Hercules Capital Inc (HTGC) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Hercules Technology Growth Capital second quarter 2014 earnings conference call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session, and instructions will be given at that time. (Operator Instructions)

Please note, today's conference is being recorded.

I would now like to hand the conference over to Jessica Baron. Please go ahead.

Thank you, Operator, and good afternoon, everyone. On the call today are Manuel Henriquez, Hercules' Co-Founder, Chairman, and CEO, and myself, Vice President of Finance and Chief Financial Officer.

Hercules' second quarter 2014 financial results were released just after today's market close. 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 pass code provided in today's earnings release.

I'd 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 SEC may differ from those contained herein due to timing delays between the date of this release and in the confirmation of 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 limitations, the risks and uncertainties, including the uncertainties surrounding the 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 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 could 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 these forward-looking statements or subsequent events. To obtain copies of related SEC filings, please visit sec.gov or visit the website www.htgc.com.

I'd now like to turn the call over to Manuel Henriquez, Hercules Co-Founder, Chairman, and CEO. Manuel.

Good afternoon, everyone, and thank you, Jessica. Thank you all for joining us today.

After the positive feedback we received from last call, I will attempt to continue to do a more streamlined approach to leave more time for Q&A, although there's a lot of activities that took place in Q2 and are also taking place in Q3, that I'll elaborate during this call that may steal some of that additional time.

With that said, I am once again pleased to report another outstanding and strong quarter for Hercules Technology on all fronts. As of the agenda for today, I will cover a brief summary or operating performance and results for Q2. I'll provide an overview of the current market conditions, including venture capital activities, IPO and M&A activities, our perspective and outlook for investment activities for Q3 and the remainder of 2014, and then, of course, I'll turn the call over to Jessica who will cover our financial results and performance in much greater detail than my highlighted section will cover.

As to the highlights of our operating performance in Q2, I am very pleased to report that Hercules delivered, yet again, a very strong second-quarter financial results and performance. We significant grew our investment portfolio by converting over $100 million of our cash balances into new interest-earning assets or loans.

We also strengthened our balance sheet during the quarter, as well as post the quarter, in liquidity position with the most recent bond raise that I'll speak to and cover later on in our discussion.

We also expanded our origination and operations teams and capabilities by growing our investment professionals that allow us to also continue to fuel the growth of our investment portfolio, which will lead to future earnings, as well as future dividend growth for the benefit of our shareholders.

Now some of the highlights. New commitments for the quarter were approximately $240 million. New fundings were equally as strong at $173 million for the quarter. We also ended the quarter with an unprecedented, unfunded commitments of approximately $230 million. These unfunded commitments represent future potential interest-earning assets and balance sheet growth if and when these unfunded commitments get drawn over the preceding few quarters.

Also, achievements during the quarter, we achieved another solid performance with 6% year-over-year growth and our net investment income of $18.6 million, or $0.30 a share. We also achieved a very impressive growth on DNOI. DNOI grew 9% year over year, at $21 million, or $0.34 per share.

We remained very committed to addressing the growing needs of many of the innovated and disrupted technology life sciences companies that we serve. To that end, as previously announced, Hercules has begun to expand its product offering or its financial solution to many of America's most promising innovative technology life sciences companies by offering a comprehensive financial suite of financial solutions that include asset-based lending, equipment-based financing, acquisition finance, senior stretch financing, and our traditional and growth term loans to more effectively compete with venture banks and other BDCs attempting to enter the venture capital marketplace or the venture capital lending marketplace.

We've launched these initiatives mid-second quarter, as they have shown great initial promise as evidenced by our recent portfolio growth of over $100 million in new loans and, of course, our unfunded commitment of over $230 million. Although much of this effort was realized late in the second quarter, we expect to see the benefits of this translate into earnings growth at the beginning of Q1 2015, and beyond.

In addition, we expanded our origination team and our origination capacity by focusing additional resources to select top-tier venture capital firms who are focused on growth stage companies. This is a very important adjunct to our origination effort as we are now widening our market reach into the venture capital community in areas that we traditionally have not focused on.

In doing so, we are willing to begin to use our balance sheet as a source of strength, as well as our high yields that we originate, by lowering our yield as necessary to effectively offer a very competitive solution in financial suites to compete with other BDCs who are trying to enter the venture lending marketplace today.

We expect to continue to deploy our excess liquidity of nearly $300 million very aggressively in the second half of 2014 and beyond. We intend to leverage our balance sheet as a source of strength as we continue to drive new investment asset growth in loans that will translate into earnings and eventual dividend growth for our shareholders that we expect to see translate into EPS growth by late 2014, and early 2015.

On the credit side, and in keeping with our historical focus on credit, you can expect Hercules to proactively continue to work diligently to prune marginal performing companies from our portfolio going to the third quarter. This effort, along with some expected M&A events with some of our portfolio companies, will lead to early payoff in Q3, of approximately $60 million to $80 million of early payoffs. This excludes normal amortizations that will take place of approximately $35 million.

Because of our proactive investment approach to managing our portfolio and pruning away marginal performing companies or credits, we anticipate that net loan growth for the investor portfolio going into Q3 will be flat to declining $20 million to $30 million.

On the dividend front, our Board of Directors declared a 36th consecutive dividend since inception of $0.31 per share in the second quarter of 2014.

Now let me turn my attention to some liquidity events in our portfolio. In Q2, we had one company complete both an M&A event and immediately complete a IPO event, and that was Glori Energy during the quarter. We also finished the quarter with five portfolio companies in IPO registration whose names are listed in the earnings release for much greater detail.

Because of the recent increase in market volatility and unpredictabilities as evidenced today, especially as it relates to many of the leading technology companies, we are seeing many potential technology IPO candidates choosing to delay or defer their IPO offerings for later in 2014, if not into Q1 of 2015.

Because of this prudent wait-and-see rationalization by the venture capitalists in these portfolio companies, we ourselves have chosen to adjust our own potential realized gains for 2014, downward, to $20 million to $30 million for the previously guided $40 million to $60 million, driven in part by the delay in the Box IPO, which was originally anticipated in the first half of 2014.

Like always, much of this anticipated gain is certainly subject to market conditions and equity capital markets remaining cooperative.

Now turning my attention to some of the venture capital marketplace activities, I must say, I was quite impressed with the level of venture capital investment activities that took place in the first half of 2014. The venture capitalists invested a staggering $25 billion in the first half of 2014, which compares to the $35 billion invested in the entire 2013 period of time.

This was the highest level of venture capital investments since Q1 of 2001. With nearly $14 billion of that $25 billion invested in Q2, to over 900 companies, we have seen a dramatic increase in demand for venture debt financing as evidenced by our own portfolio growth and as evidenced by our nearly $240 million of newly signed commitments during the quarter. This speaks to Hercules' growing brand awareness and growing franchise [value] within the venture capital community, as well as our willingness to expand our product offering to help service the needs of these companies, all are leaning to higher and increased deal flow from the venture capital community.

In terms of what was interesting to see during the quarter was the allocation of some of the investment activities. We saw a continued decline in information technology companies as we ourselves have been declining our information technology allocations for the past eight quarters. And, in fact, of the $14 billion invested in Q2, 21% of that, or approximately $3 billion, went to information technology, a dramatic decline of approximately 34%.

Business services and financial services companies, along with consumer services, each saw approximately $3.3 billion and $3.9 billion on investment activities going specifically into consumer services, also known as social medial or ecommerce transactions.

Healthcare itself saw a decline to approximately $3 billion of activities, or 21% of the investment in the second quarter.

Now turning my attention to VC exits, not surprising, as we advocated ourselves in the first quarter of 2014 earnings call, we saw a contraction in IPO companies going public. In fact, we saw the number contract to 25 completed IPO companies in the second quarter 2014, down from 38, raising $2.2 billion. Notwithstanding the number has declined, 25 million dollar companies going public is still an impressive number, of which one of those was a Hercules company, as I have referred to earlier as Glori Energy.

At the end of the second quarter, Hercules finished with approximately five companies in (inaudible) IPO registration. Not to be left behind, in the second quarter, we finished with an impressive 117 warrant positions in various technology and life sciences companies that we hold equity or warrant in those companies waiting to achieve an IPO event.

For the first half of 2014, 63 companies have successfully completed their IPOs, raising approximately $5 billion. On the VC fundraising, a very important indication of the health and well-being of the venture capital community, the venture capitalists themselves were quite successful raising money. They themselves raised $7.4 billion in the second quarter of 2014. And, although the amount is down by just 28% from the prior quarter, it is still a very strong first half of the year, not seen for quite some time raising approximately $18 billion of capital in the first half of 2014, a very impressive achievement by the venture capital community and our primary source of deal flow and repayment of our debt.

So I'm very happy to see that numbers remaining strong as they were in the venture capital.

Now turning my attention to the outlook for 2014, or the rest of 2014, including Q3. We certainly began to make various critical long-term strategic changes to our organization, most of which I started referring to in Q1 earnings call. We [set for] the foundation of change going into Q2 and laying out a foundation that I expect to be the bedrock of our growth for the next 10 years.

These changes will continue throughout the remainder of 2014, as we are gradually stepping into these changes on ensuring that our foundation and growth for the next 10 years [in place] sustain the continued market presence in them in the market that we see and our ability to continue to generate growing deal flow and new investment activities on behalf of our shareholders for new earnings and dividend growth.

As we begin to deploy the liquidity in our balance sheet, you can expect to see earnings growth begin to take shape further late in Q4, and certainly by Q1, as we start to convert this new liquidity.

We are still targeting and are confident of a portfolio growth of approximately 20% for FY14. This represents approximately ending the year with an investment portfolio, or I should say investment loan portfolio or approximately $975 million, or a billion dollars. That's of course if socio-market conditions remaining cooperative as we continue to deploy capital.

Looking into Q3, remainder of 2014, Q3, as a reminder for everybody on the call, that Q3 tends to be our slowest origination quarter. We took advantage of this slow origination quarter to make most of the structural changes that we're talking about, which I will refer to here in the foregoing paragraph, talking about our balance sheet and increasing our liquidity of our balance sheet and retiring some of our debt.

In an effort to ensure sufficient liquidity to meet this growing expectation of increased activities in Q4 and beyond, we successfully closed $100 million 10-year bond offering that we successfully priced at 6.25%, that is fixed rate in interest. This is very critical, as Hercules continues to originate loans with an average yield in about the 13% to 14% range, giving us a 600 to 700 base point spread yield on those assets.

However, I would like to remind everyone that you can expect that the initial interest expense associated with our new $100 million bond offering, will cause a near-term increase in the overall interest expense. That, in turn, will cause a potential negative impact into earnings as we deploy our new-found liquidity into earning assets.

That drag on earnings is expected to be approximately $0.01 to $0.015 in Q3, and should begin to dampen in Q4, as we convert that new liquidity into earning assets. The notes will significantly enhance and give us a competitive advantage on our long-term liquidity position and satisfy our growing unfunded commitments and our growing pipeline of new companies seeking capital, as well as lower overall cost of capital, as we continue to improve and lower our overall cost of our balance sheet in the debt financing.

In addition, on August 7th, we recently retired approximately $33.5 million of our existing convert bonds. Those bonds are exchangeable, or convertible, I should say, through September 30th, 2014. The impact of the retirement of the convertible bonds and Q3 EPS, with the issuance of approximately 921,000 shares, will cause an impact in Q3 earnings of approximately $0.01 to $0.02, attributed to the increase in the fully diluted shares to approximately 64.3 million shares that we'll have at the end of Q3.

Lastly, on the liquidity front, during the quarter, we also took advantage to test our ATM offering that we have available to us. During the quarter, we issued $10 million of equity offering under our ATM program, all highly accretive to book, raising net $9.5 million, and issuing 650,000 shares.

The impact of this capital raise and testing of our ATM, will cause an impact on earnings of approximately $0.01 in Q1, attributed to the denominator of shares of 650,000 shares being impacted on that calculation.

As to growing the firm and focusing on our foundation and growth, we are continually and actively hiring investment professionals at all level at Hercules. We've recently hired individuals for our operations in the finance and accounting group, as well as key members of origination team. We are actively looking to hire more individuals as we continue to expand our product offering and help service the needs of our venture capital and venture-backed companies in the marketplace.

We took these steps to ensure that our historical credit performance and diligence in monitoring our portfolio companies, as we looked for continued growth sustained through 2015, that we have the foundation in place to ensure that the rigors of our history are maintained in the discipline and credit underwriting discipline are maintained to ensure a prosperous and strong, growing portfolio.

[Truth is, many] hires, we expect SG&A to gradually increase commensurate in Q3, and catch up eventually in Q4. We have chose to make the strategic decision in Q3 to ensure that we are well positioned, as I said earlier. The growing pipeline and demand for venture debt has reached unprecedented levels. Many of our competitors, do not have access to the capital market, and are currently unavailable to raise additional equity capital.

With that, we are seeing more and more companies looking to seek financial partners who have a strong balance sheet and the wherewithal to withstand any change on the capital markets to be able to operate and fund their unfunded commitments if and when needed.

Our balance sheet has become an important source of strength and an important stent of confidence to our companies and our venture capital backed partners. We thank them both for their confidence and their continued deal flow that they provide us in the coming quarters and in the future.

As to our pipeline, I am happy to report that as of August 7th, our pipeline is quite robust with over $1.3 billion of pending transactions being evaluated for potential investment opportunities. Of the $1.3 billion, $135 million of that is represented in signed term sheets as of August 7th, 2014.

In addition to that, we have closed so far in the quarter, in Q3, approximately $48 million of commitments, and we funded $14 million of that. That is a very important ratio to keep track of that we'll speak to further in our Q&A session, but we are seeing a continued decline in the commitment to funding ratio from historical levels of 75% to 80%, to now modulating more closer to on the 50% to 65% level, that we've seen back in 2012. This is one of the reasons why you're seeing a growing, unfunded commitment number as well.

We finished with nearly $230 million of unfunded commitments. As I said earlier, this is critical as it represents future portfolio growth that if and when these companies draw down this money, we now have embedded asset growth internally identified with that unfunded commitment.

I am proud to say that as of August 7th, we have secured loan commitments of over $570 million, surpassing any other BDC attempting to establish a venture debt origination effort.

At this run rate of $570 million, we will easily eclipse the $1 billion mark in new originations, something that's never been accomplished or achieved at Hercules before. However, I want to caution, that is a significant number.

We are on pace and comfortable to shoot for a $700 million to $750 million level. But if things continue the way they are, it is not unforeseen to actually achieve a $1 billion origination mark in 2014.

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

Thanks, Manuel, and thanks everyone for listening today. I'd like to remind everyone that we filed our 10Q, as well as our earnings press release after the market closed. I'll briefly discuss our financial results for the second quarter of 2014.

Turning to operating results, we delivered total investment income or revenue of $34 million, a slight decrease of 1.4% when compared to the second quarter of 2013. Year-over-year decline was driven by the decrease in weighted average loans outstanding and is partially offset by increased loan fee acceleration due to early payoffs and loan restructures during the second quarter of 2014.

The all-in effective yields on [our investments] during the second quarter was 16.9, down by approximately 1% relative to the previous quarter. The decrease is primarily due to the effect of fee accelerations that occurred from a higher volume of loan early payoffs and restructures in the first quarter of 2014, as compared to the second quarter of 2014.

As we [signaled at the] beginning of the year, we are focusing on portfolio growth. We expect our investment origination yields to gradually compress by 30 to 50 basis points [for quarter] in 2014, as we deploy our excess cash balances into new interest-earning assets.

Interest expense and loan fees were approximately $7.6 million during the second quarter of 2014, as compared to $8.8 million during the second quarter of 2013. The year-over-year decrease is primarily attributed to the Q1 early payoff of $34.8 million of SBA debentures and $63.7 million of amortization of the asset-backed notes that has transpired since the second quarter of 2013.

The weighted average cost of debt increased to 6.3% in the second quarter of 2014, versus 6% during the second quarter of 2013, primarily attributed to the acceleration of fee amortization triggered by the amortization of the asset-backed notes in the second quarter of 2014.

Operating expenses for the quarter was $7.8 million, as compared to $8.2 million in the second quarter of 2013. The decrease was primarily due to a decrease in our (inaudible) compensation.

Q2 of 2014, net investment income was $18.6 million, compared to $17.6 million in the second quarter of 2013, representing an increase of approximately 5.7%. Net investment income per share was $0.30 for the second quarter of 2014, as compared to $0.29 for the same period of 2013.

We recorded approximately $7.3 million of net unrealized depreciation on our investments during the quarter. Of this $7.3 million of depreciation, $6.1 million was primarily attributed to net collateral-based impairments on our debt equity and warrant investments in seven companies.

We recorded $2.5 million of gross realized gains, primarily from the sale of warrant and equity investments in five portfolio companies. We ended Q2 of 2014, with total investment assets, including warrants and equity at a cost basis at approximately $995 million, with net up by $107.9 million from our investment portfolio balance of $887.7 million as of March 31st, 2014.

The increase was driven again by a strong origination and funding activity of new growth investments totaling approximately $173 million in the quarter. The debt portfolio company count increased by 10, up from 80 to 90 since March 31st of 2014. And this is attributed to three companies [setting us off], offset by the addition of 13 new companies, which span all of our industry verticals in a debt portfolio in Q2 of 2014.

As Manuel noted, we anticipate $60 million to $80 million of early payoffs in the third quarter. The companies which we believe may pay us off are from some of the earlier vintage years represented in our current investments portfolio, and, as a result, we do not anticipate a large revenue acceleration impact from these investments paying us off.

That investment amortization typically commences 9 to 12 months after an interest-only period that we have on our term loan, and the amortization is scheduled to occur over a 36- to 42-month time frame. Apart from earlier payments, we currently have scheduled amortization, as Manuel mentioned, of approximately $35 million from our portfolio on a quarterly basis.

With respect to the credit quality of our portfolio, the credit quality remains very solid. The weighted average loan rating of our portfolio was 2.10 at June 30th, 2014, reflecting a slight degradation in credit quality from 2.05 at the end of the first quarter.

We had three investments on nonaccrual at the end of the quarter, with a cost basis of 2.4% of the total investment portfolio and 0.7% of the total investment portfolio at fair value.

Regarding Hercules' liquidity, at the end of the second quarter, we had approximately $221 million in available liquidity, which includes $116 million of cash and $105 million of credit facility availability.

As of June 30th, our debt-to-equity ratio, including (inaudible) was 72.9%, lower than 76.1% as March 31st, primarily due to the amortization of the asset-backed notes.

As a reminder, our $192 point million (see press release $190.2 million) of SBA debentures are excluded for regulatory leverage calculation purposes. The exemption effectively allows us to leverage beyond a 1-to-1 debt-to-equity ratio to 1.29-to-1, which means that at the end of Q2, we had additional capacity to add $368.9 million of leverage on our balance sheet.

Our net leverage, which is calculated based on total debt minus cash, is approximately 55.3% at the end of June.

In June 2014, we utilized the ATM equity distribution agreement we put in place last summer. We sold 650,000 shares of common stock for total accumulated net proceeds of approximately $9.5 million, all then accretive to net asset value.

Note that subsequent to quarter end in July, we further bolstered our balance sheet for sustainable long-term growth. We closed a bond offering of $100 million 10-year 6.25% note and received notice yesterday of the underwriters' intent to exercise a greenshoe.

We intend to deploy the capital from the bond offering to fund new investments over the course of the next few quarter as we identify the right opportunities.

This week, as Manuel mentioned, we also retired approximately $33.5 million of our existing convertible notes with a combination of stock and cash payments. Note, we issued 921,000 of additional common shares in conjunction with this conversion. As a result, we anticipate a $0.01 to $0.02 noncash impact to our Q3 earnings due to the accelerating origination fees and the amortization acceleration of the conversion feature.

The present quarter impact of the net additional liquidity from our new bond offerings and retirements will be a net increase in interest expense of approximately one penny in the third quarter.

Our net asset value at June 30th, was $658.9 million, or $10.42 per share, compared to approximately $653.3 million, or $10.58 per share, as of March 31st. This small per share decrease in net asset value is due to dilution from the new shares from the ATM offering and as well due to the annual employee stock grants.

Finally, consistent with prior quarter, we'll be distributing a dividend of $0.31 to our shareholders, and this payment is scheduled to occur on August 25th.

But on closing, as Manuel mentioned, we are optimistic due to what we are seeing in the venture debt marketplace and we've been active in investing in a new origination talented team to address these opportunities that we see.

However, as we are Hercules, we will continue to take a cautious and steady approach to onboarding new assets in the third quarter and beyond.

As we noted, due to our proactive investment portfolio monitoring and management, we are cycling out of various investments, and we anticipate our debt investment portfolio will be flat quarter over quarter with the potential to decrease by $15 million to $25 million. So we remain committed to our strategy of controlled growth and we intend to continue to acquire stringent underwriting standards which have resulted in our stellar [first 10-year] performance and historically low historical loss rates.

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

Thank you. (Operator Instructions) Ron Jewsikow from Wells Fargo Securities.

I just had two quick questions here. What percentage of the new originations would you say fall into kind of the new ABL strategy, relative to your more traditional mix?

The ABL, as I said, just really started earnest in Q2, so little to none. The really outstandings that were -- the funded [basis] represent ABL, because it takes awhile to get the borrowing base to get the mechanics going. So little to none yet.

All right. And then just kind of, I guess then the long-term opportunity of that, kind of what percentage of originations? You kind of gave the 700 to a billion range for this year, depending on the market environment. What percentage in the long run do you see that making up of your origination mix?

I think that when you look at on a commitment basis, not on a funded basis, which is a critical issue --

Yes.

-- you're looking at that in a, I guess a fully focused year or a fully 12-month year. They give you probably as high as, on a billion dollar level, give you as high as 25% of the portfolio. On a funded basis, it'll probably be somewhere around 10% to 15% of that on a funded basis. But on a committed basis, it can be as high as 25%.

That's great color. And then just one last question and I'll hop back in the queue. I was wondering if you could talk about your decision to issue the 10-year baby bonds or term debt relative to maybe other options for financing, like securitizations, converts, or something else.

Well, don't underestimate that we are not going to be doing that as well. This is simply a very important critical part of the 10-year growth foundation that we wanted to show our ability to tap the 10-year bond market as a critical laddering out of maturities for our debt offerings, and especially when I can lock in 10-year paper at 6.25%.

We are certainly and will be actively approaching the securitization markets again sometime, I would say considerably something in the next six months or less you could see us tap the securitization market as you continue to convert new liquidity into funded assets.

We remain, as everything we do, very flexible in terms of the market, and where we're doing that. But, yes, securitization remains a very critical part of our funding strategy and certainly lowering our near-term cost of capital even further.

That's great color. I'll hop back in the queue. Thanks.

Thank you. Aaron Deer from Sandler O'Neill.

Manuel, the growth this quarter was very impressive, and you sound pretty optimistic going forward. Although, your guidance with respect to the third quarter, I guess was a little surprising. I understand the projected payoffs that you're anticipating.

But it looked like the number of term sheets was down. And I'm just trying to reconcile your guidance. How much of this slowdown, if you will, is really due to seasonality versus other factors that might be going on.

Well, a big significant part of it is, in fact, seasonality. So there's two embedded questions you're asking there. The portfolio decline, just to be very crystal clear here, is driven almost entirely by us.

If you have been following us for many years, you will see that it's pretty typical that we will proactively approach what we deem to be growing credit situations very proactively. And, in fact, look to prune or purge marginal credits or companies that seem to be showing evidence of stress or deterioration. And we tend to do that very proactively and look to managing the balance sheet as self evidence with our credit historical performance.

So if that means that we end up giving some earnings up because of credit quality, I am more than happy to give up a penny or two in earnings and not have a $20 million to $30 million capital loss from a bad loan. And that's exactly what we're doing here. And we do that pretty periodically throughout our history.

As to the term sheets, Q3 has always been slow. But I got to be honest, $576 million of signed term sheets through the August 7th or August 4th, is a pretty significant number when we had, I think it was $700 million of signed term sheets all of last year. I think that the element of the portfolio growth that you're seeing is certainly, as evidence, as I indicated in our opening remarks, attributed to the funding to commitment ratio. That funding to commitment ratio is both purposefully being managed by us downward, meaning that historical 75% to 80% funding rate, we are putting much more structured loans on the books. And those loans have purposefully structured risk mitigants to it.

Some of our competitors who don't know the asset class very well, venture debt, are willing to do deals. They don't have the structures. We invite them to come in and do all that they want. We're not going to do those deals. We are going to be congenially focused on credit quality and focused on sustained quality of earnings growth and we don't get paid for assets under management. So we care more about credit and margins than anything else.

And then what type of companies is it that you're pruning? Are there specific verticals or lending categories where you're pulling back from?

No. Actually, it's not discriminated against any one particular category. We're just seeing some signs of stress in the overall market. There is some anxiety on some companies that were -- let me be very clear.

A lot of venture lenders that don't know venture lending very well, rushed in over the last five or six quarters and did what they thought were a bunch of pre-IPO companies at quite excessive valuations. Those companies are now coming back around looking for money.

We have some of those in our portfolio companies that were also looking to achieve an exit event or liquidity event that have now seen that window being pushed out. And until we see a higher level of confidence of capital being injected in those companies, those companies represent a higher level of risk.

And we feel that currently that risk is not being properly priced. And other new, naive venture lenders are more than willing to absorb some of those assets. We're more than happy to encourage those assets to go see them.

And then lastly, in addition to the ABL and equipment finance, you also mentioned, I think acquisition finance, and there might have been one other, two new lending categories that you mentioned.

Can you talk about what types of yields you expect on each of those categories?

Well, the acquisition finance you mentioned, very attractive area. And what's going on in the acquisition finance is a lot of our later stage venture capital backed companies are looking to acquire either technology or customers from some weaker private companies and using our financing to actually bolt on either technology or customers through these acquisitions in order to groom themselves for a potential IPO.

So those transactions are very attractive to do. They're fraught with many due diligence issues as you -- looking at a target and making the due diligence analysis as a target and financial modeling it out.

So the growth that we'll see going into 2015, I mean, acquisition finance is probably going to be a $50 million to $100 million line of business maybe initially, because we're dealing with venture-backed companies, not necessarily lower middle market companies.

On the (inaudible) finance, this scenario that we're being pulled in every day more and more by our own portfolio companies, asking us to expand our product offering, we historically have said no to equipment-based financing. And now we have finally chosen to open up our balance sheet and now pursue those.

Those are equally attractive transactions because they offer what is basically a typical large backend final payment. It's called the end-of-term payment that you see done. So they have a [particularly] lower coupon rate on the front end, but have an effective yield that often time is much higher than the term loan, for example.

And then ABL, asset-based lending, is another asset item that we've been pulled into by our companies who have basically chosen not to go pursue a bank and want to stay with Hercules longer term. And so now we're offering anywhere between a $2 million to $20 million ABL line, and those will typically have an interest rate anywhere between 7% to 8% on a coupon rate, and they could have different structures to make that yield totally higher than that as well.

Okay. Thanks for taking my questions.

Thank you. Greg Mason from KBW.

Just to follow up on kind of this prepayment activity in the third quarter, calling the portfolio. Just is this companies that have financing options and you're just not defending your position and letting them go? Are you proactively telling them, listen, we want out, you need to find other financing?

Well, [I'm not going to say] specific to that question, I would say that we, as the incumbent, always have the option to defend the credit. In many of these cases, we're choosing not to defend the credit and let the credit find financing somewhere else.

Okay. Great. And then in the Q, you mentioned that you have filed for co-investment exemption with other affiliates. Are you looking at raising other funds or other strategic alternatives? Or what's that regarding?

Sure. As we look at the next 10 years, we are [certainly] looking at multiple different family of funds, if you will, like an Aries, like an Apollo, among others out there, a TPG. And we've come to the conclusion, similar to what these other very formidable and very reputable players have also noticed is that by having very specific vertical entities or funds that could complement our current activities, makes a lot of sense to leveraging the brand across these verticalized funds.

So we're certainly evaluating multiple different options in that area. We have yet to close on an initiative right now. But we are actively evaluating multiple different strategies by having verticalized entities that are in transactions by which Hercules does not work in today. And we feel that having a sister relationship with an affiliate fund would really strengthen the brand, and, more importantly, increase our access across the board to companies in different verticals or stages that we're not investing in today.

Okay. And then one last modeling question. Could you give us some level of the accelerated income in the quarter that was in the total interest income line, just ballpark?

Are you referring to Q2?

Yes.

Yes. So as we said, the total effective yields for the portfolio was 16.9%. Our historical rate of natural yield on the portfolio hasn't changed that much. There has been, as we talked about on the call, a slight degradation in our yields on a natural basis. But I believe historically, we've disclosed that a couple hundred basis points are typically related to the one-time effect of early payoffs and loan restructures.

So we don't know -- and, Greg, the other way to look at it is, so-called one-time fees that have become kind of a core one-time fee event is probably in the $2.5 million level. And then any one quarter you could add what is genuinely unpredictable one-time fees, if you will, the variability of that is probably another $2.5 million to $3.5 million that can vary wildly quarter over quarter.

As Jessica said in her comments, a lot of the early payoffs that we're seeing in Q -- anticipated in Q3, are going to be older vintage companies. So they're not going to have a lot of accretion of fee acceleration because they've been on the books for quite some time. And so these have been on the books for 18, 24 months, and, therefore, the impact of any early payoff is significantly dampened, contrary to what you saw occur in Q1 or Q4 of last year.

Great color. Thank you.

Thank you. Douglas Harter from Credit Suisse.

Most of my questions have been answered. But I guess just one, Manuel. I guess, can you talk about the timing of why raise the 10-year debt in front of a quarter where you're expecting kind of flat to down and still have significant cash position?

Well, first of all, we all are very cognizant of the global capital markets and the global geopolitical crisis going on. And with an unfunded commitment pipeline of $230 million and a growing backlog of signed term sheets, as well as a pipeline, the last thing I want to do is put our franchise at risk on having hit the brakes on new origination activities in Q4, because the capital markets are not there.

And I'd rather raise debt than equity, because the impact in EPS can be managed a lot more efficiently. And I think that the opportunity to raise 10-year paper that's locked in at 6.25%, I'll do all day long. And as evidenced by the incredibly successful offering that is, I feel in a very good position from a liquidity point of view to capitalize on the market we're going to be looking at Q4 and Q1, that we think a lot of that liquidity will be absorbed.

The other element of your question is that when the capital raise was being initiated for the bond, our credit outlook at some of these companies was not as gelled as it is today. And, therefore, the prepayment number was significantly south of what it is today. And we run a very fluid portfolio and credit process.

We are constantly, weekly or bi-weekly, evaluating the credit performance of the portfolio on a continuous basis. And so I'd rather be long liquidity all day long, than short liquidity with a growing pipeline.

That makes a lot of sense. Thanks, Manuel.

Thank you. And that concludes our question-and-answer session for today. I would like to turn the conference back for any closing comments.

Well, thank you, Operator, and thank you, everyone, for joining on this call today. And once again, we look forward to meeting with most investors and analysts in the upcoming conferences. We have a very busy September and early October on conferences and non-investor road show meetings that we'll be doing.

Our first conference coming up will be the RBC Financial Institution Conference September 16th, in Boston. We also have the J.P. Securities Conference September 30th. I believe we also have the Credit Suisse Investor Conference in mid-September in Manhattan as well.

If you'd like to arrange a meeting at any of these conferences or spend more time with management, we'll be happy to do so. Please contact our Investor Relations Department. And once again, thank you for your continued interest and support of Hercules Technology. And we are continually working hard on behalf of our shareholders.

Thank you very much, Operator.

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may now disconnect. Everyone have a good day.