Hercules Capital Inc (HTGC) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Hercules Capital Q2 2017 earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time. (Operator Instructions) As a reminder, this conference may be recorded.

I would now like to turn the conference over to our host for today's call, Mr. Michael Hara. You may begin.

Thank you, Latonya. Good afternoon, everyone, and welcome to Hercules' conference call for the second quarter 2017. With us on the call today from Hercules are Manuel Henriquez, Founder, Chairman and CEO, and Mark Harris, Chief Financial Officer.

Hercules' second quarter 2017 financial results were released just after today's market close and can be accessed from Hercules' investor relations section at htgc.com. We have arranged for a replay of the call on Hercules' webpage or by using the telephone number and passcode provided in today's earnings release.

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

In addition, the statements contained in this release that are not purely historical are forward-looking statements. These forward-looking statements are not guarantees of future performance and are subject to uncertainties and other factors that could cause actual results to differ materially from those expressed in those forward-looking statements, including, without limitation, 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 be proved 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.

Forward-looking statements contained in this release are made as of the date hereof, and Hercules assumes no obligation to update the forward-looking statements or subsequent events. To obtain copies of related SEC filings, please visit sec.gov or our website, htgc.com.

With that, I will turn the call over to Manuel Henriquez, Hercules' Chairman and Chief Executive Officer.

Thank you, Michael, and good afternoon, everyone, and thank you for joining us today for the Hercules Capital second quarter 2017 earnings call. During today's call, I will be providing a brief overview of our strong financial results and select key highlights and accomplishments during the quarter, followed by a summary of the venture capital marketplace and activities, and conclude with a brief outlook for Q3 and the second half of 2017.

I will then turn the call over to Mark Harris, our CFO, for a more detailed overview of our financial results and accomplishments for Q2 and conclude with a question-and-answer session.

With that, let me get started. We delivered another robust quarter, with net investment income, or NII, of $0.31 per share and DNOI of approximately $0.33 per share. This outstanding achievement was made possible by the hard work and dedication of our origination and business development teams, who delivered an impressive performance of new commitments of nearly $400 million for the first half of 2017, ending in June 30, 2017.

In addition, we're also beginning to realize the benefits from the Federal Reserve's recent 3 rate increases, translating into accretive earnings and expected continued earnings growth in our investment portfolio. As we continue to maintain a highly asset-sensitive balance sheet, we are well-positioned for any future rate increases.

We anticipate at least one additional rate increase in 2017, and as a reminder, each 25 basis points increase in prime rate equates to approximately $0.03 in annual NII earnings per share with the shares we currently have outstanding today.

I am also delighted to report that we are realizing material improvement in both our nonaccrual and overall credit performance of our loan portfolio, with both key indicators returning to historical low levels. We are expecting further improvements later in Q3 as we continue to finalize and complete the M&A transaction on a various handful of pending companies who are completing M&A events, which will further improve our credit performance and outlook for the rest of 2017. That, of course, is if these M&A transactions get completed.

The completion of these events would further strengthen our overall credit performance and put us in an extremely good position and at historical low levels on a credit and nonaccrual level for Hercules and Hercules' history.

We're also seeing a very healthy activity of demand from current and prospective portfolio companies or clients seeking new loans, as demonstrated by our nearly $400 million of new closed commitments and $340 million of gross fundings that took place in the first half of 2017, putting us on pace for a potential record year of new originations and commitments for the year.

As further evidence of this growing demand is our healthy pipeline of transactions heading into Q3. We currently have over $1.3 billion of potential new investment opportunities of which we are evaluating right now, giving us confidence in continuing to pursue our origination expectations for the second half of the year, which I'll elaborate further during this call.

It is becoming very apparent scale matters within the venture lending industry, and having access to a broad range of capital and capital sources is equally as critical to building a successful venture lending business that continues to afford the growth that Hercules has realized and achieving the stature that Hercules has in the marketplace today as a leading and a top venture lender in the marketplace outside of the non-banking community.

Now for some highlights and key achievements during the quarter. In an environment where origination activities continue to be challenged for many of our BDC peers, coupled with tightening credit spreads, margin compressions and increased levels of early loan repayments, Hercules Capital's direct venture lending platform continues to prove its resiliency and strong brand recognition amongst our venture capital partners and innovative venture capital-backed entrepreneurs, as we continue to realize and grow our investment portfolio with the strong achievements that we saw in our realized and published financial performance in the second quarter of 2017.

Now, specifically to cover some achievements during the quarter, we delivered another strong year-over-year performance for our shareholders, with solid growth across many key indicators. We grew total assets by approximately 14% to $1.6 billion. We grew total debt investment at cost by approximately 5% to $1.32 billion. We grew quarterly total investment income by approximately 11%, or $48.5 million, while also growing our net investment income by approximately 8% to $25.3 million.

In addition to these achievements, we also generated solid and sustained total shareholder returns, or TSR, for our shareholders consistently over the past several years. For example, 1-year, 5-year and 7-year total shareholder returns were 16.6%, 69%, and 127.1%, respectively, for those same periods, generously delivering results that exceed much of the BDC industry for the same periods.

And finally, we accomplished much of these results while maintaining our historical strong credit discipline while also maintaining a very strong balance sheet and high liquidity position, with approximately $355 million of available liquidity to continue to grow our investment portfolio. We intend to put this capital to work in the later half of 2017 and principally in the fourth quarter of 2017.

Now, turning my attention to show key highlights in the market development within the venture capital and innovative marketplace, our primary focus. The venture capital marketplace continues to show solid levels of vitality and sustained pace of new investment activities, with $17.4 billion of invested capital during the second quarter.

For the first half of the year, the venture capitals were exceptionally busy, with $33 billion invested for the first half of the year, which places VC investment activities on pace to potentially exceed all of 2016 levels of $54.7 billion of capital investments, this, of course, according to Dow Jones VentureSource.

Our continued achievement and success over the past 13-plus years is because of our outstanding, dedicated team of employees. These employees are responsible for our success and continued hard work. Without our employees' hard work, these outstanding results would not have been achieved. We worked diligently on behalf of our shareholders and continue to work even harder for that of our portfolio companies and client companies who continue to select Hercules as their capital provider of choice when it comes to growth capital in the form of venture debt.

I remain deeply grateful to our shareholders, our VC capital partners, and to the many wonderful, innovative entrepreneurs who continue to select and have the confidence in Hercules Capital and of our reputation as a long-term capital partner.

Hercules Capital is widely recognized as the largest leading BDC venture lender in the marketplace today. This is further evidenced by our sustained and steady growth of new relationships with innovative, venture capital-backed, pre-IPO, M&A, high-growth companies, with nearly $400 million of new commitments and $340 million of gross fundings completed during the first half, all culminating to our extremely strong total assets of approximately $1.6 billion at quarter-end only serve as evidence of our position in the marketplace today.

Thank you, and thank you for your trust and confidence in us, and we continue to look forward to being your partner as we continue to grow our company and your company together with our entrepreneur and innovative CEOs and founders of these great companies.

Now, let me take an opportunity to discuss our views of the marketplace and anticipated activities as we enter the second half of 2017. As we enter the third quarter, we are extremely well-positioned. We have a low net leverage balance sheet, a highly liquid balance sheet to originate new investments, and to meet as we pursue selective underwriting of critical new investment activities during the quarter.

I expect Hercules Capital to continue its very effective and time proven slow-and-steady strategy as we continue to deploy our capital. This slow-and-steady strategy has worked well for us for well over a decade, and we are not about to abandon it.

As we continue to wait for an improved and improving competitive environment, we are seeing an improved economic outlook as we look to continue to deploy capital commencing fairly aggressively in the fourth quarter.

We are also eager to see greater clarity from Washington on various key economic issues, such as tax reform and healthcare reform, as well as Congress tackling and hopefully passing legislative and regulatory reforms that are critical to our business and many of our portfolio companies, which will further benefit and fuel the growth of economic growth and loan demand for many of our portfolio companies.

Although it may be a bit early to call this an improving trend line, we are finally beginning to see encouraging signs of early portfolio repayment activities beginning to ebb and moderate as we enter into the second half of 2017. We are nonetheless optimistic, anticipating a return to more normalized levels of repayment activities.

At this point, we feel comfortable seeing $75 million to $100 million of early repayment activities for each of the subsequent next 2 quarters. As early payment activities ebb, we are anticipating realized modest portfolio growth late in Q3 2017. We expect to stay slightly ahead of early repayments by the end of Q3 and generate net portfolio growth by the end of Q3 of approximately $15 million to $25 million net of $100 million of anticipated early repayment activities during the quarter.

I would also like to remind everyone that Q3 is typically our seasonal slowest origination and funding quarter for capital deployment and investments. Conversely, the fourth quarter is typically our most robust period of investment activities, hence why we expect to see fairly significant growth in the portfolio by Q4, and you'll see that from our history of over 13 years of data that Q4 tends to be our most robust period.

Because of our continued patience, discipline and hopeful anticipation of tapering of early repayment activities, as previously discussed, we are anticipating realized overall net portfolio growth on a cost basis of approximately $50 million to $150 million net over the second half of 2017. This is mostly expected to be realized during the fourth quarter and, of course, again, net of the $150 million to $200 million of anticipated early repayment activities that we expect over the next 2 quarters.

Notwithstanding nearly $150 million to $200 million in forecasted early repayment activities for the second half of 2017, Hercules Capital anticipates entering new commitments in the second half of 2017 of nearly $350 million to $400 million of gross new commitments, which, if achieved, more than will offset any impacts on the projected early payoff activities that we just disclosed to you.

As a reminder, and as evidenced in our forecasting and our capabilities on predicting early payoff activities, I will call your attention that in Q2, we believe strongly that early payoff activities was anticipated to be between $50 million to $75 million. As you can see from our public filings, that number was dramatically higher than that. In fact, we actually realized $166 million, or nearly $90 million to $100 million higher, in early payoff activities that we were anticipating.

But not for the resilience of our team and our strong marketplace presence, our team was able to absorb nearly $100 million of unanticipated early payoff activities to keep the portfolio relatively flat coming into Q3. That is a testimony of our capabilities in the marketplace and our access to transactions in the marketplace.

Predicting early repayment activities remains an aloof and difficult item, since we do not control or have insight as to which company or when a company may choose to pay off its loan balances early. In fact, we typically have less than 30-day visibility or notice, so it is subject to significant variability and market conditions on early payoff activities.

Overall, our business continues to prove itself in its resiliency as we continue to execute and deliver strong financial performance for our shareholders. We are entering Q3 with a solid book of business and a pipeline currently at over $1.3 billion.

However, we remain very discerning on selecting new investment opportunities while attempting to maintain a fine balance of portfolio growth and margin discipline. We refuse to chase yields down the balance sheet, we refuse to compromise our long-standing credit discipline, and we're not going to simply chase yields down or underwrite credit simply to generate earnings for earnings growth purposes. We are not that institution. We remain focused on our balance sheet and disciplined in underwriting processes.

Our existing pipeline should position us well as we work towards the growth objectives for the second half of 2017, subject, of course, to favorable market conditions remaining in place and low margins stabilizing.

Now, as I wrap up my prepared remarks, let me share some quick updates on key developments from the venture capital marketplace. As a reminder, our data does come from Dow Jones VentureSource.

Venture capital fundraising activities -- the venture capital fundraising activities were, yet again, strong. As a leading indicator to future venture capital investments, the VC's fundraising was quite successful during the first half of 2017, with an impressive $21 billion of capital raised, on pace to exceed all of 2016 and certainly lays a good foundation for continued investment activities by VCs in the second half of 2017 and beyond. We're quite encouraged by this activity, and we're certainly seeing that activity translate into investment opportunities for us to pursue.

Venture capital investments -- equally impressive start to the first half of 2017, the pace for venture capital investing activities was nearly at $33 billion to 2,100 new and existing companies receiving capital from the venture industry, and, of course, putting the VCs on pace to exceed their total capital investments in 2016, which were $55 billion to 4,000-plus companies. Of the $33 billion invested during the first half of 2017, in the second quarter alone, VCs invested $17 billion to 1,100 companies.

Now, on a more solace note -- and I would like to make this more exciting, but I can't -- VC IPOs remain stagnant. VC IPOs remain aloof and not anywhere near where they should be. We saw only 25 venture capital IPOs, and 25 of those companies successfully completed their IPO's debut, on pace, ironically, to exceed all of 2016 of 38. That said, Hercules currently has 7 IPOs -- 7 companies in IPO registration currently filed under the JOBS Act looking to complete their very own IPO debuts.

However, given the recent high-profile IPOs that took place with Snapchat and Blue Apron, they have not fared as well post their IPO initial public offerings and find themselves trading well below their initial IPO prices. This has added fuel to the growing debate and skepticism on private company valuations, especially as it relates to private unicorn company valuations.

For those of you who may not be familiar with the term unicorn, unicorn simply refers to companies that -- private companies that have valuations in excess of $1 billion, of which there are currently 120 unicorns in the marketplace today.

Unfortunately, because of these two high-profile IPOs, we anticipate that because of these companies' IPO performance after their offering, that it may have a potential chilling effect on allowing other companies worthy of pursuing IPOs and seeking liquidity or exit via an IPO to most likely delay their offerings further for the near foreseeable future.

Having said that, and contrary to public perception, VCs overwhelmingly realize exits of their investments primarily through M&A activities and not so by IPO activities, which tend to get and generate all the media attention. M&A activity continues at a nice and steady, healthy pace with transactions and amounts paid during the second quarter, with 142 companies being acquired at valuations that tipped $19 billion through the second quarter, culminating in 305 transactions completed and $45 billion of transaction values so far in the first half of 2017 -- again, putting it on pace to also exceed all of 2016, which had $97 billion of M&A activities.

As evidenced by our very own press release issued on June 29, 2017, Hercules Capital was equally busy with its own portfolio on exit realizations through M&A activities. And in fact, nearly 100% of Hercules exits realized during the second quarter were related to M&A activities that took place. M&A activity continues to remain very robust and healthy in our own portfolio. We are expecting similar levels of activities as we head into the second half of 2017, assuming, of course, sustained and favorable market conditions.

In closing, we completed an outstanding quarter, with a solid finish for the first half of 2017. We are extremely well-positioned entering Q3 '17 with over $355 million of liquidity. We have access to the equity capital markets through our ATM program, and we have access to the debt capital markets through our debt ATM program. We continue to source and evaluate potential new and interesting investment opportunities to convert our liquidity and continue to drive gross originations for the second half of the year in the $350 million to $450 million, the majority of which are expected in the fourth quarter.

We expect to continue and adhere to our slow-and-steady growth strategy and looking to grow our total investment portfolio by year-end to $1.4 billion to $1.45 billion with what we see today in light of the $200 million-plus of early payoff activities. Again, we expect to finish the year between $1.4 billion and $1.45 billion, driven in no small part to the fourth quarter activities that we're anticipating.

And finally, as I'm sure many of you are interested in receiving an update, I wanted to address the issue of our own externalization announcement and process that we shared with you earlier in the year. As we have previously indicated in our earlier press release, the company's board of directors continue to work diligently with our respective advisors on the previously announced expanded review designed to determine the most appropriate investment advisory structure that enhances and aligns shareholder value, as many of you kindly shared your feedback during that process.

We expect this process will continue until late Q3 or mid-Q4, at which time the respective advisors will present their findings to the company and the board of directors. It would be inappropriate and premature for me to comment any further on that process until the board of directors has concluded its own process and evaluation.

Now let me turn the call over to Mark Harris to review our Q2 financial performance and results. Mark?

Thank you, Manuel, and good afternoon or evening, ladies and gentlemen. I'm pleased to report our second quarter results with our true industry-leading venture lending platform that continued to deliver strong financial performance, even with the strong headwinds from early payouts and amortization in the quarter.

Today, I will complement Manuel's remarks with a focus on key performance metrics that drove the second quarter earnings, but before I do this, I want to comment on our outstanding continued long-term performance metrics that we've achieved from inception through the second quarter of 2017, such as our remarkable low net losses of $4.8 million on a cumulative basis since inception or, over the 13-year history, an effective 0 annualized losses since inception basis points.

Our continued strong performance in terms of a return on average equity of 13.2% and return on average assets of 6.8% in the second quarter is the highest amongst all BDCs. Our resilient origination platform that delivered almost $190 million of fundings in the face of $201 million of headwinds, all happening in one quarter.

Our ability to work with and monetize positions when there are refinancing and other actions, and, finally, the resilience of our dividend policy, which has driven $13.40 of dividend income to our shareholders since our public offering and 16 consecutive $0.31 dividends per quarter declared, including the second quarter of 2017.

With that, let's turn my attention to the second quarter key performance metrics. I'd like to first start off with the resilience of our origination platform. We had strong investment fundings of $187.3 million in the second quarter, or 22.2% increase from the first quarter 2017 of $153.3 million. This includes the addition of 7 new portfolio companies that accounted for nearly 66% of our originations in the second quarter.

Prior to the conversion of one position of debt-to-equity, our loan portfolio on a cost basis was able to stave off the $201 million headwinds from unscheduled early payoffs and scheduled amortization, or reduction of only $13.6 million. This resulted in our debt investment portfolio balance of $1.324 billion at the end of the second quarter on a cost basis.

In the second half of 2017, we expect to see growth in our debt investment portfolio between $1.4 billion and $1.45 billion at cost, subject to more normalized levels of unscheduled early payoffs in the quarters, per Manuel's previous comments.

Secondly, I'd like to turn to the strong income statement performance that we saw in the second quarter. Our net investment income was $25.3 million in the second quarter, or $0.31 per share, which is an increase of 11.5% and 10.7%, respectively, over the first quarter of 2017. This was driven by the increase in our total investment income of $48.5 million in the second quarter from $46.4 million in the first quarter of 2017, or an increase of 4.5%.

Our net investment income margin increased to 52.2% in the second quarter, which was on the high side of our trailing 8-quarter average of 50.6%. Our interest and fee expense was $10.6 million in the second quarter, which was in line with our expectations of around $10.5 million to $11 million per quarter, subject to changes in our borrowing base.

Our SG&A increased to $12.6 million in the second quarter from $11.2 million in the first, which was driven in part by our variable compensation plan, which rewards our team for strong originations, and other corporate expenses in the period. We continue to believe that our SG&A will be between $11 million and $12 million, but as Manuel spoke to earlier, lighter in Q3 and higher in Q4, as the third quarter is typically quieter in terms of fundings compared to that of the fourth quarter, which is usually our strongest funding quarter in the year.

Our net interest margins continue to expand to $37.9 million in the second quarter of 2017, from $33.9 million, or, if you remember, adjusted for a one-time acceleration of finance costs for the retirement of the $110 million 7% 2019 notes, and interest overlap would adjust that to $36 million, which is still an achievement in the second quarter at $37.9 million.

Further, our net investment margin as a percentage of average-yielding assets was 11.1% in the second quarter, compared to that of 10.1% in the first quarter of '17, as we were able to generate more income over in our growing yield asset base while effectively managing our cost of capital.

Third, I'd like to talk about our significant undistributed earnings leading into the second half. As we disclosed last quarter, we closed 2016 with $34.2 million, or $0.42 per share, of undistributed earnings or spillover, which was the result of Hercules overearning our dividend in that year on a tax basis.

Today, we estimate our undistributed earnings remain strong, with an estimated spillover of $28 million as of June 30, 2017, which equates to approximately $0.34 per share based on the second quarter weighted average share count. While this considers the first-half performance of 2017, it will be subject to change from both the remaining performance in the second half of 2017 and any tax adjustments at year-end.

However, like we saw in 2015, this allows us to have the tactical ability to implement strategy for the long-term benefit of Hercules while maintaining our current dividend policy. It has always been our strategy that we maintain a variable dividend policy, which typically evaluates our expected financial performance on a rolling 12-month basis. The board will evaluate our dividend policy each quarter and determine if any changes are warranted, ranging from one-time distribution or special dividend to an increase or decrease of our expected dividend distribution policy.

Now, talking about credit and our improving credit in our near-term outlook, in the second quarter 2017, our weighted average credit rating improved to 2.27 from 2.43 in the first quarter, and our watch list grades, which are grades 3-5, decreased from 39.4% to 33.6% on a cost basis primarily from the conversion.

Our nonaccruals decreased to 2.9% as a percentage of our total investment portfolio on a cost basis and 0.3% on a value basis in the second quarter of 2017, which was consistent with our historical performance levels. We expect 4 to 6 companies to complete or be through their M&A process in the third quarter, although some may close in the fourth quarter, which we believe will have the ability to significantly reduce our nonaccruals in the future periods.

Looking at our NAV, we saw our NAV increase to $117.5 million (sic - see press release, $817.5 million) in the second quarter from $807.9 million in the first quarter, or an increase of 1.2% to $9.87 per share. This $9.6 million increase was a result of $2.5 million increase in our asset base at value and a decrease in our liabilities of about $7.1 million.

We saw assets increase by 2.5 to nearly $1.6 billion in the second quarter of 2017, which was mainly driven by the increase in cash of approximately $16.6 million and a decrease in our total investments at value of $10.8 million. Our liabilities decreased $7.1 million in the second quarter of 2017 to $771.3 million, which was caused by the amortization in our securitization, and $13.5 million due to paydown in the quarter, offset by a combined increase in interest accrual related to our convertible bonds and our 6.25 bonds of about $5.7 million.

Given this performance, we saw strong investment income performance in the quarter, with our ROEs increasing to 13.2% in the second quarter from 11.9% in the first and our return on average assets increasing to 6.8% from 6.2% between the second and first quarter of 2017, respectively.

Next, the strong liquidity at quarter end. We finished the end of the second quarter with $355.4 million in available liquidity, which was comprised of $160.4 million in cash and $195 million of undrawn availability under our revolving credit facilities, which are subject to borrowing base leverage and other restrictions.

Our cash alone, if invested at our core yields of 12.1%, could add another $0.07 in NII per share based on the second quarter weighted average shares outstanding and demonstrate the potential financial impact of putting this cash to work.

Further, given our net regulatory leverage, which excludes SBA debentures, as we have exemptive relief from the FCC, declined to 50.9% in the second quarter from 54.7% in the first quarter, which leaves us ample room for growth.

With our cash position at the end of the quarter and self-imposed 1:1 to 1.1:1 GAAP leverage, this potentially would enable us to add approximately $0.09 of NII per share on the same basis we previously discussed.

Finally, I want to discuss our asset sensitivity, which is one of the hallmarks of our financial statements. As we've commented in the past, we have a very well-positioned portfolio with a highly asset-sensitive balance sheet in the event of future interest rate movements.

Given 94% of our loans are variable interest rate loans with floors and 100% of our debt outstanding was fixed interest rate debt at the end of the second quarter, a 25- and 50-basis points increase in the benchmarked interest rates would be accretive by $0.03 and $0.07, respectively, of NII per share on an annualized basis.

Thus, in closing, we're very pleased with the current position at the end of the second quarter. Our liquidity position allows us to grow our book opportunistically and cautiously. Our long-term focused approach and disciplined underwriting standards will enable us to continue to drive strong results for the foreseeable future.

With that report, I now turn the call over to the operator to begin our Q&A part of our call.

(Operator Instructions) And our first question comes from John Hecht of Jefferies.

Real quick, you give some guidance for the range of yields in the portfolio. Is that contemplating a rate hike in that margin, or would a rate hike increase that yield range?

We never publish perspective yields related to any rate hikes, because we don't know if they're going to happen, so the answer is, no, it does not reflect any rate hikes that may happen. As to the former part of your question, as we indicated in our release today, we expect yields to modulate slightly downward. We are seeing yield compressions ourselves, and I think the new guidance for yields that we are putting out there on the senior secured sole lender to our companies is going to be more in the neighborhood of 11.5% to 12.5% range, and it's probably down in the last 12 months by 100 basis points or so, so now we're forecasting that the more normalized yields are going to be 11.5% to 12.5% of the overall weighted portfolio on a core basis.

Okay, thanks for that color. This quarter, you gave some good details and breakouts to the fee kind of components of sort of recurring and one-time fees. Just a couple questions on that. I know one-time fees are one-time fees, but I think you tend to have those every quarter. What's like an average pace of what you would consider non-recurring fees in any quarter? And then is the recurring fee kind of component the amount you announced or reported this quarter? Is that a typical rate?

So I'll let Mark expand on that. Look, we've been grappling with this problem now on what is a normalized one-time fee that kind of occurs consistently, and I would tell you that, after 13 years here, that number is probably $3 million to $4 million, is kind of the expected continuation of this reoccurring fee level. Then after that, it becomes more driven by extraneous events, but I'll let Mark kind of expand on the fee color for you.

Yes, it's a difficult question to answer, because obviously it's a function of what's paying off and how old it was on our portfolio. The comment that I would make is we did the breakout because, obviously, it was required under the SEC rules, but I think to really kind of answer your question on point, I'd take it a little bit differently, which is more of a percentage of the early paydowns that we see, and that can typically range between 3% and 5%, but it's difficult because you need to understand what the aging is of what's paying off.

And I would just expand on that that it's highly likely that the breakout you see now most likely won't be repeated, because it's an anomaly under the reporting requirements under GAAP that if you have big interest that composes approximately 5% of your income, you have to break it out, and only -- in our history, this is the only quarter that happened, and we're not expecting that to occur in Q3 and beyond again. It was driven by early payoff activity this quarter.

Okay, that's helpful. And then you have a pretty big pipeline, and you've given us some good color about what you think will converge in the next couple quarters -- or convert, excuse me. Any interesting characteristics or trends you're seeing in the pipeline in terms of maybe industry developments or geographic components that we should be talking about?

I think that I would describe the industry right now as growing, healthy demand for capital. I think everybody is looking to position their balance sheets rolling into the second half of '17, especially if the IPO market seems to be nonexistent, and everybody wants to have capital just in case something happens within the administration or the broader economy. So I think that -- if you really want my opinion, I think that you're seeing a lot of companies pursuing an insurance type liquidity enhancement to their balance sheets, and we're expecting a fairly healthy growth of activities.

We do believe and are seeing early signs that competition is beginning to ebb also quite a bit. A lot of our players that we certainly see are either out of money, have liquidity constraints or origination limitations, or other factors that are not allowing them to be back in the marketplace, so even though we're forecasting yield compression, we're hoping to see that yield compression begins to bounce off the bottom, meaning 11.5%, and rise, hopefully, in first quarter of '18. But we're seeing a broad range of companies looking for capital right now. No one industry is being highlighted, and no one industry is being discriminated upon, because it seems to be across the board right now.

And our next question comes from Ryan Lynch of KBW.

The first one has to do with kind of the market environment. I mean, there was obviously a robust second quarter as far as capital deployed in the VC market. I was just wondering what exactly is driving or has been driving the strong prepayments that you guys have received in your portfolio in the second quarter? And you guys also expect fairly healthy prepayment in the third and fourth quarter, and then you said you expect them to maybe ebb a little bit. So what's driving the strong prepayments that we've seen historically, and then why do you guys expect those to start to kind of slow down a little bit later this year?

So it's funny that we use the word now more conservative, $100 million, when in our history, that would've been a robust quarter, so that kind of tells you the new paradigm that we're operating under, where $100 million of early prepayment activities is no longer considered to be robust.

That said, what is driving it is probably bifurcated in two kind of high-level buckets. The first bucket, or 50%, will be driven by a M&A event. That the company is being acquired is a big driver for some of these refinancings. And the second driver of that, the next major bucket, probably a third of it, will be driven by -- bank refinancing is probably a third of it, and then the remaining corresponding balance is, believe it or not, equity. Equity is a big competing process for us, and most investors may say why would people want to use equity to displace debt? Well, when you're getting inflated valuations, it makes a lot of sense to actually overcapitalize your company with equity when you're getting excess valuations.

And so as VC activity remains very robust with $33 billion invested, and given that the IPO market is nonexistent, the meaningful part about that is that private companies have to survive longer privately, which means they consume more capital, and they want to be cognizant of dilution, so debt becomes a great demand vehicle to mitigate dilution as they're having to wait longer for an exit event, whether it's an IPO or an M&A event. And we have good charts in our website. If you look at our investor deck, we actually have good data from Dow Jones that shows you the vintage years of exits from M&A and the vintage year of exits from an IPO event for a company. They're correspondingly about 5.6 years and 7 years for an IPO to go public.

Okay, thanks for that color. And then kind of following back up on the prepayment fees and accelerated IOD, with $75 million to $100 million of prepayments, early prepayments, in the third quarter, that's about one-half or two-thirds, depending where it lands, of the prepayments that you guys received in the second quarter and kind of on pace for what you guys received in the first quarter, so should we expect -- I'm just trying to think for modeling purposes, expect prepayment fees in the third quarter to be about one-half or two-thirds of what we saw in the second quarter, or pretty similar to what we saw in the first quarter of this year?

I would say that, right now, answer -- the hardest thing for us to answer this question is that -- is prepayment coming in at $75 million, $50 million, or $100 million? And I think that if you assume that it comes in at $100 million of prepayment activities, for example, I think that a fair number to use is probably $4.5 million to $5.5 million of total fees, of which, as I said, $2 million to $3 million, $3 million to $4 million are kind of normalized levels of expected normal fees. So I think if you press me, I think $4.5 million to $5.5 million of fee income in Q3 is probably the right cadence to look at and maintain.

Okay. That's definitely helpful. And then you mentioned the high-profile IPOs like Snap and Blue Apron not really doing so well post IPO, which has pushed back the IPO timeframes for some potentially smaller companies that probably could stand an IPO, but just because of those high-profile ones not working out well, it's pushed back that timeframe, so does that provide any sort of opportunity for you guys to provide more capital to these companies, since they're actually going to stay public longer?

Obviously, that's worse from the standpoint of you guys being able to exit any companies you have warrants or equity investments in if they're not going to IPO, but, conversely, if companies are staying private longer, I would assume they still need to raise capital. Does that provide an opportunity for you guys to be able to provide them debt capital while they're private for longer?

Yes. This is where scale is critical in the business. With a $1.6 billion balance sheet, our ability to have high-concentration positions of $40 million, $50 million, $60 million transactions, we could easily absorb that without any problem, and when you want to play in the pre-IPO market, you have to have the ability to be offering a minimum of $50 million to $100 million transaction sizes to make sense, or else you really don't move the needle for these companies. If you're a small venture lender in the marketplace, you cannot rightfully do that and maintain your RIC status on diversified portfolio requirements.

We have the capabilities and the wherewithal to actually do just that. So we are actively evaluating a lot of those opportunities, but we're also very cognizant of what we consider to be potentially overvalued companies as well, so it's a significant structural issue when you look at these investments to ensure that we realize the returns that we believe are warranted and what the return the company is willing to offer. And in that process is an engagement of trying to find the happy point for the borrower and the lender to reach, and I think that a lot of our activities in Q4 are going to be related to just that.

Okay. And then just one last one, if I can. This quarter -- we talked about this happening, but Sungevity got converted to equity to Solar Spectrum. There was an asset purchase with another player for those assets. I just wanted to know if you guys could give any update on kind of the outlook of the business. I saw it had another write-down this quarter, the equity position, so any sort of update you guys can provide would be great on that business.

So, clearly, we're disappointed on the Sungevity transaction. It's a testimony to the dangers of a President with a Tweeting interest. That wiped out the Solar interest of that particular company with a Tweet that happened sometime in Q4 of last year. That said, I will tell you that post the merger and emergence out of bankruptcy, the new partners to which we are associated with in the new company and the trajectory that company is on and the new management and strategy they're pursuing, we're actually quite encouraged by the future of that company.

Now, clearly, we have to execute, but I think that the downsizing and right-sizing of Sungevity into the new company, I think that we're probably more optimistic, but we're in the first inning and -- but we are encouraged with what we're seeing, and we're certainly encouraged by the cost-cutting measures and the reverting to profitability that's going to be happening here in short order of the new company. And so we're pretty optimistic that in 18 to 24 months from now, we could see a sizable recovery of our investment and cost basis on that transaction.

And our next question comes from Aaron Deer of Sandler O'Neill.

Just a few questions for you. First, I'm still just trying to, I guess, reconcile some of your comments with respect to the anticipated loan yields. It sounds like from what you're saying is that your competitors are being hamstrung by their liquidity and size and that that's actually causing something of a pull-back in the competitive environment or improvement in the competitive environment, yet you're guiding down on the yield by 75 basis points despite a 3 fed rate hikes over the past year. So I'm just -- is there a shift in the types of companies you're financing, or what is it that's creating this downward pressure on the yield?

We refuse to go do second lien or subordinated deals. We want to remain senior secured on the transaction, and we're looking and pursuing what we deem to be the more higher-quality companies that are out there, and those high-quality companies are still receiving pretty aggressive bank deals that are being done. So I think banks remain fairly aggressive in their nature, and that's where we're not seeing a significant drop in competition, but as you'll see in our overall yield, our core yields are now down to 12.1%, and we'll think that we'll trough those yields sometime in the next quarter or two. I think that we'll end up troughing the overall portfolio somewhere around 11.5, 11.6, is what our models are telling us right now, and then we start bouncing off that low as we start onboarding new loans. But everything that we're seeing in the market, we'll still continue to see further compression in yields.

Okay. And then, Mark, maybe a question on the -- it looked like the G&A expense was up sharply from kind of where it's been running. Was there anything nonrecurring or unusual in there that's going to drop back out in the third quarter?

No, my comment would be that, again, as the originators originated a lot of the -- our variable bonus plan really kind of kicks in on the salary side of it. On the G&A side of it, we would expect it to really kind of come down just a little bit, but, overall, we're trying to manage the G&A the best we can with the growing platform, with adding future capacity for new hires, et cetera. So it's one of those that we would expect to maybe come down a little bit and level off, but that's where I would expect it to come in.

Yeah, I would encourage you to look at what we said in Q4. We talked about expecting our SG&A to rise a couple million dollars in 2017, and we're still on that trajectory. We're controlling it a little more, but we still expect that to continue, because we're adding headcount. I mean, for example, we're actively looking to hire 10 to 12 additional brand new hires in the business as we continue to grow the platform because of the loan demand that we're seeing in other areas, so we're very much actively looking to grow.

Okay. Those 10 to 12 new hires, those are all relationship managers, not -- that's forward client-facing folks?

No, that's system-wide. That's both the operations center as well as the --

That's across the board.

Yes, across the board.

Okay. And then just a quick question on the externalization, just in terms of the process. Who are the advisors that the board is working with on that?

We have not disclosed any of the advisors purposely, but you can safely assume that they're well-recognized investment banks and had to go through a fairly meticulous RFP process, and the banks were selected, but they're well-recognized national banks.

And our last question comes from Leslie Vandegrift of Raymond James.

So just a quick question on externalization. You said you can't really get into the process yet. It's expected to end about end of third quarter. But in the Q, you talked about the risks between the two structures. One of the internally managed risks that has been added is the size, the inability to scale up to size, so is there a max size you're looking at if you stay internal?

The answer is there's no arithmetic max size to internal. It has more to do with product offering and the ability to offer more attractively margined transactions. I think I've spoken about this many times in the past. The ability to complement an asset-based lending transaction that may price somewhere in the neighborhood of 7% -- 6.5%, 7.5% yield -- I don't think we should be doing that out of the existing fund today, if you will, because it lowers the overall yield and consumes that much more capital.

So the ability to have an affiliate relationship with a fund to be able to do transactions at a more attractive margin, a lower-margin transaction such as an ABL, would be highly complementary and accretive to our shareholders at the Hercules fund if that's the path we decide to take. So growth is a hard one to answer, because it's a function of the venture capital marketplace and continued access to the equity and debt capital markets and as well as sustaining the yields that we like to originate in the business, to have the margins to operate the business and generate the ROEs that we like to find attractive for our shareholders.

All right. Thank you. And then just one other quick question on that, in that same section. The other risk on staying internal that's discussed seems to be the risk of key personnel leaving, and it specifically calls out senior management and you, sir. And just curious if there have been offers to senior management to leave if you stay internal, or if you yourself have considered that?

I think that we are in a highly competitive environment, and when you have the quality of the platform that we have and the high caliber of professional individuals that we have who are highly trained in the venture lending platform and world, the answer is, just like our loan portfolio is being assaulted by folks looking to take loans off our books, you can imagine that our highly skilled and talented individuals are equally receiving similar offers, which is why you're seeing our compensation go up a little bit on the SG&A level as well. But we don't have slavery in this country. Everyone is a free agent, and we want to make sure that we offer an attractive compensation program that certainly allows us to motivate and retain critical individuals in the organization.

And our next question comes from Christopher Nolan of Ladenburg Thalmann.

Manuel, any comment you can give in terms of coin offerings, Bitcoin and so forth? Is that possibly starting to encroach on companies going public, or is that starting to become a factor? Because it's starting to get more traction in the Wall Street Journal, at least.

Well, Bitcoins are a lot like canaries in the coalmine. It all depends on how you want to interpret it and how you want to look at it. There is governments who believe that Bitcoin is the new future commerce currency. There are others who are dreadfully fearful of a Bitcoin untraceability of doing that. As an example, as you may or may not know, when ransomware occurs, the latest methodology of renumerating or compensating the ransom holder is that they have to then pay using Bitcoins as a way of clearing, so Bitcoin is getting credibility by nefarious activities that are going on in the marketplace.

I have to honestly say we've looked at Bitcoins as a currency to also be prepared to look at it and use it. It is unclear whether or not, believe it or not, under the 40 Act and the custodial requirements that we're required to use for capital, if whether or not we're even regulatorily able to use Bitcoins as a currency of choice, but we have looked at it. We are still evaluating it, but there are a lot of regulatory obstacles to make that a currency of choice.

And ladies and gentlemen, I'm showing no further questions from the phone lines, and I'd like to turn the call back over to Manuel for closing remarks.

Well, thank you, everybody, and thank you for joining us on the call today. As you all know, we typically pursue many typical road shows, non-deal road shows. In the coming months, we will be at the Private Debt Investor Conference in September, and we will also be at the KBW Midtown march in October in Manhattan, and we'll also be at the Wells Fargo conference in, I believe, it's November of this year as well, and we'll be doing a European road trip tour as well with investors, so you can expect to see a lot of us during the next 2 or 3 quarters in the marketplace. With that, if you would like to meet with management, feel free to contact your investment bankers or our own investment IR department, Michael Hara, to schedule that. With that, thank you for your time, and thank you, operator.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day.