Hercules Capital Inc (HTGC) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Hercules Technology Growth Capital Q3 2011 earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions.) As a reminder, the conference is being recorded.

I would now like to introduce your host for today's conference, Colin Hoover, Investor Relations of Hercules. You may begin.

Thank you, operator, and good afternoon, everyone. On the call today we have Manuel Henriquez, Hercules' Co-founder, Chairman and CEO, and Jessica Baron, Vice President of Finance and Interim Chief Financial Officer.

Hercules' second [sic - see press release] quarter 2011 financial results were just released after the market closed. They can be accessed from the Company's website at www.htgc.com. We have arranged for a replay of the call at Hercules' webpage, or by using the telephone number and passcode provided in today's earnings release.

I would also like to call your attention to the Safe Harbor disclosure in our earnings release regarding forward-looking information. 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 and other factors we identified from time to time in our filings with the Securities and Exchange Commission.

Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions can prove to be inaccurate and, as a result, the forward-looking statements based on those assumptions also can be incorrect. You should not place undue reliance on these forward-looking statements. The forward-looking statements contained in this release are made as of the date hereof, and Hercules assumes no obligation to update the forward-looking statements or subsequent events. To obtain copies of related SEC filings, please visit sec.gov or visit the website, www.HTGC.com.

Now, I will turn the call over to Manuel Henriquez, Hercules' Co-founder, Chairman and CEO. Manuel?

Thank you, Colin, and good afternoon and thank you, everybody, for joining us today.

I want to start by providing a summary of our Q3 performance and results, and then continuing with my standard historical perspective on the business environment, our business in general, the competitive landscape, and then, of course, turn the call over to Jessica, who will be more specific on our financial results and performance during the third quarter.

I'd like to also acknowledge Jessica's team and Jessica's hard work and leadership in our accounting group, who continues to do a good job and executing on her job as the Interim CFO. I'm very happy to see her achievements and her accomplishments in that new role that she's been leading the organization with. So, thank you, Jessica, for that hard work and your team.

Let me speak now to the details of Q3 2011. First, let me touch on our portfolio growth for the quarter. As many, many of you have vocalized over the last three or four quarters, asking us when we would convert our liquidity to earning assets, we have patient and we decided to -- now is the time to commence that operation. We have now deployed almost $100 million in new assets during the quarter, which I'll get into in specifics shortly.

As we indicated before, we have now begun the process of converting that liquidity into earnings assets. The market environment is quite strong for venture debt activities. It also is high demand for venture debt activity, which means that we have to sort through much more opportunity than normal to maintain our high level of risk performance and credit performance we've done historically.

Q3 marked a record quarter for the Company in terms of both new commitments and the fundings for the quarter. Total new commitments exceeded $215 million in the third quarter alone. That is up 160% from the same period last year. Fundings, not to be left behind, was also a tremendous accomplishment during the quarter. Gross fundings for the quarter exceeded $147 million in gross fundings during the quarter, or up 256 -- excuse me, 259% from the same period last year for net portfolio growth of $100 million. Year to date, Hercules has now exceeded over $0.5 billion in new investment activities so far in the first three quarters of the year, and we're on track to exceed all the origination commitments that we did in 2010 of $520 million, to exceed that in 2011.

We ended the quarter with total investment assets of $577 million, an increase of 41% over the same period last year. However, it has become apparent with the many conversations that we had with investors since the last second quarter earnings call and the non-deal roadshows we've participated in recently, that many investors and analysts are still confused as to how best to write and model the financial performance of Hercules.

I have to remind everybody that we have three components of assets that are critical. We have earning assets, which are our debt portfolio; our warrant portfolio; and, of course, our equity portfolio. For modeling purposes, as you'll see in the third quarter results, approximately $513 million of our assets are interest-earning assets. Those are the assets by which you should use to model your projections for us as a company.

$70 million of that, approximately, is both -- a component of both debt -- excuse me, a component of equity and warrants in our portfolio that do not generate any interest income. We'll be happy to elaborate in the Q&A session on our current yields and how best to look at that.

Although we had a tremendously strong quarter and we've demonstrated strong asset growth, most of the assets, or the vast majority of those assets, came on line at the end of the quarter, thereby having little economic impact or benefit for us during the quarter because the vast majority of those assets were funded at the end of the quarter. This, however, positions the portfolio well for Q4 for continuing accelerated growth.

However, as we turn our attention to Q4, and as evident most recently in the media, and continued volatility today, given the uncertain economic times that we face and the ebbs and flows of the capital market, we remain very steady-hand on our origination efforts. And we will continue to monitor the markets and not overspend our liquidity. If we see concerns or greater macroeconomic situations changing for the negative in the foreseeable future, we will hold back on our liquidity and maintain a very conservatively balanced balance sheet.

Now, specifically to Q3 results. We reported total investment income of $18.7 million, or up 20% year over year. Net investment income, or NII, was at $8.6 million, or up 5.5% over the same period last year at $0.20. DNOI was also up at 6.7% for $9.5 million, or $0.22 a share.

As we indicated during our Q2 earnings call, we did in fact realize less early payoffs, but in line with what we expected to see of approximately $30 million in early payoffs during the second quarter. We are expecting to see a same or similar amount of payoffs in the fourth quarter of approximately $15 million to $30 million of early payoffs in the fourth quarter, which we'll speak to that and you'll see in the subsequent events disclosed in the earnings release.

Let me remind everybody that we consciously made a decision at the end of Q2 to pare back or lower middle market exposures for exactly this volatility and economic times we're facing today. That paring back of our lower middle market exposures of approximately $75 million in Q2 took us some time to refill and reposition the portfolio back into that position for the loss of that capital. You'll see that capital had been fully replaced at the end of third quarter at $100 million in new assets that are booked during the quarter.

We continue to maintain a very conservative and very credit-conscious management underwriting strategy, especially given the economic times that we're in. That credit performance is continued reflected in the highest level credit performance of our portfolio since the founding of the firm of 1.96, the strongest it's ever been in the Company's history. That is self-evident of our continued stewardship on monitoring the credit outlook and continuing to manage our balance sheet from a very disciplined and conservative position.

We focus a tremendous amount of our attention on portfolio diversification and risk mitigation as best of our capabilities in an all uncertain market. This is why, as we indicated during our Q2 earnings call, we have shifted our portfolio into a 50/50 mix, 50% technology and 50% life sciences. We believe that's a prudent step to take as we continue to look at an uncertain economic environment, although we continue to fund selective assets and grow our portfolio in this more challenging environment which we still believe represents a very good investment cycle for us.

Moving to yields. We did continue to see compression during the third quarter and we continue to see compression in our yields of approximately 160 basis points as we've been anticipating and we've been discussion with investors since the beginning of 2011. If you recall our intention, we started 2011 with the perspective that we expect to see 150 basis points to 250 basis points yield compression during 2011 in our portfolio. As of today we've seen a total compression year to date of approximately 160 basis points in our total yield portfolio, in line with what we expected and well positioned for what we expected to see happen in the marketplace.

This shifting in compression has been driven by also our own conscious decision to rebalance the portfolio away from lower middle market loans, which have traditionally higher, older coupon yields than that of current venture debt loans that have lower interest rate yield, but offer long-term upside potential because they trade off current yields for that of warrant income for the future, if and when they monetize.

Now, as we turn our attention to Q4 and beyond, we continue to take advantage of this investment environment. We continue to add select members to our team. And as most recently announced, we've expanded our geographic footprint into the Mid-Atlantic and Southeast region with our offices now located in Virginia to continue to give us reach in the Mid-Atlantic region where we otherwise had had no historical reach before in that environment. We're very optimistic and very bullish of the opportunities that we can see in the lower middle market -- excuse me, in the Mid-Atlantic region and the Southeast region of this country.

As we turn to Q4 and 2012, I am happy to report that we have a very strong pipeline of transactions, coupled with a very strong visibility of unfunded commitments. We finished the third quarter with approximately $148 million of unfunded commitments, giving us visibility to asset conversion in the coming quarters.

However, I'd like to remind everybody that not all originations, not all commitments end up becoming funded assets. Many of our unfunded commitments are tied to performance (inaudible) of the Company and might not translated into funded assets as we anticipate of $148 million to fully convert. We also maintain ample liquidity just to ensure that, in the event that all those unfunded commitments become funded assets, that we have ample capital to make that come to fruition.

As to the pipeline, I am surprised to say that we have had the strongest pipeline that I have not seen since 2007. We currently have over $1.5 billion of companies interested in capital that we are sorting through, and taking our time to sort through given the demand for capital that's out there, and ensuring that we maintain that credit discipline that we have in the past.

So far we've seen $129 million of signed term sheets. As we turn to Q4 we have $45 million of commitments that we've closed to far in Q4. And we're very optimistic on the latest activities in Q4. However, we do not anticipate that we're going to overrun significantly more than $129 million of signed term sheets that we have today and the $45 million of converted term sheets already to committed assets in the fourth quarter.

I would like to remind everybody that we are taking a cautious look to the fourth quarter, despite a very strong pipeline; that you will not expect to see the same asset growth in the fourth quarter. As we continue to fund assets, we're going to do it in a much more controlled fashion in the fourth quarter until we see strong markets improvement. However, we will, and expect to see portfolio growth in the fourth quarter.

Now, to speak to the venture capital marketplace. The venture capital marketplace continues to perform quite strong. And in fact, the third quarter results were even higher than I was anticipating to see in the venture industry, which is a good surprise. According to Dow Jones Venture Source, the venture capitalists invested $8.4 billion in the third quarter, representing a 29% increase over the same period last year.

By sector, we saw continued strong demand in consumer information services, which received $1.3 billion of capital, more than doubling that same level of 2010. Followed by the information technology sector, receiving $2.1 billion of capital to 227 transactions during the period. And of course, you then saw the next (inaudible) strong sector is business and financial services, raising $1.5 billion of investment activities during that period of time. And then rounded out by our life sciences sector that received medical devices, about $807 million, biopharmaceutical at $715 million, and medical IT at $200 million in activities, almost emulating the portfolio that we have here at Hercules as we monitor our companies.

Stage of development. We're generously focused on having a diversified portfolio. Seed or first round of financing represented 21% of the venture capital marketplace investment activities. However, that is a sector that we've consciously and continuously remain not focusing much attention to and represents generally less than 2% or 3% of our current portfolio today.

Second rounds or expanded stage companies, representing 18% of the capital of the venture industry in the third quarter, and later stage taking on the balance, or almost 58% of the total capital raised by the venture industry in the third quarter.

Now, exits. As we all very much are aware of, the IPO market remains illusive at best and something that seems not to be able to come to fruition. However, we have some interesting activities going on the third quarter -- in the fourth quarter, excuse me -- that will potentially break that. We have the Groupon, Zynga and Angie's List IPOs, all important bellwethers, that give an indication of how the IPO market will sustain itself.

I'm very happy to report that in the third quarter we had 10 venture stage companies go public from the venture industry, raising $505 million. Not being left far behind, M&A, the largest segment of exits on 122 companies, raising $13 billion of capital in their transactions.

Interesting enough, the third quarter ended with 61 venture stage companies at IPO registration. That is up from the prior quarter. Interesting to that fact, of the 61 venture stage companies at IPO registration, 7 of which, or 11%, represent Hercules existing portfolio companies in IPO registration, a testament to our team's ability to select the right companies and identify the right targets for liquidity events.

In addition, Hercules continuously has warrant positions in over 104 companies that represent potential future exits and additional capital upside for our investors. However, not all expected warrant positions will monetize, which we'll remind folks during this call as well.

Lastly, and wrapping up the venture industry overview. The venture capitalists were quite busy during the third quarter raising capital as well. They raised $2.2 billion of capital to 32 funds. But more important is their year-to-date performance. The venture capitalists raised over 9% on a year-to-date basis over the same period of 2010 at $10.6 billion to 90 funds during the year, a very strong indication of the health and vibrancy of the venture industry itself and a testimony to the continued investment pace that we see for the venture capital marketplace.

Turning my attention to our portfolio. As I indicated, we have currently 104 warrant positions and 37 equity positions in various life science and technology companies in our portfolio. We do not expect that the majority of our warrant position will monetize. Indeed, we actually expect 50% or less of the warrant positions to monetize, with the balance of the 50% not monetize to any value whatsoever. However, we expect the monetization of that portfolio, as evidenced by historical performance, to monetize at a 1x, and in some cases as high as 8x. We caution that you should not model our portfolio at an 8x times multiple as that would be excessive. We have seven companies in IPO registration and we're very proud of that achievement.

In summary, we delivered a very solid portfolio growth in the third quarter. We expect to see continued earnings growth as a fully-invested portfolio begins to generate interest income in the fourth quarter. We expect to see modest payouts, as I indicated earlier, of $15 million to $30 million in payoffs in the fourth quarter. And we're continuing to add liquidity to our balance sheet, as evidenced by the announcement made prior to the beginning of the call, where we now secure a new $55 million credit facility with the partnership of Union Bank of California and RBC providing us a $55 million three-year credit revolver to continue to grow our portfolio.

With that, I'll turn the call over to Jessica.

Thank you, Manuel. And thanks, everyone, for listening today.

During the third quarter we achieved approximately $18.7 million in total investment income, compared to $20.8 million for the second quarter of 2011 and $15.6 million in the third quarter of 2010. This year-over-year growth was due to a higher average outstanding balance for our interest-bearing investment portfolio and due to one-time fees and accelerations of fees related to early payoffs. The sequential quarter-over-quarter decline is primarily related to lower accelerations due to lower early payoffs in the current quarter relative to the last quarter.

As we've shared with you in our prior earnings calls, the impact of early loan payoffs on fee and interest income is very hard to predict quarter to quarter. Excluding early payoffs, we believe on a normalized run rate that the portfolio effective yield should be approximately 14% to 14.5% and fee income should be $1.1 million to $1.3 million per quarter.

As noted, the effective yield on our portfolio investments during the third quarter was 16.7% compared to 19.1% in Q2 of '11 and 16.2% in the third quarter of 2010. Excluding the income acceleration impact from early payoffs, the effective yield would have been 14.2% for the quarter, as compared to 15.7% for the preceding quarter. As Manuel indicated, the 150-bp decline in yield is a result of our portfolio concentration transitioning from lower middle market investments, which have higher yields but lower equity realized gain upside, to debt investments with warrants attached in venture-backed life science and technology companies.

I would also like to point out on PIK income, which is non-cash revenue, which we must in turn pay to our shareholders in dividends, this continues to be a small component at less than 2% of our total investment income for the quarter.

Our total cost of debt increased to $4.3 million in Q3 of '11 from $3.8 million in Q2 2011 and $2.5 million incurred in Q3 of '10. These increases are driven by $1.1 million of interest expense on our $75 million of convertible notes issued in April -- on April 15th of this year. Approximately 300K of this amount is non-cash interest expense attributed to the accretion of the fair value of the conversion feature on these senior notes.

Our weighted average cost of debt increased to 6.5% in Q3 '11 from 6.2% in Q3 of '10. The year-over-year increase was driven by a lower weighted average cost of debt on outstanding SBA debentures at 5.2% in the third quarter of 2011 versus 6.1% in the third quarter of '10, offset by the higher weighted average cost of the debentures at 8.1%.

Operating expenses for the quarter, excluding interest expenses and loan fees, totaled $5.8 million as compared to $6.6 million in the prior quarter and $5 million in the third quarter of 2010. This year-over-year increase has primarily been related to higher comp expenses, which have been a function of expanding our origination team. The quarter-over-quarter improvement in operating expenses can be attributed to declines in consulting, recruiting and executive severance costs.

Q3 '11 net investment income, as Manuel mentioned, was $8.6 million, or $0.20 per share, based on 43.1 million shares outstanding, compared with $10.4 million and $0.24 per share based on 43 million shares outstanding in Q2 2011 and $8.2 million, or $0.23 per share, based on 35.2 million shares outstanding in Q3 of 2010.

Our net unrealized depreciation during the quarter was approximately $800,000 and primarily attributed to fair value adjustments on our debt warrant and equity holdings in accordance with [ASGA 20] and due to the market price decline o four publicly traded equity and warrant investments during the quarter.

Net realized losses for the third quarter were approximately $1.6 million, primarily due to the termination of our warrants in LaboPharm, Inc., and $600,000 -- of $600,000 -- and the write-off of equity in Solarflare of $600,000 as well.

Since inception, net realized losses total approximately $49.4 million on a GAAP basis. This represents 1.9% of total commitments since inception of greater than $2.6 billion, or approximately 27 basis points on an annualized basis.

A final point on our P&L. Our increase in net asset value for the quarter, which is a total of our net investment income, net unrealized appreciation and net realized gains, was approximately $6.2 million or $0.14 per share, versus a $24.3 million or $0.56 per share for the prior quarter.

Now, moving on to the balance sheet. I would like to first provide a summary of the investment portfolio. Our total investment portfolio grew by $101.3 million as a result of our debt investment funding activities. As Manuel mentioned, we closed approximately $216 million in commitments and funded approximately $147 million to new and existing portfolio companies during the quarter.

We experienced a more normal level of principal amortization and repayments this quarter. A total of $45.2 million of principal payments received during the quarter include $31.8 million of early payoffs and $13.4 million of normal amortization. The net result of our funding and principal collection activities was almost a 25% growth in the fair value of our yielding loan portfolio balance from $411 million at 6/30 to $513 million at 9/30.

Some further points on the loan portfolio. At quarter end 91.1% of our loans have floating rates or floating rate with lower interest rates, as Manuel mentioned. 99% of our loan investments are in senior debt investments.

We are particularly pleased with the loan portfolio credit quality as well. The weighted average loan rating of our portfolio was 1.96 at September 30, compared to 2.04 on June 30th. This results in the highest credit quality grade in the portfolio since 2005. Quarter over quarter, the rating improvement is primarily attributed to the payoff a rated 3 company and the upgrade of three companies from -- rated 3 to rated 2 or to rated 1.

We have just one loan on nonaccrual at the end of the quarter that has a carrying value at a zero value and is consistent with prior quarter.

At September 30th, 2011, combined, our equity and warrant investments at fair value represent approximately 10.9% of the total portfolio. Our warrant positions in 104 portfolio companies provide us with the option to potentially invest approximately $70.7 million of additional capital, in addition to the $35.8 million of equity investments at fair value at quarter end. We believe these non-interest-bearing assets could provide capital returns to the Company in the future, particularly once the IPO and M&A market reemerges for us; however, of course, there are no assurances that this will occur.

Turning now to describe our liquidity. As of September 30th we had approximately $226.6 million of availability comprised of $96.3 million of cash, $95 million of borrowing capacity under our credit facilities, and approximately $36.3 million of capacity under the SBA program.

Subsequent to quarter end, in fact yesterday, and announced earlier today, we renewed and amended a Union Bank facility. Union Bank and RBC Capital Markets have made commitments of $30 million and $25 million, increasing the facility to $55 million from $20 million. The amendment also extends the maturity date of the Union Bank facility by approximately three years to November 1st, 2014. The Union Bank facility is priced at Libor plus 2.25% with a floor of 4% and requires the payment of a non-use fee of 50 basis points annually. Combined with our $75 million Wells Fargo facility, we now have total commitments of $130 million under the credit facilities with three-year terms. As a reminder, pricing on the Wells facility is Libor plus 3.25% with a floor of 5% and a non-use fee of 80 basis points annually.

A few words on our other debt sources. During the third quarter Hercules had approximately $188.7 million in outstanding debentures outstanding under the FDIC program. At quarter end we have capacity to draw another $36.3 million FDIC program.

During the quarter we raised (inaudible) of 2.87% per annum for 10 years on $25 million of outstanding debentures under our second SBA license, bringing the overall weighted average interest rate to 5.2% on our outstanding debentures as of September 30th.

As I previously mentioned, in April we successfully closed an offering of $75 million of 6% convertible senior notes which will mature in April of 2016. As a reminder, the conversion price for these notes is at $11.89 per share, subject to customary anti-dilution adjustments.

So, finally moving on to the dividend. As you may have seen in our press release this afternoon, we distributed a dividend of $0.22 per share during the third quarter and announced that the Board has declared a $0.22 dividend payable on November 29th to shareholders of record on November 14th, 2011.

So in closing, we had a strong third quarter as we on-boarded net in excess of $100 million of quality yielding assets. Our credit quality of 1.96 is the highest it's been since inception. We maintained our disciplined approach investing in portfolio companies as our best-in-class origination team grows the pipeline. Our liquidity places us in a great position to service this investment demand and to build our portfolio during 2012.

Now, Operator, we're ready to open the call for questions.

(Operator Instructions.) Kyle Joseph, JMP Securities.

Hey, guys. Congrats on what must have been a very busy quarter for you guys. I was hoping to get the discount accretion in the second quarter versus the third quarter. Could you guys give us that?

I'm sorry, you broke up there. What was your question?

The difference or the change in the discount accretion you guys saw between the second quarter and the third quarter.

Are you referring to our investment portfolio or to a liability?

Oh, I'm sorry, to your investment portfolio as a percentage of your revenues, basically is what I'm getting at.

You're looking at what is the impact of OID in our --

Right.

In our revenues? Yeah. There was a slight compression in that return as a component of our revenue quarter over quarter. There was approximately a 30 basis point decline quarter over quarter in that particular revenue feature.

Alright. And then in terms of your new investments, could you give us a little idea on -- how many investments did you make during the quarter?

From a company count perspective?

Yes.

I'm sorry, I don't have the number exactly in front of me, but I believe that it was approximately 12 to 15 new portfolio companies.

Okay. And then could you give us an idea on the yield on the new commitments versus those that are paying off?

As we indicated earlier that we -- the yield spread -- well, again, let me back up. Because we have four unique verticals that we're focused on, life sciences, clean tech, lower middle market, and arguably medical devices, they all have slightly different yield spreads when you look at it. But in aggregate, the -- all those running off compared to the new loans that are being on-boarded, you'll probably see about 150 to 200 basis points difference in those loans. Because we're shifting away -- the loans that are running off are lower middle market which don't have any warrant associated with them and they have a higher cash yield component. The venture assets that are coming on line have a slightly lower yield basis, but have the warrants for future upside potential in returns.

So, we've seen on an apples-to-apples basis, excluding any warrant contribution, you're seeing about a 150 to 200 basis points compression in those yields.

Okay, thanks. And just one last question. Given the increased market volatility, can you give us an update on the competitive front? Are you guys seeing some competitors head to the sidelines, or --?

Well, it's funny. The competitive environment has changed quite dramatically, and continues to change quite dramatically. There is still competition because we're not seeing the yield spreads expanding as you may see in other categories, like lower middle market or other traditional areas that are out there. We're seeing the inverse of that, that spreads are not widening, they're actually being either maintained or tightening a little bit.

Banks still remain a player that are having an insatiable appetite to originate assets at whatever spread they can get in order to offset the continued pressure that they're having from their depository base. So, banks continue to be a competitive environment. But, the fact that we did $216 million in the quarter also speaks for itself on the competitive environment. And I can assure you that with our pipeline, although there's competition out there, we are able to still select the right deals we want to invest in.

Okay, great. Thanks for answering my questions.

Greg Mason, Stifel Nicolaus.

Great, thank you. Manuel, could you talk about your available capacity? And what I'm interested in is how much capacity do you need to keep unfunded or available to fund kind of these outstanding commitments that you always have in your business model? What's the amount of liquidity you're comfortable with using today?

Yes. This is the same guy who asked the question I had too much liquidity two quarters ago, right? No.

Look, at we tell investors all the time, our business is one that is very difficult to predict and plan because venture capital companies are required or need to raise capital every 9 to 14 months. That said, let me answer your question as to specifics.

As we indicated in the past, and I'll do it again because it's an important exercise, when we have for example $100 million of commitments, we never expect that full $100 million of commitments to turn into funded assets. We generally expect about 75% of those to 80% of those assets -- excuse me, those commitments, to become assets themselves. So, $100 million in commitments would equate to about $75 million to $80 million in funded assets over a three-quarter period of time.

So, in the case of $148 million -- let me break it down now in small bite sizes. So today we have $148 million of closed unfunded commitments. I would argue that half of that is contingent upon development or milestones that the company must achieve or accomplish in order to be able to gain access to that liquidity. So, you could argue that 50% of that may not fund because it has funding milestones. However, if the company achieves those milestones, we then have a strong visibility on seeing unfunded commitments become earning assets right away.

Second element. We have $129 million of signed term sheets. Of those, 80% of them usually end up executing a final loan security agreement and become unfunded commitments. Of that $129 million, less than 20% -- let's make the math easy, call it 24% and let's round down. That $129 million becomes $100 million in unfunded commitments.

During that quarter when those convert, we generally expect to see 35% of that become outstanding assets upon them closing and drawing down on that initial draw. The remaining balance up to that 75% of that $100 million will then fund over the proceeding quarter or two, and they also may include milestones.

So, although I have $148 million of unfunded commitments, $129 million of signed term sheets, showing about $277 million, I don't expect to see more than $50 million to $70 million of that fund in the next 60 to 90 days.

Does that answer your question?

Yes. Yes, thank you for that clarity. And then could you -- as we look at the signed term sheets, $136 million in 9 deals, that comes out to about $15 million a deal. That feels to me a little bigger than what you usually do. Is there a change going on in the size of investments that you're making, or is that just circumstance?

No, it's a little bit of both. It's a conscious decision because life sciences' assets, by all standards, are generally larger in commitments than that of technology companies. We're not at all shy about our concerns about the technology sector. And over the last three quarter of 2011 we think that the tech sector has been a little frothy.

We have purposely deemphasized technology investing over the last three quarters because we think that, in the April through June timeframe, a lot of the private company evaluations kind of run up quite heavily in anticipation of the Zillow IPO, the LinkedIn IPO. And now, of course, you have Zynga and you have Groupon, other IPOs.

We think that the tech sector, although technology-wise is still attractive, we think that the valuations and the yields in that sector are a little bit ahead of themselves. And we expect to see some yield correction in that that's going to happen here shortly. Hence, the emphasis more on life sciences, which have larger exposed dollars out of the box.

Okay, great. Thank you, Manuel.

Joel Houck, Wells Fargo.

Okay, thanks. If we just strip out the lower middle market for purposes of this question, can you talk about what are the all-in yields on the venture debt coming in versus what's rolling off so we can get kind of a sense for the margin compression on that product?

Sure. So, the interesting component of that is -- and I'll break it down for you in kind of the three or four high-level buckets of yield makeup, which is probably more than you're looking for, but I'm par for the course on over-answering questions.

We're seeing interest rates still holding on fairly historical norms of 10.5% to 11.5% range. So, the interest rates themselves, the coupon rates if you will, are remaining pretty consistent. The cash component, the fee -- the funded fee component has seen some compression of about 20 to 30 basis points, and that's down to around 75 to maybe 125 basis points currently. And it's down about 30 basis points or so from historical levels.

Then, you have another component which is called back-end fees which, for accounting purposes, behaves a lot like PIK. Historically, we've seen an average of say 1.5 to 2 points on PIK interest or back-end fees, if you will, from an accretion point of view and that's seen probably the most compression, around 50 to 75 basis points compression when it comes to those back-end fees on an average bas.

And then you have the last component, which is the accretion of the economic value of the warrants, more commonly referred to as OID. And OID is a component of yield. And you see some compression on the OID, primarily driven by slightly lower warrant coverages than we've seen historically. So, historically you may have seen us at a 10% to 8% warrant coverage. Today, we're seeing more like a 9% to 10% warrant coverage on average deals. And the fact that the warrant percentage is slightly lower, you'll see a compression in the OID component as well.

Okay. No, that's good color. I mean, I guess when you kind of look out over the next quarter or so, I mean, would you say -- would you anticipate that the competitive pressure would abate or is this -- what you're seeing kind of what you expect to continue to put on in the next couple quarters?

Well, as we indicated at the beginning of the year, we give investors -- although we don't use the guidance, we (inaudible) giving investors the heads-up that we are expecting to see 150 to 250 basis points compression. And we're -- as I said, right down -- got it right down the middle there. Right now about 160 basis points compression.

We are seeing evidence that the compression is slowing down. And I still expect to see probably 30 to 50 basis points more in compression leading into the fourth quarter and then kind of plateauing at that level. So, you're looking at maybe a total compression of 200 basis points from the beginning of the year to the end of this year and then stabilizing in that range, which equates to, for a modeling purpose, somewhere in the neighborhood of around 13.5% to 14% level.

Okay, good.

Including the OID.

Okay, yes. And then -- I mean, your book value stability, I guess, is to be commended. Maybe talk about -- with the recent bounce in the equity markets, particularly at the end of September, what you guys saw on your equity or warrant book and why it held up so well.

Well, let's be clear. We did see some volatility on the mark-to-market on the book, on the warrant position. So, you can't sit here and see a 50% contraction on the S&P and the NASDAQ and not have it translate into some kind of compression on your book.

But as a reminder, the reason why it was not such a strong impact is our equity book is approximately 5% of our total assets and our warrant book is almost the same thing, about 5% of our total assets. So, it'll take a lot to move 90% of a base when the two components of volatility are 10% today. So, that's one reason why it was somewhat muted in terms of its volatility or impact, but we did see some of that as well.

The other factor to keep in mind is, unlike most other BBCs out there, I believe the last time I checked the statistic, we have 90% of our book is floating-rate loans with Libor or prime-based floors. So, in any declining rate environment, we're well protected. Any rising-rate environment, after a certain adjusted period from the floor, we'll start seeing earnings accretion on the base. So, the (inaudible) is well positioned in that area.

Okay. Then the last one is on the new Union Bank facility. Can you tell us what the advance rate on that is?

It's pretty much standard at 50% advance rate.

Alright. Thanks. Great quarter, guys.

Thank you very much.

Aaron Deer, Sandler O'Neill & Partners.

Hi. Good afternoon, everyone. Just maybe a quick follow up on your discussion here on the mark-to-market. Was the adjustment on the mark-to-market, was that entirely due to the equity and the warrant valuation adjustments? And then maybe any adjustments due to rate, or was there also any credit component to that?

Well, there's always a credit component to every mark-to-market. Remember, we run a credit book that is subject to some changes quarter to quarter, just on the mere fact that we invest in venture stage companies. And venture stage companies have to raise capital every 9 to 14 months.

So, out of the companies approaching around the financing, if we don't see evidence of a capital round coming together, we may be forced to impair the loan on a fair value basis to reflect what the (inaudible) would be in the event that we have to do that. So, there could be a fair market value impairment strictly related to a capital raise that's pending or not pending on a transaction. And there are other components and I'll let Jessica answer since she does most of the mark-to-market.

Right. We did see some appreciation in the debt portfolio, which was offset by debt appreciation in the warrant and equity portfolio and that is attributed to the contraction and the interest rate environment. So, when we have assets booked at a higher yield in a previous quarter and we do set up a market analysis on them as of the measurement date, which in this case is 9/30, we did see some fair value appreciation. But at the same time, when we're talking about all these data points with respect to our debt portfolio, you can see that the difference between cost and value is still extremely small at about $9 million for a total portfolio value of $513 million as of 9/30. So, we are doing all the steps and analyses, it's just that they're having a diminimous effect on the portfolio.

And Aaron, as a reminder, when you onboard $100 million in new assets --

Right.

That's going to help dampen any kind of volatility on valuation because you just on-boarded them.

Right. Okay. And I think all my other questions were addressed. Thank you.

(Operator Instructions.) Douglas Harter, Credit Suisse.

Thanks. I was wondering if you could talk about your outlook for the ability to add additional lenders to your facilities.

Well, Doug, if you asked me that question two months ago I would have said very high. If you ask me today, it's gotten more opaque. It changes. I have to honestly say that the commercial banks in this country are experiencing a (inaudible) of credit concerns as you're seeing happening around the rest of the world. Which, ironically, is also a good opportunity for us because we're seeing them -- some signs of slowing down from a competitor point of view in this asset class. But, it also impairs our ability to get -- to garner additional credit lines from other banks.

Now, that said, we are in dialogue and continue to have dialogues with other banks to join the syndicate, but we're not expecting to make any new banks to join the syndicate until probably sometime at the end of Q1 or later because we don't necessarily need them right away. But there are conversations that keep on going. A lot of banks we've been talking to now for well over a year and they just continue to show interest, but little of execution.

Great. Thank you.

Thank you. I'm showing no further questions and would like to turn the call back over to Manuel Henriquez, President and CEO, for closing remarks.

Thank you, Operator. Think you, everyone, for being on this call today. And as usual, if you have any addition questions or would like to schedule time with management as we move through non-deal roadshows in the coming weeks, please feel free to contact our Investor Relations Department.

And also, we'd like to remind everybody that we will be presenting -- pardon me -- at the Baird Technology Conference coming up here shortly on November 29th in San Francisco as well. If you'd like to schedule a meeting with anybody in the management team at Hercules, please call 650-289-3060 and either speak with Jessica Baron, our CFO, or Sally Borg in our Investor Relations Department. With that, thank you very much and thanks everybody for continuing to be our shareholders. Operator?

Ladies and gentlemen, this does conclude your conference. You may all disconnect and have a wonderful day.