Hercules Capital Inc (HTGC) 2017 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome the Hercules Capital Fourth Quarter and Full Year 2017 Financial Results conference call. (Operator Instructions). I would now like to turn the conference over to Mr. Michael Hara, Senior Director of Investor Relations. Sit, you may begin.

Thank you, Brian. Good afternoon, everyone, and welcome to Hercules' conference call for the fourth quarter and full year of 2017. With us on the call today from Hercules are Manuel Henriquez, Founder, Chairman and CEO; David Lund, our Interim Chief Financial Officer; and Gerard Waldt, our Corporate Controller, and Interim Chief Accounting Officer.

Hercules' fourth quarter and full year 2017 financial results were released just after the today's market closed and can be accessed from Hercules' Investor Relations section at htgc.com. We have arranged for a replay of the call at Hercules' web page 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, 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 identify from time to time in our filings with the Securities and Exchange Commission.

Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions can prove to be inaccurate, and, as a result, the forward-looking statements based on those assumptions also can be incorrect. You should not place undue reliance on these forward-looking statements.

The forward-looking statements contained in this release are made as of the date hereof, and Hercules assumes no obligation to update the forward-looking statements or subsequent events. To obtain copies of related SEC filings please visit sec.gov or 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 on our call for the Hercules Capital fourth quarter and full year 2017 financial results.

We have plenty of great news to share with you today regarding a strong finish to Q4 2017 and the many great achievements realized during the year as well. However, I want to first start out by acknowledging our greatest assets: our wonderful and tremendous team of outstanding employees, who continue to step up and deliver exceptionally strong results. I am enormously proud of our team and their continued execution and delivery of strong financial performance and results for our shareholders. They are what makes Hercules Capital successful.

Now let me take a moment to share with you some of our achievements and financial results. I am once again very pleased and delighted to announce yet another outstanding and very robust fourth quarter performance for Hercules Capital culminating in and delivering another record performance on multiple fronts for the full year of 2017 for our shareholders.

During the fourth quarter, we continued to see material improvements across many of our key credit performance metrics, improved credit outlook as evidenced by our historical and exceptionally low levels of non-accrual loan rates of a mere 90 basis points -- that's .9 -- as well as continued overall weighting, improved credit rating and ranking in our own investment portfolio overall. In addition, we have successfully managed to maintain a steady core investment yield of 12.5% while also maintaining a very robust effective yield of 14.2% during the quarter while seeing a continued healthy transactional pipeline for new deal generation and for potential new funding transactions to complete in the coming quarters.

Although competition remains persistent, it is nonetheless changing as we are seeing a shift to more aggressive push by commercial venture banks lending and in some cases completely irrational commercial venture bank underwriting, which has led to very aggressive underwriting and an attempt to build loan portfolio at whatever cost. That said, we are seeing an improving competitive landscape as many of the existing BDCs as well as select new entrants continue to struggle in building deal flow and portfolio growth, many of whom have highly concentrated non-diverse loan portfolios and rely on inferior underwriting practices to help build their investment portfolios.

As a reminder, portfolio diversification is an important cornerstone to prudent portfolio management and mitigating concentration risk. Diversification is paramount to sound portfolio management and a core principle that Hercules Capital is continuously focusing on and maintaining as evidenced by a diversified loan investment portfolio and strong credit performance and outlook over the many years.

Venture lending continues to represent a highly attractive, high-yield and desired asset class as evidenced by above normal levels of early loan payoffs, which exceeded $500 million alone in 2017. However, the asset class has also proven to have high barriers to entry and continues to prove a tough asset class to gain scale and build meaningful large diverse loan portfolios. Many of these challenges with our various competitors has caused them to not secure the market share they have attempted to do and also have struggled to build any meaningful position or scale in the business. In doing so, they have managed to build subscale investment loan portfolios that eventually will cause problems for them.

In an environment where origination activities continue to be challenging for many of our BDC peers coupled with tightening credit spreads, accelerating margin compression, continued industry-wide increased levels of early payoff activities, Hercules Capital direct venture lending platform continues to prove its resiliency, strong brand recognition amongst our venture capital partners and innovative growth clients by allowing Hercules to realize a solid fourth quarter and strong finish to 2017.

To put things in context and better perspective, let me share with you some of the hard-earned facts of our achievements in 2017. Hercules Capital experienced materially elevated early loan repayments in 2017 of approximately $506 million. In addition, we realized scheduled normal loan principal amortization of approximately $120 million, which when added together, represents a total of $626 million of loan repayments, or nearly 50% of our loan portfolio turned over during the year.

And yet, Hercules Capital successfully absorbed and grew its investment loan portfolio on a year-over-year basis. This speaks to the true resiliency of our platform and our scale within the market itself. For most companies, experiencing a 50% loan portfolio turnover in 1 year would have been overwhelming and potentially an insurmountable task to conquer, but Hercules Capital platform accomplished just that. Our team rose to this challenge and successfully originated and funded $765 million in new transaction, fully absorbing the impact of early loan repayments without compromising our credit score, our investment yield and overall credit quality, ending the quarter with a 12.5% overall core yield.

Our focus and commitment to maintaining a solid credit underwriting discipline while also remaining one of the top performing BDCs by continuing to execute for our shareholders remains one of our most critical focus as an institution. As a reminder of our steadfast principle, if we are unable to source high-quality new funding opportunities, we would prefer to wait out the cycle for an improved market than to chase yields down the balance sheet or the cap structure or materially shift our historical credit underwriting disciplines simply to make a quarterly earnings. History has shown, as many BDCs have pursued similar strategies, it ultimately has proven to be ineffective.

During the fourth quarter, we completed our first strategic initiative by successfully securing and acquiring the high-quality venture loan portfolio from Ares Capital for approximately $120 million and $5 million of equity in warrant securities for a total of $125 million. Given the success of this acquisition, we expect to continue to evaluate and pursue additional strategic initiatives in 2018 and beyond as we seek to augment our own origination activities and opportunistically seek to grow our platform by identifying potential new accretive opportunities to further grow earnings and dividends for the benefit of our shareholders.

In addition, during our call today, I will be discussing the following select highlights and items: an overview of our strong financial performance and select key achievements during the fourth quarter and the full year of 2017, a quick summary of the very impressive finish and activities completed by the venture capital community in 2017 and conclude with a brief outlook for Q1 and the first half of 2018. I will then turn the call over to Gerard, our Senior Controller, along with David, our Interim CFO, who will follow with a more detailed overview of our financial results for the fourth quarter. And then we will conclude with opening the call for Q&A.

Now, let me take a few moments to highlights some of the achievements of our fourth quarter as well as the full year. We delivered a record total investment income of $50.2 million for Q4, representing an increase of 6% year-over-year, which resulted in a very strong adjusted net investment income of $0.32 when adjusting for the one-time events related to our early and partial loan -- excuse me -- bond redemptions of $75 million, which we retired in the fourth quarter. On a GAAP basis excluding the impact of this result would have been a $0.29 on a GAAP basis, $0.32 on an adjusted NII basis by adding back that one-time event.

However, it is important to remind everyone and highlight that during the fourth quarter we completed this partial retirement of $75 million of bonds on our 6.25% notes. These notes included 2 events. They included a non-recurring interest expense due to the required announcement of redemption of the bonds of 30 days and double interest costs during that period of time together with the acceleration of the unamortized offering cost representing in aggregate $2.4 million or $0.03 a share as a one-time non-recurring expense.

This outstanding achievement was made possible by the hard work of our team, who delivered an impressive performance in Q4. For example, total new commitments of over $330 million, gross fundings of over $271 million for net portfolio growth of approximately $116 million; this notwithstanding the fact that we had $124 million of early payoffs during the quarter.

In addition to these outstanding achievements, we've also continued to generate solid financial performance for our shareholders. For example, we generated 1-year, 5-year and 7-year TSRs of 1.8%, 166% and 223% respectively for our shareholders. As a reminder, TSRs stand for total shareholder return, which includes stock appreciation and dividend distributions. These results, especially our 5- and 7-year results, far exceeded many of our BDC peer groups by a significant factor. In addition, we generated very strong and healthy ROAs during the quarter. We had ROAs of 6.3% and also very impressive and strong ROEs of 12%.

We consistently deliver strong results that exceed many of our BDC group peers, which is a testimony to the venture lending focus that we operate under as well as a testament of our team's ability to select the continuation of strong solid credits that we invest in. We accomplished much of these results while maintaining our historical credit discipline, maintaining a very strong balance sheet and a high liquid position with approximately $286 million of available liquidity to continue to work to grow our investment portfolio, which we are putting to work pursuing our slow and steady strategy in 2018.

And lastly, regarding our year-over-year results, we achieved also very strong records. For 2017, we recorded record total investment income of $191 million, an increase of 9% year-over-year. Also recorded record NII income derived from $96 million of net investment income representing a 4% year-over-year and excluding one-time events in the prior year related to litigation settlements that we received proceeds from. Record total investment assets also were a record at $1.4 billion, an increase of 8% year-over-year, and record total debt investment portfolio of $1.42 billion or 4%, and culminating in record total assets of $1.65 billion compared to $1.46 billion or 13% on a year-over-year basis.

In addition to our record financial performance, we continue to strengthen our balance sheet and liquidity position while also lowering our overall cost of financing and maintaining our growth target spread allowing our platform to remain highly competitive in this rapidly changing market. In 2017, we successfully retired -- excuse me -- we successfully raised $230 million at 4.375% in a convertible debt offering. We also raised $150 million in our first-ever institutional investment-grade bond offering at 4.625% of notes due on 2022. We also fully redeemed $110 million of our 7% 2019 notes and partially redeemed and retired $75 million of our 6.25% notes.

Another important achievement was our earnings spillover. We also successfully generated our fourth consecutive year of projected earnings and dividend spillover of approximately $23 million representing $0.28 per share in undistributed taxable income based on the current share count at year end. This accomplishment of having an earnings spillover affords us the flexibility and ability to consider multiple different options for the benefit of our shareholders as we focus on the continuation of growth of our platform and continue to pursue new opportunities that may make long-term sense at short-term costs without having to compromise a dividend cut.

As the BDC industry begins to show signs of consolidation, scale is becoming paramount especially in direct private lending as it affords many advantages not afforded to smaller subscale platforms especially BDCs that are subscale. As we enter Q1 2018, we continue to see a very healthy level of new loan demand and activities amongst our current and prospective portfolio companies as demonstrated by our total new commitment of over $891 million and over $764 million of gross fundings during the year in 2017.

As you can see from our press release, as of February 20th, 2018, we have already secured $255 million of closed and pending financial commitments for the first quarter of 2018, and this with a whole entire month still remaining in the quarter. We feel very confident and very assured on our ability to continue to execute on behalf of growing our portfolio with the demand of deals that we're seeing in the marketplace and our scale in the market itself.

Further evidence of this growing demand is our healthy pipeline of companies seeking debt financing heading into Q1 2018 with over $1 billion of transactions currently in the pipeline that we are processing and analyzing for potential future investments to make.

Now, let me take an opportunity to discuss our views of the market and anticipated activities as we enter the first quarter of 2018. As we enter the first quarter of 2018, we are extremely well-positioned, having low net leverage and we have a highly liquid balance sheet to originate new investment activities that meet our select underwriting criteria. I expect Hercules Capital to continue its effective and time-proven slow and steady strategy of growth, which has served us well for over a decade and continue to pursue and evaluate strategic opportunities to continue to grow the portfolio opportunistically to remain a highly competitive platform for the benefit of our shareholders.

Now, let me take a moment to outline our expectations for early repayments in Q1 and the first half of 2018. As we saw with the early payoffs in the fourth quarter of 2017, we are anticipating higher than normal elevated levels of continued early payoff activity through at least the first half of 2018, and we are anticipating elevated repayment levels of $125 million to potentially $150 million or higher for the next 2 quarters of the year.

In addition, we are taking the approach, as we've done many times in the past, to proactively execute some portfolio rotation and pruning of select investments positions within our investment portfolio. These activities alone will further add to the anticipated elevated levels of early payoff activities as we conclude our rebalancing of our portfolio by mid-Q2 2018. These activities along with the anticipated elevated early levels of payoff could actually end up showing early repayment activities to exceed the $150 million or greater from what we're seeing today.

However, given the persistent elevated levels of early payoff occurring across the industry, it is becoming impossible to predict any levels of early repayments beyond 30 days as evidenced by our $0.5 billion of early payoff in 2017 and, of course, the 24% unexpected increase in early payoff in Q4. In addition to that, we are seeing a shift and a change in the mix of our early payoff clients that are paying off, with older loans paying off rather than younger loans paying off, which means that the impact from income accelerations will be much less muted -- more muted, excuse me -- than it would be from earlier or younger companies paying off our loans.

What that means is that we do not expect to see a significant increase in velocity of fee income derived from some of these more mature early payoff activities. That is not to say that we're not going to get some benefit from these activities; it just will not be our historical higher level because of the older duration of these older loans we have in our books.

As a reminder, predicting early repayments remains a very difficult task since we do not control or have insight as to which company or when a company may choose to pay off its loans. In fact, we typically have less than 30 days' notice or visibility so it's subject to significant variability and market conditions. Given the uncertainty surrounding early repayments and anticipated continued industry-wide elevated repayment activities, we are now unable or uncomfortable to provide any reliable quarterly forecast as it has become impossible to predict these levels. That said, we do anticipate elevated levels to continue for at least the first half of the year, and we're anticipating activities to be at or above the $150 million levels alone in Q1 and maybe higher when you include the portfolio rebalancing and rotation that we're effectively underway right now.

As a wrap up to my prepared remarks, let me share with you some quick updates on key developments for the venture capital industry. Venture capital fundraising remains very strong. Venture capital fundraising, the leading indicator of future VC investments, finished 2017 at $37 billion. This level of activity lays out a good foundation for continued investment activities by VCs for at least the first half of 2018 and beyond.

Even more impressively strong was VC investment activities. Venture capitals invested in the fourth quarter of the year and throughout 2017 over $65 billion of activities were invested to over 3,400 new transactions that were completed. This compares and contrasts to the $50 billion that were invested in 2016 representing a very healthy increase of 30% year-over-year.

But more impressive to that was the flow of capital that these investments went into. Later-stage investment allocations by VCs received the lion's share of the allocation representing nearly 60% of the capital invested by VCs went into later-stage companies, which I'd like to remind everybody is, in fact, Hercules' sweet spot or focus on investment activities. We were very delighted to see those levels of capital investments by VCs into those companies.

Liquidity, IPOs. 57 venture capital-backed companies successfully completed their IPO debut in Q4 exceeding the 2016 38 IPOs. Excuse me; I should have said 57 IPOs in 2017 as compared to 38 IPOs in 2016. Hercules had 3 companies complete IPOs in the fourth quarter. ForeScout, Aquantia, and QuatRx made their fourth quarter debuts and represented 5% of the aggregate IPO activities in 2017 were Hercules portfolio companies. All 3 thus far have appreciated nicely from their IPO prices.

M-and-A activities remain very robust. Having said that and contrary to public perception, venture capital is doing just fine with the solid pace of realized exits from their investments through M-and-A activities. Since 2010, M-and-A represented 91% of the exits realized by the venture capital industry. M-and-A activities continue to be an important and critical part of raising capital and creating the cycle of investment activities for the venture capital community.

With a steady and healthy pace, transactions during the year amounted to approximately $76 billion of M-and-A activities for 2017. Hercules had 19% of those M-and-A companies were Hercules companies representing 3% of the overall M-and-A activities in the venture capital marketplace. As a recap, we had 5% of the IPO activities taking place in the market and 3% of the M-and-A activities taking place in the market were Hercules portfolio companies.

In closing, we completed another outstanding quarter with a solid finish to 2017 despite higher than anticipated early repayment activities which along with scheduled amortization represented over 50% of our loan portfolio turning over. Yet our team of investment professionals once again successfully rose to the challenge, originated new investment activities to fully absorb and still manage to grow the investment loan portfolio; a testament to the achievement of this organization.

We continue to be well-positioned overall for growth. With over $286 million of available liquidity, we have plenty of capital to invest and seeking for the right opportunities to make those investments in. We continue to source and evaluate potential new investment opportunities and deploy capital in the first quarter. As I indicated earlier, we already have $257 million of term sheets either in-house, closed or about to be closed, already exceeding our quarterly expectations for Q1. And again, we still have one more month to go.

We also recently issued a press release earlier this week announcing the redemption of $100 million of our 6.25% 2024 bond expected to be redeemed early in Q2 2018. As part of this redemption, we anticipate to expense unamortized origination issuance costs of approximately $2.5 million or representing $0.03 per share. The partial redemption of the $100 million in bonds will equate to approximately $6.6 million in interest expense in savings representing approximately $0.08 per share.

With that, I'll turn the call over to Gerard and David to review the fourth quarter. Gentlemen?

Thank you, Manuel, and good afternoon, ladies and gentlemen.

We are pleased to report our fourth quarter results. Today, we would like to focus on the following financial areas that impacted our fourth quarter earnings: our origination platform, the accretive benefit of the Ares venture debt portfolio acquisition, our income statement performance in Q4, credit outlook and our liquidity.

With that, let's turn our attention to the origination platform. Our originations platform continues to grow. We had total investment fundings of $277.4 million in the fourth quarter from a total of 27 portfolio companies, offset by $150.7 million of payments from unscheduled early payoffs and regularly scheduled amortization, for net investment portfolio growth of $126.7 million.

On a cost a basis, our debt investment portfolio balance ended at $1.44 billion at the end of the fourth quarter or up approximately 4% from the beginning of 2017. This is a significant achievement given that we experienced approximately a 44% increase in unscheduled early payoffs and regularly scheduled amortization from 2016 to 2017. Our core yields were 12.5%, slightly down from the 12.6% in the previous quarter, however still at the high end of our normalized levels of 11.5% to 12.5%.

I now would like to discuss the benefits of the Ares venture debt portfolio we acquired in the quarter. At the beginning of November 2017, we completed the acquisition of the Ares venture debt portfolio, which consisted of 12 debt positions in 10 portfolio companies and 2 equity warrant only positions respectively for $125.8 million. The portfolio was immediately accretive to us in the fourth quarter. It had a weighted-average yield of approximately 11.7%. We recognized total interest income of $2.2 million, or $0.03 per share, during Q4. As Manuel mentioned, we expect to see a similar type of benefit in Q1 2018.

With that, I'd like to discuss our income statement performance for the fourth quarter. On a GAAP basis, our net investment income was $24.5 million in fourth quarter, or $0.29 per share, which is a slight increase in net investment income of $24 million from the third quarter. On a pro forma adjusted basis, our net investment income closed at $26.9 million in the fourth, or $0.32 per share. The adjustment is due to the $75 million partial redemption of our 6.25% 2024 notes that occurred. Due to the redemption, we had a non-cash charge on the acceleration of $2 million and a 30-day expense overlap of $400,000, or $0.03 NII per share, impact.

Total investment income was $50.2 million in the fourth quarter, an increase of 9.4% from $45.9 million in the third quarter. The increase in total investment income is due to growth in the investment portfolio, which includes the Ares acquisition where we saw an 8.7% increase in our weighted-average principal outstanding from the third quarter as well as an increase in the amount of fee income from one-time accelerations from early unscheduled payoffs of $124.2 million during the quarter.

NII margin was 48.8% in the fourth quarter, which was a decrease from the third quarter of 52.3%. The decrease is due to the previously mentioned $75 million redemption that occurred during the quarter. Adjusted NII margin was 53.6%.

Our interest and fee expense was $13 million in the fourth quarter, which was higher than the third quarter due to the non-cash charge and 30-day interest overlap of $2.4 million. Our SG-and-A increased to $12.6 million in the fourth quarter from $11.4 million driven by an increase in variable compensation due to achievement of performance and funding objectives.

Our net interest margin was $37.2 million in the fourth quarter, up from $35.4 million in the third quarter. As a percentage, our net interest margin remained flat at 10.4%.

Lastly, we have a very well-positioned portfolio with a highly asset-sensitive balance sheet in the event of movements. 96% of our loans are variable interest rate loans with floors and 100% of our debt outstanding was fixed interest rate debt. A 25 basis point or 50 basis point increase in benchmark interest rates would be accretive to interest income and net investment income by approximately $3.2 million and $6.4 million respectively on an annualized basis, or $0.04 and $0.08 respectively of NII per share annually.

Now I would like to turn it over to David Lund, who will discuss our credit outlook and liquidity.

Thank you, Gerard. Our credit and near-term outlook remains solid. In the fourth quarter of 2017, our weighted-average credit rating improved to 2.17 from 2.24 in the third quarter of 2017 while our non-accruals remained near historic lows and stayed flat at 0.9% as a percentage of the total investment portfolio on a cost basis and 0% on a value basis during the fourth quarter of 2017.

Turning to our liquidity position, we finished the end of the fourth quarter with $286 million in available liquidity, which was composed of $91 million in cash and $195 million in undrawn availability under our revolving credit facilities, which are subject to borrowing base leverage and other restrictions. Our equity ATM program issued approximately 842,000 shares with net proceeds of approximately $10.8 million at an average price to book of 1.29.

Also during the quarter, we closed our first investment-grade bond offering of $150 million at an interest rate of 4.625%. We used $75 million of the proceeds to partially redeem our 2024 notes as we have highlighted earlier. As a result of this transaction, our weighted-average cost of capital during the quarter was 6.4% and while the future weighted-average cost of capital is expected to be approximately 5.4%.

Our net regulatory leverage, excluding SB debentures, as we have exemptive relief from the SEC, was 62% at the end of the fourth quarter versus 49.4% at the end of third quarter. Our net GAAP leverage, which is GAAP leverage less cash, was 84.6% in the fourth quarter versus 72.2% at the end of the third quarter.

Thus in closing, we are well-positioned at the end of the fourth quarter heading into 2018. Our liquidity position also allows us to grow our book strategically and cautiously. Our long-term focused approach and disciplined underwriting standards will enable us to deliver strong results for the foreseeable future.

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

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

First question is a little tied to just modeling characteristics for this year. Number one on that is, what should we think about just in terms of G-and-A trends over the year? And second, you did mention given uncertainty around prepayments and repayments about the fee income. What is a decent level, kind of base level, of fee income that we should consider for the business?

It is so hard to answer the fee income question because it is heavily skewed by the age of the credit paying off. Historically, we've seen more of the credits paying off that were more younger in nature thereby deriving a 2% prepayment penalty or acceleration provision or call protection trigger. Lately, we're seeing a bit more mature companies with call protections of under 1%. And so we don't have a good handle on what and how to model it out because we don't know ourselves. So I don't know how to answer your question other than we don't know.

I guess in framing it, then, if you had a similar pace but mature companies, would it be half as much fee income? Is that one way to frame the other side of it?

Here's a way of looking at it. A way to kind of model out prepayment activities is using a ratio of anywhere between 2% to 4% of the loan being repaid, is probably range of income acceleration you can expect to derive from those loans. So 2% to 4% of that range, i.e. take the 3% if you will, and it's probably a good moniker or gauge to use.

Okay, that's helpful. What about G-and-A? How should we think about that?

As we said in our third quarter earnings call and as we look into 2018 and beyond, I think that SG-and-A is probably going to get modeled up by probably -- we're expecting it to go up probably $1 million a quarter or so. But that's something -- it's somewhat in our control as well, when we dial it in. But I think that you can expect G-and-A to probably rise about $1 million a quarter or so. And I think that's we kind of where we are focusing on right now.

Okay. And then final question. I'll get back in the queue. Rates going up. You guys have quantified the benefit to NII as rates move in 25 basis point increments. What happens, though, to prepayment or repayment activity as rates go up? And how does the rate environment affect your kind of, I guess, management of the capital structure as well?

Well, there's a lot of questions in there. Yes, we are highly asset-rate-sensitive. We're very, very happy about that. We have not seen unnecessary correlations with a rising rate environment in any ebbing of our early payoff activities as evident with the momentum going into our Q1 right now that we're seeing.

As it relates to the impact on the overall portfolio, yes, it's about $0.03 or $0.04 annually for every $0.25 increases. And I think the last part of your question was legacy loans versus new refinancing. Is that what the second part of the question was?

The last part of the question was how does a rising rate environment affect your management of the capital structure? Do you migrate any rate exposure in the liability side of the capital structure? Or are you going to keep a consistent mix?

No, what I would tell you is that I think that in a rising rate environment you're going to be looking at your maturity walls and your staggered maturities, that you want to make sure you have a well-disciplined cap structure. And so as you've seen us do, we've now retired 7% bonds. We've now retired 6.25% bonds. And we replaced those with low 4s% and mid-4s% bond offerings, generating savings of 300, in some cases 400 basis points. So there's a lot of activities there that we expect to do.

So I think the answer to your question; when you take into account the most recent announcement of $100 million of bond redemptions we did, we have another $83 million of legacy bonds that we expect to retire later on in 2018. It could be maybe late Q2 or early Q3. But we are looking to potentially retire those bonds as well and replace them with additional lower cost of financing. So you can expect us to continue this pace of rotating out of more expensive longer-term debt and replacing it with more attractive longer-duration debt outstanding.

And our next question comes from the line of Jonathan Bock from Wells Fargo.

Finn O'Shea in for Jonathan this afternoon. Just to start out also with a quick modeling question. Do you have an update on your target investment portfolio size?

Well, we do. The hesitation in my response is that I am pedaling a bike with the wind in my face right now with early payoff activities. So our target for year-end remains in the $1.6 billion to $1.7 billion, however that is significantly impacted by what is the normalized level of early activities on principal repayment that may occur in Q2, Q3 and Q4. We just don't have that visibility yet. So we're simply modeling out and expecting that Q3 and Q4 may modulate back down to more normalized levels of $100 billion -- $100 million a quarter. But we think that Q2 and Q1 could experience early repayment activities above those levels.

If we're wrong in that, which I hope we are, that means that the portfolio will have a greater tendency to migrate towards the $1.6 billion or better. But right now, I think it's too early in '18 to have any visibility as to what that portfolio may look like because of the inability to have an accurate forecast of portfolio repayments.

Okay, very well. That's helpful. And then sort of related, I think you mentioned enacting sort of a portfolio rebalancing by sort of managing portfolio companies to pay off. Can you give more color on that agenda? Is it based on hold sizes or sectors? Just any color there on what we can expect from that front. And then, for that matter, do you see any risk in perhaps alienating VC sponsors?

Oh, I don't think we have that problem. We did $865 million of activities. I think we have the other problem. I think that we need to be more selective than what's going on that we already are selective enough.

I think the answer to your question is -- on your first part of your question -- is I am not going to specific tell you what sectors I'm cycling out of and what companies I'm doing because part of that is proprietary to what we're doing on portfolio management or rotation, and I don't really feel compelled to provide a roadmap to my competitors on how we do things and why we're cycling out of certain industries. However, I think that you will soon see when we do our Q1 filings that you will see very much what you just asked. Concentration issues we're cycling out; certain industry verticals we're cycling out. And we're consciously rotating out of certain positions because we want to be in a slightly different position going into 2018 than we're coming out of it. And we're taking opportunity now to rebalance the portfolio -- and we've done this from time to time -- to position ourselves in even a stronger credit outlook, which I think will even lead to a better credit performance than we already have already today.

Okay. No, that's also very fair and helpful. And just one more if we may. Is there -- are there any parameters for the ATM program. You described it as just-in-time. Is it totally manual? Or is it you run it at certain valuations or leverage ratios, anything like that?

Sure. No, I'm sure you want me to tell you that, but I can't. How we manage the ATM is also very specific to Hercules cap structure. I will tell you that it's a factor of looking at; where are we on a leverage spectrum? What are our capital needs and anticipated capital needs? What is the impact on EPS on any equity issuance?

As an internally managed BDC, we care a lot about earnings and sustainability of dividends, which is why we have $0.28 in earnings spillover. We're very, very aligned with our shareholders and we have really no interest in simply raising capital to raise capital that cannot be deployed and that makes sense.

So I think that one of the greatest pressure relief valves that you can use is an equity ATM program to help ameliorate rising leverage concerns and then right-size your liability structure by having that ability to raise just-in-time equity if and when needed. And it's proven to be an extremely effective tool for us over the years. And we're one of the few BDCs that trade above book if you're taking advantage of the ATM program.

And our next question comes from the line of Ryan Lynch from KBW.

First question. Last quarter you spoke about, after the Ares portfolio acquisition, you talked about you were evaluating maybe 2 other potential portfolio acquisitions. Are you guys still reviewing those? Or have those passed? And are you guys currently in the market for taking on whole new portfolios going forward?

I think that we're reviewing multiple different opportunities, not just 2 right now. Look it; the biggest challenge for us in reviewing any portfolio is that making it through the Hercules credit screen is exceptionally difficult. And Ares aside, because Ares is a great quality shop and they did wonderful job of underwriting so we felt comfortable with that. However, as we evaluate many opportunities, we are finding ourselves with significant differences in marks than what the seller is holding investments at. And as such, I think it's a more challenging environment to transact on an acquisition that is -- well, we deem to be accretive to ourselves and for our shareholders and what the seller deems.

So it's not un-typical that you can end up chasing 2 or 3 different acquisition opportunities and not one of them come to a head because of valuation disparities and discrepancies that are quite vast. I can assure of one thing I've learned in this process; not everybody has a consistent ability to mark their books and sometimes those books are -- I don't know how they're marked because they don't make a lot of sense to us.

Okay. Well, that's good to know. I appreciate the conservatism of not chasing deals just to grow the portfolio. Following up on John Hecht's question a little bit on positioning your balance sheet. You guys have done a great job positioning the balance sheet for rising rates. 100 basis point increase is roughly $0.15 per share. One question I did have because maybe I'm not as familiar with the VC-backed debt versus standard middle market debt. In standard middle market debt, as LIBOR rises, a portion of that impact will likely be offset by compressing credit spreads. So a portion of the rise in rates is going to be effectively eaten away by competition. How is that -- how does that -- how do you expect that to play out as in the VC debt world? Do you expect a portion, a significant portion, or at least a portion, of increases in the prime rate to effectively be eaten away by lower credit spreads?

So that's a very astute question and I actually applaud you. It's an excellent question to be asking. And the answer is that there is some impact related to the accretion or benefit of a rising rate in our portfolio. And so that $0.15 that you referred to, a portion of that will note be realized ultimately because that would assume the portfolio is static.

And to your question on the specificity related to the asset class of venture lending, unlike lower middle market, the asset class of venture lending is both short-term in nature and amortizing. And so what happens is, as a portfolio is naturally is amortizing down, the benefit of that accretion of sustainability of that loan outstanding for a longer period of time is somewhat evaporated because of the amortization of paying down the principal. Further augmenting that statement is the fact that the average duration of venture loans are hovering now under the 18-month period of time, so which means that we are not going to be able to derive the full impact and benefit of a rising rate because the expected loan portfolio, the venture loan portfolio, will cycle out. That's evidenced, as you saw in 2017, where we had $500 million of early payoff activities. That obviously has a drag on the accretive benefit of a rising rate environment because those loans typically do not get the benefit from that rising rate environment.

So that $0.15 is certainly the mathematical impact, however, I think the practical impact is somewhat going to be less than that. What it is, I don't know because once a portfolio stops any early payoff activities and stabilizes, if you will, it starts rising above the 22 to 24 months that we saw historically, you would see the benefit of that coming back in higher EPS. Sorry, long-winded answer, but it's a complicated question.

Yes, that makes sense. And yes, I understand that. A lot of moving pieces, hard to predict. But that's helpful color.

And then I just had one last question on Solar Spectrum or Sungevity. With the U.S. imposing 30% tariffs or border taxes on imported solar panels, does that have any impact on Solar Spectrum's business model?

You know, it does. And we've had multiple conversations about this. And as much as I don't want to make the statement, obviously our preference, and I can't speak on behalf of the company itself, but it certainly is a preference to buy American installed by Americans for Americans. So that is our preference.

However, with an imposed tax, even still some of the foreign manufacturer panels are either, A, higher energy conversion and, B, still slightly cheaper. But the good news is that the grid is still expensive and people want to go to solar cells. So it does have an impact. It just simply switches vendors. Though different than you thought. I think you saw Whirlpool and Maytag and Samsung arguing about their washing machines. People are still going to be buying all those brands and they -- solar offers different solutions in different panel manufacturers. So I don't think it's going to curtail the business meaningfully. And I don't think it will impact our margins very much. We'll pass on those costs, which is ironic, to the consumer itself anyways.

And our next question comes from the line of Tim Hayes from B. Riley FBR.

Relating to your commentary on early repayments, you mentioned the mix has shifted to older loans. How have the yields on those loans compared to the portfolio average?

Well, I mean it's evidenced by you're seeing that the core yield didn't really oscillate very much from quarter to quarter. It remained fairly static. So the good news is that -- what I will tell you is that some of the more mature loans that you're seeing paid off and some of the larger loans being paid off in Q4 and certainly in Q1 so far tend to have actually a lower yield than the prevailing yields that we're seeing in the market right now. So I don't think you're going to see a material change in the overall core yields as you replace those legacy loans with new loans.

Okay, got it. And then could you just give us some color on how core yields were impacted from kind of the different moving parts; one being the dilution from the Ares portfolio acquisition, two being kind of spread compression, and three being the impact from higher rates?

Well, I mean you can see it for yourself. As evidence, I think we're at 12.6% last quarter and we're 12.5% this quarter. So if Ares caused a 10 basis point decrease, I'll take it.

The answer is that clearly, the Ares portfolio was probably, conservatively, 70 to 100 basis points lower than what we're seeing our overall core yields. And I think we indicated when we did the transaction I think we were expecting it to be low 11s% and it turns out to be probably more in the effective nature that it's fully digested by us probably mid- to high 11s%. So that's kind of the benefit of that. But it's slightly, again, lower than what we're seeing some of our older transactions in the market But we'll still take a high 11s% earning portfolio, which is good. And like I said, the evidence is -- it's in the numbers. Q3 to Q4 you saw only a 10 basis point delta in a change in the core yield. So nothing materially occurred there.

As to the rate impact, it's hard for us to really put a fine point on quantifying how much of that sustainability of core yields was directly correlated to a 25 basis point increase in the index rate. I just don't have the answer to that. I mean I don't know if we could probably run it. We could probably figure it out. But I don't have the answer to that for you on this call.

Okay, yes. No worries. That's helpful. And then another one for me. Just given the higher prepayments in the past quarter and your expectation for elevated prepayments this quarter and assuming that all the proceeds from the bond issuance were used to either redeem the 2024 notes or fund growth, do you expect an earnings drag from undeployed capital this upcoming quarter? And if so, can you help just kind of quantify that on a per-share basis?

Wow.

Is that too tall of an order?

Well, no. I mean it's almost asking for guidance.

Yes, okay.

Look it; the answer is that we've already given you an indication. We eliminated or have neutralized a big significant part of exactly your question on earnings drag. And by making the announcement of retiring $100 million of bonds, that has a material and chilling effect on cauterizing that earnings drag that you're referring to. And in fact, as we said, retiring $100 million of bonds will relieve $6.6 million of interest expense from the balance sheet or representing $0.08. So it's a highly accretive move to do, let alone that it's an expensive bond that I can replace in the market today at probably 200 basis points, 180 basis points lower than that, if not more. So it's the right thing to do. It's the right thing for our shareholders. And I have no problems with that decision that we made. I think it's the right one. And to exactly your point, it certainly alleviates and ameliorates a lot of that earnings drag that you're referring to.

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

I'll just stick with the same kind of thought on the funding side. Given this decision to let go of some of your higher-cost but longer-duration funding, how are you thinking about that in terms of -- because I know you've always been pretty thoughtful about funding with longer term, but now you're shortening the duration on your liabilities in a rising rate environment. When you think about if you had to replace those funds with something of a similar duration, would you still be getting a material cost save in terms of the rate paid?

Yes.

Okay. But with what the new stuff that you've putting on over the past quarter was -- has a couple years shorter duration, right?

Well, we're not done doing what we're doing. But the answer to your question is that looking at -- and I'm just trying to find the table we have in our charts. When you look at how we look at the balance sheet management, yes, one of the critical things we look at is duration. We have a significant part of our credits that had 2024 maturity. And we can actually go out and do 5-year, 7-year and even 10-year bonds right now.

What we're looking at and our decisions on that capital raising is getting a better perspective of; what are the competitive environments looking like? What are the yields? One of the things that people don't realize, and you can easily run this analysis running a CapIQ or FactSet, is that since the inception of Hercules, which is now almost 14 years, we've maintained the solid gross spreads of managing our liability management in our spreads of nearly 700 -- well, it's like 600 to 700 basis point gross spreads between our cost of funds and our investment yields that we're getting in the marketplace. That has been incredibly consistent for that nearly 14-year period of time.

And so yes, we're looking at the balance sheet, but I'm not particularly worried about it because everything I'm talking about going out in the market and doing is pushing me out to 2023 anyways as opposed to some of the stuff I'm retiring and cleaning up is 2024. So the fact that I can go out and save, conservatively, 150 to 250 basis points on gross spreads and simply give up 6 months to maybe a year at most in duration, I'll take all day long.

Okay. And then I guess flipping to the yield side of the equation then. You said that you expect stable core yields going forward. Does that include the expectation for a few rate hikes this year? Or do you anticipate that that's -- you're not going to be able to charge, pass that on to customers? In other words that the competitive environment has kind of eaten up that benefit from higher Fed funds rate?

Aaron, you're always so dark. No. Our yields don't include -- we never include any benefits of rising rates environment in our core yields and anticipated yields. So we don't do that because unless they happen, we just don't know. So we don't do that.

Secondly, I think as I said at the beginning of call, the competitive environment is changing quite dramatically. And we're beginning to see, although in some segments of the market pretty ferociously competitive, in other areas we're realizing nice yields or sustained yields.

So I think that right now having a core yield -- and I think that we generally tend to handicap it between 11.5% and 12.5%, I think that our core yield probably will oscillate between quarters of anywhere between 20 and 30 basis points in any direction, up or down. And I think that is a normal tolerance that we're fine with seeing it go that way.

And we can actually make that impact less or more by doing exactly what we're doing now with doing some portfolio rotations. This is something we've done many times in the past. We think that right now is the right time to be cycling out of certain credits and certain segments of the market where we think that the valuations are probably too rich and we think the margins and the spreads are probably tighter than they should be. And others feel differently and we're happy to kind of let go some assets in that area.

Okay. And then just one last question. You mentioned your expectation, or hope anyway, for to $1.6 to $1.7 billion at year-end. I missed what that was. Was that total investments for value or was that interest-earning investments? What number was that?

Let me just -- hold on second. Give me one second. I just want to pull it up for you. So Aaron, we just looked it up. It's about $1.66 to $1.75 billion in total debt investments and loan -- so total investments. Sorry, total investments. So you got about $50 to $75 million in equity and warrant derivatives in there. So you back that out, you're going to be at $1.55 to $1.65 billion, I think is the safe range on the debt portfolio.

Our next question comes from the line of Christopher Nolan from Ladenburg Thalmann.

Manuel, the $1 million per quarter in increased G-and-A, is that basically just going for retention compensation? Are you increasing the headcount or just paying people more?

I think it's all of the above. I think that we are seeking to hire I think right now no less than 12, 10 to 12 people we're trying to hire. We have an abundance of business. So everybody on this call, we're hiring. So we're hiring. Because of that, we are seeing the need to have retention programs in place. Talent is highly sought after in this marketplace right now. We want to make sure that our people are motivated. We want to make sure that our historical credit performance is sustained. And so we care a lot about making sure that the interest of our employees and ourselves remains aligned. So yes, part of that is retention-driven. Part of that is increased compensation. And part of that is new hires. I mean literally all of the above.

Great. And then the 600 basis point investment spread that you mentioned earlier, given everything that's happening, is it fair to assume that's probably going to drift up to the higher end of that level, assuming the Fed tightens and everything else, and it could exceed 700 basis points?

Look it; the answer to that is I don't know, but I suspect the answer is yes. When I ran the analysis, I kind of thought I knew what it was, but when I actually ran it, and it's an interesting exercise to run on FactSet or CapIQ, the fact that it is so consistent for the entire formation of Hercules was even surprising to me. Because I know I focus on it, but I didn't realize it was that tight. So yes, the 600 or 700 basis point gross spread is, I'll say, is a very, very strong performance and result. And we suspect that that's going to continue and possibly improve. So I don't disagree with your question on improving.

And then final point. Is it fair to assume that the increased G-and-A would basically eat up a lot of this increased investment spread assuming it happened?

No. We don't think that's going to have a significant impact on the overall performance of the credit book.

I'm just saying in terms of EPS.

No, I don't think it will.

Okay.

I think that we have enough margin and enough -- I think we have enough business that we feel pretty good about 2018 with what we know right now. Again, it's only February. But we're pretty happy with where we're going and what we're seeing in the market. So we're quite encouraged about our business right now.

Our next question comes from the line of Casey Alexander from Compass Point Research.

First, just a point of clarification. When you discussed what you thought sort of the range of repayments would be, $125 to $150 million, that was for both the first and then a similar amount for the second quarter. Is that correct?

Not quite. What I said was that early repayment activities, from what we know in Q1, are probably going to be in the elevated level of $125 to $150 million. In addition to that, and this is where it slides to Q1 and Q2, as we conduct our portfolio rotation that we're speaking about, it will clearly add to those numbers. But portfolio rotation is a delicate exercise and dance and some may be realized in Q1 and some may spill over to Q2. But notwithstanding that statement, the $125 to $150 million is what would have been the normalized early repayment activities that we can't control that's being elevated upward.

For Q2, our best indications right now, without any evidence from any of our portfolio companies, is that we're only expecting Q2 to be in the neighborhood of $125 million of elevated early payoff today and then taper back down in Q4 and Q3 of $100 million right now. So Q1 is higher spilling off of Q4 of '17 and then we expect it to start cresting back down in Q2 and then stabilize back at $100 million a quarter in Q3 and Q4, for what we know today.

Okay, great. Now secondly, I noticed that your Grade 1 investments jumped $155 million quarter to quarter to $345 million. I'm assuming that that is indicative of indications or what you have as a feeling for early prepayments that elevate something to Grade 1. But is that also in your background been indicative of potential equity gains in the future as well?

Well, Mr. Casey, you're doing your homework. Scary, but the statement is correct. It is an early indicator or a leading indicator of anticipated early payoff activities. So yes, it does serve to that purpose, that barometer, if you will.

As to the second part of your question, a change to Level 1 does not necessarily indicate an equity realization event because the loans will always preempt an equity realized gains by generally 2 to 3 years. So I wish it was that correlated. But on the loan issues, you're absolutely correct on your statement that a rising Level 1 is generally an indicator of expected early payoff activities.

Okay. And then lastly, when you do a transaction like the Ares transaction, that's not like a newly-originated portfolio. That's a seasoned portfolio. So when you do that transaction, doesn't that naturally accelerate your expectations of prepayments?

So without getting into how we do things, the answer to that statement is not necessarily correct. Because of our capabilities in underwriting and our knowledge of these companies, the statement that you are missing is that, although practically speaking your comment is correct, that would presume that we didn't have the anticipation of extending more credit to those particular companies that we bought and increasing the exposure to some of these higher-quality credits and good investments that exist there.

So what you're saying is that you picked items out of their portfolio that have the potential for add-on investments.

Yes.

Our next question comes from Robert Dodd from Raymond James.

Is it fair to say, given the high level of repayments that you just talked about, the normal amortization and then the rebalancing, is it fair to say that you'd expect the portfolio to shrink in Q1, maybe Q2, and then expand to get to your target in Q3 and Q4? Is that kind of the shape of the year that's realistic right now?

So the answer to your question is clearly on elevated prepayment activities in Q1 and some of the rotations that we're doing, for those who know us, we're not going to simply go underwrite silly deals to simply backstop that because we're the ones making the conscious decision to rotate out of the portfolio certain positions. And so yes, the portfolio may have a contraction in Q1. But we're choosing to do that because we think we're going to be in a better credit position by letting some of those credits cycle off. So yes, I think that you'll see a dip in Q1 and then a kind of return to the mean probably by Q2 and then growth in Q3 and Q4. So that's -- you're not -- directionally in your right comment.

Right. I appreciate that. I agree with you. I mean chasing a few hundred basis points in yield in exchange for credit losses is a lousy trade and shareholders certainly don't want you to do that so I think it's the right call.

Secondarily, on G-and-A, the $1 million a quarter. I mean are we talking from kind of -- the Q4 level was obviously a bit elevated because you had bonus accruals from a good year, et cetera. It was $12.6 million. It was $11.4 million in Q3. Which one of those am I supposed to -- I mean what SG-and-A are we looking at, 50, 54 for the year budget? Again, right now. Things change obviously. But can you give us kind of a ballpark of the number? Is Q3 the right one to go from? Is Q4?

I'm sorry. You lost me in your question, which thread you're asking me.

Well, for G-and-A combined, obviously Q4 was $12.6 million, Q3 was $11.4 million, right? And when you're saying it's going to grow $1 million a quarter, what's my starting point? Because Q4 obviously was elevated because of bonus accruals. But is that the right run rate to start from or is the lower number, Q3, the right number to start from?

I think that if you look at it, it's probably going off of the -- Q4 is beginning to show that. But you're absolutely right. Q4 has slightly elevated because of the origination activities during Q4. So that's probably a little more on the inflated side.

So honestly, I would just take a blend. And show you so if you look at it, I think we ended up in 2018 -- excuse me, 2017, around $47 million of G-and-A excluding interest expense with comp and G-and-A. And I think that -- I mean the answer it's going to go up by $4 million.

Right. Fair enough. Fair enough. Got it.

That's what we're showing it to go. And it is going to be contingent upon -- obviously, some of that is upon pretty good origination activity. So there's some variable comp associated with that. If for some reason something happens and we decide pull back, then that comp G-and-A will probably pull back by $1.5 million-$2.5 million in Q3 and Q4. But right now, everything that we're doing is modeling a delta or a variance of $4-plus million from '17 to '18.

Got it. Got it. Appreciate that. If I could -- kind of following up on all these questions about rates. I mean if we look at the fourth quarter last year, and there's a lot of things that have changed between then and now, core yield is now 12.5%. Obviously, average kind of base rate is up 60 basis points over that period, right? So we've seen 40 basis points of core yield compression. To your point, and I think you addressed this on the question of like does it transfer in a competitive environment, do you see the benefits. You talked about that on the second quarter. You've been ahead of the game. And it really gets competed away, right? So the question mark here really is -- and obviously, you answered one of the questions earlier. You don't factor that into your core yield expectations of 11.5% to 12.5%. But does the -- put it simply. How much does the rate curve actually matter versus the competitive environment?

Clearly, the competitive environment is the more prevalent leading indicator of accretion to the portfolio or lack thereof. However, to look at apples to apples, Q4 '16 and Q4 to '17, there is a material mission in the fact set and that is that we took out one of our major competitors, which is Ares' portfolio. And so now having Ares not in the marketplace among others out there who have no access to capital because they're trading below book or they're overly-leveraged or they have a concentrated loan portfolio, they have been impacted by inability to access the equity capital markets for growth. That is a more accretive position for us to be assuming and that's why I said that I think that the competitive landscape is improving when it comes to BDC and other market entrants aside from the non-bank players. The bank players remain very aggressive, but the non-bank players are being capped out financially and therefore we're able to take advantage of that improving spread market.

Our next question comes from the line of Henry Coffey from Wedbush.

In terms of listening to all this, nobody likes prepayments. Everybody would like to see growth, et cetera. But when you're talking about core yields holding steady, some positive portfolio rotation, building up the quality of the business and then your ability to refinance high-cost debt, it seems like we're in a pretty good -- you'd like to grow, but you're in a pretty good position to earn and cover your dividend.

Yes, to answer that Henry, the earnings spillover, $0.28 a share, you got it.

Right.

We're extremely well-positioned right now. And an abundance of liquidity.

Yes. And so you'd like to grow, but you're not and it's okay. Really two questions. Are there chances for you actually to start thinking seriously about increasing the dividend again or you prefer to stay right where you are?

So my response on that question has always been historically that decision is up to the board of directors to conclude. My recommendation as a chairman and the CEO and founder of the company is I like raising dividends when I have even a larger earnings spillover because I like to be a little conservative and have that extra horsepower if and when I need it, when I want to make investments in the business that may actually bring my NII number below my dividend. I can make those investments for long-term capital building of the business and not worrying about the stress of the dividend not being covered.

So the answer to that question is that I think that the dividend policy certainly merits being revisited probably at the end of Q1 and in earnest at probably end of Q2, at which point you could look at a supplement or other dividend increases you may want to look at like, for example, sprinkling in maybe a penny of a special in each one of those or supplemental dividend at that point. But I think in fairness, it's a dialogue and conversations that the board will engage in probably at the end of Q1, most likely the middle of Q2.

And the other side of what you're doing, and some of your earlier speakers alluded to this, we're in an environment where other parties are being more aggressive. Valuations are inflating, et cetera, et cetera, et cetera. What sort of impact is that having on the underlying fair value of the portfolio particularly in 2018?

So not to reveal my playbook, but to exactly your question, with this euphoric environment that we are witnessing with every asset is good not matter what the price is, we are more than happy to cycle out, rotate out credits that we may think it could be problems later on in the future. And because we're in such an exuberant market, we're going to take advantage of that and prove the outlook of our portfolio even further by recycling out those credits and replacing them with new credits that we feel even stronger about. So we're taking advantage of that.

What's the second part of your question? I'm sorry, I forgot.

No, I'm just saying that we're in the kind of environment where valuations are increasing, willingness to lend is increasing. And doesn't that increase the likelihood of M-and-A and other positive developments that could help clean up some of your more troubled assets?

Well, the problem is that I wish I had a lot of troubled assets. I don't. I'm down to 90 basis points of non-accruals and my credit book is probably one of the strongest it's been in a long time. So I have earnings spillover. I have great credit outlook. I have abundance of liquidity. I have portfolio rotation that's sustaining my core yield. I'm not sure what more I can do better than what we're doing right now as an organization. So we're actually very happy and delighted where we stand today. And we are just taking advantage of just being hyperly-selective on the deals that we're looking at to continue to grow and sustain a high-quality portfolio.

But as I said in our commentary, if we don't think that the yield spreads that we are seeking can be had, we'll then do like we did in this quarter; announce that we're going to pay back some bonds and generate $6.6 million in savings, which are earing accretive to $0.08 per year, and continue to manage the balance sheet effectively. So we're always aligned with our shareholders as an internally managed BDC and we don't care about any one. We care more about sustainability of earnings and dividends and credit quality.

Right. What I'm trying to get at is don't you think we'll be seeing more positive fair value marks either on the realized or the unrealized line in 2018? I know you don't want to comment there, but it seems like exactly the kind of environment that drives that process.

Yes. I mean if you believe the Fed, who has been reaffirming that there are going to be 3 rate increases in fiscal 2018 because a strong and growing economy, GDP going up 3% and the PPI Index is just as rising, meaning inflation is coming, I mean everything is boding for an upward left chart. So yes, everything is encouraging.

And I am seeing no further questions and I would like to turn the call back to management for any closing remarks.

Thank you, operator, and thanks, everyone, for joining us today on the call.

As a reminder, we will be participating at the RBC Capital Markets Financial Institutions Conference on March 7th in Manhattan, in New York City, as well as the B. Riley FBR 19th Annual Institutional Conference on May 23rd in Santa Monica, California, as well as other upcoming events and non-deal roadshows that we'll be conducting in the first quarter. If anyone has an interest in scheduling a meeting, please let us know and reach out to either RBC Capital, Michael Hara, or B. Riley and FBR to schedule those meetings. I will tell you that we have a very busy schedule with non-deal roadshows coming up, but we will try to accommodate all the rowing requests that we have and we'll be happy to, if we have time, to certainly meet with anybody who would like to meet with us. So thank you very much for your time and good afternoon, everybody.

Ladies and gentlemen, this concludes today's call. Thank you for your participation. Everyone have a great day.