Hercules Capital Inc (HTGC) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Hercules Technology Growth Capital second quarter 2015 earnings conference call. At this time, all participants are in listen-only mode. Later, we will conduct a question and answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this conference call is being recorded. I would like to now introduce your host for today's conference, Senior Director of Investor Relations, Mike Hara. Mr. Hara, you may begin your conference.

Thank you, Candace. Good afternoon, everyone, and welcome to Hercules' conference call for the second quarter of 2015. With us on the call today from Hercules are Manuel Henriquez, Founder, Chairman, and CEO; Mark Harris, Chief Financial Officer; and Andrew Olson, Vice President of Finance and Senior Controller.

Hercules' second quarter 2015 financial results were released just after today's market close and can be accessed from Hercules' Investor Relations section at www.htgc.com. We have arranged for a replay of the call at Hercules' webpage or by using the telephone number and passcode provided in today's earnings release.

During the course of this call, we may make forward-looking statements based on current expectations. Actual financial results filed with the Securities and Exchange Commission may differ from those contained herein due to timing delays between the date of this release and in the confirmation and final audit results. In addition, the statements contained in this release that are not purely historical are forward-looking statements. These forward-looking statements are not guarantees of future performance and are subject to uncertainties and other factors that could cause actual results to differ materially from those expressed in the forward-looking statements including, without limitation, the risks and uncertainties including the uncertainties surrounding the current market turbulence and other factors we identified from time to time in our filings with the Securities and Exchange Commission.

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

And with that, I will turn the call over to Manuel Henriquez, Hercules' Founder, Chairman, and CEO.

Thank you, Michael. Hey, good afternoon, everyone, and thank you all for joining us on the call today. I would first start off the call by welcoming our new CFO, Mark Harris, who I believe represents an outstanding addition to our senior management team given the extent of experience and background in distressed lending, Asian capital markets, an also as a former CFO. Welcome, Mark, and we look forward to working with you and growing the organization.

Now let me turn my attention to Q2. Q2 was a very solid quarter for Hercules. On many fronts, we achieved growing NII of $0.23 per share, expanding our investment portfolio, expanding both our core and effective yield, as well as expanding our senior management team and board of directors.

In Q2 2015, Hercules reached another significant milestone of achieving just under $5.5 billion of capital commitments to venture growth-stage companies since inception of December of 2003, representing over 325 companies who have chosen Hercules as their financial partner. I cannot emphasize the significance and importance of that distinction and I'm deeply grateful for the selection of those companies in choosing Hercules as their partner along with the venture capitalists and entrepreneurs. So, thank you very much for that. We are deeply, deeply grateful for that continuation of the vision and support of the entrepreneur and venture capital community that has led to the following financial performance that we will discuss on this call.

We executed on all fronts, working on growing our DNOI and NII back to historical levels of $0.31 per share. We expect to accomplish this over the next two to four quarters subject, of course, to market conditions and remaining cadence of originations and effective yields to increase during that period of time, both of which will lead to closing of the gap between our dividend and our current NII as we continue to grow the portfolio.

Now, for some of the highlights before I turn the call over to Mark and Andrew, our VP of Finance, to provide you a summary of financial performance. First, both Hercules and the venture capital community were extremely busy during the second quarter of 2015. Hercules, in turn, originated nearly $245 million of new debt and equity commitments during Q2, another very strong performance. As to the first half of 2015, I'm proud to say that we accomplished nearly $500 million to the approximately $516 million of debt and equity new investments for the first half of 2015, putting us on pace to potentially exceed all of 2014 if we continue this level of performance.

The venture capitalists, in turn, were very, very busy. The venture capitalists invested nearly $21.5 billion in the first half versus $34 billion in 2014. The venture capitalists invested -- excuse me -- $35.9 billion in the first half versus $57 billion all invested in all of 2014. In Q2 2015, alone, the venture capitalists invested $19 billion to over 1,000 transactions or deals representing nearly a 15% increase quarter over quarter; a very, very impressive number and a number that was actually higher than I was anticipating the venture capital activity to do.

But, what's most impressive was that this was the sixth consecutive quarter of more than $10 billion invested by the venture capitalists in a single quarter and the highest quarter investment activity since 2000. The venture capitalists continue to be very focused on growing their investment portfolio and we're excited to participate in this new wave of investment activity being pursued by the venture capitalists.

Why? Because, as the venture capital community continues to invest in these companies, all of these companies have become viable candidates and potential prospects for Hercules to convert as potential future portfolio companies and continue to grow our investment portfolio. It is a very critical component to continue to see investment capital activities taking place in the market, as that is a primary source of deal for Hercules and our continued source of funding for our portfolio companies to service our own debt.

With that said, Hercules continues a very focused and disciplined growth in our portfolio throughout 2015. We are still focused on growing the portfolio to a total of $1.3 billion to $1.5 billion. And, as you'll see in this call, we are now approaching the lower end of the growth curve of $1.3 billion and it's only the first half of the year.

We achieved $85 million of loan net portfolio growth during the second quarter, representing an 8% increase. For the first half of 2015, we achieved an impressive $219 million of net portfolio growth, representing 23% growth on a year-to-date basis and 23% as compared to Q4 of 2014; well on our way to achieving the 30% to 50% portfolio growth.

At the end of Q2, our loan investment portfolio represented $1.17 billion. I want to highlight that number because we have noticed that some analysts and investors have erroneously taken our total investment portfolio result and tried to multiply it by an effective interest rate yield. We would like to draw the attention to our investors and our analysts to please focus on the loan investment portfolio when calculating your effective yields and our future income that we derive from that portfolio.

We are confidently on track to continue to track to the bottom end of that growth of $1.3 billion with nearly $1.17 billion of loan portfolio achieved to date. With the ample liquidity that we have on our balance sheet and the ability to expand our leverage on our balance sheet further up to the 1.1-times multiple, we feel that we have ample liquidity to continue to execute and deliver the results on our portfolio growth. However, we remain very cautious and selectively investing in companies as we approach a tighter liquidity position as we want to ensure that we select the best of the companies that we find out there that offer the most attractive yields and the best loan-to-value as we underwrite to continue that portfolio growth.

Thirdly, Q2 represented a very strong and beginning to see our core effective yields and our effective overall yields begin to rise. Although we had anticipated a slight drop in our core yields in Q2, we, in turn, experienced a slight increase in our overall yields including our core yields. That is a mixture and a combination of the asset mix between deemphasizing slightly our asset-based lending, or ABL, revolver-type financing with new loans that we were originating during the quarter.

Normal and early repayments remain relatively flat and as we expected contributing to our core yields and our effective yields as follows. Our core yields during the quarter rose from 12.8% in Q1 to 13.2%. We had been expecting to see core yields trough around 12.6% to 12.7% and, in turn, they rose.

Our effective yields, in turn, also rose. And, in fact, our effective yields during the quarter rose by 100 basis points. The effective yields ended at 13.8%, up from 12.9% in Q1; a trend that we expect to continue to see throughout the second half of 2015. However, I would caution I expect Q3 effective yields to rise modestly from the 13.8% level but begin to rise in Q4 to 14%-plus levels in Q4 as we expect to see an increase in early repayment activities begin to take place from our portfolio as our portfolio begins to mature in Q4 and beyond.

I am delighted to see much of the work that we have made and much of the investments that we've made in our infrastructure and our organizations once again begin to take hold. I know many investors were concerned about the dip in Q4 and Q1. But, as I indicated in our call previously, these are purposeful investments that we've made to ensure that our platform was well-positioned for growth in the coming years as we then accelerate growth later on in 2016 and beyond as we grow our investment portfolio overall. In an effort to do that, we made the conscious decision to make the investments necessary that we believe would lead to this growth, which I'm happy to say are beginning to take shape and begin to pay dividends on our performance.

That has manifested itself with the growth in DNOI and NII, as you see in Q2, at $0.27 and $0.23 respectively. NII for Q2 was $16.8 million or equivalent to $0.23 per share, up an impressive 29% over Q1 NII. Conversely, DNOI representing $19 million or $0.27 a share was also up a respective 21% over Q1; an very strong indication that our investment is beginning to bear fruit and we expect to see a continuation in growth in both NII and DNOI throughout 2014 as we work to close the gap by the end of the year or sometime in Q1 where we should expect to see DNOI and NII start matching our dividend rate at $0.31 per share.

I expect operating expenses to begin to level off in the second half of 2015 as both the majority of investments have already been put in place for the operating expenses and infrastructure. Yes, we may see gradual increases in variable compensation directly correlated and attributed to continued portfolio growth. I remain committed, as I said earlier, I remain committed to covering our dividend through DNOI and NII and I am confident in our team's capabilities as we continue to grow the portfolio and also beginning to see an additional increase in effective yields that will further help drive and close the gap as our effective yields begin to rise, generating additional interest income that would help further close the gap. This is why we have given a prospective target of three to four quarters because if effective yields rise sooner than we expect that actually may make the NII close the gap sooner; meaning occurring by Q4.

Now, for today's agenda. A brief summary of the key operating metrics and highlights of Q2; an overview of the current market conditions including venture capital activities, M&A, and IPO events; and our prospective outlook for the investment activities for Q3; and then I'll turn the call over to Mark Harris, our CFO, along with Andrew, to cover our financial performance of the Company in Q2.

I want to take this moment to say, thank you, Andrew, for stepping up as our interim CFO. You've done a masterful job and a great job and you continue to do an outstanding workmanship. So, thank you for that commitment and your support as a team player.

Now, key highlights for Hercules outstanding accomplishments and performance during the quarter. As most of you have been with us for a long time, I'm proud to announce that we completed our 40th consecutive quarterly dividend of $0.31 per share, representing nearly $11 in distributions to our shareholders since our IPO in June of 2005. Our total investment assets have increased to $1.24 billion representing a 7% increase quarter over quarter. Again, I want to emphasize the total investment portfolio of $1.24 billion includes both equity and warrants in that composition and $1.17 billion of that is interest-earning loan assets.

With that said, we ended the quarter with an extremely strong liquidity position of nearly $216 million of liquidity available to us on our balance today. This liquidity will afford us the ability to continue to grow our portfolio and we have access, as Mark will cover in his presentation, additional access for additional leverage in our portfolio to grow the portfolio beyond that $216 million of liquidity. You can certainly expect over the next two to three quarters that we will continue to convert debt liquidity if and when we believe that the quality of assets that we want to invest in and the yields and structures are favorable for what we deem to be an appropriate investment.

We continue to lower our overall cost of leverage or funds and most of you have seen in this quarter that we've begun this process by redeeming $20 million of our $84.5 million April 2019 due -- excuse me -- due April 2019 baby bonds of 7%.

We experienced subdued and below normal unscheduled early principal repayments. Total principal repayments during the quarter represented $78 million, of which $47 million of that was basically unanticipated early repayments. In short, flat to Q1, and as we expected. I want to emphasize again, we do expect to begin to see a gradual increase in early repayment activities primarily focused on the fourth quarter that will help further lead effective yield growth in our portfolio.

The reason for that occurrence is, as our portfolio begins to mature from an overall weighted-composite age, we expect the portfolio, once it starts achieving an 18-month or greater maturity, that you would tend to see a higher level of early repayment activities take place. This is a very nice showing on the performance of our team and continue to pick the right companies as we focus on growing the portfolio and not seeing these early repayment activities take place.

Now, as to our portfolio base and their performance on achieving liquidity events on their own, we have seen six portfolio companies currently file for IPO offerings. Subsequent to quarter end, Neos Therapeutic and ViewRay both have completed their public offerings. Also during the quarter, one of our oldest investments, Atrenta, also completed definitive agreement to be acquired by Synopsis.

All of this culminates into additional realized gains that, on a year-to-date basis, equates to approximately $2 million of realized gains that also further serve to continue to provide future dividend coverage and/or a potential future spillover dividend coverage and this will just revisit to our shareholders in the form of those capital gains.

As I indicated at the beginning of the call, Mark Harris has officially begun as our CFO and his effective date was August 1. And, finally, as we indicated in our press release, I am proud to say that our diligent efforts and our board's governance committee has been working diligently on expanding our board. I am proud to say that we now have gender diversification on our board with Mrs. Susanne Lyons recently joining our board as well as Mr. Rod Ferguson and Joe Hoffman most recently joining our boards. That makes the totality of our board now of seven board members, six of which are independent board members. I felt that this was a critical step in the future growth of our company of having a widely-diversified board with extensive experience in the categories and areas of our investment activities.

Now, turning my attention to the venture capital marketplace and specifically the activities in IPO. Deal flow continues to be very robust. I am proud to say and happy to say that Hercules continues to enjoy a very robust pipeline. At quarter end, we had nearly $1.3 billion of transactions, which are defined as companies looking for financings and we're in the process of vetting those opportunities by conducting due diligence and engaging in discussion of those companies. This gives us a high level of comfort on our capabilities to execute and continue to deliver the results for our shareholders.

However, we have remained very, very conservative in our outlook as we are very selective in deploying our liquidity capital to the right companies. We will not compromise credit. We will not compromise yields. And we stay to our (inaudible) and our historical credit performance. And that is; remain selective. Be cautious in growth. Be slow and steady and not worry about, necessarily, quarterly growth, but worry about long-term portfolio value creation for our shareholders. We remain committed to that endeavor and I feel comfortable that we'll achieve our goals with that discipline in place.

Our leadership and market reputation is self-evident. With nearly $250 million of new commitments executed in Q2 alone, is a testimony to our firm's ability to attract and work with the venture capital and entrepreneur communities and also seeing venture growth-stage companies seeking the support and backing of Hercules. I'm deeply grateful to the hard work of our origination team. Without that team, this continued growth and perseverance would not have been made possible.

However, I want to make sure that we look towards the second half of the year and we look to changes that we expect to occur. We're seeing evidence that Q3 is becoming or returning, I should say, to historical normalized levels. What I mean by that is that Q3 typically is our slowest period of time. The last two years that has not been the case. However, we are seeing evidence today that Q3 is beginning to normalize itself back to historical levels and Q3 typically represents around 15% of our historical origination activities. I am happy to see that. It allows us to continue to be very selective and be prepared for a very strong and expected Q4 2015.

I'm expecting the fourth quarter of 2015 to be a very strong quarter and also end up being a back-end weighted quarter on new commitments and originations. We are extremely well-positioned to take advantage of that and, in fact, I would say we're better positioned than most of our competitors with our ability to have dry powder and additional access to liquidity to grow the portfolio.

With that said, the competitive landscape remains strong. It by no means has ebbed meaningfully. It remains strong, but becoming rational. What I mean by that is those players with capital are beginning to exercise prudent judgement and becoming selective. We're beginning to see evidence that silly-priced deals and light-covenant stretch deals are beginning to go away. I think that we need one more quarter to have that shaken out and those with capital will be able to take advantage of the well-positioned portfolio opportunities in the fourth quarter and the first quarter of 2016. We are purposefully positioning ourselves for that expectation in the marketplace.

The increased liquidity in the market does have and has continued to led to our biggest competitor bring equity capital, not other-debt financings. Many of other companies are experiencing disproportionately high valuations due, in no part, by no short order, by the increase in liquidity in the market and everyone trying to position their portfolios to find the next available exit event from an M&A or an IPO event. Equity capital is now, by far, our biggest competitor in the marketplace today.

We are seeing that also in our own portfolio by seeing increases in valuations on many of our private companies who receive higher valuations. In one perspective, we welcome that. It solidifies our portfolio position with our companies and strengthens our own debt position and amortization from our companies. But, it does lead to higher valuations that give us some bit of a concern as the market is approaching fairly frothy levels in valuations out there. However, by remaining disciplined and staying focused and adhering to our historical underwriting standards and criteria, we feel that we're more than able and prepared to navigate those waters as indicative in our 11-year history and historical credit performance that speaks for itself.

I have recently been on the road meeting with many investors. I was struck by many facts and misunderstandings that I learned on the road with our investors. Two items in particular stood out the most. One, that Hercules was an early-stage investor, which is not true. And the second, that Hercules loan book is not asset-sensitive, which is also not true. So, let me opine on both of those opinions and help set the record straight for our investors and our analysts to better understand the Hercules portfolio make-up and why we're well-positioned for what we are.

First and foremost, despite what some of our competitors may say, Hercules generally does not invest in early-stage companies. And, in fact, our portfolio is probably less than 2% focused on early-stage companies. In fact, our portfolio is extremely well-positioned to be venture growth-stage companies. These are companies that will be pursuing IPOs or M&A events anywhere between 36 months to 24 months and, in some cases, less than that. Our performance in our liquidity events speak for itself on our portfolio. And I would call your attention to our investment portfolio and all of our companies listed on our website.

The other item was much more striking. And that is the misconception, despite our 10-Q's disclosing, our asset sensitivity on our portfolio. Hercules made a conscious effort beginning in 2007 to change its construct and moving its portfolio to variable loan pricing. And, in fact, nearly 97% of Hercules' portfolio is indexed off of prime or LIBOR rates as floating. As you'll see, both in our press release and our 10-Q, 100 basis points movement, for example, in prime rate will lead to nearly a $10 million net investment income increase representing nearly $0.14 that would drop straight to the bottom line.

Our entire liability structure, with the exception of $15 million of our Wells bank line, are all fixed rate in nature, well-positioning for any future rate increases and allowing us to have a highly-accretive growth in investment income on behalf of our shareholders. I am very proud about that accomplishment. We've worked diligently over the last seven years to position the portfolio to make sure that we're asset-sensitive. I want to make sure that is addressed unequivocally.

As to the venture capital support. Venture capital companies continue to experience good exit events. Those exit events have been manifested in portfolios of Hercules with six companies filing for IPOs, one completed M&A event, and two completed IPO events. Venture capital fundraising also remains quite strong and, frankly, at astonishing levels. The venture capitalists raised $13.5 billion in Q2 versus $8 billion in Q1 for a total raise of nearly $20 billion in the first half the year.

Venture capital allocations also tend to emulate the Hercules portfolio. Business and financial services saw a 30% increase quarter over quarter in investment activities. Information and technology, however, was down to 28% signaling some of the concerns that venture capitalists may have with some hardware investment activities. Consumer services, gaming, on the other hand, experienced a very strong 20% increase, while healthcare experienced a 20% decrease and energy and utilities a 1% decrease in investment activities.

In terms of exits, 27 venture capital companies went public, raising $2.6 billion, 91 companies achieving M&A events or exits for securing nearly $10 billion in valuations. And, as I said earlier, six of our companies are in registration, two completed IPOs, one completed M&A event, and we have realized gains and losses for the year of nearly $2 million for future distributions.

Now, and finally turning my attention to the remainder of [2015] Q3. Q2, as evidenced, delivered very strong performance. We are firing off on all key indicators. The key indicators that we look to and monitor all give us confidence in our continued selectivity to grow portfolio and continue to drive NII and DNOI forward. This gives us ample confidence in covering our dividend.

Loan growth in Q3 is expected to be between $30 million to $50 million as we get more selective and as we see a return to more normalized levels of Q3 slowdown in investment activities. As we've indicated historically in the past, Q3 typically is the slowest period of time because primarily our venture capital partners are typically on vacation and thereby our underlying portfolio companies are usually unable to hold board meetings and therefore approve and close financings that are pending.

Loan origination and funding activities continue to be back-end loaded in the quarter. I think that this has now become the new norm and we are adjusting our own models and our own forecasts to take into account that loans are funding later in the quarter thereby not adding a lot of accretion into income because the loans remain outstanding for a much shorter period of time during the quarter because the back-end loaded nature in the quarter. We would ask and call our investors to take that into consideration and begin to effectively look at and use weighted-average loan balances intra-quarter as opposed to only using the ending loan balance during the quarter. Why I say that? It is very typical that early repayment and amortization typically are front-end loaded while new loans that being funded are back-end loaded hence, yielding a lower intra-quarter weighted portfolio yield balance.

We expect during Q3 that our core yield to stabilize between the 12.5% to 13% range, while our effective yields would modulate between the mid-12% to mid-13% levels. As we approach Q4, and again repetitive to what I said earlier, we expect our effective yields to begin to rise to low- to mid-14% levels that will have a contribution effect on the positive to help growing our NII even further. However, it is very difficult for us to actually forecast exactly what that number may be and that could lead to a one-penny swing in NII merely on effective yields occurring in the quarter late or early in the quarter.

As I turn my attention to operating expenses, which we are scrutinizing quite heavily, we expect to see that our operating expenses should begin to flatten out in Q3 and Q4. We are hiring slower than I would anticipate. However, we remain focused on expanding our origination team and business development team by additional eight to 12 investment professionals. However, that process, like our investment activity, may take anywhere between 12 to 15 months. We hire and invest under the same criteria. We're highly-selective and we'd rather go slow than rush.

Now, turning my attention to dividend coverage and NII. We remain very confident in our ability to cover our dividend both from continued growth in organic DNOI and NII as evidenced in Q2 2015 as we've shown growing to $0.23 per share. However, many investors also during the road show seem to have forgotten that we have an earnings spillover of nearly $16.7 million representing $0.23 a share that, in the event that we would run short on covering our dividend through NII or DNOI, we have literally $0.23 of additional coverage just by our earning spillover, well and before any additional contributions or help from capital gains in our portfolio. We remain very focused and believe confidently that we will grow and close the gap in our DNOI or NII to our dividend coverage sometime in the next three to four quarters.

As we turn our attention, we generated nearly $0.43 in NII for the first half of 2015. As I said a minute ago, we also have $16.7 million of earnings spillover representing $0.23 a share. Let's not forget, as we continue to harvest portfolio gains, as we've done and expect and continue to do, we already have $2 million of realized gains net in our portfolio representing $0.03 in potential dividend coverage if and when needed or, better yet, representing future dividend spillover or carryover for future years to our shareholders or supplement our dividends in the future.

Add to that our eventual and potential realized gain for our Box holding and, to be conservative, let's assume that that gain represents anywhere between $13 million to $20 million in net gains. That gives us an additional $0.18 to $0.28 in additional dividend coverage, which I hope not to rely on, but we have as a fallback if we need to if for some reason DNOI and NII grows less rapidly than I expect it to. I do not expect that to occur. I do believe that DNOI and NII will continue to grow on a very consistent cadence for the next three quarters at an average rate of $0.02 per quarter on NII. That, of course, is contingent upon the continued market condition remaining favorable and our deployment of capital and continued realization of realized early payoff activities leading to effective yields to increase.

Because of this, you can actually begin to model out the possibility of an earnings spillover in fiscal 2014 to 2015 directly correlated to the realization of gains. That should give our investors the confidence that we've had internally about our dividend coverage and our ability to continue to grow and cover our dividend with confidence.

We continue to be very disciplined in credit. I have to emphasize again; we will not rush to underwrite. We do not underwrite simply to try to make quarterly numbers. We remain disciplined in our credit approach, in our tenacity on ensuring that our historical credit underwriting standards remain in place. I am proud to say that, since inception, nearly 11 years, our cumulative net GAAP losses are just under $10 million for the entire 11-year period of time. That represents a loss rate of less than 2 basis points on nearly $4.4 billion, $4.5 billion of commitments. That speaks to our discipline and our focus on prudently growing our investment portfolio and continuing to add value for our shareholders.

On liquidity, nothing of this whole entire discussion would be complete without a crisp understanding of our liquidity position. We have nearly $216 million of dry powder to convert into interest-earning loans. Let's, for example, assume the $1.1 billion of loans that we have. Add to that the full $216 million gets deployed. You are looking at nearly $1.3-plus billion of investment loans earning income at 13%, 13.5%, 14% yields. When you do that math, you will see the confidence that we have in ourselves in continuing to execute and grow NII and dividends.

With that, we're focused on prudent growth. We have additional liquidity. We can leverage our portfolio if we so choose to do so. We have the ability with the executive order from SEC to actually leverage our portfolio to 1.25 to 1. Our comfort zone, as we've indicated on many calls in the past, is approximately 1.1 maximum leverage that we feel comfortable, at this point, going up to. With that leverage capabilities we have more than an abundance of capital due to our portfolio. Mark, during his overview, will provide you with much deeper insight into that.

Mark, at this point, I'd turn the call over to you.

Thank you, Manuel, and good afternoon, ladies and gentlemen. I'll briefly discuss our financial results for the second quarter of 2015 and add some context to the reported numbers.

Investment income increased to $38.1 million in the second quarter versus $32.5 million in the first quarter of 2015, an increase of 17% quarter on quarter. Our loan portfolio grew on a cost basis to $1.17 billion in the second compared to $1.085 billion in the first or an increase of approximately 8%. Further, our weighted-average loans outstanding during the quarter grew by $101.7 million in the second quarter compared to $80.9 million in the first quarter.

Core yields, which exclude the effect of fee accelerations that occurred from early payoffs and one-time events, increased to 13.2% in the second quarter compared to 12.8% in the first quarter, an increase of approximately 3%. This increase is mainly attributable to the expiration of commitments in the second quarter. We expect our core yield to stabilize at a range of 12.7% to 13.2% on a going-forward basis.

The GAAP effective yields increased to 13.8% in the second quarter from 12.9% in the first quarter, an increase of approximately 85 basis points. This increase is primarily related to the acceleration of interest and fees pertaining to early loan pay-downs and payoffs, which we're $47.3 million in the second quarter compared to $46.5 million in the first quarter of 2015. We expect the second half of 2015 to pick up as our loan portfolio ages, which we'll discuss shortly, but most of this will take place in the fourth quarter.

Interest expenses, excluding fees, fell by 4% to $7.6 million in the second quarter compared to $7.9 million in the first quarter of 2015, a decrease of approximately $300,000. This was largely due to the retirement of the $20 million of our 2019 7% baby bonds at the end of April, which saved us approximately $230,000 in interest charges in the second quarter. Further, our 2012 asset-backed notes that were paid off in the second quarter had another approximately $120,000 of savings compared to that of the first quarter.

I do want to point out that we drew down $50 million on our Wells Fargo facility, but there was no meaningful impact on our interest expense in the second quarter as we drew down at the end of that quarter. I would like to point out that the Wells Fargo facility has an interest rate of LIBOR plus 325 basis points with no floor on LIBOR. Thus, we would expect a quarterly interest charge of approximately $450,000 going forward, pertaining to this draw down at current LIBOR.

In an attempt to reduce our weighted-average cost of capital, we have begun the process to look at our financing options mostly to finance out our 2019 7% baby bonds, which will all be callable at the end of September. In the event we retire those bonds, there would be a non-cash charge of $3.4 million due to acceleration of debt issuance costs pertaining to this financing that were previously capitalized.

Future interest rate hikes are always on our agenda. We monitor that closely and we believe we have a very well-positioned balance sheet in the event of future interest rate movements. As Manuel stated first, we always keep an eye on the Federal Reserve minutes and discussions as well as other market trends and information. But any increase in interest rates should not have a material impact on our interest expense as 92% of our debt are fixed-interest rate facilities.

Second, 97% of our loans are variable interest rate loans with floors. Thus, a 50 basis points increase in the prime rate, which most of our loan agreements are based, would be accretive to our interest income by approximately $5 million on an annualized basis.

Our weighted-average cost of debt was 6.1% in the second quarter, which is the same as the previous quarter. Fees were flat as weighted-average cost of debt remained constant between periods due to pay-down of 2012 asset-backed notes and related acceleration of fee expenses in the first quarter compared to that of the pay-down of the 2019 7% baby bonds in the second quarter and the related acceleration of fee expenses.

Backing out acceleration of non-cash fee expenses, we were at 5.5% in both the first and second quarter. However, with our efforts to reduce our weighted-average cost of debt, we would like to see this fall below 5% and have started our efforts to find financing alternatives, as we discussed earlier on this call.

Net interest margin increased to $29 million in the second quarter from $23.1 million in the first quarter or an increase of 25%. Net interest margins as a percentage of average yielding assets excluding equity further improved from 8.2% in the first quarter to 10.2% in the second quarter. Much of this increase was taking our previous liquidity drag and putting it to work on new loan origination opportunities.

Operational expenses, excluding interest and fees, increased in the second quarter to $12.2 million from $10.1 million in the first quarter or an increase of 20% quarter on quarter. G&A went up to $4.1 million in the second quarter from $3.6 million in the first quarter or an increase of 12%. This increase was mainly stemming from external legal, consulting, and recruiting fees in the second quarter, which we do not expect to continue in the longer term. Employee compensation increased to $8.1 million from $6.5 million or an increase of 25%. This increase is consistent with our continued portfolio growth as we increased our variable compensation accrual for the team accordingly.

Net investment income increased to $16.8 million in the second quarter versus $13 million in the first quarter or an increase of 29%. On a per-share basis, net investment income increased to $0.23 per share in the second quarter from $0.20 per share in the first quarter or an increase of 15%. Non-GAAP, excluding the two-step method, came in at $0.24 a share in the second quarter. This once again demonstrates the positive performance we continued to maintain throughout the first half of the year with a net loan portfolio growth of $218.6 million on a cost basis.

Debt funding in the second quarter was $160.2 million, taking us to $367.2 million for the first half of 2015. Debt commitments in the second quarter were $239 million taking us to $508.5 million for the first half of 2015. Further, much of our origination in the first quarter happened towards the tail end. For example, $74 million was funded in the last 15 days so the first quarter didn't get the full benefit of those investments.

Realized gains were $2.1 million in 2015 or $0.03 per share as well. We did have unrealized depreciation of investments of $12.8 million in the second quarter compared to an appreciation of $5.6 million in the first quarter. Remind you that 92% of our overall investments are in loan portfolios and, of that, our impaired loan portfolios, which accounts approximately 10% of that amount on a cost basis, has appreciated by $7.4 million. The other 90% of those loans on a cost basis had appreciated by $1.5 million.

Our equity, which comprises of 6%, had depreciation of about $5.7 million. 63% of that depreciation were in public shares where $2.1 million were in the private shares. And, last, warrants, which account for only 2% of the overall portfolio, had depreciation of $1.2 million.

Overall, our loan portfolio increased to 96 companies in the second quarter from 91 companies at the end of the first quarter, an increase of 5%. We added nine new companies to our debt portfolio and we also had four companies pay off their debt in the second quarter. Our average contractual terms are still between 36 months and 42 months. However, with prepayments, IPOs, and M&A activity, we still experience, on most, an average center between 22 months and 24 months with prepayments usually beginning, on average, in the 19th month.

The weighted-average age of our portfolio at the end of the second is young, given the velocity of prepayments we experienced in 2014. As such, we would expect to see retention in our portfolio over the next couple of quarters leading to loan growth that Manuel had spoken to.

With respect to credit quality, we remain solid with a weighted-average loan rating improvement slightly in the quarter to 2.25 in Q2 versus 2.26 in Q1. The number of our non-accrual loans did increase by one compared to the previous quarter. However, one of our non-accruals also showed signs of improvement, which we are monitoring very closely.

Liquidity went from $321.8 million in the first quarter to $216.4 million in the second quarter. Cash fell by 55.8% to $116 million at the end of the second quarter largely from a $20 million payment on the 2019 7% baby bonds as well as $22 million dividend payment and loan origination activities.

Our credit facility availability fell from $150 million in the first quarter to $100 million in the second quarter as we drew down $50 million on our Wells Fargo facility, as previously discussed. Our debt to equity ratio remains strong. Regulatory leverage, which is excluding SBA as we have an exemptive relief from the SEC, was 60.5% at the end of June versus 55.6% at the end of March. Total leverage, including the SBA, was 86% at the end of Q2 versus 80.5% at the end of Q1. And total net leverage, without cash, including the SBA, was 70.4% at the end of Q2 and 58% at the end of Q1. Based on our net regulatory leverage ratio, we have the ability to add another $294 million of debt without breaching our debt-equity ratio requirement.

Net assets did fall by $19.6 million to $743.7 million at the end of the second quarter primarily due to the dividend payout in the quarter of $22 million. NAV per share was $10.26 versus $10.47 last quarter.

Last, we're pleased to be declaring our 40th consecutive dividend of $0.31 per share that will be paid on August 24th, as approved by the board of directors, with a record date of August 17th. Based on our current projections, we expect our 2015 dividends to be covered through a combination of our operational performance and the spillover of $16.7 million we have from 2014.

With that report, I'll now turn the call over to begin our Q&A period.

(Operator Instructions). John Hecht, Jefferies.

Thanks very much and congratulations on a good quarter and thanks for taking my questions. Real quickly, we're aware that you guys are very sensitive on an asset-sensitivity level. But I'm wondering, and forgive me if you commented on this, Mark, but what happens if rates, as rates go up toward that 100 basis point increase? For instance, what happens when rates are up 50 basis points? Are you guys still accretive in that zone?

Yes. The answer, as I said in my previous remarks, if it goes up 50 basis points, it would be approximately $5 million accretion overall. We talked about, Manuel did, if it was 100 basis points. Remember, as interest rates go up, obviously it impacts anything that's variable. Well, on our own debt side we're pretty fixed so it's not going to really impact that. As I said, 90%-plus is fixed-rate loans. But, almost all, 97%, are variable-rate loans in terms of the investments that we give. Therefore, any interest rate movement on the upside definitely would be accretive to the overall P&L.

Okay. I did catch that. Thanks for reminding me and clarifying that. You have one new NPA. Which one is it or which company is it and what's the NPA as a percentage of cost now?

Our overall non-performing assets or non-accruals are limited to, I think three companies right now. And, Andrew, would you give that number please?

Yes. On non-accrual compared to total loans is 3.9% and it's $46.1 million.

In aggregate.

Okay. That's very helpful. And then, Manuel, you talked about your biggest competitor now is equity and you've been talking for a couple quarters about some markets being a little bit bubbly or frothy. With that in mind, are there any sectors you're keeping away from simply because of valuation?

Well, look it, social media remains a very lofty market. There are some SaaS models, software as a service models remain pretty well-priced out there. I think we've seen a little bit of a run-up in valuations of some of the life sciences portfolio companies. We've seen the life sciences give up a little recently, which we think is an appropriate kind of pressure relief on that sector. So, I think that sector still has good growth opportunities there. But we tend to avoid what a lot of people call the unicorns. We tend to focus on high-quality, high-duration, sustained companies in value, not just momentum investment.

So, I think that the overall venture capital marketplace, although it is seeing some pretty hefty valuations, I don't think the valuations are necessarily nosebleeds yet. So, I think that there's still some room for growth out there. And we certainly welcome some of these valuation increases that are happening because some of our own portfolio companies are benefitting from that and also benefitting the ability to raise equity capital, higher valuations that serve to amortize their debt. So, the ecosystem is quite healthy and we like that.

Great. Thanks very much, guys.

Thanks, John.

Chris York, JMP Securities.

Good afternoon, guys, and thanks for taking my questions. So, Manuel, could you help me understand the guidance a little bit in regards to timing for covering the dividend? Because, given your comments on the yields potentially expanding to 14% in Q4 and then commitments still on pace for record levels at year end and then in addition to your expenses flattening out, it seems like the timing could be conservative by potentially a quarter or two.

That's exactly right. I mean you hit the nail on the head. I don't want to come out and be overly aggressive, saying that the dividend will be covered in three quarters. There is a possibility that could happen, but there's a lot of -- that is a perfect alignment of the planets. And I don't feel that that level of aggressiveness is prudent or warranted so I'd rather defer to a window that is actually happening in three or four quarters. But there's absolutely no question; with sustained portfolio growth and any spike in effective yields, you actually close the gap sooner. You're absolutely right.

Okay. And then switching gears a little bit; could you comment on how you are viewing the SECs consideration of treating unfunded commitments as debt for BDCs?

Sure. Look it, we've had a great and continued positive dialogue with the SEC. I would say that the staff at the SEC has been very willing to engage in what I consider to be very good substantive discussions. I think that the SEC is prudently and, frankly, appropriately reviewing the unfunded commitment category. I think there are some potential players that may have been a little bit more abusive of that practice, if you will.

However, one of the most important things to note, unlike lower middle market lending, is that venture capital lending specifically has earmarks of very hard and steadfast milestones that these companies must achieve. Not only that, it is often the case, notwithstanding even the achievement milestone, that we have the discretion to valuate in due diligence and decide whether or not we want to fund into that situation as well. So, discretion remains very much in our capabilities and that's something that we worked really diligently with the SEC staff to kind of help orientate them and understand our particular asset class in this area.

I think that the staff is probably, hopefully, will provide some open public outcome or outlook on this issue in Q3. But, at this point, we've had what I consider to be very constructive and very meaningful conversations with the SEC staff on this front.

We are also proactively taking steps to adjust how we, ourselves, underwrite and historically have used unfunded commitments to also negate that and whittle that number down fairly quickly here between now and year end where the unfunded commitment situation will be -- I don't want to say necessarily insignificant, but will be dramatically lower than it is today. And we've made conscious efforts and continue to make conscious efforts to make changes to our own business model to accommodate those potential changes that the SEC may mandate down the road.

Great. Yes, that's all very helpful. I did notice that unfunded commitments did come down here in Q2; essentially, the lowest level since Q1 of 2014. And then, also in your press release that you did note the unavailable commitments due to milestones.

Yes. I mean it's a very, very important distinction and discerning that caveat there where these unfunded commitments are not contractual obligations until such time as their earned and performance by the company and then we agree to release on diligence. So they're, in essence, almost meaningless from that context.

However, we strongly do believe that when an unfunded commitment is readily available to the company, that is something that we will need to reserve for and look after as we've done historically. And, in fact, we've now included in our investor presentation deck a historical chart that gives, I think, a trailing eight quarters of what that unfunded commitment looks like and you'll see it's about 13% or so of our portfolio. And that's what we have historically managed the business to and you'll see that self-evidence in our presentation.

Great. Thanks for that additional color. And then, you've invested in the platform over the last couple of quarters to build out the infrastructure at Hercules. Given this investment in the business and recent changes in conditions at some other competitors, I was wondering if you could give us an update on thoughts of acquisitions.

You're putting me on the spot. Look it, we have said from time to time we remain very acquisitive. We are looking at and continue to look at portfolios, teams, and companies to acquire. And we remain actively looking at those. I mean it's hard for me to go beyond this other than, yes, we're interested; yes, we're evaluating opportunities. And that's, I think, the extent that I think I'm comfortable with.

One of the most difficult things for us to encounter is that when we superimpose our credit screens on targets, we find that valuations and fair value impairments are more lighter than we would deem to be appropriate. We are very much a credit shop and we are very diligent when it comes to that. And, a lot of targets tend to break down on yields and credit.

Got it. Yes, I know that you're potentially limited if you're looking at something to comment. But, let's see, maybe philosophically. So, how are you thinking about the culture at Hercules and fit when considering, I guess, maybe new hires and then, down the line, potentially acquisitions?

Well I think you've got to bifurcate the question into buying assets and buying a team. And they're both materially different.

The softer nature, i.e. buying a team, is a much more comprehensive process. Cultural fit, as we all know from any acquisitions, are very tough to assess and handicap. It is not untypical that you may see 25% to 35% of the workforce just attrition out naturally upon a change in control. Certain teams that we're looking at we would like to, obviously, have a good retention program in place.

All of these acquisitions that we're evaluating are potentially be accretive and offer a widening of our platform. But, honestly, until we're closer, until we have more definitive agreements, all these acquisitions have complete different colors and look and feel to themselves in doing that. Obviously, an asset acquisition or portfolio acquisition is much easier to kind of dial in. And we are evaluating some of those as well.

Great. That's it for me. Thanks very much.

Thanks, Chris.

Greg Mason, KBW.

Great. Thanks, Manuel. Just to follow up on Chris' questions, still on the unfunded commitments. I think it's a big issue that people still -- we can't still fully get our head around. So, if we think about in your press release you talked about $216 million of available liquidity to make new loans, but you've got $160 million of the unfunded commitments. Is the way the Commission is looking at it, would that $160 million of unfunded commitments essentially sop up a huge part of that $216 million of liquidity? Or is the calculus different than that?

Well, look it, I'll have Mark jump in here as well. First and foremost, I'm not going to pretend to speak for the Commission or how they're feeling and how they're envisioning things. I think the Commission will eventually put out a public paper on their view on this issue. We would welcome that strongly.

But I think that, to the heart of your question, you're addressing a fundamental flaw that people don't seem to remember. Hercules does not do seven-year bullets or five-year bullets. So, the cash flows that we get on a quarterly basis are quite tremendous, as you see in Q2. So, it's not untypical that we're seeing $50 million to $100 million of cash flows just coming in by normal amortization, which could range anywhere between $30 million to $40 million a quarter. Add to that unexpected early repayments that can be anywhere between $40 million to $70 million a quarter and that gets you $100 million to $110 million of normalized cash flows that come in. And, yes, those cash flows that you can point to as sources of funding to help further backstop any of those unfunded commitments.

Secondly, a lot of those unfunded commitments we are working to whittle down and would naturally begin to drop meaningfully between Q3 and Q4 just both naturally and how we're restructuring a lot of our deals. So, we think that this situation, if nothing is done, will automatically correct itself on its own by Q4. But we are working, clearly, with the staff and helping them understand our business model and working collaboratively with find a good balance and language that, hopefully, the staff will put out in this issue. But, clearly, yes, the liquidity, looking at liquidity is a way of, I think you used the word mopping up or dampening down those unfunded commitments. Absolutely. Mark, anything you want to add?

Yes. I mean I also would add one of the comments that you made is we have $216 million of liquidity and I also mention that we have $294 million of ability to increase if we should so choose. The other comment that I would make in the aggregate numbers that you're referring to, $85 million of that are revolvers, which typically are not drawn down. So, it's very much a pro forma.

And the last comment I would make, since I've had direct discussions with the Securities and Exchange Commission, is I think they're realizing by just going out there with a broad stroke of BDC may not be the right way to do it because you do have small-middle market lenders versus venture debt lenders and we all are very different in terms of our unfunded commitments. So, as we start to work through that, we're still optimistic that there may be a distinction or that the SEC would come out with an official ruling that's, hopefully, softer than what we're reading about in the papers right now.

Okay, great. I appreciate those comments. On the $150 million of 7% notes that are still outstanding, those are callable now. You called a little bit of them. What is your thought process in terms of, now that you've got an investment-grade rating from S&P, going out and doing more of kind of an institutional bond deal and essentially refinancing those out for, hopefully, meaningfully lower coupons? Are you thinking about that? And what do you think that could potentially look like?

Sure. Let me try to answer the question. Obviously, again, in the previous part of my call, I mentioned that we're at about 5.5%, backing out non-cash fees, in terms of our cost of debt. We're going to try to drop that below 5%. We have already began the process to look at other financing opportunities in the capital markets, to do what you just discussed.

But, I do want to clarify for you that not all of those bonds are callable right now. Only at the end of September will all of the 2019 7% baby bonds be callable. So, I don't want to give the impression that we can do that as of today.

And, Greg, one thing I would add that as we've been kind of testing the markets and evaluating the market and the different options, as a hypothetical, you can presume, for example, that if we were to go out in the market and replace the loans, the $150 million of the 2019 bonds at 7%, you could actually if you want as an illustration use a 4.5% or a 4.6% coupon rate, for example, that will translate into 2.5% to 2.4% savings on that $150 million. So, you're looking at that's a real impact to our bottom line that could be as much as $7 million of interest rate savings to our shareholders and our investors.

But, more importantly -- which is something that we really do want to do and will do. That's highly accretive. But, more importantly, it allows to have a better competitive position by having an overall weighted cost of funds that will be in that sub-5% level that gives us the ability to have wider NIMs and wider net interest margin for the benefit of our shareholders that we intend to do in the market. So, you're absolutely right. We do expect to tap the traditional market here shortly.

Great. Great commentary. Thanks. I appreciate it, Manuel.

You're welcome.

Robert Dodd, Raymond James.

Hi, guys.

Hi, Robert.

One just clarification first. Just to be clear, the $1.3 billion to $1.5 billion target for the end of year, that is a target for the loan book, right? Not the total portfolio.

Yes. That's what -- when we look at those numbers, we focus primarily on interest-earning assets. So, yes, it's mostly the loan book. And we're at $1.17 billion today so we're well within striking distance of just getting to that point. But, yes, it is in reference to the interest-earning loan book, which is basically only $130 million away from that target on the low end of the range.

Right, got it. And then if could, on the prepayment acceleration that you're expecting in kind of Q4, starting in Q3, can you give us any color on the source of that? Obviously, you're primary competition you say right now is equity. So, just is there so much VC equity floating around that you expect more equity injections and that's going to result in a pay-down? Or is it M&A activity? M&A activity I would expect to flow into realized gains potentially. So, I mean different sources generate different other incomes for you as well.

There are many factors, two of which you just highlighted that are correct, that point to the early payment activities occurring. Q4 typically is the strongest quarter ever for, typically, venture lenders. And, certainly, the continuation of IPO monetizations and M&A monetizations will certainly contribute to that acceleration.

However, there's more a fundamental process that's underway. And that is venture portfolios typically only have a duration of 22 months to 24 months. Even though we may underwrite for 36 months to 42 months, the average tenor of the outstandings are typically 22 months to 24 months of our loan portfolios. As the portfolio begins to mature, and our composite age of our portfolio that we grew in the second half of 2014 and it grew in the first half of 2015, is relatively young for what's called a composite age; the static age of the portfolio.

So, as an example, let's assume that static age of the portfolio is around 13 months or so. As you notch every other quarter under your belt and it gets older and goes from 13 months to then 16 months to 19 months, at that crossover point, which is at 19 month mark more or less, as Mark said earlier, you start seeing acceleration of prepayment activity just because you're reaching the natural tenor of the portfolio at 22 months to 24 months.

And because of that, and this is how detailed we are at Hercules and how much we look at our portfolio, we can actually tell you that we could see an increase in that monetization or exit events taking place in that portfolio naturally recycling itself as it eclipses that month 19 and beyond that point.

Okay, got it. Thank you.

You're welcome.

Finn O'Shea, Wells Fargo Securities.

Sorry about that, guys. I had myself on mute. Following the Silicon Valley Bank quarter it looked at first like those guys were going to retrench a bit. But, from what we're hearing, they seem to be saying that the provisions were a couple idiosyncratic one-off types. So, if you can give us an update on what you're seeing from activity from the bank side.

Well, I mean, clearly I can't opine what a bank does and doesn't do. I think that the bank competitive environment remains no different than it was last quarter and the last few quarters. I think that the banks remain competitive. I think that the regulatory environment in the bank is increasing. That is actually a favorable outcome for our landscape. And I think that some of the banks have already spoken about the increase in regulatory activities and increasing reserve requirements in their own business model that may be adversely impacting them.

As to the credit issue, I can't speak to a specific Silicon Valley Bank. They're a fine institution. They're very good players. They know what they're doing. And I think that they're probably right. It's probably indigenous to two unique credits. We're not seeing any broad systemic credit concerns in our portfolio right now. And so, I think that I would be agreeing with Silicon Valley Bank that it's probably just isolated to two random variables, random credits. But we're not seeing any systemic issues in our portfolio as of yet, either.

Okay, great. Thank you. And then just a smaller question. If you could provide a bit more color on what we'll see from here in terms of SG&A and comp. I think you said we'll see some scale from here, but with a bit higher of a variable expense.

Yes. I think that our G&A has pretty much begun to plateau. I don't think it's going to materially move in any one direction up or down. And I think that comp is now going to be variable-related, meaning it's correlated to portfolio increases that's going on and you'll see that increase in the variable comp aspect of it. But I do not expect any more material increases in overall OpEx excluding interest expense, obviously.

Interest expense will go up. We indicated that earlier that about $500,000 $450,000 and such will start going up just attributed to the Wells Fargo borrowing at $50 million. But, beyond that -- and also I need to highlight again in the event that we end up doing the retirement of our 2019 $150 million baby bond, that that will lead to a significant interest savings. If and when that is done, that would further lower your overall OpEx when you include interest expense.

Okay, very well. Thank you.

Thanks, Finn.

Hugh Miller, Macquarie.

Hi. Thanks for taking my questions.

Hi, Hugh.

Hi. So, I guess one other, not to bash the subject, but with regard to the unfunded commitments. Obviously it seems as though you're going to try and take a strategy of maybe adjusting the terminology and the language in which you're underwriting those commitments. Do you think that that -- is there a risk at all that that could put you at maybe a competitive disadvantage by not having kind of a formal mandate for an unfunded commitment with or without milestones or just with milestones relative to maybe some non-BDC competitors?

Well, I think, as we've said, and the expression I think comes to mind is; rising tide affects all boats in this context. So, I don't think that we are any different than anybody else. I think that we've taken a more proactive approach and working diligently with our companies and also with the SEC staff on working on language and changing some of our business practices. And I think that the industry as whole will probably end up conforming to similar changes as we address this issue.

At the end of the day, the whole senior security definition and asset coverage ratio is very much a fluid issue. As you know, there is a bill on the floor for consideration by Congress that actually could ameliorate this whole entire discussion by raising the overall asset coverage ratio limits as well.

That said, we're not waiting for that. We have taken a proactive approach to adjust that issue. We do not think it will have an impact whatsoever in our business. And if some of our competitors want to go do that issue, let them. I don't think it's something that we're going to get concerned about because, on how we underwrite, we don't get caught up with what others are doing. We do what we do and we think it's the right underwriting thing to do.

And, if the SEC staff makes -- this is an important point for them, well we're going to work with the staff in finding that solution with them together. It's something that, as an institution, I believe it's very important that we need to work with our regulators and also listen to them, but constructively we have feedback from them as well.

Okay. That's helpful. And then a follow-up question. Just if I take a look at the 10-Q, it looks as though exposure to kind of the energy technology names has increased over the past six months. Can you just give us a sense of what you're seeing there for opportunity and what you think the risk-reward is relative to other areas?

Absolutely. I think that's a great question. There's absolutely no question that we actually truly like and are seeing very, very attractive investment opportunities in the renewables area. We are not necessarily interested in looking at clean-tech solutions that are fossil-fuel dependent. Most of our investments are much more disruptive and enabling solutions in that area. And I think that we are one of the few players that I'm aware of right now that has an active interest in growing in that area. But, we are not looking to have much exposure to volatility on oil prices or fossil fuels. Our companies are much more focused on improvement of the environment, reducing contaminants, getting lower cost of operations of, for example, on electric vehicles or busses, as an example. So, our strategy in the energy area is much more enabling disruptive than it is petroleum-based in focus.

Okay. Thank you so much.

Christopher Nolan, MLV and Company.

Hey, Chris.

Hey, guys. All my questions have been asked and answered. Thank you very much.

Alright, Chris. Thank you.

Aaron Deer, Sandler O'Neill.

Hi, Aaron.

Hi, guys. Just following up on the capital question. You had previously kind of hinted at the idea that a capital raise and equity raise could be possible before the end of the year. I guess, given some of the uncertainty surrounding the unfunded commitment treatment and your forecast, is it possible we could be seeing a common raise before year end or is that more likely pushed out further into 2016 or beyond?

It is certainly not in my interest to do a capital raise at stock prices these levels whatsoever. And if that means that one of the strategies that we do is slow down originations and stop around $1.3 billion, $1.35 billion, it is something that we will definitely do, barring any kind of forced capital raise. We do not like to issue equity at these levels.

We are internally managed. We are directly aligned with shareholders. I'm one of the largest shareholders and I actually do not want to see unnecessary dilution. And so, I think that we're going to be very prudent and very unwilling to do equity raise at these prices unless we're absolutely forced to, which I don't think we will be. But, that is our intent. So, I don't think an equity raise in this year at these prices is absolutely on the table, no.

That's great. And then, one for you, Mark. You guys don't seem too worried about credit. But I was just wondering if you could give some color behind the increase in the grade-5 loans in the quarter. And of the $7.5 million loan impairment how much of that was credit-related?

So, a lot of the -- the one particular credit that was put into non-accrual in the 5-rated category was attributed to a change in strategy going on in the company. We're not going to get into that specifically because these companies are private. And when the change in strategy takes place, often times you're waiting for the financing strategy to then follow. However, because of fair value accounting, often times we're forced into a fair value situation where we need to make sure the loan is properly reflected from a value.

We actually believe two of the credits in the non-accruals will begin to show change, positive change taking place as early as Q3 and possibly as late as Q4. And one of the credits, in particular, is doing or showing, I should say, very strong signs of improvement. And the other one is, in the last couple weeks, showing a much better outlook. And so, I think that we're going to take it month by month and continue to look for positive affirmation and, ultimately, positive equity infusion into these companies that will then give us a much more solid confidence and footing to do any mark in change.

Okay. Good stuff. Thanks for taking my questions.

Thank you.

(Operator Instructions). Doug Harter, Credit Suisse.

Thanks. Manuel, historically you've been very conservative around the use of your warehouse lines. Can you talk about, as growth happens in the back half of the year here, your willingness to use those lines?

There's absolutely no question that -- it's very interesting issue for me, a quandary for me. In certain quarters, investors want me to have more leverage. In other quarters, they get concerned about leverage.

And so, there's never a really good balance. And what we are saying is, because we believe in the portfolio and the availability of good opportunities, that beginning to use our bank lines, especially with the capital markets, that are open and willing and coupled with that our institutional investment-grade rating, our confidence in securing additional bank financing, whether it's bond or additional bank financing, is pretty much there.

And so, one of the things that we'll do because we have the ability to leverage up to 1.25 to 1, we feel confident and willing to go up to the 1.1 leverage level. But that probably will not happen until late Q4, maybe early Q1, for example. It's going to be a subject of what do we feel that the quality of the assets that we like and the yields of the assets that we like. We will toggle the portfolio to that level.

As you go to that level, you can see more or less a pro forma portfolio that would be near the $1.4 billion level at the 1.1 leverage point. And so, that kind of gives you an indication that when you look at a portfolio that goes up to that full 1.1 leverage point, again, just slightly under $1.4 billion, and you multiply that anywhere between a 13% and 14% yield or any yield you want to use, you'll see the level of accretion that drops to the bottom line for our shareholders in terms of NII growth.

And that's something that we have been purposefully growing quietly into that and that's when you see I said earlier that we think the cadence of earnings growth is going to be probably at $0.02 per quarter growth and you can add a penny to that plus or minus on increase in portfolio fundings or effective yields going up. Than one penny can oscillate between just those two factors, effective yields or portfolio growth, that drive further that earnings growth in the Company. And that will be driven by leverage because we don't want to issue equity at these prices.

So I guess, following up on that, understandable that you don't want to issue equity at these levels. I guess, how do you balance kind of the near-term opportunities versus potentially starting to dial back growth a little bit sooner and sort of allow that opportunity to sort of spread out the growth over potentially a longer period of time?

That we don't have an interest in doing. We want to get to that core portfolio of $1.3 billion, $1.4 billion, $1.5 billion. At that point, we have the optionality to decide what we want to do. There's absolutely no question that a prudent thing to do, especially with stock at these prices, let the earnings catch up and let the stock catch up to the earnings. And, therefore, grow the portfolio to $1.3 billion, $1.4 billion and you wait a quarter or two or more. I mean, it's really a function of seeing good stock appreciation return back, cover the dividend, and really begin to show the investor community that this platform is as strong as it historically has been and will continue to be. And if that means that we have to grow and stop a little bit, I don't have a problem with that because we'll be throwing off very strong earnings at that point.

Great. That makes sense. Thanks, Manuel.

You're welcome.

Thanks, Doug.

I'm not showing any further questions. Mr. Manuel, please proceed with any further remarks.

Well, Candace, thank you very much. Thank you for joining us today. As most of you know, typically after these earnings calls we participate and attend various investor conferences from the various banks that follow us. We will be attending conferences here, shortly, in Boston and some in New York. And if you would like to have participation or attend one of those meetings, please let Michael Hara, our Investor Relations department know. We'd be happy to schedule it if we have available time. And, again, thank you shareholders. Thank you, analysts. And we look forward to our next earnings calls. Thank you very much, everybody.

Ladies and gentlemen, this does conclude your conference. You may have a great day.