Good day, and thank you for standing by. Welcome to the Hercules Capital Q3 2022 Earnings Conference Call. At this time all participants are in a listen-only mode. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Michael Hara, Managing Director of Investor Relations. Please go ahead.

Thank you, Susan. Good afternoon, everyone, and welcome to Hercules conference call for the third quarter of 2022. With us on the call today from Hercules are Scott Bluestein, CEO and Chief Investment Officer; and Seth Meyer, CFO. Hercules’ third quarter 2022 financial results were released just after today’s market close and can be accessed from Hercules’ Investor Relations section at investor.htgc.com. An archived webcast replay will be available on the Investor Relations web page for at least 30 days following the conference call. During this call, we may make forward-looking statements based on our own assumptions and the current expectations. These forward-looking statements are not guarantees of future performance and should not be relied upon in making any investment decision. Actual financial results may differ from the forward-looking statements made during this call for a number of reasons, including, but not limited to, the risks identified in our annual report on Form 10-K and other filings that are publicly available on the SEC’s website. Any forward-looking statements made during this call are made only as of today’s date, and Hercules assumes no obligation to update any such statements in the future. And with that, I will turn the call over to Scott.

Thank you, Michael and thank you all for joining us today. Despite continued market volatility and general uncertainty around the economic and capital markets environment, Hercules Capital continued to deliver strong operating results in Q3. Our results can be summarized by strong earnings growth and momentum, improving yields, record originations and stable credit. Our record originations performance in the first half of 2022 continued with record Q3 gross debt and equity commitments of over $817 million. Our gross fundings continued to be strong during the quarter with over $307 million, which once again led to strong net debt investment portfolio growth of over $105 million during the third quarter and a record $465 million for the first three quarters of 2022. Year-to-date through Q3 2022, we delivered record gross debt and equity commitments of $2.48 billion and record gross fundings of $1.1 billion. Since the close of Q3 and as of October 31, 2022, our deal team has already closed $286 million of new commitments bringing our total year-to-date closed new commitments to $2.76 billion, which is a new company record surpassing our 2021 record of $2.64 billion. We have pending commitments of an additional $176 million in signed nonbinding term sheets, including our pending commitments, we are nearing the $3 billion mark for the year, a milestone achievement for Hercules Capital. This record level of originations and resulting record net debt investment portfolio growth is driving our core income and NII per share higher and combined with the current rate environment has put us in a strong position to be able to raise our quarterly based distribution to $0.36 for Q3. Our third base distribution increase in the last 12-months. Let me recap, some of the key highlights of our performance for Q3. Our record Q3 originations activity was…

Thank you, Scott, and good afternoon ladies and gentlemen. Hercules continues to be positioned extremely well to navigate the current market and operating environment. Our operating platform in Q3 benefited from over $475 million of investment portfolio growth year-to-date. A rising interest rate environment and a strong balance sheet that is funded primarily with fixed rate long dated unsecured term loans. This combination of events increase net investment income to $50 million, a 25% quarter-over-quarter increase or $0.39 per share in Q3. This was achieved by delivering another record core income combined with a more normal volume of prepayments. Credit remains strong and non-accruals continue to be less than 1% of the portfolio positioning us well to continue to generate strong operating results. With that in mind, let’s review the following areas. Income statement performance and highlights, NAV unrealized and realized activity, leverage and liquidity and then finally, the financial outlook. First income statement, performance and highlights. As previously mentioned, net investment income was $50 million or 25% more quarter-over-quarter or $0.39 per share in Q3, total investment income was $84.2 million as guided in the second quarter earnings call driven by 21% growth in the debt portfolio year-to-date on strong new business, lower prepayments and an increase in benchmark rates. Our effective and core yields in the third quarter were 12.9% and 12.4% respectively compared to 11.5% and 11.3% in the second quarter. The increase in the core yield was due to an increase in coupon interest as a result of base rate interest increases. We expect this trend to continue with the full quarter impact of the third quarter Fed policy interest rate changes as well as the decision today. Turning to expenses. Our gross operating expenses for the quarter increase to $36.1 million compared to $35.1 million…

Thank you. [Operator Instructions] Our first question comes from Crispin Love of Piper Sandler. Your line is open.

Thanks. Good afternoon everyone. Scott, so you said early in your comments that you’re avoiding certain industries and end markets. I was just curious if you could give a little bit more color there maybe the types of deals that you’re passing on and what industries you are less interested in and currently?

Thanks, Crispin. We get asked that question a lot and consistent with prior quarters, we’re not going to publicly speak to the industries that we’re avoiding. I think if you look at some of our SOI disclosure, it should become fairly evident, but we have a pretty cautious look at certain industries right now, given the macro environment and given some of the equity market volatility that we have seen and we expect to continue to see. So, we’re being very cautious. I will say that we’ve shifted the portfolio over the last several quarters to be much more centered around established stage and expansion stage companies. And so when you look at sort of the three buckets that we consider part of the venture ecosystem, early stage expansion stage, and established stage companies, where largely out of early stage investing at this point, and the vast majority of our portfolio right now is in the latter two buckets, which we think is just a safer credit profile in this environment. There are some obvious things that we have avoided historically and that we will continue to avoid. So, we’re not touching any deals that we believe have cannabis exposure. We’re not touching any deals that we believe have crypto exposure and then for any more clarity we’re just not going to make any public comment.

All right. Thanks Scott. That’s helpful. And then Seth, I’m looking at your core yield guide. I think you said 12.5% to 13.5% as I’m just looking back to the last couple quarter. So you did 12.4% in the third quarter that compared to 11.3% in the second quarter. Just based on the recent rate hikes that we saw in the third quarter, do you think the core yield year – excuse me, core yield towards the higher end of your guidance range makes sense? Or is there a reason to not think that? And then relatedly, is there a point where you’ll hit a feeling on what yields can do regardless of future rate increases?

Yes, great questions, Crispin. Yes, we give a wide range because, of course, we are going later stage, in a lot of the companies that we’re approaching and introducing to the portfolio. And at times that may introduce a lower core yield to the portfolio compared to the existing portfolio. I do think it’s fair that we’ll probably be at the midpoint of that range or maybe to the end, but we’re also trying to make sure that we’re very cautious acknowledging the fact that there could be a turnover in the portfolio and that could change. But Scott, maybe on the historic perspective of the industry where you see and where there’s it might be a cap.

Yes, I mean, I think it’s fair to assume Crispin at some point, there will be a cap in terms of how much more appreciation you’ll see from a core yield perspective, but we certainly don’t think we’re at that point yet.

All right. I appreciate you take my questions that make sense on the later stage of companies. Thanks guys.

Thanks, Crispin.

Thank you. Our next question – as we compile our next question comes from Kevin Fultz of JMP Securities. Your line is open.

Hi, good afternoon, and thank you for taking my questions. My first question is on portfolio company liquidity. Scott, on the last earnings call, you shared some insightful statistics around portfolio company liquidity. Just curious if you have updated stats that you could share with us as of September quarter end.

Thanks, Kevin. Similar and consistent with what we did during COVID, we did not update that and we don’t plan to update that on a quarterly basis. I will say though that we do track liquidity on a pretty consistent basis and we really did not see a material change quarter-over-quarter. So to the extent that we did provide that guidance publicly, you wouldn’t see a material difference. I would also note that this is the third consecutive quarter where fundraising at the portfolio company level has remained strong in each of Q1 and Q2 we saw our debt portfolio companies raise over a $1 billion of new capital that actually accelerated a bit in Q3 where our portfolio companies raised nearly $1.5 billion and we’ve had several events already take place in Q4. So, we’re watching liquidity very closely, obviously given some of the stress that we’re seeing in the market, but as of the most recent data that we have, we continue to be comfortable with how the portfolio was positioned as it relates to liquidity.

Okay, that’s helpful. And I believe you said in the past that you tend to lean into funding activity and life sciences and the life sciences vertical when there is elevated volatility in the market. I’m just curious if your funding activity is starting to reflect that given a transitioning market backdrop.

It does, and I made that reference in my prepared comments. We had a very strong quarter with respect to debt commitments. It was a record quarter for us with $817 million. We continued to see strength from both our technology and life sciences team during the quarter, but if you look at the breakdown of our actual commitments in the quarter, there was more of a waiting this quarter towards the life sciences side and that was intentional given some of the macro environment that we’re seeing.

Okay, that makes sense. And I appreciate you taking my questions and congratulations on a really nice quarter.

Thanks, Kevin.

Thank you. [Operator Instructions] The next call comes from Ken Lee of RBC Capital Markets. Your line is open.

Hi, thanks for taking my question. One question on the internal credit grading. Wondering, if you just talk about some of the key factors, that you’re seeing that as driving some of the movement of companies within those buckets there? Thanks.

Sure. Thanks Ken. So really not a lot of movement quarter-over-quarter, last quarter we were at 2.13 in terms of weighted average credit rating across the debt portfolio. Slight uptick to 2.20 in Q3. And that’s really, if you look at our historical moves, that’s not a material move in any way. 2.20 is still at the very low end of our historical range, which in normal periods has been in the 2.2 to 2.45 range. There was a little bit of movement in terms of the individual ratings. The rated 5 loans improved, so we have no rated 5 loans. The rated 1 loans moved down slightly. The primary driver there was actually the fact that we did some new deals with existing rated 1 credits. Every time we do a new deal, we tend to move those deals back to a rated 2 because we’re resetting our underwriting expectation. And then there was a little bit of movement within the 2s, 3s and 4s, but really nothing of note.

Got it. Very helpful there. And just one follow up. Wonder if you could just update us on some of the potential outlook for the revenue stream from the private credit fund, the Hercules Advisor. I think you’ve talked in the past about the potential for seeing some dividends from that side of the business at some point. Thanks.

Yes, sure Ken. This is Seth. So at the moment we’re clearly doing the cost sharing and the BDC is benefiting a little bit from loans to help finance the RIA as it comes into a cash flow positive position. We expect that dividend flows potentially in the back half of next year could occur or at early parts of 2024. And so, we would expect the BDC to really start to see the true benefit of the management fees that it’s collecting, overcoming the costs that it’s being allocated, but it’s really don’t forget dependent on tax earnings and profits determine the timing of it. Scott?

Yes, Ken I would just maybe add a few things to what Seth said. If you look at quarterly disclosure, we are disclosing the amount of deals that we are funding out of our private fund business. In 2021, that was over $225 million of fundings year-to-date through Q3. So including the most recent information in our press release, which was just released, we have already funded nearly $325 million out of the private fund business. So as you can see, if you combine the 2021 numbers and the year-to-date numbers, that business is ramping up considerably, which gives us continuing comfort that not only are we going to continue to see the expense reimbursement, but that the dividend income stream as that performance fee and as the management fee start to pick up, we’ll continue to provide some substantial value for the shareholders of HTGC.

Got you. Very helpful there. Thanks again.

Thanks, Ken.

Thank you. [Operator Instructions] Our next caller is Christopher Nolan of Ladenburg Thalmann. Go ahead please. Oh, I’m sorry, my mistake. Our next question is from Ryan Lynch of KBW.

Hey, good afternoon. I had a question on just broader market dynamics. I mean you guys put up some good slides on the overall venture capital activity going on and from your slides you can see that fundraising has been really strong, continues to be really strong in 2022, but mergers and acquisition, so exit activity has really just fallen off a cliff so far in 2022 and investment activity has dropped over 2021, but still remains healthy. But I’m just wondering how should we read kind of that drop off and mergers and acquisitions and exit activity, how does that – what should we read into that as far as how you guys are looking at the environment and how is the health of the VC market today?

Thanks, Ryan. Great question. Let me speak first to sort of the VC market just broadly in terms of fundraising and investment activity. We have historically tracked those two statistics on a quarterly basis because we think that they are most reflective of the health or vibrancy of the ecosystem, and they’re both equally important. VC fundraising and VC investment activity. If we look at fundraising first, the year-to-date data has been incredibly robust, $151 billion raised through the first three quarters that is already representative of a record year for the industry. When you look at the investment data, there has absolutely been a pretty significant slowdown or pullback from what we experienced in 2021. When we look at the year-to-date data and we compare it to any previous year outside of 2021, it’s actually very strong, very healthy, and still fairly robust. So in comparison to last year, which was a record year, there’s been a significant slowdown in pullback, but we continue to look at the data that we’re seeing with an optimistic lens because it does reflect very strong investment activity, just not on a year-over-year basis, because you’re comparing it to record levels of investment activity of $344 billion in 2021. In periods of volatility, it’s not a surprise to see. And if you look historically at other periods of volatility, you’ve seen the same sort of same thing happen in the industry. That exit activity slows down considerably, on the IPO side that market has essentially been non-existent year-to-date. We have had a couple of IPO events. We’ve had five year-to-date, including one in Q3, but we expect IPOs to continue to be fairly slow for the next several quarters. On the M&A side, it’s been more active than what we’ve seen on the IPO side, but it’s still down. And what we would attribute, the sort of the down tick to is the uncertainty of the market. A lot of companies trying to figure out what to do next. A lot of companies and boards right now are in that sort of exploration stage where they’re having discussions, should they raise dilutive equity? Should they approach secured lenders for non-dilutive debt financing? Or should they explore M&A? In Q3, in our portfolio, we saw an uptick in M&A activity, some of which were disclosed, some of which have not yet been disclosed because those conversations are ongoing. And I will just tell you anecdotally, from the conversations we’re having with our 100 portfolio companies, we continue to expect to see a healthy level of M&A certainly over the course of Q4 and into the first half of next year.

Okay, that’s helpful backdrop on the market. The other kind of market question that I had, I mean, there’s been a pretty significant drawdown of deposits flowing out of, tech focus banks. I would just love to hear what, if any sort of impact that would have on your investment outlook and potential competition in the marketplace?

Yes, it doesn’t change much for us in terms of the outlook. We really don’t compete with banks on the vast majority of deals that we do. There are a handful of banks that we’ll see from time-to-time. There are a handful of credible and reputable longstanding banks that we will partner with on an occasional basis. We expect that to continue and with respect to how the banks are doing in terms of deposits or funding, it could cause the banks to be a little bit more conservative and certainly a little bit less aggressive. But I would tell you that in the majority of deals that we go after, we’re not competing head-to-head with commercial banks.

Okay. That’s helpful commentary. I appreciate the time this afternoon.

Thanks, Ryan.

Thank you. [Operator Instructions] And our last question at this time comes from Christopher Nolan of Ladenburg Thalmann. Your line is open.

Hey guys. Most of my questions have been asked, I guess a little call in life science some rotation, is there a favorite area like drug development or devices or services within life sciences?

Yes, I mean if you look at our historical data and if you look at the makeup of our current portfolio in terms of our disclosure there is certainly a bias towards diversified drug discovery, drug development, but we have exposure to virtually all sectors of the life sciences ecosystem. And our emphasis is continuing to be on having a diversified portfolio, whether it’s with respect to our tech book or our life sciences book.

And I guess on the capital structure, and excuse me if this might have been asked earlier, but given that you guys have growing so big, and size is becoming an issue where you’re focusing on later stage companies, any consideration of basically [Audio Gap] securitizing deals and just getting them off the balance sheet?

So it’s not really consideration now. Right now we’ve been very successful utilizing unsecured debt and the capital markets as well as in the rare instances we’ve done a some of the securitizations, we did pay off those too that we had historically last year and not removing them from the balance sheet and the way that you’re, you’re talking about. But we would look to secured funding when we saw that it was the right opportunity for our balance sheet. But at the moment we’ve been pretty successful utilizing a combination of the credit facilities where we have great support from the institutions that back us in that capacity as well as making trips to the capital markets, at the right cadence and timing because the credit facility capacity and going the unsecured route.

Got it. Okay. Great. Nice quarter. Thank you.

Thanks Chris.

Thank you. At this time, I would like to turn it back to Scott Bluestein for closing remarks.

Thank you, Susan. And thanks to everyone for joining our call today. As a final note, we will be participating in both the Jefferies BDC Summit and Fitch Ratings BDC Conference on November 16, the JMP Securities Financial Services and Real Estate Conference on November 17, and the KBW Midtown March on December 14, all of which are taking place in New York. If you would like to arrange a meeting with the Hercules management team, please contact each of the financial institutions mentioned directly or Michael Hara. We look forward to reporting our progress on our next yearend earnings call. Thank you all and have a great rest of the day.

Thank you for your participation in today’s conference. This does conclude the program. You may now disconnect.