Hercules Capital Inc (HTGC) 2020 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Hercules Capital Q4 2020 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference call is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Michael Hara. Thank you. Please go ahead.

Thank you, Sherrie. Good afternoon, everyone, and welcome to Hercules Conference Call for the Fourth Quarter and Full Year 2020.

With us on the call today from Hercules are Scott Bluestein, CEO and Chief Investment Officer; and Seth Meyer, CFO.

Hercules' fourth quarter and full year 2020 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' web page or by using the telephone number and passcode provided in today's earnings release.

During this call, we may make forward-looking statements based on current expectations. Actual financial results filed with the Securities and Exchange Commission may differ from those contained herein due to timing delays between the date of this release and in the confirmation and final audit results.

In addition, the statements contained in this release that are not purely historical are forward-looking statements. These forward-looking statements are not guarantees of future performance and are subject to uncertainties and other factors that could cause actual results to differ materially from those expressed in the forward-looking statements, including without limitation, the risks and uncertainties, including the uncertainties surrounding the current market turbulence caused by the COVID-19 pandemic and other factors we identified from time to time in our filings with the SEC.

Although we believe that the assumptions on which these forward-looking statements 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. These 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 our website.

And with that, I'll turn the call over to Scott.

Thank you, Michael, and thank you all for joining us today. We hope that everyone is staying safe and healthy. I am incredibly proud of what our team was able to achieve in 2020.

Despite the challenges associated with the COVID-19 pandemic, Hercules Capital was able to deliver yet another strong year of solid execution, outstanding financial results and solid credit performance. We were also able to demonstrate to our 100-plus borrowers the importance of having a partner with a strong and stable balance sheet and our ability to grow with the companies as they scale.

In 2020, the health and vibrancy of the VC ecosystem, continued strength of our origination platform, robust liquidity position and strong balance sheet put us in position to deliver achievements on multiple fronts, including record total investment income of $287.3 million, up 7.2%.

Record net investment income of $157.1 million, up 9.7%. Record undistributed earnings spillover of $107.7 million or $0.94 per share based on ending shares outstanding. Record available liquidity of $673.3 million. Record total assets of $2.6 billion, up 6.6%. Over $1 billion of new debt and equity commitments for the third consecutive year. 22 IPO and M&A events. And finally, formation of Hercules Adviser as a wholly owned subsidiary of Hercules Capital.

We continue to manage the business to maximize liquidity, ensure balance sheet strength and maintain substantial operational flexibility in the current environment. Continuing with the theme throughout 2020, I'm going to provide an overview of our performance in Q4 and then discuss key areas of the business that we feel are important. I will also be providing an update on some of the work that we did in 2020 to further strengthen our platform and position us for future growth.

Let me recap some of the key highlights of our performance for Q4. We originated more than $151 million of new debt and equity commitments and delivered gross fundings of nearly $130 million. Our fourth quarter debt and equity fundings were weighted towards existing portfolio company relationships, largely driven by continued strong performance and the achievement of milestones across the current portfolio.

During Q4, we chose to stay disciplined and true to our focus on strong underwriting parameters as an abundance of equity capital and loosely structured debt created challenges in terms of prudent new business origination. Being at scale affords us the opportunity to be aggressive when we believe deal quality warrants it, but also pull back when warranted.

Our debt and equity commitments in Q4 were to a mix of technology and life sciences companies, although they were weighted more towards technology companies after a record Q3 performance from our life sciences team.

Our investment team has hit the ground running in 2021, and we are very pleased by our performance on originations quarter-to-date despite continued frothiness in the capital markets. Since the close of Q4 and as of February 18, 2021, Hercules has already closed $294 million of new commitments, and we have pending commitments of an additional $248 million in signed nonbinding term sheets.

Q4 was unusually strong with regards to portfolio company exits and an abundance of liquidity and capital availability across our ecosystem. This, combined with continued very strong performance across our portfolio, drove record early payoffs and strong effective yields during the fourth quarter.

While prepayments are always difficult to predict, the strong activity that we saw in Q4 validates our model of being a disciplined underwriter of credit in this asset class and being able to identify and partner with some of the leading companies in our core verticals.

The velocity of capital in our ecosystem makes achieving and sustaining scale difficult, but we have proven the ability to do this over the last 16-plus years.

Early loan repayments were over $282 million, which was up from $191 million in Q3, and above our guidance of $100 million to $150 million. Nearly 50% of the Q4 prepayments were attributable to M&A exits or strong equity capital market activity. Given the strength that we are seeing across our portfolio, we expect prepayments to remain elevated near-term before reverting back to a more normal cadence in the second half of 2021. For Q1, we expect prepayments to be between $150 million and $200 million, although this could change materially as we progress in the quarter.

The increase in early loan repayments during Q4 resulted in higher fee income as compared to Q3 and stronger GAAP effective yields.

In Q4, we generated total investment income of $75.3 million, net investment income of $42.2 million or $0.37 per share, resulting in 116% coverage of the base cash distribution and a 13.3% GAAP effective yield.

While the heavy Q4 prepayment activity and resulting portfolio decline will reduce our NII short-term, we are confident and remain focused on building the portfolio the right way with an emphasis on quality and positioning the credit book for the long term.

Credit quality on the debt investment portfolio again improved in Q4 with a weighted average internal credit rating of 2.16 as compared to 2.22 in Q3. Overall, our Grade 1 and 2 credits increased to 68.7% in Q4 versus 64.4% in Q3. Grade 3 credits decreased to 29.7% in Q3 -- in Q4 versus 34.1% in Q3. Our rated 4 and 5 credits made up 1.6% of the entire debt portfolio fair value.

In Q4, we had 7 debt investments on nonaccrual with a cumulative investment cost and fair value of approximately $31 million and $11.9 million, respectively, or 1.3% and 0.5% as a percentage of the company's total investment portfolio at cost and value, respectively.

Subsequent to quarter end, we have exited one of our nonaccrual loans with a full recovery of all principal, interest and fees, and we have received net cash proceeds from a second nonaccrual loan that fully covers our Q4 fair value on that position.

As a result of continued strong performance across our portfolio, the exceptionally strong equity capital markets and robust exit and IPO activity, our Q4 NAV per share increased by nearly 10% to $11.26, the highest net asset value per-share mark that we have seen since Q4 of 2008.

At the onset of the COVID-19 pandemic, we spoke about our focus on liquidity and balance sheet strength and maintaining strong credit quality. In 2020, we were successful in both areas. We ended Q4 with record liquidity of $673 million, which provides us with substantial coverage of our available unfunded commitments of $180 million and the ability to fund our ongoing anticipated business activity. This continues to give us the ability to be aggressive on new deals and take advantage of any potential market dislocation when we believe that it is prudent to do so.

With net regulatory leverage of 77.6% and no near-term material liability maturities in 2021, our balance sheet is exceptionally strong and well positioned. In terms of how our portfolio companies are managing through the current environment and their ability to continue to raise capital to fund growth, we are very pleased by what we have seen to date.

When looking at our entire outstanding debt investment portfolio, we currently estimate that nearly 80% of the portfolio currently has 12-plus months of liquidity on balance sheet with another 16% with 6 to 12 months of liquidity currently on balance sheet. Loans that have 3 months or less of liquidity make up less than 3% of the outstanding debt portfolio. Of the loans with 12-plus months of liquidity, over 76% or approximately 61% of our entire debt portfolio currently has 18-plus months of liquidity on balance sheet.

Capital raising across our portfolio also remains strong. Since our last earnings call, 16 of our debt portfolio companies have raised new capital totaling over $1.8 billion. Since the beginning of the COVID-19 outbreak in the United States, we have now had 49 of our current debt portfolio companies raised a total of nearly $7 billion of new capital.

For the year, we had 14 M&A events and 8 companies complete their initial public offerings. The venture capital ecosystem continued to exhibit strength and finished the year in record territory for the third consecutive year.

For 2020, venture capital funds raised a record of $73.6 billion compared to $58.7 billion in 2019, and invested over a record $156 billion compared to $103.3 billion in 2019 in the U.S. according to data gathered by PitchBook and the National Venture Capital Association. That cash continues to put them in a strong position as the pandemic endures.

Our focus continues to be on maintaining an appropriate level of liquidity, actively managing our credit book and working with our companies and financial partners proactively. Our investment team has been incredibly busy evaluating an active pipeline that currently exceeds $1 billion of potential investments, but our bar for new deals remains high and we continue to be very selective and prudent with capital deployment.

I would also like to discuss our shareholder distribution. Our NII per share of $0.37 in Q4 generated 116% coverage of our quarterly base distribution of $0.32 per share. In addition to our eighth consecutive quarterly cash distribution of $0.32 per share, we are also declaring a supplemental distribution of $0.05 per share.

Our warrant and equity portfolio is designed to provide potential upside returns to our shareholders above and beyond our net investment income as well as mitigate potential debt losses that may occur.

As of Q4 2020, we have generated undistributed earnings spillover of approximately $107.7 million or $0.94 per share, subject to final tax filings. This provides us with additional flexibility with respect to our variable base distribution going forward and the ability to continue to invest in our team and platform.

Finally, I would like to briefly touch on some of the progress that we made in 2020 in terms of strengthening and expanding our platform. We made significant investments throughout 2020 in our team, infrastructure and systems. We added talent to all levels of the organization and made a series of investments in our technology and systems that we believe will best position us for future growth.

After extensive dialogue with our shareholders over the last 18 months or so, we made the decision to seek SEC no-action relief in order to be able to create a registered investment adviser as a wholly owned subsidiary of HTGC. We received that approval in May of 2020 and subsequently established Hercules Adviser.

Having this in place puts us in a position to be able to expand and diversify the platform with the potential of raising and managing new funds down the road. Because of the unique structure of having the BDC wholly owned registered investment adviser, all new potential future activity under the RIA would be done for the benefit of our shareholders.

In closing, I would like to acknowledge and thank each of our dedicated and talented employees for their contributions to our strong performance in 2020. This past year was a challenging year for many. And despite that, our employees maintained their commitment to the company and their focus on ensuring our continued success.

I would also like to, once again, thank our portfolio companies and their financial sponsors, our shareholders and stakeholders for their unwavering support of our company. Our unique business model and asset class proved its resiliency in 2020, and we believe that the innovation economy will continue to demonstrate its strength as we eventually return to a new normal.

Thank you very much, everyone. I will now turn the call over to Seth.

Thank you, Scott, and good afternoon, everyone. With another solid quarter for Hercules, we completed 2020 having successfully raised $77 million of equity, $170 million of debt, obtained a new SBIC license with $175 million of attractive financing for qualified investments, and upsized our MUFG-led credit facility to $400 million while improving the terms and pricing.

We ended the year with record liquidity, as Scott mentioned, and modest leverage, positioning ourselves very well to opportunistically take advantage of the market in 2021.

Our ROAE, or NII over average equity, was 13.8% for the fourth quarter; and our ROAA, or NII over average total assets, was 6.6% for the fourth quarter.

The year was a testament to the strength of our business, ability to access the capital markets on an as-needed basis and grow where and when we saw the right opportunities. Our teams work collaboratively to manage the business from a remote working environment in a seamless way, providing the sustainability of the platforming, no matter the challenge.

Today, I'll focus on the following areas: the income statement performance and highlights; NAV; unrealized and realized activity; leverage and liquidity; and finally, the outlook.

With that, let's turn our attention to the income statement performance and highlights. Net investment income was $42.2 million or $0.37 per share in Q4, an increase of nearly $3.5 million or $0.03 per share compared to the prior quarter. Total investment income was $75.3 million, an increase of $7.1 million -- 7.1% compared to the prior quarter. The main driver for the increased total and net investment income during Q4 was an increase in coupon interest and fee income driven by higher payoffs.

Our effective and core yields in the fourth quarter were 13.3% and 11.8%, respectively, compared to 12.6% and 11.3% in the third quarter. The primary driver for the increase in the effective yield was again related to the higher payoffs.

Turning to expenses. Our total operating expenses for the quarter increased to $33.2 million compared to $31.6 million in the prior quarter. Interest expense and fees increased to $17.2 million from $16.6 million in the prior quarter due mainly to additional fees related to the private placement in November 2020 and the acceleration of fee recognition for the partial pay down of the 2018 securitization due to the reinvestment period ending.

SG&A expenses increased to $16 million from $15 million in the prior quarter. The increase was driven by higher legal and other professional fees and excise taxes. Our weighted average cost of debt was 5.2%, a small increase compared to the prior quarter due to the 2018 securitization, ending the reinvestment period and the related fee acceleration.

Let's now switch the focus to the NAV, unrealized and realized activity. During the quarter, our NAV increased $1 per share to $11.26 per share. This represented an NAV per share increase of 9.7% quarter-over-quarter and 6.7% increase year-to-date. The main drivers for the increase were the net change in unrealized appreciation of $123.7 million, including reversals of prior unrealized appreciation of $16.8 million, mainly due to investments disposed of or written off, and outearning the dividend in the quarter.

Our $123.7 million of unrealized appreciation was driven by the mark-to-market of the equity and warrant portfolio as well as the yield adjustments on our debt portfolio. The key drivers of the unrealized appreciation were approximately $109.5 million of mark-to-market appreciation, including the reversal of prior depreciation due to sale and/or write-off in the equity and warrant portfolio and $14.2 million of appreciation on the loan portfolio. Excluding the reversal of prior depreciation on loans, the loan portfolio experienced an $11.5 million yield base appreciation.

Net realized losses in the third quarter were $14.7 million, comprised of $6.4 million from 2 loan positions, $6.7 million of net losses from the write-off and disposal of equity positions and $1.6 million of net losses from the write-off or expiration of certain legacy warrants.

Next, I'd like to discuss our leverage. For leverage and liquidity at the end of the quarter, our GAAP and regulatory leverage was 100.6% and 93%, respectively, which decreased compared to the prior quarter due to the increased early repayments in the quarter. Netting out cash on the balance sheet, our GAAP and regulatory leverage was 85.3% and 77.6%, respectively, putting us in a very strong leverage position heading into 2021.

In November 2020, we announced the successful issuance of $50 million of long 5-year dated notes in a private placement with a fixed coupon of 4.5%, which is well below our current cost of debt. At the same time, we announced the commitment to draw an additional $50 million for a total of $100 million in March 2021 with a fixed coupon of 4.55% on the later tranche. This offering done with institutional investors further strengthens our balance sheet and liquidity position and demonstrates our ability to attractively tap the capital markets when we feel it prudent to do so.

We ended the quarter with record liquidity of more than $670 million. Our liquidity continues to be enhanced by our normal course, monthly principal and interest collections as well as early payoffs. As a reminder, our early payoffs and normal amortization provide us significant monthly inflows that we can use to delever when and as needed.

Finally, let's address the expectations and the outlook points. With over $280 million of early repayments in Q4 2020 and a resulting $184 million decline in the debt investment portfolio on a cost basis, our NII in Q1 will be down as we look to prudently build the portfolio back up.

Based on the strong Q1 quarter-to-date activity and our existing pipeline, we expect the NII decline attributable to the Q4 portfolio decline to be short term in nature. Our core yield guidance of 11% to 12% continues to apply heading into 2021.

For the first quarter, we expect SG&A expenses of $16 million to $17 million, slightly higher than the prior quarter as Q1 always has higher employer payroll taxes. We expect our first quarter borrowing costs to increase modestly due to an increase in the fee recognition as to the 2 securitizations are now in natural runoff and continued pay down of our second SBA license.

Although very difficult to predict, as Scott communicated, we expect $150 million to $200 million in prepayment activity in the first quarter. Finally, as mentioned earlier, we've received approval for the SBA license, providing $175 million of attractive financing for qualified investments.

In closing, we delivered a solid quarter in Q4. And going forward, we will continue to focus on the things that we believe will position us best, given the current operating environment.

I will now turn the call over to the operator to begin the Q&A part of our call. Sherrie, over to you.

(Operator Instructions) Your first question comes from the line of Crispin Love from Piper Sandler.

Can you speak to the recent proliferation of SPACs in the market and any impact or potential impact that you could see on Hercules or the broader VC industry? I know venture fundings are near-record levels based on multiple industry sources. But are there any worries that because of the SPAC demand that it could dampen venture demand in the near to medium term?

Sure. Thanks, Crispin. There's no question that the SPAC market has exploded here over the last several quarters, and that has provided significant tailwinds with respect to the existing portfolio. If you think about our activity across the portfolio, right now, we have 5 companies that have signed agreements, as publicly disclosed, to complete SPAC transactions. And that's -- for us, that's a pretty significant part of our portfolio on a relative basis compared to what we would typically see in a normal quarter.

On the origination side, I don't think it's just limited to SPACs. There's been an abundance of equity inflows into the ecosystem, and that has certainly created some challenges in terms of prudent underwriting. But we take a long-term view, and we actually think that when you think about it on a long-term horizon, it's actually very beneficial to the ecosystem. It validates that these companies have a very long life cycle. Ultimately, these companies will continue to need growth capital. And so if they do a SPAC financing or if they do an equity financing near term, those are great opportunities for our team, which I think have some of the best relationships in the business to pursue those deals down the road.

And so I think as long as you take a long-term approach to these things, which is how we built this business and how we're going to continue to operate the business, we look at the abundance of equity, whether it's private, public or SPAC-related, as a net positive to the ecosystem.

Okay. That's all really helpful. How are you and the Board balancing the regular and the supplemental distribution levels right now? The regular distribution has been very stable in recent years. And recent net investment income has been covering that distribution. And then you also have that very nice spillover right now about $0.94. So what do you think that you and the Board would need to see to be able to bump that -- bump the regular distribution?

Yes. It's a great question. And as you know, we have a variable dividend policy. So it's something that the Board evaluates on a quarterly basis. And we don't just look short term, we look long term when we're making those decisions.

We've been very clear in terms of our public guidance on the last several calls that we see absolutely no risk to that $0.32 base distribution, and we would reiterate that guidance on this call now.

If you think about what we've been able to do in terms of the special distributions, we've been able to deliver to our shareholders a supplemental or a special distribution in 6 of the last 7 quarters on top of the $0.32 base distribution. And obviously, subject to market conditions, I think one of the things that we're going to look at near term here is trying to find a way to provide a little bit more consistency and continuity to those supplemental distributions.

We're in tremendous position where we have $0.94 spillover currently, $107.7 million. We're also sitting on, per our public filings which were released after the close today, some pretty substantial unrealized gains across our equity and warrant portfolio.

So we continue to be very confident in that spillover number. And I think one of the things that we'll look at near term here is, again, as I mentioned, trying to provide some additional consistency and continuity to those supplemental distributions that we've done in 6 of the last 7 quarters.

Your next question comes from the line of David -- Devin Ryan from JMP Securities.

So I guess first question here, I'd like to dig in a little bit more just on kind of the pace of underwriting or investment activity in the fourth quarter and the progression into the first quarter. I think you talked a little bit about kind of looser conditions in the fourth quarter. So I'm curious kind of how things have evolved from that until now. Clearly, a lot of activity thus far for you in the first quarter. And so is that just a function of just they're kind of looking through more opportunities. So you're seeing more of that -- it's interesting and you could be selective or has pricing or terms actually changed since the fourth quarter?

Yes. I think it's all of the above, Devin. When you think about our business, right, it ebbs and it flows. And I think part of being a disciplined credit underwriter is kind of knowing when to be aggressive and knowing when to pull back.

In Q3 of last year, we delivered record commitments of $514 million, record fundings of $266 million. And then frankly, in Q4, we just saw a lot more interesting activity across our portfolio as the companies continued to achieve milestones and sort of continued to show progress that we chose to be a little bit more aggressive in terms of capital deployment across our current portfolio. And we just didn't see a lot of interesting attractive opportunities in terms of the new business side of things.

Part of that was driven by the strong equity capital markets, and part of it, as I mentioned, was -- there were several deals done in our ecosystem that we just thought didn't make a ton of sense from an underwriting perspective. And rather than chase those deals, we chose to sit those out. And whether that was kind of a year-end push by some other managers or not, I think it's difficult to say. But if you think about what has sort of changed for us in Q1, we haven't seen that same aggressiveness and sort of desire to put assets on the books that we saw from some other players in Q4. And I think our team has taken advantage of that.

We've also kind of seen -- this business is about a 90- to 120-day cadence between when we start initiating contact with these companies and when we can sort of get through our process and get a deal done. So a lot of the great work that our team did in Q4 has just come to fruition in Q1, and that's put us in a great position to start the year where we've already closed $294 million of new commitments, and we have signed term sheets of another $248 million. So very pleased by what we're seeing quarter-to-date so far.

Okay. Terrific. And -- can I have a follow-on to some of those comments. Clearly, a lot of capacity on leverage side relative to targets and (inaudible) market. So as you guys look out over the next few quarters, how should we think about leverage trajectory? And are you comfortable taking leverage up in what's a strong market right now, kind of in the normal course of business? Or are you really looking to keep kind of more dry powder just to the extent we get maybe some more interesting opportunities or we get some dislocation?

Yes. I'll address it at a high level, and then I'll turn it over to Seth. But we've significantly delevered through the course of Q4 as you saw in our announcement, a 100.6% GAAP leverage, 93% regulatory leverage. That 93% is well below our sort of target leverage or ceiling leverage on a regulatory basis of 125%. So we would expect to bring that leverage back up as we prudently deploy capital here in the first half of the year.

I also think it just speaks to the strength of our balance sheet, right? There is absolutely no need for us to do anything right now short term on the equity side of things. And we have plenty of capacity and room within our existing leverage targets to be able to use that leverage to fund our growth in the first half of this year.

Yes. The only thing I would add is our thesis has been that we expect 2020 to be split in between a COVID period and a post-vaccine period in the second half. And we want to make sure that we're well positioned with the liquidity and leverage. And so that's why we've not taken steps to lower our liquidity. We have taken steps to make sure that our leverage stays well maintained. And we have great opportunities right now to go out and add additional leverage but don't need it yet.

So we'll see how the first half of the year develops, and then we'll take decisions in the second half of the year on how we deploy that capital that we already have.

Your next question comes from the line of Christopher Nolan from Ladenburg Thalmann.

Hercules Advisers, could you elaborate a little bit on that? Is that one of -- are you going to be a sub-adviser to other funds and BDCs or what?

It gives us a lot of flexibility, and there's nothing definitive at this time, Chris, that we would be prepared to announce or discuss. But what we've done is we've sought SEC no-action exemptive relief to be able to set up a registered investment adviser as a wholly owned subsidiary of the public BDC. We received that approval in 2020 that was announced publicly in an 8-K that we put out in the middle of last year. And that now gives us the optionality to be able to explore a variety of things. We could raise private pools of capital and manage to sort of grow and diversify the platform outside of the BDC. We could do a variety of other things as well.

I think the key point of distinction that I would make though is that given that the RIA is wholly owned by the public BDC, any of the activity that we do underneath the RIA would be for the benefit of our public company shareholders.

Great. Okay. Good. That's helpful. And then the realized loss offset, is that related to OptiScan at all or is that other loans?

Yes. We had -- we did realize 2 losses on loans in Q4. We don't usually disclose the individual details, though.

Yes. Chris, the largest driver was the OptiScan equity position.

Your next question comes from the line of Finian O'Shea from Wells Fargo Securities.

First question on the RIA, Scott. I appreciate the color and understand from Chris' question, you aren't going too far into detail. But a question on SPACs. A couple of your alternatives peers have been facilitating SPAC vehicles. They're, I think, very -- they tend to be very lucrative for the manager. And for Hercules, that would be a chance to potentially really move the needle. I'm not sure how that works under an RIA format. But is there anything you can elaborate on, say, even the potential, if not willingness for you to do that?

Thanks, Fin. Not at this time. I think the RIA gives us tremendous flexibility. But I think when you think about sort of what we're going to do potentially underneath the RIA, it's going to be very consistent with what we've always said, which is we're going to stick to what we're good at and where we've kind of built scale and longevity.

And so we'll certainly look at new things and we'll explore some new things. But I think there's a tremendous amount of growth for us from a platform perspective within our existing ecosystem. And I think that's where we're likely to be sort of much more aggressive short term in any RIA-related activity.

Okay. And perhaps another sort of technical question on your equity gains. There's obviously a few pretty large ones unrealized and there are lockups. Are you -- in the context of, say, these lockup agreements, are you able to directly hedge these equities like, say, back puts, to be frank. If you had the view that today's market was very frothy for those IPOs and such, is that something you can and would do?

In the vast majority of lockup agreements, you are contractually prohibited from hedging-related activity. So in virtually -- in most cases, we are not able to do so.

Your next question comes from the line of Ryan Lynch from KBW.

First question, there's been a lot of discussion about the current market conditions. You talked about it being pretty frothy as there's been a lot of activity in the venture capital market as well as the big increase in SPACs. I'm just curious, what if the -- and you kind of talked about you guys, the terms and structures being a little weaker in the fourth quarter, which is part of the reason that you guys pulled back in some of your fundings.

So my question is, what if these conditions continue or even increase for the next several years? Do you have any sort of -- will there be any sort of change in your investment philosophy or the way you approach the market in terms of maybe the life cycle you look to partner with a company at? Or any comments on how you would approach very frothy markets for a very prolonged period of time going forward?

It's a great question, Ryan. I think you can look at our Q1 quarter-to-date activity. And I think you can sort of -- you can ascertain from that that it's not something that we expect. What you saw in Q4, we don't expect it to be with us for long. There will be periods and quarters where it will ebb and flow, and we'll pull back and we'll be a little bit more cautious.

But Q1 already quarter-to-date, we're on pace to -- assuming all the signed term sheets obviously get through our process and close -- to have over $500 million of new debt and equity commitments in Q1 alone. So I think our team has historically done a very good job at staying disciplined. I think a mistake that a lot of people make is when they chase the equity. So just because the company raises equity capital, they think that it's a great underwriting or a great credit story. And it's just our view that that's not always the case.

And so what I think our team does very well is we underwrite to the credit and to the profile of the company. We don't necessarily underwrite to the equity story or the post-money valuation or how much equity capital is being raised because those things come and go. And at the end of the day, you've got to have a fundamental business that you're underwriting to.

In terms of sort of the broader question that you're asking, I think being able to sort of sustain the success that we've had over a 16-year period, we've now funded and financed nearly 600 different companies. We've committed in excess of $11 billion over the last 16 years.

And so we've just built up a tremendous proprietary network of relationships and portfolio companies and deal flow that our team can take advantage of, and not just within the existing portfolio, but in new opportunities as well. And as our balance sheet has gotten stronger, as our liquidity position has gotten stronger and as our asset base has increased, we have greater flexibility today to go upstream in terms of the types of companies we're going after to focus more on that established stage part of the market where those deals tend to be a little bit larger, require a little bit more sophistication.

And I think that's where you're likely to see the majority of our activity here, short to medium term.

Got you. That makes sense. And then kind of pivoting. I appreciate the conversation and the questions that you've mentioned around dividend. But you mentioned $108 million roughly of spillover income today. If I look at your portfolio with 3 investments, you could have realized gains of another $100 million just in 2021. Of course, those valuations could change. You never know where that will end up. But based on today's prices, you could have an additional $100 million gain.

So $0.05 supplemental or special dividends isn't going to really work to try to manage your historical spillover income plus the potential for these realized gains. So have you developed any policy for how you are thinking about approaching, distributing or managing these potential huge gains coming in 2021 in combination with your already very large spillover income?

Yes. So look, I think the word potential that you use there is important, right, because the unrealized gains, they are potential future realized gains, right? Those have not been monetized, and we'll obviously see how the market reacts. And we'll make our decisions in the ordinary course in terms of when and if we do want to monetize and harvest some of those gains.

We're in great position with respect to the dividend. We're sitting on, as you just said, $108 million spillover and $0.94 per share. We made the decision for this quarter, obviously, to do the $0.32 base distribution and the $0.05 supplemental distribution.

As I mentioned in response to one of the earlier questions, the Board is obviously aware of the size of the spillover, and it's something that we're going to evaluate here near term. And I think the goal for us, certainly, on the next call here, will be to try to find a way to provide a little bit more consistency and continuity with respect to how we handle those supplemental distributions.

But it just gives us tremendous flexibility to continue to not only ensure coverage of the base dividend, but also to provide this additional upside through the form of the special dividends to our shareholders. And we will look near term here to try to provide a little bit more consistency with respect to how that will look, certainly over the next several quarters.

Yes. Certainly, it's definitely a favorable position to be in and a good problem to have.

Your next question comes from the line of John Hecht from Jefferies.

Most of my questions have been asked. But I guess as the first 1 is a little bit of a follow-on from the last discussion is, you talked about a bit of a frothy market, and you guys don't stretch, you're very selective and you have been. But on 1 token, you had -- you mentioned kind of a frothy market. On the other side, I think your core spreads actually increased from Q3 to Q4. You've got a lot of momentum right now.

So maybe just a broader discussion about the competitive environment. Clearly, it shifts on a quarter-to-quarter basis, but maybe what are you seeing now, Scott, from where we are on an intermediate or longer-term perspective and competition relative to prior couple of years?

I think -- so first, John, thanks for the question. I think the biggest competition we have right now continues to be the equity markets. We're just seeing tremendous velocity of capital in the public equity markets which primarily impacts our public life sciences portfolio, in the private markets which primarily impacts our private technology portfolio. And then also in sort of the alternative equity side, right? We've got 5 companies right now that have signed SPAC transactions. We had 8 IPOs in 2020. We had 2 IPOs in Q4 alone, following very strong IPO activity in Q3.

And so I think, right now, from a competitive perspective, the competitor that we see in the majority of deals is actually equity. There are kind of the traditional debt players that we come across in the ordinary course. Not a lot has changed there outside of what I mentioned in my remarks, which is, in Q4, we did see several players just choose to get very, very, very aggressive on the debt side of a couple of deals. And our team did what we encourage them to do, which is to kind of sit those out and let others chase those deals.

We haven't seen that same trend so far in Q1, and I think that's allowed our team to be much more aggressive in terms of capital deployment. And I think that you can sort of see that in the numbers, right, with $294 million of commitments already closed and then another $248 million signed. And on top of that, we're sitting on a $1 billion pipeline right now of deals that we've qualified and we're actively looking at.

Yes. Okay. That's helpful. And then maybe kind of higher-level commentary on -- I know you guys have been in similar industries over time, SaaS and life sciences and some renewables and so forth. Anything kind of big picture oriented that would lean you into focusing on 1 of your subcategories more than the other in the near term?

No. I think what we've always tried to do is run a balanced credit book. And in the current market, we're targeting that same sort of 50-50 exposure that we've targeted over the last year or so here, and that's what we're continuing to target. We want to make sure that our portfolio is balanced.

Being able to underwrite, originate and structure technology transactions and life sciences transactions underneath 1 umbrella is a significant competitive advantage. And that's something that I think is very unique to the Hercules platform. And there will be quarters like Q3 of last year where our life sciences team will outperform, and then there will be periods like Q4, where our technology team will significantly outperform.

The goal for us over the course of a year or so is to keep that as balanced as possible. And right now, we're continuing to target that book at roughly 50-50 exposure.

Your next question comes from the line of Sarkis Sherbetchyan from B. Riley Securities.

Just wanted to follow-up on the outlook commentary. I guess if we were to kind of make it very simple, right, would you think that the first half of '21 looks a lot like the back half of your fiscal '20 period? And then as you kind of build the book back up for fiscal '21 second half, would that kind of look more like just, let's say, like a regular quarter of originations and repayments?

Yes. Sure. Thanks for your question. So I think the second half, I'll start with the end of your question, we would expect to be more of a pre-COVID environment. You see the evidence of the market development, even the equity markets are anticipating that increase already with pretty high valuations. So I would expect that the second half of 2021, we would expect more of a pre-COVID environment for ourselves, although that may take a little bit of time to kick in.

For Q1 and Q2, I would expect that it would be more like the second half of 2020, where we're still being very prudent in who we're approaching and working with and taking the right deals as opposed to not all the deals.

Great. And as I look towards kind of the net interest margin, a piece of the component seems to be your ability to take the cost of debt down. I guess any comments on further opportunistically taking the average cost of debt lower. And as you deploy back into a more normal environment, if you will, kind of the hopes of gaining a better and better spread then essentially?

Yes. That's a great question. I think that you're spot on that we will continue to work to drive down our cost of debt. In our current position with excess liquidity of more than $670 million available to us, we're not taking steps of approaching the market. We did in November in anticipation of expecting that 2021 was going to be a banner year again as the growth and the vaccine comes out.

But until we utilize the majority of our liquidity, including the new SBIC license for $175 million, I would expect that we'll be cautious in bringing that rate down. You'll actually see it go up a little bit in the first half of the year. And the reason why is because we're paying off that second SBIC license. The securitizations are actually running off. But our long-term debt, the average price associated with that is coming down with the steps that we've taken in the private placement market, with the fact that we lowered the cost of the credit facility last year and with the expectation that as we start to utilize the liquidity that we already have, the market is expected to stay at a very low priced basis for a protracted period of time.

The Fed indications clearly are that we can expect low interest rates for the foreseeable future. We will definitely be taking advantage of that as we need to. But first, we need to use up this liquidity as the market kind of turns and the right opportunities come our way. And then we will get back to work at raising additional debt when we need it at the lower cost that we see in the market right now.

Your next question comes from the line of Casey Alexander from Compass Point.

Most of the questions have been answered, but I do have 1 question. The expansion of market capitalizations, and given the fact that you guys have a reasonably tight market capitalization constraint, could you remind us what that constraint is before a loan falls into the bad asset bucket? Is that because of the expansion of market capitalizations forcing a look at earlier-stage companies that are maybe a little less mature? And is that a part of the reason why perhaps you're pulling back -- pulled back some on originations in the fourth quarter? And is there the possibility of using the RIA bucket as a method of being able to invest in some of those larger companies and get them off balance sheet?

Thanks, Casey. So again, 3 parts there. So part one, the market cap test for purposes of the bad asset or ineligible asset test is $250 million. That's a onetime test. It's done at origination. And so to the extent you originate a loan that has a market cap below that and then it appreciates above that, it does not taint that asset. So it's a onetime test done at the original onboarding of that loan, and it's $250 million.

In terms of the second question, absolutely no impact on our new business activity. We have always maintained a pretty substantial healthy margin against that 30% bad asset bucket, and we continue to maintain a very healthy margin against that bucket now. So that did not impact any of our recent or near-term investment activity.

And then the third part is absolutely yes. So one of the potential benefits of the RIA structure is that it would allow us to be more aggressive in that part of the market on a go-forward basis without the constraints of the $250 million bad asset test for purposes of the public BDC. So that is one of the drivers of that decision. And again, I think the key theme with respect to that RIA activity would be to the extent that we did do something in terms of a private credit fund, then went after that market more aggressively, because it's wholly owned by the public BDC, it would be done for the benefit of our public company shareholders.

There are no further questions at this time. I'm going to turn the call back to Mr. Michael Hara.

Thank you, operator, and thanks to everyone for joining our call today. We look forward to reporting our progress on our next Q1 2021 earnings call. Also, we will be virtually attending the RBC Capital Markets Financial Institutions Conference in March. If you are interested in meeting with us at this event, please contact RBC Capital Markets or Michael Hara. Thank you, and good afternoon.

This concludes today's conference call. Thank you all for joining. You may now disconnect.