Hercules Capital, Inc. (HTGC) Q1 2026 Earnings Report, Transcript and Summary

Good afternoon. My name is Stephanie, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Hercules Capital First Quarter 2026 Financial Results Conference Call. [Operator Instructions] Please be advised that today's conference may be recorded. [Operator Instructions] I will now turn the call over to Michael Hara, Managing Director of Investor Relations. Please go ahead.

Thank you Stephanie. Good afternoon everyone and welcome to Hercules conference call for the first quarter of 2026. With us on the call today from Hercules are Scott Bluestein, CEO and Chief Investment Officer; and Seth Meyer, CFO. Hercules 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 following the call. During this call, we may make forward-looking statements based on our own assumptions and current expectations. These forward-looking statements are not guarantees of future performance and should not be relied upon in making any investment decision. Actual financial results may differ from the forward-looking statements made during this call for a number of reasons, including, but not limited to, the risks identified in our annual report on Form 10-K and other filings that are publicly available on the SEC's website. Any forward-looking statements made during this call are made only as of today's date, and Hercules assumes no obligation to update any such statements in the future. And with that, I'll turn the call over to Scott.

Thank you, Michael, and thank you all for joining the Hercules Capital Q1 2026 Earnings Call. In the first quarter of 2026, Hercules delivered another strong quarter of record originations, record total investment income and stable credit performance. During the quarter, we navigated through a period of significant market volatility. This was driven by a sharp pullback in certain parts of the equity and credit capital markets, macro concerns largely centered around the conflict in the Middle East as well as industry-specific concerns surrounding across private credit and the long-term impact from AI disruption. Since our first origination over 21 years ago, Hercules has maintained a disciplined credit first model that has served our shareholders and stakeholders well through a variety of market conditions and multiple cycles, and that will remain our focus going forward. Our balance sheet and liquidity position is strong. Our portfolio credit performance remains stable and our investment portfolio continued to generate net investment income in Q1 that comfortably covered our base shareholder distribution by 120%. Coming off a record-breaking year in 2025 for both originations and fundings, our momentum accelerated in Q1 with all-time record originations of over $1.81 billion. This is consistent with the guidance that we provided on our Q4 earnings call in February and the release that we put out in early April. The strong new business activity in the first quarter helped to deliver a new record for total investment income despite operating in a declining rate environment since late 2024. Driven by the growth of both the public BDC and our private credit funds business, Hercules Capital is now managing approximately $6.1 billion of assets. An increase of 21.8% from a year ago. To manage our growing asset base and expanded platform. We currently have 65 investments in credit professionals, over 25 finance and accounting professionals and 120 dedicated full-time employees in total at Hercules. As we entered 2026, we noted on our last earnings call that we continue to expect higher-than-normal market and macro volatility, and it certainly has played out that way. Aside from the general market volatility experienced year-to-date, largely from AI disruption fears and the conflict in the Middle East, the results have been enhanced focus on liquidity and redemption across the broader private credit space. These particular issues are concentrated largely in the non-traded BDC segment where the investor base is predominantly retail and the shareholders hold quarterly redemption rights. Hercules is different. 100% of the equity capital that we manage in the publicly traded BDC is true permanent capital that is not subject to redemption. Our investment adviser subsidiary manages exclusively institutional GP LP funds with predetermined long-term or evergreen investment periods, no retail investors, no non-traded BDCs, no near-term redemption risk. This capital structure is deliberate and we believe it allows us to execute a long-term strategy through cycles without unpredictable redemptions and without forced asset sales. We remain confident in the strength and stability of the Hercules platform and our ability to continue to generate strong operating results irrespective of the market backdrop. With the expansion of our platform capabilities over the last several years and our expectation for continued market volatility, we continue to expect a robust new business environment for Hercules in 2026. Our platform scale, balance sheet and liquidity allow us to play offense during market volatility, which should position us to see a robust pipeline of high-quality companies throughout the year. As we have done over the last several years, we will continue to manage our business and balance sheet defensively, while maintaining the flexibility to take advantage of market opportunities. This includes continuing to enhance our liquidity position as needed, further tightening our credit screens for new underwritings, staying focused on asset diversification and maintaining our higher-than-normal first lien exposure, which was approximately 89% in Q1. Let me now recap some of the key highlights of our performance for Q1. In Q1, we originated record total new debt and equity commitments of $1.81 billion and gross fundings of over $706 million, which led to $298 million of net debt investment portfolio growth. We generated record total investment income of $141.5 million and net investment income of $88.1 million or $0.48 per share. We generated a return on equity in Q1 of 16.9%, and our portfolio generated a GAAP effective yield of 12.8% and a core yield of 12.2% and which was consistent with our guidance. We expect core yield to remain relatively flat in Q2, given that the Fed is holding interest rates steady. As we have consistently communicated throughout 2025, we have increased leverage to support our continued growth and return effectives, allowing us to continue to focus on what we believe are high-quality originations versus chasing higher-yielding assets with more risk. While delivering record new originations in Q1, we still maintained a conservative and defensive balance sheet. Consistent with our objectives, GAAP leverage increased to 115.4% in Q1, up from 104.4% in Q4. Our Q1 GAAP leverage was at the high end of our typical historical range of 100% to 115% but still below the average of our BDC peers. We ended Q1 with over $1 billion of liquidity across the Hercules platform. The current market volatility is creating a very favorable capital deployment environment for Hercules and we want to ensure that we are positioned to opportunistically take advantage of that for the long-term benefit of our shareholders and stakeholders. The focus of our origination efforts in Q1 and was on maintaining a disciplined approach to capital deployment while emphasizing diversification across the asset base. Our Q1 commitments and fundings activity was weighted slightly towards life sciences companies. which reflects a more defensive posture. In Q1, approximately 56% of our commitments and 60% of our fundings were to life sciences companies. while approximately 44% of our commitments were to tech companies. We funded debt capital to 34 different companies in Q1, of which 13 were new borrower relationships. During the quarter, we were again able to opportunistically increase our commitments and fundings to several portfolio companies that have continued to demonstrate strong performance. As it always has been, being able to continue to support our portfolio of companies as they scale is an important part of our business and a key differentiator of our expanded platform capabilities. Our available unfunded commitments increased slightly to $397.4 million from $385.6 million in Q4, still maintaining a more defensive positioning of the portfolio. Coming off a record Q1, we expect originations to moderate in Q2 and be more back-end weighted. Since the close of Q1 and as of May 1, 2026. Our investment team has closed $79.2 million of new commitments and funded $32.3 million. We have pending commitments of an additional $506.1 million, in signed, nonbinding term sheets, and we expect this number to continue to grow as we progress in Q2. We will maintain a high bar for new originations. Our investment teams are continuing to update our modeling assumptions, structuring and underwriting criteria given the rapid pace of change that we are seeing across the technology ecosystem. The volume of deals that we are screening and passing on remains elevated, and we intend to continue to remain disciplined, patient and focused on the long term while being aggressive where we believe it makes sense. Early loan repayments of $225.8 million came in at the higher end of our guidance for Q1. For Q2 2026, we expect prepayments to increase materially and be in the range of $350 million to $500 million, although this could change as we progress in the quarter. The increased guidance on prepayments in Q2 is being driven largely by M&A. And we believe that this positions us well to redeploy this capital in what we expect to be a more favorable originations environment. Our net asset value per share in Q1 was $11.90 a decrease of 1.9% from Q4 2025. We had $31.1 million of net unrealized depreciation from debt investments during the quarter approximately $23.2 million or 75% of which was attributable to market yield adjustments associated with the general market volatility. In addition, we had $12.3 million of net unrealized depreciation attributable to valuation movements in publicly and privately held equity positions. Again, largely associated with the general market volatility experienced during the quarter. We ended Q1 with solid liquidity of $454.5 million in BDC and over $1 billion of liquidity across the platform. With healthy liquidity, a low cost of debt relative to our peers and 4 investment-grade credit ratings we remain well positioned to compete aggressively on quality transactions, which we believe is prudent in the current environment. Credit quality of the debt investment portfolio remained strong quarter-over-quarter. Our weighted average internal credit rating of 2.11 was stable relative to the 2.20 rating in Q4 and remains within our normal historical range. Our Grade 1 and 2 credits increased to 70.5% compared to 66.6% in Q4. Grade 3 credits decreased slightly to 28.6% in Q1 versus 31.7% in Q4. Our rated 4 credits decreased to 0.8% from 1.7% in Q4 and we had 1 rated 5 credit at 0.1%. Our loans rated at 4 and 5 as of Q1 were a combined 0.9% which is the lowest that we have reported since Q2 2022. In Q1, the number of companies with loans on nonaccrual remain the same with a single loan on nonaccrual with an investment cost and fair value of approximately $10.7 million and $3.7 million, respectively, or 0.2% and 0.1% as a percentage of our total investment portfolio at cost and value, respectively. As of the most recent reporting that we have, 100% of our debt investments that are on accrual are current with respect to the payment of scheduled principal and interest. With respect to our broader credit book and outlook, we generally remain pleased by what we are seeing on a portfolio level but our portfolio monitoring remains enhanced given the continued volatility in the markets. We believe that our conservative underwriting and ensuring appropriate structural alignment on the deals that we do will continue to serve us well. Our asset base is intentionally diversified with approximately 50% of our assets in our life sciences vertical, and approximately 50% of our assets in our technology vertical. No single subsector makes up more than 25% of our total investment portfolio and our bet investments are spread across 139 different companies. Consistent with our historical experience as of the end of Q1 -- the average loan duration across our debt portfolio was approximately 21 months. While we remain pleased with the exit activity that we saw in our portfolio during the quarter, we are seeing that in certain parts of the market, there appears to be some ongoing pricing and process discovery. The sharp pullback in equity valuations year-to-date in certain technology sectors has slowed some ongoing M&A discussions as buyers look to establish what the new norm may be for exits, particularly with respect to valuation and exit multiples. This is something that we will monitor over the coming quarters. In Q1 and Q2 quarter-to-date, we've had 4 new M&A events in our portfolio, which included 1 life sciences company, and 3 technology companies announcing acquisitions. We also had 2 portfolio companies file registration statements for their IPOs with 1 of those companies completing their IPO in April. We view this as a positive sign for our ecosystem. Based on current market conditions and volatility, we continue to expect M&A exit activity to accelerate in 2026, although with more uncertainty with respect to valuations and process timing. In Q1, PIK declined meaningfully as a percentage of total revenue. falling to approximately 9.1% from 10.5% in fiscal year 2025. And we expect that figure to continue declining in the near term as loans pay off and accrued PIK is collected in cash. The most important point on PIK, however, is its source. Approximately 91% of our Q1 PIK income came from PIK that was part of the original underwriting, not of the result of any credit or performance-related amendment. This is PIK by design, not PIK by distress. Reinforcing that point, more than 98% of our Q1 PIK income came from loans rated 1, 2 or 3 and excluding a single convertible loan, every loan with a PIK component on accrual status is also paying cash interest. Cash collections support the same conclusion. We collected $15.3 million in cash payments on accrued PIK during Q1. And because the majority of our PIK bearing loans were originated in 2024 and 2025, we expect strong cash collections to continue throughout 2026 as those loans approach their expected duration. We continue to use PIK judiciously and where we do, it is typically a small component of the overall deal economics. Our investment and credit teams continue to monitor the impact of AI on our portfolio and the broader markets. The pace of change is rapid and we expect the disruption we are seeing to play out over several years. Our most recent reporting and our ongoing dialogue with our companies and their investors continue to be constructive. Many companies across our portfolio have been embracing AI as a competitive differentiator and are experiencing tailwinds from AI adoption, greater operating efficiency and faster cycles of innovation and go-to-market. Those companies that are more aggressively integrating AI into their core product offerings are benefiting from increased adoption and AI acceptance. We continue to expect AI to disrupt numerous industries over time and that there will be both winners and losers. Over the coming years, business models will change, margin profiles may change and in many cases, companies may actually become more efficient and innovative. Our investment teams will continue to pursue software transactions as part of our origination efforts, and we will remain disciplined and conservative in terms of our approach to financing the sector. Venture capital investment activity in Q1, again, paralleled what we experienced in our deal flow and originations. Q1 2026 investment activity was the highest quarter on record at $267.2 billion according to data gathered by PitchBook and VCA. While the aggregate data remains strong, it again needs to be noted that the deal value was extremely concentrated and that over 88% of the Q1 deal value involved AI and machine learning companies. Q1 fundraising improved and totaled $47.8 billion, across 172 firms. The capital was heavily concentrated among a few established managers. M&A exit activity remained consistent with Q4 but exit value in Q1 was extraordinary at $311.7 billion compared to $143.9 billion for all of 2025. Consistent with the aggregate data for the ecosystem. During Q1, capital raising across our portfolio reached an all-time high with 21 companies raising approximately $3.4 billion in new capital. Despite the market volatility year-to-date, we have not observed a pulled portfolio. Subsequent to quarter end, we have had an additional 10 companies raised over $900 million in new capital. Given our strong sustained operating performance, we exited Q1 with undistributed earnings spillover of $149.1 million or $0.80 per ending shares outstanding. For Q1, our net investment income covered our base distribution by 120% and our full distribution, including our $0.07 supplemental distribution by 102%. This is our 23rd consecutive quarter of being able to provide our shareholders with a supplemental distribution in addition to our regular quarterly base distribution. Finally, I would like to highlight our recent announcement on May 4 regarding the expansion of our leadership team. Effective May 18 and Seth will become President of Hercules. Seth and I will continue to work closely on scaling our platform and enhancing our operational capabilities to ensure that we continue to deliver long-term value for our shareholders and stakeholders. Succeeding him as CFO will be Andrew Olson, who is returning to Hercules after working most recently at Revelation Partners, and prior to that, SVB Capital. Andrew's experience and track record in finance, alternative assets and private credit is strong, and I welcome him back and look forward to working with Andrew again. To continue to build on our success and position Hercules for its next phase of growth. As we set our sights on the continued growth and scaling of our platform, I believe that this expansion of our leadership team will best position us for continued long-term success. In closing, our scale institutionalized lending platform and our ability to capitalize on a rapidly changing competitive and macro environment continues to drive our business forward and our operating performance to record levels. Our continued success is attributable to the tremendous dedication, efforts and capabilities of our 120 employees and the trust that our venture capital and private equity partners place with us every day. We are thankful to the many companies, management teams, and investors that continue to make Hercules their partner of choice. I will now turn the call over to Seth.

Thank you, Scott, and good afternoon, ladies and gentlemen. Q1 2026 was another all-around strong quarter for Hercules Capital, building on the record-setting pace established in 2025. As communicated by Scott, our strong business momentum continued into the first quarter as we delivered all-time records for both new originations and total investment income. We delivered strong growth across both the BDC and our wholly owned RIA managed private credit fund business, which continues to provide us with significant capital flexibility and capacity. Notwithstanding a more volatile and challenging market backdrop in Q1, the Hercules platform delivered strong and stable financial results. We continue to maintain strong available liquidity of $454.5 million as of quarter end in the BDC and more than $1 billion across the platform, including the advisers funds managed by our wholly owned subsidiary, Hercules Adviser LLC. As previously disclosed, during the quarter, we strengthened our liquidity position even more by issuing $300 million of institutionally backed 5.35% unsecured notes due in 2029. In addition, we raised over $50 million in accretive capital via our ATM to help support our nearly $300 million of net debt portfolio growth during the first quarter. Finally, based on the performance of the quarter, Hercules Adviser delivered another quarterly dividend of $2.1 million to HTGC which, when combined with the expense reimbursement of $4.6 million resulted in approximately $6.7 million of NII contribution to the BDC for the quarter. These points in mind, we'll review the income statement performance and highlights, NAV, unrealized and realized activity, leverage and liquidity, and finally, the financial outlook. Turning first to the income statement performance and highlights. Total investment income in Q1 was a record $141.5 million, an increase of 3% quarter-over-quarter and 18.4% year-over-year, supported by our continued debt portfolio growth. Core investment income, a non-GAAP measure, increased as well to a record $134.9 million compared to $133.3 million in Q4 and was up 16.8% on a year-over-year basis. Core investment income excludes the benefit of income recognized because of loan prepayments. Net investment income was $88.1 million or $0.48 per share in Q1, an increase of 1.3% quarter-over-quarter and 13.8% year-over-year. Our effective and core yields were 12.8% and 12.2%, respectively, compared to 12.9% and 12.5% in the prior quarter. The decrease in core yield was near the midpoint of our communicated range, in line with our guidance and driven by the continued impact of rate reductions in the second half of 2025. Although as noted previously, this impact has been progressively muted. As of quarter end, more than 75% of our prime-based loans were at the contractual floor and thus the impact of any future rate reductions will continue to be muted. First quarter operating expenses were $58.1 million compared to $54.9 million in the prior quarter. Net of costs recharged to the RIA, our net operating expenses were $53.4 million. The increase in operating expenses was largely driven by increased compensation tied to record quarter for new originations. Interest expense and fees increased to $30.8 million compared to $28.2 million in Q4 due to the growth of the business and corresponding increase of leverage to support our record origination activity. SG&A increased to $27.2 million, just above my guidance on the growth of the business. Net of costs recharged to the RIA, the SG&A expenses were $22.6 million. Our weighted average cost of debt remained stable at 5.1%. Our ROAE or NII over average equity increased to 16.9% for the first quarter compared to 16.4% in Q4, and our ROAA or NII over average total assets was 8.1% compared to 8.2% in Q4. Switching to NAV unrealized and realized activity. During the quarter, our NAV per share decreased by $0.23 to $11.90 per share or 1.9% quarter-over-quarter. The main driver was net unrealized depreciation on investments, primarily reflecting broad-based increases in market yields during the quarter. Our $45 million net unrealized depreciation was primarily attributable to $31.1 million -- excuse me, of net unrealized depreciation on debt investments, approximately $23.2 million of which was attributable to market yield adjustments associated with market volatility in the quarter. There was also $7.9 million in fair value markdowns of 2 previously impaired loans. Additionally, $12.3 million of net unrealized depreciation was attributable to valuation movements in publicly and privately held equity and $1.9 million of net unrealized depreciation was due to reversals of previous quarter appreciation upon a realization event. This was partially offset by $0.3 million of net unrealized appreciation attributable to valuation movements in public and privately held warrants. Hercules had unrealized losses or net realized losses of $0.6 million in Q1, primarily due to losses on legacy equity investments. Turning next to leverage and liquidity. In line with our previous guidance, our GAAP and regulatory leverage increased to 115.4% and 99.7%, respectively, compared to 104.4% and 88.6% in the prior quarter due to the growth in the balance sheet being financed primarily by leverage to support our record originations activity. Netting out leverage with cash on the balance sheet, our net GAAP and regulatory leverage was 113.5% and 97.8%, respectively. We ended the quarter with $454.5 million of available liquidity. As a reminder, this excludes capital raised by the funds managed by our wholly owned RIA subsidiary. Inclusive of these amounts, the Hercules platform had more than $1 billion of available liquidity as of quarter end. The strong liquidity positions us very well to support our existing portfolio companies and source new opportunities. As previously disclosed, the quarter -- during the quarter, Hercules Capital raised $300 million of institutional 5.35% unsecured notes due in 2029. As a final point, we continue to opportunistically access the ATM market during the quarter and raised approximately $52 million in the first quarter, selling 3.5 million shares. The ATM usage was driven by our record new business originations and which drove very strong net debt portfolio growth in Q1. Finally, on the outlook points. For the second quarter, we expect our core yield to again be in the range of 12% to 12.5%. As a reminder, 98% of our debt portfolio is floating with the floor. And as of today, more than 75% of our prime-based portfolio is at the contractual floor. Although difficult to predict, as stated by Scott, we expect $350 million to $500 million in prepayment activity in the second quarter. The expected elevated prepayments in Q2 will provide us with significant flexibility and optionality and with respect to liquidity and capital raising. We expect our second quarter interest expense to increase compared to the prior quarter based on the debt portfolio growth. For the second quarter, we expect SG&A expenses of $27.5 million to $28.5 million and an RIA expense allocation of approximately $4.5 million. Finally, we expect a quarterly dividend from the RIA of approximately $2 million to $2.5 million per quarter. In closing, we have started 2026 with record-setting momentum, delivering all-time highs in originations and total investment income while navigating meaningful market volatility. Our balance sheet, liquidity position and credit discipline positions us well to continue scaling our platform and capitalizing on opportunities throughout the year. As Scott noted, effective May 18 I will be transitioning to the role of President at HTGC where I will continue to work closely with Scott and the rest of our senior leadership team to further scale and diversify the Hercules platform. During my 7-plus years at Hercules, the company has delivered exceptionally strong operational and financial performance as well as record platform growth. And this expanded leadership team positions us for continued success. I look forward to working closely with Andrew and the rest of the Hercules Capital team in my new role. I will now turn the call all over to the operator to begin the Q&A portion of the call. Stephanie, over to you.

[Operator Instructions] We'll take our first question from Brian McKenna with Citizens.

Okay. Great. Hope everyone is doing well. And congrats, Seth, on the new role. So given your focus on the venture market, it's not shocking you have more exposure to "software" but your portfolio is really one of the best, if not the best performing BDCs in the market today based on ROE and credit quality. It would be helpful to get your perspective on why there's such a big disconnect between the reality and fundamentals of your business relative to perceptions? And then from your seat, what are the biggest drivers of your portfolio delivering such strong results despite all the recent volatility.

Yes. Thanks for the question, Brian. I think it's sort of consistent with what we talked about on the last call that we did in February. Underwriting and venture in growth -- in growth -- venture in growth stage market is fundamentally different than traditional underwriting. If you look at how our investment teams underwrite software loans specifically, and we talked about this extensively on the last call, we are generally targeting to be under 1x debt to ARR. We are generally targeting to be sub 20% LTV. We are generally targeting to be debt to invested equity of less than 30% so there is significantly more equity cushion beneath our debt across the majority of our software companies. We've also said consistently we are very confident in our portfolio. We're not perfect. We've made mistakes before. I'm sure we will make mistakes again. But from everything that we are seeing to date, we continue to feel pretty good about how our portfolio is holding up. I would also emphasize that our portfolio is highly diversified. 50% of our investment portfolio is in our life sciences vertical, and then a significant portion of our technology portfolio is not in software companies. Many of the non-software industries are performing incredibly well in the current environment, and that gives us confidence that the portfolio as a whole will continue to perform well.

That's helpful, Scott. And then I appreciate the commentary around prepayments for the second quarter. I mean, it is a significant amount of capital coming back to you and ultimately, that's going to get redeployed. Two questions here. How should we think about fee income in the second quarter? And then how do all-in yields and spreads on new deals today compare to the investments tied to the prepayments?

Sure. So a couple of things there. On the prepayment side, we did increase our guidance pretty significantly for prepayments in Q2. I want to emphasize that we view that as a positive indicator of the quality and strength of our portfolio. The majority of that increased guidance is coming from known M&A events that have either already happened or that we expect to happen in Q2 and that gives us confidence in the overall portfolio quality that will lead to slightly higher fee income in the quarter. We're not going to give any specific guidance on what that will be because that still has to play out? And then with respect to the second part of the question on spreads, I would say a couple of things on this. So first, in the midst of the most volatile parts of the last 4 months, which I would sort of highlight as late February and early March, we did see probably 50 to 75 basis points of spread widening on new originations. I would caveat that by saying that over the last 30 days or so as the volatility has decreased -- we've seen some of that come back in. So while we are seeing some spread benefit, I would sort of say 25-ish basis points relative to where we were at the beginning of the year. I think the most important thing that I would highlight is actually not on the spread, but it's the fact that we are very focused on enhancing structure across the underwriting on new loans. And that will continue to be our priority going forward versus pushing or fighting for an incremental 25 to 50 basis points of spread.

We'll take our next question from Crispin Love with Piper Sandler.

This is Ben Graham on for Crispin Love. I'm just wondering if you could discuss the deployment backdrop for 2026. I know you've touched on how market volatility can create a favorable backdrop for you and just wondered if that's continued for the most part. And if there's been heightened deployment in any particular sector such as tech or life sciences?

Sure. Thanks, Ben. So with respect to just deployment, a couple of comments. Number one, we're going to continue to focus on diversification. We think having a diversified portfolio on the asset side has been critical to our historical success and we think that it will be critical to our go-forward success. So continuing to try to find the right balance between life sciences and technology. From a big picture perspective, I would tell you that we continue to be very optimistic about originations in 2026. Our Q1 activity was a record-breaking for us at $1.8 billion of commitments. We've closed an additional approximately $79 million of commitments quarter-to-date, and we have another $506 million of signed nonbinding pending commitments. And as I said in my prepared remarks, based on the current pipeline, we expect that number to continue to grow. And our investment teams are continuing to stay very focused and patient and disciplined with respect to capital deployment. But given the volume of deal flow that we are seeing given how we've positioned our business in terms of having appropriate liquidity and conservative balance sheet, we feel pretty optimistic about what that will translate into for 2026 capital deployment.

We'll take our next question from Cory Johnson with UBS.

I was wondering if you can maybe square '08. So you guys have had or having quite a bit of M&A in your portfolio when the M&A market is a bit slow, I guess, at the moment. So I guess what maybe are you seeing in your portfolio, what type of companies are you seeing the M&A market where you're able to see the success and have upcoming higher prepayments and such?

Thanks, Cory. I think honestly, the credit goes to our investment teams. I've said this consistently over the last several years. I think our investment teams do an incredible job at identifying, selecting and underwriting deals for the best companies that are out there. And they've done a great job over the last few years, finding companies that we think are very attractive M&A targets for both strategic and financial buyers. Year-to-date, we've had, as I mentioned in my prepared remarks, we've had 4 new companies announced M&A events that covers both life sciences companies and technology companies. I would also emphasize that we are aware of several additional companies in our portfolio that are in active M&A discussions and so I think that gives us confidence that we'll see continued strong M&A activity for the remainder of 2026. I would sort of caveat that statement by saying and reiterating what I said in my prepared remarks is that we are seeing some, I would say, increased variability with respect to timing and valuation, and that's something that we'll continue to monitor over the coming quarters.

And then just one other thing, going back to the structural changes that you mentioned that you've been able to see in the terms of your underwriting. You also had mentioned earlier about how there was a significant decline in PIK. Is that decline in PIK that you're expecting, is that just to do with the payoffs? Or are you sort of more leaning a way towards PIK. Is that something that's possibly changing in the terms that perhaps you might not have to give as much on that end as perhaps you did before to win deals?

Sure. Great question Cory. And I would sort of say 2 specific things. So first and foremost, the majority of the deals that we underwrote with PIK occurred in 2024 and 2025, and that was consistent with our public guidance about moving into larger, later-stage, more mature companies where PIK is a little bit more prevalent. Given the fact that our average loan duration has tended to be roughly 18 to 24 months over the last several years, we expect, and we're currently seeing many of those loans now come up for prepayment. As those loans prepay, the accrued PIK is satisfied and paid in cash. So we saw significant activity related to that point in Q1 and we expect to continue to see significant activity over the next several quarters in that regard. The second element is also what you just asked, which is we are intentionally deprioritizing PIK on new investments. And so it's really a combination of those 2 things. But the largest driver of the decrease has to do with the fact that we had significant cash collections, and we expect that to continue in 2026.

We'll take our next question from Casey Alexander with Compass Point.

First of all, congratulations, Seth, on the new posting. And Andrew, welcome back to the publicly traded BDC marketplace. I'm struck by -- that's a really healthy amount of prepayments that you're suggesting. And to my knowledge, at least one of them is a really good-sized software prepayment and I'm just wondering, this gives you -- does this give you a chance to kind of influence and restructure the portfolio a little bit and move off of software some or Hercules' history has been to kind of fly into the wind when things get turbulent, and that's where better results have come from? Seth said, there's higher optionality coming from these repayments. And I'm just kind of curious as to how you think you might use that optionality to influence the portfolio?

Yes. It's a great question, Casey. And again, we did increase the guidance pretty considerably, and we feel very confident with that increased guidance because of either already occurred or known M&A events and you identified one, which is a large software loan that has already repaid as a result of M&A. We view it very favorably and it does give us the opportunity to reposition the portfolio on a go-forward basis. That does not mean we are deprioritizing software. That does not mean that we are running from software companies. And I said that specifically in my prepared remarks, our team is continuing to look at, evaluate, identify what we think are very strong, attractive software loans, and we're going to continue to pursue that. Having said that, all of that recycling gives us the ability to also redeploy that capital into other parts of our technology book, space tech, defense tech, network communications, business services, et cetera. And so I would expect to see a repositioning of the portfolio as that capital comes in from payoffs and as our teams get to redeploy it. We are focused on identifying what we think are the most attractive debt opportunities irrespective of specific subsector allocation.

Okay. Great. My follow-up to that is, I would imagine that if there's a software deal being done, that spreads are considerably wider, but most participants that we've heard from thus far have said that as health and happens, when there's volatility and considerable widening of spreads deals just kind of dry up in that sector. Is there stuff that can actually be done? Are there deals that are actually getting done that are out there because some of the other participants in the market have said that it's really short.

Yes. So it is certainly less than it was, but it has not dried up. So we are continuing to see, we are continuing to evaluate, we are continuing to talk to venture and growth stage software companies. I would say that the volume right now is lower than it was, for example, in the second half of last year, but I would absolutely not characterize it as having dried up. The ones that we are speaking to in our team's opinion, are of a very high quality and deals that we would feel very comfortable underwriting. Whether we can get to a point where a deal makes sense for us and them is still TBD, but that's certainly not slowing down our capital deployment, as evidenced by the fact that we have between closed quarter-to-date and pending quarter-to-date over $580 million of signed term sheets.

We'll take our next question from John Hecht with Jefferies.

I think this is just sort of an extension of the last discussion, and that is when you are getting to the table to do a new debt deal or with a software company or somebody that might be in the thesis of vulnerable to changes from AI. What are -- you guys are getting consistent terms well covered, which is consistent with what you guys have had forever. What are the -- I'm interested in the other side of that equation are the venture capitalists, when they're adding more capital to the businesses, are they taking a different approach to valuation or how they think about deploying their capital back into these businesses?

Yes. Thanks for the question, John. A couple of things. First, with respect to new investments, I want to emphasize again -- as we think about underwriting in this environment, we are choosing to prioritize structure over pricing. So rather than pushing for an additional 20, 25, 30 basis points of yield, our teams are pushing for tighter structure, stronger covenants and better overall underwriting. Whether you ultimately close a deal with a 12% yield or a 12.25% yield, not going to make a big difference. You closed the deal that's not structured appropriately and it results in a loss it's going to make a big difference. So that's what we are emphasizing. That's what we are prioritizing with respect to new originations.

Okay. And then -- you mentioned -- I mean this is consistent with what everything you would say, but a little bit more in bioscience and less in tech and the time frame given what you just said. Anything worth calling out in life sciences that is an interesting development that you guys are sort of following and think could be the big new wave of opportunity?

Yes, it's a great question. I think the key for us is portfolio balance, right? We tend not to overreact to a material degree in either direction. For the last several quarters, we have been slightly more weighted towards life sciences, but we're talking about 55%, 60% allocation versus our sort of traditional 50-50 target. We're seeing high-quality opportunities on both life sciences and technology. I think specifically on the life sciences side, I would sort of note a couple of things that we think are ultimately tailwinds. Number one, there's obviously been a fair amount of disruption and turmoil with the FDA. I think that has caused a lot of what we believe to be very strong companies to want to be positioned from a balance sheet strength perspective. And so we're seeing companies that maybe historically where the FDA was a little bit more sort of consistent and reliable. We're seeing those companies want to strengthen their balance sheet and get ahead of that. So I think that's working in our favor. Obviously, we're watching the developments at the FDA pretty closely. But we have continued to see companies produce strong positive clinical results. We have continued to see companies get drugs approved. So we're very optimistic about what the life sciences ecosystem looks like on a go-forward basis. And I do just think these companies right now, given some of the FDA uncertainty and volatility want to strengthen their balance sheets and get ahead of that, and that's working in our favor.

We'll take our next question from Christopher Nolan with Ladenburg Dolman.

Scott, on your comments on prioritizing structure over yield, given AI right now is everything is in flux for these companies, and it could result in replacing a lot of headcount. Is the structure about expense -- income statement related items, more so than in the past?

Yes, Chris, I certainly appreciate the question. I'm not going to give our road map on a public call, just given that we're doing some very specific things right now on the underwriting and structuring side, and we want to keep that internal and proprietary. I will say that we have made some changes with respect to how we are thinking about structuring these deals that involves duration that involves structure that involves covenants. It really involves the totality of things. And there's no one size fits all. There's no cookie cutter for us. We try to custom tailor a solution for each individual company that we think gives us the best risk-adjusted returns.

Great. And then as a follow-up on the increased M&A activity, how much of this is being driven by AI just companies looking to exit?

Very little of it, to be honest. There's a balance -- our increased guidance reflects the balance of life sciences and technology companies. In the majority of those, there's really no correlation at all to AI. On a couple of the larger M&A events, you could argue that strategics are trying to get ahead of the AI curve, but we would not attribute the increase to anything specifically with respect to AI.

[Operator Instructions] Our next question from Ethan Kaye with Luca Capital Markets.

I'll keep it relatively short here. You mentioned, just a follow-up on the PIK conversation. You mentioned you're deemphasizing pick on new investments. I guess I'm just curious what's the motivation for doing that? We've heard kind of many peers over the last several years defending the virtues of PIK usage. I guess I'm curious whether something has changed in your view on that topic?

It's a good question. Nothing has changed outside of -- we were pretty consistent that we did not want PIK to become a significant part of our income. Towards the end of last year, our PIK as a percentage of revenue increased to approximately 10.5%. That was close to sort of the self-imposed limit that we have put internally. So I think naturally, we just want that to slowly work its way down. And I would also say in the current environment, we are not finding a need to use PIK as frequently as we were over the course of '24 and '25. And all else being equal, we would certainly prefer cash versus PIK income.

I'm showing no further questions. I would like to now turn the call back to Scott Bluestein for any closing remarks.

Thank you, Stephanie, and thanks to everyone for joining our call today. We look forward to reporting our progress on our Q2 2026 earnings call. Thanks, and have a great rest of the day. Thank you.

This does conclude today's Hercules Capital First Quarter 2026 Financial Results Conference Call. You may now disconnect your lines, and have a wonderful day.