Hercules Capital Inc (HTGC) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Hercules Technology Growth Capital's Q2, 2012 earnings conference call. At this time all participants are on a listen-only mode. Later, we will conduct a question and answer session and instructions will follow at that time. If anyone should require assistance during the conference, please press *, then 0 on your Touch-Tone telephone. As a reminder, this conference is being recorded. I would like to introduce your host for today's conference, Mr. Colin Hoover, Investor Relations of Hercules Technology. Mr. Hoover, you may begin your conference.

Thank you, operator, and good afternoon, everyone. On the call today are Manuel Henriquez, Hercules Co-founder, Chairman and CEO and Jessica Baron, Chief Financial Officer. Hercules second quarter 2012 financial results were released just after the market closed today. They can be accessed from the Company's website at www.htgc.com. We have arranged for a replay of the call at Hercules' web page or by using the telephone number and pass code 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 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 current market turbulence and other factors we identify from time to time in our filings with the Securities and Exchange Commission. Although we believe that the assumptions on which these forward-looking statement are based are reasonable, any of those assumptions can [provide] 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 for subsequent events. To obtain copies of the related SEC filings, please visit sec.gov, or visit the website www.htgc.com.

I would now like to turn the call over to Manuel Henriquez, Hercules Co-founder, Chairman, and CEO. Manuel?

Thank you, Colin. Good afternoon and thank you, everyone for joining us today. We have much to share with our investors this quarter and another outstanding quarter and strong growth and performance by our team. I'd like to briefly give you some of the agenda. I plan on speaking briefly on our operating performance and results for Q2. I will share with you my observations and discussion points on the current environment in both the venture capital marketplace and in pending legislation in Congress, as well as our view and perspective of what will come in the second half of 2012. And then lastly turn the call over to Jessica Baron, our CFO.

Now turning my attention to the second quarter results. I'm pleased to announce the progress and continued building of our portfolio and continued asset growth in our portfolio and earnings growth in our portfolio. We delivered a record-high total quarterly investment income of $23.9 million, representing approximately a 15% increase, year over year. We also achieved an 18% increase, year over year in growth of NII income at $12.3 million, or $0.25 a share. DNOI, not to be left behind, also showed impressive growth at 19.5% year over year growth to $13.5 million, or $0.28 a share in DNOI.

All this translates as strong coverage of earnings growth and, more importantly, strong coverage of dividend coverage of our earnings with our performance.

Also showing strong growth in our portfolio was our asset growth in our portfolio. We grew the assets in our portfolio by 52% to approximately $723 million of investment assets at the end of the quarter, again, representing a 52% increase year over year on the performance of the portfolio itself.

Consistent with the first quarter this year, we continued our controlled, slow and steady growth approach to building assets. We will continue that approach in the coming quarters, especially in lieu of the current economic conditions in Europe and the looming US election.

In terms of specifics on our balance sheet, we had interest earning assets of approximately $650 million at the end of the quarter, representing the 57% growth that I mentioned earlier. New commitments during the quarter were equally as strong. We finished the quarter with $139 million in new commitments during the quarter, bringing the first half of 2012 to $240 million of new commitments during the year, well on track toward the guidance we shared earlier of the $500 million to $700 million. However, given our controlled look for the second half of this year, we believe that new portfolio commitments will range more in line of the $500 million to $600 million level, as opposed to $700 million level I had shared earlier. I want to caution that we reserve the right to increase that, depending on continuing market conditions improving, if such improvements continue to occur as we expect them to see happening.

On a funding level, we experienced $112 million of fundings during the quarter. Also, as indicated earlier, we expected to see early pay-offs during the quarter and, in fact, we had early pay-offs of approximately $46 million during the quarter that occurred, coupled with another $18 million of normal amortization that occurred during the quarter.

It's important as we look to portfolio growth, we also turn our attention to expectations of portfolio growth in Q3. In Q3 we expect to see portfolio growth in the neighborhood of $20 million to $30 million of new asset growth during the quarter on a cost basis.

Turning my attention to credit quality. Overall, credit quality remained strong with an overall risk rating of 2.08, or basically flat to the same quarter in Q1, as last reported. However, given the uncertainty facing Europe, we completed an internal review of our entire portfolio to make a determination what exposure, if any, did we have to Europe and our portfolio companies had to Europe. I'm happy to say that on a direct basis, we have little to no exposure to Europe and indirectly, a handful of portfolio companies, specifically in the life sciences areas, do have exposure to Europe, whether it's in the form of conducting clinical trials or actually having sales of the clinical compounds or devices in the European market. We do not believe, however, that this exposure represents an undue risk than normal in our portfolio and we will continue to monitor the progress and exposure to our European investments and European exposure we have through our portfolio companies today.

As we turn our attention to the second half of this year, we remain steadfast and focused on credit quality and we refuse to give up credit quality and reach down the capital structure for yield preservation. We will be more than happy to forego 20 to 40 base points in yield, but maintain a senior-secured, first-lead position on the assets and not compromise our position on the balance sheet simply to preserve yield.

I remain consistent in my unwillingness not to sacrifice credit quality simply to achieve earnings growth and will be happily miss earnings if credit quality is not there.

As I turn my attention specifically to yield. As I stated, at the beginning of this year, we expected to see 50 to 100 base points yield compression in fiscal 2012. In the second quarter of 2012, we experienced an additional 40 basis points yield compression during the quarter. However, as most of you will see, the effective GAAP yield that we disclosed is approximately 15%. Unlike most [BBCs], Hercules goes one step further to provide clarity and transparency to our shareholders and we actually break out one-time events that actually impact or inflate the effective yield of the portfolio. Our adjusted effective yield of the portfolio, when taken into account, one-time event, is actually 13.3%, a 40% decline from the prior quarter, a decline which I have to give perspective, doesn't concern me, because it is in line with what we expected and consistent with our credit policies of maintaining discipline.

We are also seeing a slowing down of the compression of yield, meaning the velocity of yield compression is now diminishing. We do not expect to see continued significant yield compression in the coming quarters and I personally believe at this point that we're probably seeing another 10 to 20 basis points that may occur in Q3 and then we start balancing off and going up again on the yield basis as we start originating new assets in the portfolio itself.

Now turning my attention to the balance sheet. We continue to actively and diversify and expand our source of liquidity. We're focused on strengthening our balance sheet, improving our financial flexibility, and ensuring that we have a balance sheet that will accommodate and address our future growth needs. During the quarter, we ended up with approximately $208 million of liquidity, and we also increased liquidity during the quarter with an additional capital raise for our baby bonds of approximately $42 million that occurred in the April of the second quarter.

We recently announced this morning that we expanded and amended our existing credit facilities with Wells Fargo. This amendment to the credit facility was something that's quite important to us, and we were successfully able to add an additional year to the term, plus a tail which allows us to amortize the credit facility for an additional 1-year period of time, ostensibly extending the maturity by another 2 years. This would not have been possible without our continued strong partner with Wells Fargo and as self-evident with Wells Fargo's willingness to continue to work with us, Hercules, to amend that credit facility. Under the new credit facility, we expect to start drawing upon that facility in the coming quarters and start further leveraging our balance sheet, which is our preference as we continue to grow our asset base.

In June, we also received final approval from the SBA to be able to re-borrow an additional $24.3 million of SBA debentures. You may recall that we recently retired, at the beginning of the year our $25 million SBA debentures and we are once again now re-borrowing, or will be re-borrowing, the new debentures in the coming months.

We also expect during the third quarter to retire an additional $25 million of SBA debentures that have a cost of capital in the neighborhood of 6% or greater. This will cause $0.01 to $0.015 in impact in earnings as acceleration of unamortized fees attributed to the SBA that will occur in the third quarter. This is no different than what occurred in the first quarter of 2012. It occurred also last year in 2011. We will remain actively and continuously retire more expensive SBA debentures in coming quarters and take advantage of the low 10-year treasury rates that exist, and locking in new SBA debentures that are extremely attractively priced, representing a 200 to 400 base point savings to our current SBA debentures we have outstanding today.

Furthermore, we recently completed, in July an additional top-off of another $42 million of baby bond, 7-year senior unsecured debentures - senior unsecured debt offerings we recently did. On a year to date basis I'm happy to report that Hercules has successfully issued approximately $85 million of 7-year, unsecured bond offerings in the marketplace. This now increases our liquidity further, as I said, earlier in the call. However, I want to caution that because of the increase in capital rates that we did, attributed to the baby bond, and until that capital is deployed in the marketplace, we will carry negative spread, or impact to earnings of approximately $0.02 to $0.03 in Q3 as we convert that additional liquidity into earning assets in the coming quarters.

Turning my attention to liquidity. Despite what is an unwise, unpredictable IPO liquidity window, I have to say that I was quite impressed with our achievement as an organization. Hercules achieved a robust liquidity environment in the first half of 2012 with approximately 8 exit events that took place so far this year, 6 of which were complete IPO offerings and 2 completed M&A offerings. Because of that success, our shareholders benefitted for $8.3 million in realized gains during the quarter. We continue to have a position in over 115 different venture-stage companies where we have warrants or equity positions in. We currently have 3 additional companies, in currently in IPO registration today, Glory Energy, iWAT, and one company of ours, who has chosen to file confidentially under the JOBS Act. We also saw one company withdraw the IPO offering during the quarter as well.

As I said a minute ago, we finished the quarter a very strong [warrant] position. We have some very attractive positions in various technology life sciences companies that, in itself, one or two of these companies completed IPO offering, given our unrealized position and continued expectations of unrealized appreciation, could more than easily make up our entire unrealized -- our entire realized loss in the portfolio to date.

We have 115 different [warrant] positions, representing a very, very attractive exit opportunity. However, as we do in every call, we do not expect all 115 companies to go public or achieve liquidity events. Those liquidity events are all highly subjective and depending on market conditions, both on the M&A and IPO environment that exists.

As I do in every call -- no call is complete at Hercules without outlining and highlighting the venture capital marketplace and venture capital activities. I am happy to report that we saw a very solid and continued, vibrant venture capital investment activities. The venture capitals invested $8.1 billion in the second quarter of 2012 to approximately 860 companies representing only a 9% decline on a year-over-year basis. On the first half of the year total, we've seen $15.3 billion invested, representing simply a 7% decline in year-over-year basis.

By sector, IT, or Information Technology, remains the most robust, with approximately $2.4 billion invested to 286 companies. Software remains and continues to be the strongest sub-category within the IT, or Information Technology area, receiving approximately $1.6 billion of that capital.

Healthcare and Life Sciences combined received $1.5 billion of capital, representing a 33% decline on a year over year basis, and consistent with our outlook in the life sciences community, as you've seen our own portfolio also adjust in size accordingly as well.

Healthcare Information systems, however, was the bright spot within the healthcare area. Healthcare IT saw a dramatic increase of approximately 33% investment activity to $268 million of capital deployed to 29 companies. That said, we continue to see headwinds and renewables in energy sectors which saw a continued contraction of investment activities. These activities are only made further by the lack of clarity and ambiguity regarding the US-owned energy policy, the potential change in administration, and also struggling state and federal government willingness to do tax incentives, loan guarantees, and other forms of government assistance into that sector. Overall, capital in this sector declined 56% to approximately $293 million on a year over year basis.

As I turn my attention to stage. Early stage continues to see strong growth, with approximately 22% of the capital invested into early-stage companies. Sector-round deals saw approximately 17% of the capital and the balance into later stage companies, representing 50% -- 59% of the capital invested.

Venture capital exits, a very important indication of our ability to select and pick the right companies. In Q2, we had -- we saw 11 completed IPOs during the quarter. I'm proud to say, 2 of those IPOs were Hercules companies, during the second quarter, raising approximately $7.7 billion. Although Q2 experienced 9 fewer IPOs than Q1, it still showed an indication of willingness by investors to purchase IPO shares. M&A remained extremely robust and strong. We saw 110 exits completed by US venture-backed companies getting acquired, representing an uptick from that same period in Q1. We currently have approximately 44 companies in IPO registration that are venture-backed, 3 of which are Hercules companies today.

Lastly, in completing the ecosystem of the venture capital community. Venture capital's fund-raising, which is a leading indicator of the competence of the venture industry, also saw a very strong period of growth. 82 venture funds successfully raised over $13 billion in commitments so far in the first half of 2012, representing a 31% increase over the same period last year, a strong indication of the continued support by the limited partner community and the confidence in the top tier venture firm to continue to realize [exits] in their portfolio.

Now, bringing this to a close, as I turn my attention to Q3 and the second half of this year, as I said earlier, we will continue to look optimistically to the second half of this year, but as we've done at these periods of time, we look to that environment in a very cautious and controlled growth environment and manner. We expect to see net portfolio growth on a cost base of approximately $20 million to $30 million, up in Q3. We continue to look towards credit quality in underwriting and less forward toward yields in that underwriting process. We continue to see an ongoing phenomena that's becoming a much more consistent pattern of deals closing late in the quarter and longer to bring on the books, which means that, as those assets get onboard at later in the quarter, their contribution to earnings in that quarter is lessened.

That said, we turn our attention to Q3 with a very strong pipeline of approximately $1.2 billion, and I'm happy to report, with over -- with approximately $130 million of signed term sheets going into Q3, as of today. In addition to that, we have approximately $90 million of unfunded commitments that will translate to earning assets in the coming quarter, as well, to fuel additional asset growth.

Lastly, a lot has been made and a lot has been written, about the continued regulatory environment and potential looming changes in the regulatory environment that would be accretive or beneficial to the VCs, especially VCs such as Hercules that also have an SBIC. For example, House Bill 5929, or HR5929 as it is more commonly referred to, is a bill in front of the House today that would increase VC leverage from a one-to-one regulatory base to a two-to-one ratio. That would be significant in unlocking value for shareholders and allowing VCs to leverage their balance sheets further and be able to tap alternative sources of growth capital as we've done in a form of bond offerings as we completed both a convertible bond offering and a baby bond offering we recently completed.

Not being left behind, the Senate bill, Senate bill 2136, is specifically earmarked towards increasing the leverage of SBICs. These are small business investment companies, which Hercules is one. Currently today, the regulatory limit imposed by Congress is $225 million. Under Senate bill 2136, that limit would be increased to $350 million. We ask our shareholders and our constituents to please write letters to your Congressmen and encourage the passage of these two bills for the benefit of the VC and the SBA industry. They will both help to increase American innovation, as well as help bring down the unemployment. It's important that Congress act and move on these bills and help increase the American innovative environment that we invest in.

In closing, we experienced a very strong and solid second quarter performance, thanks in no part to the continued dedication and hard work of our team in identifying the right prospective companies. We'd also like to thank both our venture capital partners and our CEOs and managements of our portfolio companies for their continued support and belief in Hercules and continue to want to work with Hercules as they continue to build their respective business models. Although we are concerned about the US economy and the global economy, coupled with the US election, we continue to make investments in this environment, but we are going to take our time and control the investments. We do not believe it is a sprint to put assets on the books, but to continue to focus on credit quality, as we've done and continue to focus on managing our balance sheet in difficult times.

I remain very optimistic and very encouraged at what I'm seeing, and I'll share with you briefly one little anecdote. Yesterday I had a conversation with one of my portfolio companies. They start off Q2 with a dismal outlook in Europe. They recently came back from Europe and they shared one piece of information with me, which is, they saw a dramatic shift in European willingness after the Greek election that they are now beginning to increase their outlook for 2012 on European exposure. Now, I caution you. That is only one sound bite, but I was a bit surprised on how bullish they came back from the European trip and I'm encouraged by that little information.

With that said, I'll turn the call over to Jessica Baron, our CFO.

Thank you, Manuel and thank you, everyone for listening today. I'll briefly go over our results for the quarter. We filed our 10-Q as well as our earnings press release after the market closed today and here's the recap.

We delivered $23.9 million in total investment income or revenues, a quarterly record, and an increase of 14.9% when compared to the second quarter of 2011. This year over year growth was driven by higher average outstanding balances of yielding assets during the quarter and accelerated fees related to almost $50 million of early pay-offs during the quarter. The fair value of our yielding debt investment portfolio at quarter end was $647.1 million, an increase, as Manuel mentioned, of 57% from the same period a year ago. The effective yield on our debt investments during the second quarter was up to 15.2% from 14.6% in the first quarter of '12. Excluding the income acceleration impact from early pay-offs and one-time events, the effective yield for the quarter was 13.3%, down approximately 40 basis points sequentially to -- and 70 basis points year-to-date.

I'd like to reiterate that we expect to [see a]100 basis points decline in our debt portfolio's effective yields during 2012. Excluding early pay-offs, a normal run-rate on our portfolio historically has been between 12.5% to 15.5%. I'd also like to note that our [PIC] income, as historically has been the case, is immaterial to our financial statement. Once again, PIC which is non-cash revenue which must be paid out to our shareholders in the form of dividends, continues to represent a small component, or less than 1.1% of our total investment income for the second quarter.

Our cost of debt increased to $5.2 million in Q2 of '12 compared to $3.8 million in the second quarter of 2011. The increase is primarily attributed to approximately $668,000 of interest and fee expenses related to the [$43] million of senior unsecured notes due at 2019, issued during the second quarter, and approximately $250,000 of interest expense on a higher SBA debenture balance outstanding during the period.

Our weighted average cost of debt was 6.7% in Q2 of '12, which compares to 6.6% in Q2 of 2011. Operating expenses for the quarter totaled $6.3 million as compared to $6.6 million in the second quarter of 2011. The decrease is primarily due to non-recurring executive severance costs incurred in the second quarter of 2011.

Q2 of '12 net investment income was $12.3 million, compared to $10.4 million in the second quarter of 2011, representing an increase of approximately 18.3%. Net investment income per share was $0.25 for Q2 of '12, based on 48.6 million shares outstanding, compared to $0.24 based on 43 million shares outstanding in the second quarter of 2011.

Our net unrealized depreciation from our loans, warrants, and equity investments during the second quarter was $20 million, of which $12.2 million was due to mark-to-market fair value adjustments. Only $600,000 was attributable to credit impairments of our debt portfolio, and $7.2 million of this unrealized depreciation was related to the reversal of net unrealized appreciation to realized gains on warrants and equity.

Our net realized gains for the second quarter was approximately $8.3 million. We recognized a gain of $2.4 million and $800,000 from the sale of warrants in Annies, which went public in March, and Bullhorn, Inc., respectively. And $5.3 million from the sale of warrants and equity in NEXX Systems. These gains were partially offset by realized losses of approximately $200,000 due to the write-off of warrants in 2 portfolio companies.

Now, moving on to our balance sheet. I'd first like to provide a summary of the investment portfolio. We've seen significant growth in our portfolio over the last year, as results of our debt investment origination activities. As of June 30th, 2012, total investment assets were $722.8 million, an increase of $247.6 million, or 52% since June 30th of '11. During the quarter, we close debt and equity commitments of approximately $139 million and funded $112 million to new and existing portfolio companies. As Manuel mentioned, we continue to see deals closing late in the quarter. We experienced $64.1 million in principal repayments for the quarter, including $46 million in early principal repayments. The majority, once again, was incurred in April. And $18.1 million is scheduled for principal repayments.

Regarding the composition of our portfolio at quarter end, over 94.9% of our loans have floating rates or floating rates with floors, and over 99% of our loan investments are senior debt investments. We remain pleased with our loan portfolio credit quality. The weighted average loan rating of our portfolio is 2.08, consistent with the prior quarter. We had only 1 debt investment on non-accrual at the end of the quarter that had a cost basis of $7.1 million and a carrying value of approximately $169,000. Note that this is the one position we took the incremental $600,000 of unrealized depreciation for collateral impairment purposes during the second quarter. Subsequent to quarter end, we received a payment of $2 million for this position. We expect to record a realized loss of $5.7 million and a reversal of previously recorded unrealized depreciation of $6.9 million in the third quarter related to this company.

At June 30th, 2012 our warrant and equity investments combined at fair value represent approximately 11% of our total portfolio, versus about 11.5% at the end of the prior quarter. Our equity investments at fair value as of June 30th total approximately $47.6 million. Our warrant positions in 115 portfolio companies could provide us with the option to potentially invest $74.6 million of additional capital. We harvested nice gains from several warrants and equity positions already this year, and believe that this pool of assets can provide capital returns for the Company in the future. Now [spreading] our liquidity at June 30th of '12, we had approximately $207.3 million of availability comprised of $56.1 million of cash, $24.3 million of SBA borrowing capacity, and $126.9 million in borrowing capacity under our credit facilities. In mid-April we closed our first baby bond offering. We're using $43 million of 7% unsecured notes due 2019, and subsequent to quarter end we reopened the offering, raising an additional $41.5 million, bringing the total amount to $84.5 million of issuances in 2012.

As a result of adding this additional leverage, we anticipate some increase in our interest and fee expense by approximately $900,000 per quarter, or 2% to 3% in earnings, until this capital is fully deployed.

Further, on our sources of capital, we enhanced and amended our existing Wells Fargo credit facility, which includes $75 million of initial credit capacity under a $300 million accordion credit facility. Effective August 1st, we have extended the maturity date by 1 year to August 15th -- I'm sorry -- August of 2015, lowered the interest rate floor by 75 basis points, and added an amortization period of 12 months from the maturity date to pay down the principal balance.

In June of 2012, we received approval from the SBA to borrow the $24.3 million of debentures under our second SBA IC license. Should we borrow the debenture in the third quarter, during the September pooling, our pricing will be set. Based on pricing the debenture -- of the debentures at the March 2012 pooling, which had less than a 3% cost [of] pricing, we expect we could reduce our cost of debt on these borrowings by approximately 2.5% to 3% over the long term.

We ended the quarter with $200.8 million of SBA debentures outstanding.

Finally, as Manuel mentioned, we expect to repay an additional $25 million of SBA debentures during the third quarter, which will impact our earnings by $0.01 due to the accelerations of unamortized fees associated with those higher-cost debentures. Our net asset value as of June 30th was $474.8 million, or $9.54 per share, based on 49.7 million shares outstanding, as compared to $485.4 million, or $9.76 based on 49.7 million shares outstanding at the end of the first quarter. The sequential decline in NADs during the quarter is primarily attributed to mark-to-market unrealized depreciation on the investment portfolio.

Finally, moving on to our dividends. We declared a dividend of $0.24 per share, payable on August 24th to shareholders of record on August 17th. In closing, the second quarter was another solid quarter, as diversified sources of funding and strong balance sheet puts us in position to grow our investment portfolio and deliver strong earnings and dividends for our shareholders.

Operator, we are now ready to open the call for questions.

Thank you, ladies and gentlemen. If you have a question at this time, please press the * then the 1 on your Touch-Tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the # key.

Our first question comes from Jasper Burch from MacQuarie. Your line is open.

Hi. Good afternoon, everyone. Manuel, we sat down last month and chatted. You talked -- we talked about the -- how you'd kept the first baby bond issuance, you know, you could have had it a lot larger, where you kept it small, cause you really wanted sort of match your liabilities with upcoming fundings that you expected, and upcoming investment opportunities. I was just wondering, I mean, coming out with the second baby bond issuance, you know, and the potential further issuance, I mean, does that point to, sort of, a more bullish outlook on portfolio growth? And, sort of, what are you expecting for portfolio growth in the last portion of the year?

Well, it certainly does speak to my voice -- outlook for the portfolio. It is why we took advantage of that window that existed to be able to do a secondary bond offering, or top-off of the existing bond and really enhance and strengthen our balance sheet to take advantage of that growing -- the growing market opportunity.

Further evidence of that is our current active hiring. We 're in the market right now, looking to hire 3 to 5 additional new investment professionals in both our Technology and Life Sciences Group, and I historically have held back from doing that until I believe that we're facing the right environment. So you will see us start looking to deploy more capital probably sometime in the 4th quarter, right after the election. Because the election outlook will have an impact on how we make investment activity, as I described in previous calls, whether it's Republican or Democrat, it will change the landscape of investment activities.

But, you're absolutely correct. This signaling of my bullishness and outlook is, in fact, with the increase of the baby bond offering that we expect to deploy in a quarter or two. However, because of timing issues, you sometimes can't raise money when you actually need it, so in this case, we'll probably end up having the $0.02 up to $0.03 in earnings hit as we convert that new liquidity into vested assets, which, you know, I have done -- we have done in past, you know, we'll do it again this quarter.

Okay. Thanks for that color. And then, in terms of the depreciation on the portfolio, there's about $12 million that was driven by market yield adjustments. And then, also, I think, in the opening remarks, you mentioned that you expect the yield to actually climb a little bit in the 4th quarter. I was just wondering if you could give us a little bit more color, I mean, on what, sort of , the new investment yields that you're seeing are, and where those are, relative to what's already on the portfolio.

So, we got to be careful here of that. Your initial comment is correct, but the underlying premise is not. Some part of the yield that you see on unrealized depreciation is directly attributed to mark-to-market on the portfolio itself and not new asset generation. So, the difference is that you have to discriminate. When you look backwards on your current portfolio and you're looking forward to where you originate, certain assets that may be higher-yielding in the past or marked up are now being marked down to reflect mark-to-market adjustments.

So you've got to look at -- I somewhat ignore the deprecation of a portfolio related to yield. I look at it more on a GAAP basis and new assets that we're onboarding. And so what we saw occur in the second quarter was, we saw an uptick on the interest rate itself. We saw about a 20 base point increase in the underlying interest rate, but we continue to see a little bit of compression going on with items related to OID, facility fees, and other commitment fees that we have that accreted over the life of the loan, and that's where you see most of the compression -- that came from. Jessie, you want add to that?

I think that's a fair representation of what's going --

Okay. So you're seeing interest rates up but some of the fees down. So I guess, I mean, I guess I just sort of assumed that if you saw the -- like the comps go down, the portfolio comps, that means yields on portfolio comps going up, that was what drove your portfolio down. That's not the right way to look at it?

Not necessarily, because what happens is when you do mark-to-market, you know, the problem we just -- we have is that these are level 3 assets, so the so called mark-to-market is looking backwards on your -- what you originated in the last 6 months as your so-called market activity you're doing versus new deals you're doing. So we have deals that were done in the past that could have had, for example, an effective rate of 13%, when you accrete the OID and now you're doing deals at, say, 12.5%, when you take that impact over the portfolio, you adjust it. You'll see a slight compression related to OID and other components. As I said in Q1, were refusing to give up on our collateral position, and I've seen the secure position and would rather trade off yield for that collateral position. So we're seeing a bit of a compression attributed to fees and OID accretion as we take -- as we decide to take slightly lower warrant coverages that when you calculate OID, that would have a growing impact on the calculation of yield. I probably just confused the heck out of you and I apologize.

I'll just reread the transcript and I'll figure it out. And then, in terms of the fee income, it rebounded a lot the couple of quarters. It had taken sort of a dip late last year. Is that just due to the, I mean the portfolio -- turnover in the portfolio, or what's the driver of that and, I mean, sort of, what's a level that we should look at going forward?

. Yes, that's correct. If you look at the difference between our effective yield with and without the impact of early pay-offs, it's 15.2% versus 13.3%. So, yes, the driver is, like we said, almost $50 million of investment paid us off this current quarter and we're depending upon which asset that may be, you have the windfall of the acceleration of the unamortized fees.

Okay. Great. Thank you, that's all very helpful. I'll hop off.

Okay. Thank you. Our next question comes from Aaron Deer with Sandler O'Neill. Your line is open.

Hi. Good afternoon, everyone.

Hey, Aaron.

I'm going to actually follow-up on Jeff's question with respect to the yield adjustments. I just want to be clear. So the $8.3 million in the loan category, that was entirely due to yield adjustments and there was no credit or other related impact there?

Right. That was -- we really were -- wanted to accurately depict what happened this quarter with respect to our valuation adjustment. There was only 1 collateral-based impairment in the portfolio which was for $600,000. The rest of the -- these are adjustments are -- us applying the current market fair value approach which we have. There's actually some pretty good disclosures in our 10-Q about the process we applied here, but when we're calling this yield adjustment, this is -- it is what Manuel described, where we are looking at rates today versus the historical rates embedded in our portfolio. And when you compare those on an all-in basis, we see that the rates in the historical deals are a little bit lower, and when you do that comparison, you render this adjustment. Bear in mind, of course, that when these investments pass off and when, as you've seen historically in our portfolio, our [paths] are generally at par, those unamortized -- those unrealized depreciation adjustments that you see today will be reversed.

I want to, again, add to this point. I think we're one of only a few, if not the only BDC that really decides to break out yields and break out the GAAP yield to the consistent yield. So, if I compare ourselves to other BDCs out there, we have 15.3% yield and we can just leave it at that. We don't think that's the right thing to do. We think the critical thing to do is to break out and actually show that. And this is our first attempt also on putting a new table in our release to help provide even more clarity on these discussions. So, if we can -- if we need to improve those tables further, we're happy to do that as well. We're just trying to create much more transparency for our shareholders as well. (crosstalk)

I appreciate the disclosure. I'm just trying to understand the -- if the average rate is declined, then, well, shouldn't the value rise? In the portfolio?

Think of it this way, where the average rate is representative of the entire portfolio, whether that be an investment made that's still on our books from 2009 or one which was done at the end of Q2 of '12. If you look at a snapshot in time, we are seeing trends of improvement in current today rates, but you're sort of comparing the snapshot in time versus the history that's embedded in our portfolio. So, when you're seeing a decline in all-in rates, you can perhaps look at that as seeing that the weighted average, based upon what's left and what's come in the portfolio has slightly declined, and we're talking about 40 basis point here, whereas, if you were to compare the deals which were new, let's say, last quarter versus a deal which -- deals which are new this quarter, you're seeing an improvement in rates.

Let me take a stab at this way as well to help out. The loans that we're talking about are loans that are fiscal 2010 and 2011, when the market was a bit dislocated and we had a higher proportion of warrants attributed to those deals. Because of that, you have an increase in OID. And say, for the sake of illustration, those warrants -- those loans had a 14% mark-to-market yield at the time. Today you're looking at loans that are originating at the 13% level -- 13.3% level, which means you'll see about 100 basis point differential, and on weighted basis, that equates to about a 40 base point differential when you do it on a weighted basis in the portfolio. So, yes, you're correct when you look at old legacy loans that may be at a 14% level or so, versus the new loans at 13%, when you apply mark-to-market you'll see a depreciation of those legacy loans to equalize what is deemed to be the current market today, around 13%.

And then, on the -- I'm just getting some additional color on the paid-out -- I think Jessica, you mentioned what the schedule payments were for the quarter, and then I saw you had $2 million pay-down on the non-accrual Max Vision loan. Any other pay-downs that you've had quarter to date, and expectations for the quarter overall?

This early in the quarter there hasn't been any activity of note in that category.

As of today, we're not aware of any of our portfolio companies who give us an indication that they plan on paying off early in Q3 thus far.

Okay. Great. Thanks for taking my questions.

Thank you. Our next question comes from Robert Dodd from Raymond James. Your line is now open.

If I can go back to a question you've already covered, but the deployment expectations for the rest of the year. You talked about relative to the election, et cetera. There's a lot of uncertainty there. But if we look at your commitments that you've had year to date, 240, the target now may be 500 to 600, so you're kind of halfway there already. But it seems that your expectations for Q3, this is commitments versus funding, so it's apples and oranges there, but your expectations for Q3 seem pretty moderate. Given the uncertainty in Q4 around how the election's going to turn out, which is anybody's guess at this point, how comfortable do you feel -- cause it sounds like the indications here are for a pretty elevated deployment and funding number in Q4 -- how comfortable do you feel with that, given the uncertainties here?

Well, it's actually a little more comforting that that. Let me kind of break it down for you. So we finished the first half of this year with about $240 million of commitments that we disclosed on this call. We also would further disclose approximately $130 million of in-house signed term sheets are ready. So if you add those two together alone, you're already at $370 million, as of August 2nd. So, I'm actually much better off than I must have failed to clarify. So again, $240 million signed already and closed in the first half of this year. I have $130 million of signed term sheets in-house right now. Assuming all that closes, that will put me at $370 million in August 2nd, turning my attention to the remaining 4 months or so of the year. Historically, if you look at Hercules' pattern, the 4th quarter can be anywhere from $100 million to $240 million of commitments that are closed. And that's the variability that can easily top over the $600 million to $700 million level, but it's all going to be contingent upon, you know, factors leading into the 4th quarter, which I do not have good visibility on right now.

Thanks. Got it. I think that makes sense, because as I look at it, we see all that in the context of the 20 to 30 expected on cost basis, and you assess this in Q3, I mean, I guess, that's the delta of some of the term sheets you've signed, you don't expect to necessarily fund during Q3.

Bingo. That's exactly the case.

Got it.

From the pipeline point of view, I feel very, very good where we're at and how we're trending. It's just like I said on the call, things are taking, well -- things are taking longer to close, but we're also taking longer to close purposely because we want to make sure that these underlying companies are not -- they're trailing performance is not tapering off as you lead into a new closing of an investment.

Okay. Got it. Second question. Obviously, Q3, you gotten -- you've gotten rid of your one non-accrual. I mean, anything on the credit side -- any other portfolio companies that are raising concerns, could turn into non-accruals, or do you feel very comfortable this year. Your overall average credit rating has remained very stable but, yeah, we can have a wide dispersion within an average rating, after all.

Well, I'll say what I say all the time to all investors at the -- the entire majority of our portfolio is contingent upon securing additional equity around the venture capital community. At this point, as we say in every call, we disclosed the investor capital community performance and investments. At this juncture, I don't anticipate any dramatic curtailment of equity dollars being invested by the venture industry per se, which means that my outlook or my confidence level in our portfolio companies securing future rounds of equity remains stable. I am not, at this point, turned to a negative outlook on having our portfolio companies secure additional rounds of financing.

That said, as I said on previous calls and I'll repeat in this call, many of our life sciences companies are conditioned upon securing new rounds of financing by specifically achieving and accomplishing FDA milestones on progressing from a phase I clinical trial to a phase II clinical trial or a phase III clinical trial. Some of those trials are completely, entirely out of the companies' control because they have to do with science and the body's ability to digest or assimilate these compounds and see benefits out of them. But my outlook on credit has not change dramatically at all.

Appreciate it. Thanks.

Thank you. Our next question comes from Vernon Plack from BB&T Capital. Your line is now open.

Yes, thanks very much. A couple-couple questions. Can you tell me the warrant -- the gain multiples on the warrant sales, both Annies and Bullhorn?

I believe that -- well, you forgot the other one NEXX. The NEXX I can tell you, I know that one, because that one sticks out. It was a 10.17 multiple on NEXX. And I believe Annies was a 4.2 multiple on Annies, and we are going to confirm that for you right now. Annies was a -- sorry 8.3 on -- we're showing 8.3 on Annies. I'm sorry, 8.3 on Annies. And Bullhorn, I don't have that in front of me. I can get you the information but I don't have Bullhorn in front of me.

Okay, and looking at the portfolio from a diversification standpoint, it seems like the one category that went down a lot, and I haven't looked at this too closely, but it looks like software went from -- actually went up from 6% up to 12%. Is that just the result -- it's obviously the result of movement in the portfolio. But, can you help me understand that in terms of --

Yes, as I said at the call, the software category within the venture industry space received a pretty strong venture capital investment activity. It receives $1.6 billion of venture capital activity of the total $2.4 billion of all Information Technology investing. As I said in the past, we are underinvested in software and we are actively looking to increase our exposure to software. You'll see that number continue to increase in the coming quarters as we also bring down ever so slightly our Clean-Tech and our Life Sciences exposure in balance with the software growth.

Okay, and --

This is part of things that we do for risk mitigation. We will dial in sectors in stages.

Right. Jessica, in terms of the -- if you looked at the impact that early pay-offs had on investment income, I'm coming up with a number around $3 million or $0.06 cents a share. Is that -- is that in the ballpark?

That's good math.

Say again? It's good enough?

That's good math, yep.

Okay. And if I look at that, if we consider that non-recurring, although you have a certain amount of that every quarter, If I look at -- if I look at the retirement of SBA debt, which could be a $0.01 - $0.015 -- if I look at the baby bond and short term impact of $0.02 to $0.03, I'm coming out with probably a net interest income number in the third quarter somewhere in the high teens. Does that seem reasonable?

You know-

Not that you are in the business of forecasting, but (inaudible-cross talk)

We don't give guidance that tightly anyways, but I think that your logic -- I would say that your logic of extrapolation is within reason.

Okay.

But the delta of that is, as we continue to deploy the assets, and again we said that we expect $20 million to $30 million up in the quarter, albeit late in the quarter, that would dampen a little bit of that impact that you just referred to.

Sure, sure. Okay, that's helpful. Thanks.

Thank you. Our next question comes from Douglas Harter with Credit Suisse. Your line is now open.

I was hoping you could talk a little bit -- obviously you've got the Wells facility which seems like a nice facility. Was there further availability to get structures like that? Do you have an appetite to do further facilities like that?

You know, Doug I'm encouraged by the discourse that we had with Wells. I think that there is some evidence that banks are beginning to consider re-lending again. Wells has been with us a long time so they understand our credit and our credit history. So, they are quite comfortable with how we have performed and what we've done. I can't tell you with 100% certainty that others are there where Wells is, but we are encouraged by some of the dialogue going on, that probably in the first part of 2013 we will look at additional lenders to that syndicate. But as of today, I don't have anybody on the horizon. But I can tell you that they'll fall in place that quickly.

And I guess, I think we've talked about this in the past but, the 12 month amortization, is that something that would give you greater comfort in using those credit -- those credit facilities to a greater extent?

Absolutely. That is probably by far, even more so than removing the floor. Or "lessing the floor", as they say, LIBOR floor is by far the more important issue. And the reason is this, as we proved in 2009 and 2010, with our Deutsche Bank and Citibank line, the ability to have a tail, an amortization period, is vital to be able to have a control liquidation of the portfolio and not by yourself having to harriedly liquidate the portfolio and causing further impact. For those that may recall, during that period of time, we saw dramatic earning increase as we were liquidating and paying back the Citibank and Deutsche Bank $130 million dollar exposure we had. And having a tail allows us to do that control ability. Now, to bring it all together, we're also experience normal course of business between $18 million and $20 million dollars of amortization on a quarterly basis. So, having a 1-year tail and having a $75 million dollar exposure more than adequately allows us to repay that loan under normal amortization periods.

Great, thanks. And then, just wondering if you could just update us on your Facebook holdings. You know, I see that you still owned it as of June 30th and obviously it's been weak quarter to date.

Well, you're certainly being polite on being weak. It's been a pretty horrific performance. That said, the fundamentals of why we made that investment and our belief in that company remains very strong and very solid. They -- they have some challenges ahead of themselves on monetizing the mobile users. I will not short them in the context that I think that they'll figure it out and they'll crack that nut. They have a challenge ahead of them. But, just to remind everybody our cost basis on those holdings are $31.08 a share. So, on a cost basis, we're somewhere at around $3.3 million dollars down on that investment. And I believe that they will crack that nut. This morning , I think this afternoon LinkedIn reported good earnings and they're in that similar monetizing mobile users. So, I remain hopeful that Facebook will crack that nut.

Great, thank you.

Thank you. Our next question comes from the line of Jason Arnold with RBC Capital Markets. Your line is now open.

Hi. I was just curious if you could give us an update on a competitive environment amongst lenders in your space right now?

Believe it or not, Jason, nothing -- there's no dramatic change whatsoever. We are not seeing any more that we saw in Q1 and frankly not much has changed. So we're no losing sleep on the competitive environment out there. It's just been steady as she goes

Okay. Thank you for the color.

Thank you. And our next question comes from John Hecht with Stephens. You line is now open.

Afternoon, guys. Thanks for taking my questions. First, just so I'm clear, the -- after you resolved the non-accruals subsequent to the end of the quarter, do you guy have non non-accruals as a percent of fair value right now?

After the end of the quarter, that's correct.

Okay. And then, maybe I'm -- this is looking for a little bit of clarification. Manuel, what are you seeing in the market that you think your yields will rise on average -- it sounded like into the latter part of the year, maybe into the 4th quarter. Is that a function of maturing loans with lower yields, or is that a function of you're seeing better bids, you know, better pricing out there in your new bids and so that you -- you might just see some uplift in the overall portfolio with new loans going forward?

When you see the Q, you will figure this out quite rapidly. We have a handful of loans that are sub-standard yields that we have on our books that are very good quality loans that we did when we had an abundance of cash on our balance sheet, in order to help mitigate the negative spread, than make any, you know, cash at 10 basis points, I'd rather do a loan at 7% or 9% yields, if you will. As we start utilizing the remaining cash, we have the ability to vacate those loans at a lower yield, and by the removal or pay-off of those loans, that in itself will start giving rise to our overall portfolio yields.

Okay. I got you. And then, Jessica, it sounds like you have $50 million of SBA debt that you can re-price over the next -- I think you said they're 7th of September re-pricing -- if the 10-year stays around where it is today, do you have a sense for, on an annual -- interest -- is the interest savings on an annual basis?

For the (inaudible) debentures, specifically, obviously, we'll be cutting the 300 to 400 basis point right there alone for those specific borrowings. But the impact on our total weighted average cost to that will be, maybe, a half a percent, once we complete the full cycle of all the pay-offs.

Great. Thanks very much, guys.

Thanks, John.

Okay. I'm showing no further questions at this time. I'd like to turn the call back over to Mr. Manuel Henriquez. Your line is now open.

Thank you all. Thank you for your continuous interest and support of Hercules Technology Growth Capital. If you'd like to arrange a meeting or have additional questions, feel free to contact our Investor Relations department. We will also be participating at the JMP Financial Services and Real Estate Conference in New York City on September 13th and presenting at that conference. If you'd like to schedule one-on-one meetings, please contact JMP or our Investor Relations department. Again, thank you very much for being our shareholders and for being part of the Hercules Technology Growth Capital story. Thank you all.

Thank you, ladies and gentlemen, for participating in today's conference. This does conclude the program and you all may disconnect. Everyone, have a great day.

Thank you.