

Ladies and gentlemen, thank you for your participation in today’s conference, this does conclude the program. You may disconnect. Have a wonderful day.