Hercules Capital Inc (HTGC) 2018 Q3 法說會逐字稿

Good afternoon ladies and gentlemen, and welcome to the Hercules Capital Q3 2018 Earnings Conference Call. (Operator Instructions.] As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host, Mr. Michael Hara, Senior Director of Investor Relations. Please go ahead, Sir.

Thank you, Sarah. Good afternoon everyone, and welcome to Hercules' Conference Call for the Third Quarter of 2018. With us on the call today from Hercules are Manuel Henriquez, Founder, Chairman and CEO; and David Lund, our Interim Chief Financial Officer.

Hercules' third quarter 2018 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 the confirmation of the final audit results.

In addition, the statements contained in this release that are not purely historical are forward-looking statements. These forward-looking statements are not guarantees of future performance, and are subject to uncertainties and other factors that could cause actual results to differ materially from those expressed in the forward-looking statements, including, without limitation, the risks and uncertainties, including the uncertainty 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, 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. Good afternoon, everyone. And thanks for joining us on the call today. I am happy to report that we continued to have a tremendous and outstanding year in 2018. With just a few months left to the year, we're on pace to set new all-time records across many key indicators, especially as it relates to total new annual commitments and loan portfolio growth, which now we expect to exceed $1.1 billion in total new commitments for calendar year 2018. This is a level that we've never seen before and it amplifies the tremendous amount of deal flow that we're currently seeing in the marketplace.

This performance has been accomplished despite an otherwise tough and volatile times in the capital markets and many ongoing geopolitical uncertainties. However, Hercules Capital nonetheless continues to thrive and has achieved another strong and outstanding quarter for our shareholders, generating net investment income of $0.31 per share and once again covering our dividend of $0.31 from NII earnings.

As evidenced by our many Q3 2018 accomplishments, Hercules Capital has both achieved the necessary scale to succeed, but also has established itself as the BDC industry leader in the venture capital lending category as we continue to build our investment portfolio while many other smaller subskill BDC venture lenders are still unable to do so as evidenced in their Q3 earnings release and performances.

Furthermore, driving our tremendous growth in 2018 is a strong marketplace awareness and trust the Hercules Capital brand and platform has achieved within the market as the capital partner of choice among many of the top tier and select leading venture capital firms as well as many of the innovative entrepreneurs all have sought out our capital and sought us out as a capital partner. We have surpassed and set all-time new records of total new commitments in a single year which as of the end of October was already over $1 billion even though our target is $1.1 billion for the year, again, with 2 months remaining.

I truly can't say thank you enough to these amazing and visionary and innovative entrepreneurs and our venture capital partners for trusting Hercules Capital as one of their trustworthy capital partners of choice. No other venture-focused BDC lender has the market presence, the balance sheet or capabilities that we have to offer our companies. And no existing small subskill BDC venture lender in the market today has or can publicly demonstrate their ability to originate new commitments anywhere near the level of originations or scale that Hercules has achieved in the market so far.

Because of our sustained confidence in Hercules capital and our continued strong transaction demand that we are seeing in the marketplace, I am very proud to announce and declare our additional supplemental dividend of $0.02 per share to be paid in conjunction with our regular dividend of $0.31 for a total distribution to our shareholders of $0.33 in Q3 due in no small part to the strong and continued expected growth of our investment loan portfolio and of course our growing earnings and growing earnings spillover which currently stand at $27 million or approximately $0.29 per share. And this, I would like to highlight, excludes any harvesting of realized gains from our Docusign and other holdings that we have in public securities. This additional earnings spillover will serve as additional potential future supplemental dividend payments or distributions to our shareholders, especially as we continue to generate ample net investment income to cover and eventually surpass our existing dividend level of $0.31 per share as we anticipate to occur later in 2019.

Although we achieved many new financial records and achievements through the first 9 months of 2018, we are nonetheless entering Q4 with revised and heightened level of caution and controlled optimism, especially given the recent market volatilities and of course with our strong year-to-date performance. This should not be confused that we are somehow pulling back or being more conservative in the overall marketplace. It's none of that. But rather that we're being a bit more selective and a bit more skeptical on new investment opportunities given the fact that we're already at $1.1 billion on track to achieve in 2018.

Notwithstanding this new level of caution or guarded optimism entering Q4 ’18, we anticipate continued growth in our investment portfolio in Q4. In fact, we expect the net new loan portfolio growth in calendar -- in the fourth quarter of 2018 to be approximately $75 million to $125 million net-up or growth in the portfolio in the fourth quarter representing a 5% to 8% quarter-over-quarter overall loan growth.

To put things in better context, with the tremendous growth realized year-to-date, we are also on track to potentially exceed, as I indicated earlier, the $1.1 billion total new commitments in calendar ‘18. And we also expect, with the expected new net portfolio loan growth, as I previously mentioned, we now expect to add in 2018 with an investment loan portfolio balance in the range of $1.7 billion to $1.75 billion, which is higher than our original forecast at the beginning of the year that we expected to finish fiscal year-end 2018.

Given this meaningful year-to-date growth, I believe it is prudent to proceed cautiously in the remaining few months of the year and protect our balance sheet while also augmenting and maintaining ample liquidity to capitalize on new investments or acquisition opportunities as we are evaluating many of the same.

More than ever, scale has become a critical BDC competitive advantage and Hercules has successfully achieved this level of scale as evidenced by our nearly $2 billion in total assets, $1 billion in total net assets as well as our strong year-to-date capital fundraising activity of more than $450 million that we have raised in calendar 2018 in a combination of debt and equity capital raised during the first 10 months of 2018.

As we had previously shared with you during our Q2 earnings call, we had forecasted and now I'm proud to say achieved net investment income of $0.31 per share covering our dividend just on net investment income driven by the strong loan portfolio growth of 3.7% quarter-over-quarter and of course the sustained effective yields of over 13% realized during the quarter.

With that said, as we approach year-end 2018, we are increasing our year-end invested portfolio target as I indicated to the $1.7 billion to $1.75 billion and we continue to anticipate generating ample net investment income, or NII, to cover the dividend in Q4 and beyond. This will allow us to continue to possibly distribute additional supplemental dividend from our earnings spillover given the fact that we are now anticipating covering NII from earnings alone.

Much of our success and achievement would not have been possible if not for our most important human capital assets, our tremendous team of dedicated employees who have once again proven their significant importance and teamwork and strong execution allowing us to realize these great achievements on behalf of our shareholders.

Thank you all very much for your continued dedication and loyalty. I take immense pride to see many of these new records and achievements being realized as a Founder, Chairman and CEO of Hercules Capital. It truly underscores the amazing depth and level of talent, discipline and diligence that our origination team has put forward, and all of our employees contribute towards realizing these amazing milestones among many other achievements that we have realized. I am deeply in debt to you and once again, I'd like to say thank you for making this all possible.

Now for today's call, I will briefly discuss the following selected achievements and highlights. I'll provide an overview and highlight of our outstanding financial performance and key achievements during the quarter. I will provide a brief commentary on our revised level of heightened cautions and controlled optimism as we enter Q4 and our upward revision to our outlook and forecast of NII covering our dividend moving forward as well as our anticipated growth in earnings and spillover for potential future supplemental dividend distributions and payments.

I will also offer some perspective and insight into the very robust and very strong venture capital marketplace activities as it relates to fundraising, investments, IPO and M&A activities. And then of course I will turn the call over to David Lund for a more detailed and briefer overview of our specific financial results for the quarter ending Q3, 2018. And finally, as we always do in our calls, conclude with a Q&A session to address any of your questions.

And now for some select highlights and key achievements in the third quarter. Let me begin by saying we realized a stronger than expected seasonal third quarter than what we anticipated. With this new robust new origination activities that we are experiencing across all sectors that we focus on, we are proud to announce the following achievements.

We achieved another strong quarterly performance of net investment income of $29.3 million or $0.31 per share, up 22% year-over-year. We entered into total new debt and equity commitments of $235 million in the third quarter, up an impressive 52% year-over-year. We funded over $142 million in new investments for the third quarter for a total of the first 9 months of the year, through Q3, we have now funded over $706 million of new capital investments, representing an equally impressive showing of 45% year-over-year growth.

We realized materially lower early prepayments or payoff activities than we had expected in the third quarter. In fact, we realized $65 million of early payoff activities, down from the $114 million we had experienced in Q2 and well below our targets of $75 million and $100 million per quarter. This has 2 implications. Number one, it allows us to generate higher interest income. But conversely, it also translates into lower one-time acceleration fees related to early payoff activities. So there's always a tradeoff between early payoffs and consistency in building your loan portfolio.

During the third quarter, we also took time to also continue our pruning and selective rotating out of certain positions. And in fact, during the third quarter, of the $65 million in early payoffs, $42 million of early payoff was precipitated by our own actions of selectively grooming and pruning the portfolio out of certain credit positions that we felt more comfortably should cycle off of our credit book. And that's in fact what we did during the quarter. Empowered with that knowledge, this is why you'll see our revised Q4 early payoff numbers are now expected to normalize more in the $35 million to $45 million level.

With the combination of the strong fundings occurring in the third quarter and the slowdown in early payoff activities, we experienced a net portfolio growth of approximately $54 million in Q3. As I indicated just a few seconds ago, we’re now forecasting our Q3 early payoff numbers to be approximately $35 million to $45 million. With this lower expectation of early repayment activities, we also are expecting a higher interest income to be generated from our portfolio given the fact that we'll have higher inter-quarter balances than we had initially anticipated in the fourth quarter. However, because the early payoff activity will also impact other sources of income during the quarter, we also anticipate lower interest income from accelerations on early payoff or nonreoccurring fees during the fourth quarter.

When combining both of those elements of higher interest income and lower fee income, we actually still expect to achieve $0.31 in NII earnings in Q4. However, because of the timing of the fundings of the new originations in the fourth quarter and the ultimate payoff of some of these loans that may occur, that we are anticipating early payoff, we could see a swing in NII earnings of anywhere between $0.005 to $0.015 subject to when the early payoff activities take place or the targeted fundings take place in the quarter. Notwithstanding that statement, we still feel very comfortable that achieving a $0.31 in NII earnings, plus or minus $0.005 to $0.01 in either direction.

We also anticipate early payoff activities to materially pullback and remain at these subdued revised levels as we experienced in Q4 for the next few quarters or at least until we see stabilization and evidence of a stable capital markets when we start seeing a pickup in M&A and IPO activities. At which time, we expect to see an elevated early payoff activities as M&A and IPO activities starts picking up again. Until then, we're comfortable saying that we expect early payoff activities to be in the $35 million, $45 million range on a normalized basis.

As a reminder and as evidenced in Q3 results, predicting early repayments is and shall remain a very difficult task since we do not have control or visibility much beyond 30 days from our loan portfolio companies on what's going to get paid off or not. It is also subject to significant market variability and market conditions as I indicated, specifically related to M&A and IPO activities. Another important indication of our market leadership position was our ability to maintain and sustain our quarterly yields quarter-over-quarter despite an otherwise competitive market. Both our core and effective yields were basically flat or consistent with our Q2 results of 12.7% and 13.5% respectively on our core and effective yields.

More than ever, as we all face turbulent and unpredictable market conditions, our proven control and discipline of slow and steady growth strategy has once again demonstrated that remaining focused and willing to walk away from ill structured or badly priced transactions are critical fundamentals to building a successful and strong performing loan portfolio. To provide some context, despite our expected $1.1 billion plus in closed and pending new commitments in fiscal 2018, and counter to 2018, we have turned down or walked away from more investment opportunities in the third quarter than I have witnessed or recall ever doing in any prior quarter since founding Hercules back in 2003. We are acutely focused on certain criteria of underwriting and we are more than happy to walk away from a transaction if it doesn't make sense. In fact, we remain hyper selective in our underwriting and I personally would rather miss an earnings EPS forecast or consensus than sacrifice the balance sheet to simply make a quarter in earnings.

You do not achieve the level of growth that we have without that steadfast discipline in underwriting that we have achieved over the years. And with the strong deal flow that we have, we're able to pick the best opportunities that come before us. We achieved many of those outstanding results while maintaining our historical focus and prudent credit discipline as evidenced by our historical and insignificant low 20 basis points nonaccrual loans while maintaining a very strong balance sheet and high liquid position with over $137 million of available liquidity for new investment and continued growth in the portfolio.

However, post quarter growth, and as we announced this morning, I'm proud to say that we recently completed a very successful $200 million new securitization, making it the third securitization that we have completed. We have now secured over $200 million of additional liquidity to further bolster our balance sheet as we turn our attention to the fourth quarter and first quarter to fund additional loan growth and earnings on behalf of our shareholders.

In addition to the robust new loan origination activities during the third quarter, we remain very active in enhancing our right side of the balance sheet or our liability structure as we continue to proactively manage our debt and equity capital as we look to continue to bolster our growth by augmenting our balance sheet with additional liquidity. We are also actively managing our overall cost of funds while also managing our leverage within the targeted desired leverage range that we had indicated that we would maintain for the third and fourth quarter of 0.75 to 0.95.

As an example of the activities that we completed just alone in the third quarter, we successfully completed the following capital markets. We raised approximately $31 million of equity capital through our ATM, adjusted time program, all done well above book value north of 1.2x book, making a highly accretive equity offering on behalf of our shareholders. We also completed a successful 15-year bond offering, which I am not aware of any other BDC has successfully been able to place, a 15-year PAR 25 6.25 bond offering in a marketplace to which we raised $40 million.

We also just recently completed, as I indicated just a few seconds ago, a $200 million securitization, making it our third securitization as an A-rated by Kroll KBRA which was a well subscribed and a testament to our proven business model and our strong and diverse asset base that we were able to successfully underwrite and complete a new securitization at a fixed coupon rate of 4.605 with a maturity of approximately 2027. Further to that, I'd also like to remind everybody during the quarter we also received a greenlight letter from the SBA which continues to be a terrific and fantastic partner for us. We received a greenlight letter which we are now in the process of completing the final application for our third SBA license. The final steps are in process and we expect to complete the final approval from the SBA sometime in the first half of 2019, allowing us to gain access to approximately $175 million of new SBA debentures. As a reminder, on June 21, 2018, President Trump signed the Small Business Investment Opportunity Act allowing a single licensed SBA to achieve maximum leverage of $175 million. Which with our existing license of $150 million, would immediately give us access to $325 million. As a reminder, the total family of funds capacity under the SBAC program with the SBA is $350 million in total.

Lastly, as we received investment grade corporate and credit indicative rating from GBRS as a BBB flat which encompasses and includes the approval from our board to reduce the asset coverage ratio to 150% under the Small Business Credit Availability Act. This is inclusive or in addition to our existing KBRA or Kroll BBB+ rating that we have today.

All these activities allow Hercules Capital to finish the third quarter and enter the fourth quarter with an enhanced and very strong liquid balance sheet, to allow us to continue to access the equity capital markets when we need to manage our leverage within the ranges that we first described and continue our portfolio growth and our portfolio growth targets that we indicated to you earlier of $1.7 billion to $1.75 billion.

Now let me take a few moments to share with you the activities related to new business and the robust venture capital marketplace activities that are going on. We saw very strong demand for loan and transaction deal flow driven in no small part by the very impressive and robust performance by the venture capital investment activities realized during the third quarter. In fact, the VCs were so active, they invested over $27 billion, a record pace of new investments in the third quarter, making it one of the best quarters since 2000 according to Dow Jones Venture Source. At this level in run rate, the VC investment activities for 2018 are on pace to shatter all previous records related to new investment level activities in a single year and are expected to now surpass $100 billion, outpacing all of 2000 or '99, in terms of invested capital during the dot.com era itself.

Liquidity activities realized in excess of the venture capital investment community were also quite active in certain areas. Our own investment portfolio has benefited from a very strong M&A marketplace and activities. We had a handful of portfolio companies complete and announce their M&A activities which you can see listed in our earnings release that we published today in a subsequent section. IPOs on the other hand have been much more tepid. We are cautiously monitoring the IPO markets which saw an unexpected pullback with only 21 companies completing their IPO activities in the third quarter. And down from the 60 companies that completed IPO activities in all of 2017. Year-to-date for the first 9 months of 2018, we've seen 68 companies complete their IPO activities thus far, well below the 126 companies that completed IPOs in 2014. However, unlike the IPO market, the M&A market has continued to be fully resilient. We continue to see very strong activities with over 202 companies completing M&A activities in the third quarter, representing -- sorry, 574 in the first 9 months of the year. The amount paid was over $102 billion which already surpassed all of the activities of transactions in fiscal 2017 of $90 billion. As a reminder, we had over 5 companies complete M&A activities alone in the third quarter.

Now let me discuss our pipeline and new commitments and funding as we turn our attention to Q4. As I shared with you earlier during the call, in just a few months, just the few months of October alone, we have already secured or closed over $84 million of new commitments, well on our way to eclipsing the $1.1 billion target that we expect to have by year-end with still 2 months to go in the year. Assuming all these side terms to these commitments continue to convert into newly funded loans in the fourth quarter, we once again will reaffirm our belief in achieving an investment loan portfolio of $1.7 billion to $1.75 billion and representing a year-over-year loan portfolio growth of over 20% to 25% from the year-end balance of 2017 of $1.44 billion at cost or $300 million net portfolio growth alone in one calendar year.

Now, let me take a brief opportunity to discuss our views of the marketplace and activities as we enter the fourth quarter. Again, we remain guardedly optimistic but cautious by what we are seeing developing in the current markets as we enter the fourth quarter. Notwithstanding that new guarded conservatism that we have, we still have a pipeline over $1.2 billion allowing us to easily select $100 million to $200 million of transactions to fund and close during the remaining few months of the year. Our slow and steady strategy has served us very well for many, many years. In fact, for over a decade. The slow and steady strategy is credited with our disciplined growth and focus on continuing to grow the loan book despite an otherwise competitive environment and challenging economic outlooks. By remaining focused and cautious in anticipated returns to future acceleration of loan portfolio growth, we are taking our time to methodically grow our loan book to that $1.75 billion. You will soon see that when you run your mathematical models at $1.75 billion, we can easily and consistency generate interest income, or I should say net investment income, that would generate at least $0.31 in earnings or more.

In closing, we had an outstanding first 9 months of the year. Strong commitments in fundings. We delivered net overall low portfolio growth, putting us in a position to cover our dividend of $0.31 in the third quarter and beyond. Assuming sustained portfolio growth and yields, I recognize is an important measurement for many of you. At this point we feel confident in our continuation of seeing net investment income consistently cover our dividend at $0.31 and in fact we see later on in 2019 exceeding that with earnings of our own portfolio. And this is even before adding leverage to our own portfolio. Our outlook for the fourth quarter, although it remains guardedly optimistic, is nonetheless positive as we navigate towards our desired loan portfolio targets as I indicated.

And finally, as we wrap things up, the update on Hercules Capital views related to the recently passed Small Business Credit Availability by Congress on changes to leverage our asset coverage to 150%. We have received shareholder approval on September 4 and we expect to receive shareholder approval in a special meeting on December 6. I ask all shareholders to please cast your votes so we can reach the necessary quorum and move forward with our leverage. It is very important for us to pursue leverage, but as I indicated on multiple different commentary, we do not anticipate leverage for the first 12 months to exceed 1.25 at any time over the next 12 months as we guardedly increase our leverage to modest levels.

I'd like to say thank you to all institutional bond and equity holders for your time, feedback and support and recognize the many advantages our proposed and modest gradual control to increase the leverage could have a beneficial impact to the Hercules Capital model and generating higher ROEs for our shareholders.

With that, I'll turn the call over to David.

Thank you, Manuel, and good afternoon ladies and gentlemen. Today we are pleased to report our third quarter results. This afternoon I will focus on the following financial areas. Our origination platform, income statement performance, NAV and return performance, and credit performance.

With that, let's turn our attention to the origination platform. We continue to demonstrate our strength as the leading venture lending platform with total investment fundings of $142.4 million in what is historically our slowest quarter for investment activity. These investments came from a total of 19 portfolio companies, 8 of which were new portfolio companies. This investment activity brings our fundings for the first 9 months of 2018 to a total of $706.1 million, putting us on pace for a record year.

This investment activity was offset by early repayments during the quarter of $64.9 million and normal amortization of $20.4 million. As a result of this activity, on a cost basis our investment portfolio balance ended at $1.61 billion, representing an increase of 3.5% from the second quarter and 11.7% from the first 9 months of 2018. We have recently been experiencing a slowdown in early repayment activity and are projecting early repayments of $35 million to $45 million in Q4. Our core yields maintained at 12.7%, in line with prior quarter even in this competitive market. We expect Q4 core yields to be flat with Q3 at 12.7%.

With that, I'd like to discuss a few key metrics from our income statement performance for the third quarter. On a GAAP basis, our net investment income for the quarter was $29.3 million or $0.31 per share, covering our dividend of $0.31 per share from operations. Total investment income was $52.6 million in the third quarter, an increase of 6.1% from $49.6 million in the second quarter. The increase in total investment income is due to higher interest income of $49.1 million on larger weighted loan portfolio. Our weighted average principal outstanding increased by $85 million to $1.55 billion from $1.47 billion in the second quarter. Our fee income decreased by 4.8% to $3.5 million during the third quarter primarily due to lower one-time and facility expiration fees.

NII margin rose to 55.7% in the third quarter from 45.9% in the second quarter. The increase in margin is due to lower interest and fee expense of approximately $2.4 million related to the redemption of $100 million of our 2024 notes in the second quarter and lower compensation expense.

Our SG&A decreased to $12.3 million in the third quarter from $13.5 million in the prior quarter, driven primarily by a decrease in variable compensation due to performance and funding objectives relative to plan, offset by higher stock-based compensation. We anticipate our operating expenses to be between $13.5 million to $14 million in the fourth quarter.

Now I would like to discuss our NAV performance and credit outlook. We saw our NAV increase to $1 billion in the third quarter from $963.7 million in the second quarter, an increase of $0.16 per share or 1.6% to $10.38 per share. This $40.4 million increase in NAV was primarily the result of our net accretive ATM activity totaling $30.9 million. We saw our return on average equity increase to 6.9% from 5.4%. Our return on average equity increased to 12.7% in the third quarter up from 10.2% in the prior quarter. The increase in both returns was due to the higher interest income on a higher weighted average portfolio and the lower interest expense in Q3.

Lastly, I would like to discuss our credit performance for the quarter. Our credit performance remains strong in the third quarter with a weighted average credit rating of 2.23 as compared to 2.21 in the second quarter. Our credit 4 and 5 rated companies which are our primary area of focus, remained stable at just 3.1% of costs in the third quarter and our nonaccruals remained at historic lows at 0.2% as a percentage of our total investment portfolio at cost and 0% on a value basis. This makes 5 consecutive quarters where nonaccruals as a percentage of total investments at cost are below 1%.

Based on our remarks today and our overall financial performance, we are very pleased with our third quarter results. Thus, in closing, we are well positioned at the end of the third quarter heading into the remainder of 2018. Our long-term focused approach and disciplined underwriting standards and access to diversified funding sources will enable us to deliver strong results for the foreseeable future.

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

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

This is 2 very strong quarters of origination activity, pipeline is still strong. In your opinion, what's shifted in the market? Is it better, is it less competition? Or is it just higher demand because the addressable market is maybe increased?

I think it's a combination of multiple items. I think that we're seeing bank regulations have an impact. I think strong venture capital participation or investment activities is another important issue. The delay in the capital markets is forcing more companies to rethink their capitalization on bolstering up their liquidity using debt as opposed to just pure equity. Given the elongated timing now, of realizing an IPO event, companies are wanting to bolster their balance sheet to engage in better valuation discussions for M&A activities. And in general, we're seeing those companies that have established themselves begin to accelerate customer acquisition costs or customer acquisitions by revenue growth by accelerating expenditures to secure more customers, as they groom themselves for an M&A or an IPO event also is contributing to those factors.

Okay. Along with that increase in demand, your yields have moved above where you guided us earlier in the year. Is that simply more pricing power or is something else going on in the market?

In fairness to the comment, I think that the pricing yields that we indicated at the beginning of the year 11.5% to 12.5%, don't reflect the increases in overall levels of prime rate, the fed funds increases they've done recently. So I think that's one of the factors that we probably need to realize or increase our effective yield range. When we do that, we're probably right where we should be which is slightly above the mean on that range. So I think that the range that we've given beginning of the year does not take into account that benefit of the 3 rate increases that took place in the market. Notwithstanding that, we have been able to sustain pricing yields as we remain very selective in the transactions that we are involved with. Despite some of the early commentary that some other BDSs have made, we're not seeing covenant-lite deals realizing in the venture capital marketplace. I think that is probably more akin to dealing with sub $10 million venture loan transactions where the commercial banks are there in a very strong occurrence.

All right. Then final question, it looks like 8 new companies in terms of investments during the quarter. Anything worth calling out in terms of the sectors you're focused on right now for incremental investments?

You know, we've now come to learn we're not going to do that anymore. Because as we do, then we see competitors simply following us. So we're no longer unfortunately calling out what we're going to be investing in from a favorable outlook because we've now been watching some of our competitors kind of trend right behind us as we identify those sectors. So as much as I'd like to share that with you, I think it's becoming a more competitive advantage not to openly discuss that.

Your next question comes from the line of Ryan Lynch from Hercules Capital (sic) [KBW].

First question has to do with the securitization. I'm not sure if you mentioned this or not, but is there any sort of reinvestment period on the securitization before it starts amortizing? I believe the last securitization you guys did, you guys had a 1-year reinvestment period. Can you just talk about that?

Sure. This is our third securitization and each time we do one, they improve dramatically. This one has a 24-months reinvestment period and then it goes to amortize over 3-years in that process. Hence, the life of approximately 2027 if you will when the last loan is scheduled to come off. So it has a 24-month reinvestment period and has approximately a 70% advance rate on the collateral that's been posted in the securitization.

Okay, perfect. That's helpful. And then just wanted to kind of talk about your comments when you said you were going to be more cautious or more selective going forward. It sounded like those comments were made in response to the significant amount of capital, the $1.1 billion of commitments you guys have already deployed in 2018. So it seemed like that was kind of the driving force behind you guys kind of, I don't want to say pulling back, but just being more cautious and selective. But I didn't hear anything necessarily about the competitive environment that was really causing any caution. Am I framing that right? And can you just maybe provide an update on the competitive environment? Because as you mentioned, some other BDCs have talked about it being a little challenged as far as term structures and covenants.

Well some of these BDCs are only growing at maybe $30 million or $40 million a quarter at best. We're not. So I hate to -- I guess I'll say it this way. I think we're seeing a tremendous amount of the lion's share of transactions in the marketplace. So we're not seeing any significant impacts from a competitive environment in terms of our deal flow. As evidenced by the trajectory of $1.1 billion, and I would say that my tone for caution is that I can probably easily see ourselves doing $1.3 billion in transactions in one fiscal year, but I think that growing to $1.1 billion-ish is more than plenty in one year. So we are the ones purposely holding back. Not because of competition, it's because we have already achieved a tremendous amount of origination and I think that's enough growth in one fiscal year. So that's allowing us to be even more hyper selective on the transactions that we look at for the last 2 months of the year and allow us to really preserve and manage our yields the way we want it to be.

That makes sense. And then, when I'm looking at prepayments, I mean prepayments have dropped off obviously significantly from the beginning of the year and it sounds like they're going to continue to kind of trend lower in the fourth quarter. Now just kind of looking back, what really drove the big spike in prepayments in really the first 2 quarters of this year and why has it tailed off so significantly in the back half?

Sure. You may recall that we indicated both in Q1 and Q2 that we have embarked on a purposeful grooming and pruning of the portfolio. So in Q1 we enhanced or highlighted that we experienced about $160 million of the early payoff activities in Q1 were driven by our own doing on vacating 2 particular credits or loans that we cycled off on the books in Q1. So that made up $160 million plus of that early payoff activities that we saw in Q1. In Q2, we also continued the pruning, but at bit more modest levels and we saw somewhere about $40 million-ish to %50 million of early payoff activities in Q2. So that really adjusted. So again, to give you the numbers, we had $243 million of early payoff activities in Q1, about $160 million of that was our own portfolio rotation and pruning that we did was included in that number. The $114 million in Q2 had approximately $40 million-ish, $50 million or so of additional portfolio rotation and pruning that we did. And then culminating in Q3 where we had $65 million of early payoff, $42 million of that was further portfolio grooming and pruning. And we were able to do that when have such a very strong pipeline of transactions and deal flow coming in. We're able to cycle off sectors that we no longer view as favorable or we see developing larger trends that could be adverse to our secured credit position that we felt that it's better to cycle off that particular credit and take advantage of the competitive environment. Where some of our competitors may not be as astute in credit underwriting, we would gladly take advantage of that market.

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

When you talk about 2018 year-end portfolio balance of $1.7 billion to $1.75 billion, you're talking just about the debt portion of the portfolio?

Yes, that's just the investment debt portfolio excluding warrants and the equity which would add about another $100 million to $140 million to the overall total.

Your next question comes from the line of Aaron Deer from Sandler O'Neill Partners.

I just have a couple questions. One is with respect to the expenses. What changed in the third quarter performance relative to plan that caused the true up in the compensation line this past quarter?

Well, the answer has to do with it's a variable comp plan related to the origination team. There's a natural cadence that occurs typically in the second quarter and often recalibrates in the fourth quarter as individuals achieve certain minimum requirements. Once they achieve those certain minimum requirements, it unlocks incentive bonus payments to them. And then as they continue to trend, certain percentages up that continuum, as they approach the fourth quarter there can be additional benefits or overage, incentive costs that can be earned as well based on their yields and their overall performance. So the cadence is mid-year and end of year. You'll see recalibrations depending on how the overall performance is occurring. That's what drives that.

Okay, that's helpful. Then the guidance on that front, I think it was $13.5 million to $14 million, that includes the G&A compensation benefits and stock-based compensation but not loan fees, is that correct?

That is correct.

Okay. And then just a last question, just given it continues to be pretty strong growth outlook and the very significant capital market actions that you guys have taken on the funded and capital side year-to-date, what are your thoughts in terms of using the ATM, continued use of the ATM as we head into year-end here?

Well obviously the ATM has been a tremendously strategic vehicle for us because it allows us to manage our leverage ranges in that 75% to 95% leverage that we talked about. I think the ATM program remains an integral part of our strategy as we dial-in in fiscal 2019 with the presumption that our shareholders approve the leverage capacity or asset coverage being lowered to 150%. We have made it very clear however, that our first 12, possibly 15 months of the approval, we do not intend, I'll make it very clear, we do not intend to rise above 125%. And our new operating range will be 0.95 to 1.25 will be the new operating leverage range for the next 12 to 15 months shareholder approval. Which means that we'll have to use the ATM to ensure that we remain within those tolerances, no different than we've done in Q3 and Q4, or expect to do in Q4, excuse me.

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

Manuel, the 125% leverage ratio, is that a change from before? Because I recall you saying your target is to say at 100% and then occasionally have sort of a shock absorber where you could possibly pop up to 125% or so and then come back down. Or are you looking at 125% on a more sustained basis?

No. None of our models at this point show us sustained at 125%. However, the amount of demand for capital right now in the marketplace is so tremendous that we're seeing, that I would say that my initial outlook on kind of having it flare up and down at 125%, that range being kind of a little more tighter, I think it probably still will flare to 125%, but I think the cadence is probably more like 105%, maybe 1.1. That is if we decide to continue to fulfill that demand that's in the marketplace and we find the attractive pricing that we like to see in structure. I think that's a very important issue to denote, as I indicated in the call, that when the portfolio reaches that $1.75 billion and consistently remains at that weighted average level of $1.75 billion on the loan portfolio at a 13.2% yield, effectively we throw off more than $0.31 in earnings on a consistent basis. Which means that the only way we're going to decide to pursue leverage higher than that is that the asset quality has to be very strong that we're looking for. And if we do pursue that, any incremental growth above 17.50 in loan book, is going to be further additive to driving the supplemental dividends in the loan book. But at this point I just want to get through the midterm elections, I want to finish 2018 and then kind of reassess the marketplace before setting what our operating leverage target specifically are going to be for 2019. But we don't anticipate hitting the 125% leverage consistently in 2019 at this point.

Great. Also, I saw reference to a Wall Street Journal article talking about how regulators might be easing up on capital requirements, liquidity requirements for midcap banks. Given that your market is so strong and given their cost of capital generally is so low, you seem -- I mean venture debt seems like an interesting place for banks to enter into going forward. Is that part of your strategic considerations that the banks become more involved in your market?

I think there are plenty of examples of banks that have weighed into the venture lending asset class and have not performed very well doing that. I don't want to disparage the names of that particular bank, but there are a couple of banks who tried that and not worked out well. I think that venture lending is a highly specialized asset class. Silicon Valley Bank is by far a very disciplined and credible provider and frankly a good partner to have in the market. But there's only honestly maybe 3 or 4 banks that have any real true domain knowledge in this area. Many banks would like to get into this area and many banks have tried and they're lost tens of millions of dollars relatively quickly. This is not an easy asset class to manage and it's not just underwriting, but you need to have a fairly deep bench of individuals who have expertise in the verticals. As a reminder, we are not generalists. And that's a very, very important distinction amongst many of the other BDC venture lenders that are out there. Being a generalist in this asset class is a pretty dangerous thing and I would not advocate being a generalist in this asset class. And that level of expertise is not easily secured by a new bank de novo-ing assets in this category.

Great. Final question, what happened to the inter quarter portfolio update that you guys provided in the past?

A lot of folks asked us not to keep on doing it because they wanted to have it more in the earnings call. So we listened to a lot of our shareholders and we stopped doing it about 2 or 3 quarters ago. I'm torn by that by the way. But a lot of our shareholders asked us, why do it, why get rid of the surprise in the earnings call? So we're kind of trying it out. I'm a little bit mixed on it to be honest with you.

Okay. Well I vote for bring it back.

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

I've heard you talk like this before. It sounds like going into the fourth quarter, you're just -- everybody is just going to sort of take a breath and digest what you've boarded. It has absolutely nothing to do with any sense of waning demand or the quality of the business that you think you can put on. Is that accurate? Or are there some things out there that you are really worried about?

No, Henry, this team has performed exceptionally well. And given the already robust growth of $1.1 billion, maybe it tops $1.2 billion in one fiscal year, it all has to do with a tremendous year already and giving the team a little bit of kind of a break and saying thank you very much for an outstanding performance in a year of doing $1.2 billion. But can we do $1.4 billion? Probably. Do I think it's the right thing to do? Not really. I think that onboarding $1.1 billion, $1.2 billion of new commitments in one fiscal year, to me feels like the appropriate level to just take a break.

When you look into 2019, we'll refrain from any comments, but when you look at the political environment in 2019, is there any real political risk that could affect your business, or is it just kind of the general uncertainty that always surrounds an election?

I mean look, the China pressure exists. There are drug prices that exist. There are slowdowns in acquisitions related to companies on a market where Chinese are big buyers of technology. There's the HB1 visa program. I think we should have a merit-based immigration system. There are a plethora of issues that could represent constraint in capital deployment and growth in fiscal 2019. And clearly, the midterm election has huge implications with whichever party wins. Either party has its own challenges by winning or losing. And so we are taking the more conservative position of great year, let's wait and see what happens, let's have liquidity available to ourselves, take advantage of any good opportunities that surface between now and then. But we'd be in a strong advantageous position to take advantage of opening the first quarter of 2019. And that's exactly what we're doing. We feel great about where we're at. We have great earnings momentum, we have strong portfolio growth, outstanding credit, liquidity. I don't know what else to say other than we are sitting in a very advantageous position, and we just want to see the political environment stabilize a bit.

You know, in the ancient days, a long, long time ago, oh good Lord, it's like 10, 12 years ago now, there were some aspects of your securitization that sort of triggered against you and you fought through that and you survived in great shape. Then since then, it's been nothing but up. When you looked at how you structured the new securitization, can you give -- is that kind of a totally non-recourse deal? Is there any sort of risk factors that you might have to live with in the future? What is your thought around this new funding?

One of the things that I learned dearly in the credit crisis in 2008, 2010 was not to have a single concentrated funding source. In those days it was either equity and commercial banks. I think that commercial banks should represent anywhere between 25% to 30% of your liquidity and I strongly believe, like some of the top tier BDCs and stellar names like Aries, I think that having a diversified liquidity stack and ladder maturities is an absolutely integral part of risk management and we have that. We probably have one of the most diversified sources of fundings than any BDC. We just did a 7-year bond offering this year, we did a 15-year bond offering this year. We did a securitization, we've renewed our bank lines, we've increased our bank lines, we've done a convert. We have just a wide variety of funding sources all that are staggered maturities in doing so. But I think a very, very important aspect of your question is, that when you look at securitization, having done 2 previous securitizations, both done very successfully, both paying off at full par, we learned from those two securitizations and we wanted to have additional features and benefits to that. So in this case we have a 24-month revolving period on the front end, we have a 70% advance rate which means that we bear the first risk of loss of 30%. Some BDCs have actually sold off that risk. I believe that that tranche B as it refers to is mispriced, and I felt that because it's mispriced, we're better off keeping it ourselves. Which is what we did in this case because we believe in our credit underwriting capabilities so strongly. So we kept that. But there is no recourse from the securitization up to the parent because it's under an SPV, a special purpose vehicle.

Also, holding the B gives you optionality in a completely different environment than the one we're living in today. David, I'm sorry I missed the number, what was the overhead guidance for the fourth quarter?

$13.5 million to $14 million. SG&A is what you're talking about?

Yes.

$13.5 million to $14 million.

Your next question comes from Robert Dodd with Raymond James.

Just going back to your comments about the guarded optimism, etc., as we get into the latter part of the year. On the $1.1 billion, which is a very good number and a record number, in terms of onboardings and commitments, etc. But what you seem to be saying is you could do $1.3 billion, there's $1.3 billion in deals you think, obviously haven't been through the underwriting yet, but they would check all the boxes, they'd meet the criteria, they'd meet your underwriting standards which are strict. And you have the capital to do them, but you just don't want to. I mean because you've had a good year already and you're going to push things out to next year. Is that -- am I thinking about that right? I mean that just doesn't seem very consistent with your prior pattern which is when you've got capital, don't do a bad deal even when you've got capital. And when you've got a good deal, do it.

Well, you know, people are human. And you don't want to burn out your team. It's almost like the Red Sox going through the whole entire bench and leaving your last pitcher to pitch 9 innings and burning his arm out as we saw in the World Series. So I think I approach this business on a more practical level which is I think that people deserve a break. I think they've worked exceptionally hard and I think ending the year at $1.1 billion to $1.2 billion is more than fine. And like I said, I also want to wait and see what the midterm elections bring. So by the time the midterm election is casted and counted, we've already baked in what that number will be for the remainder of the year, since there's only obviously 40 days left in the year at that point. So I think the pricing may be different on the back side of the election and that's another reason why I'm going to wait. I think the pricing may be better on the back side.

Okay, very fair point. Right now you're saying $1.1 billion to be clear, right? But depending on how things play out and whether you get the vote on maybe extended leverage as well which I think you will get, but it's not locked in stone yet. But if you do get that and the elections play out and pricing moves, that $1.1 billion might change.

I think with a vote of leverage and the outcome of the election, whatever that may be, being a favorable environment and stabilizing of the capital markets, absolutely that number will go up.

Your next question comes from Finian O'Shea with Wells Fargo Securities.

First, on the asset sensitivity, we often see a schedule here I think of maybe $0.04 or a quarter point. Looking on your yield slide, you can see the loan coupons increase presumably due to mostly the base rates. But your core yields are pretty stable. So is there another form of spread compression via perhaps loan discounts and fees kind of going away in your market? Is that a way to think about it or is there something else?

No. It's really, as you can see on that slide 26 you're referring to, you saw 30 basis points increase in the cash loan coupon rate and the overall core yields remained flat at 12.7%. I think part of that simply has to do with the recently onboarded new loans that are basically onboarded at or similar to the price of the loans that were offboarded. So you have this net neutral portfolio which again, I'll take all day long. Which means the portfolio is consistently performing to the same legacy assets that ran off.

I'm going back a couple of years though.

Oh, Jesus, okay. Well, I'll try and answer the question a couple of years ago.

That's fine.

What would you like to ask me?

Oh, you mean -- sorry, moving on. We'll take it offline. Another slide that caught me is an uptick, and I'm not sure if you addressed this on the call in the commentary, the uptick in unfunded commitments. Is this just sort of one-off that's kind of popped up for couple of quarters now to levels last seen before sort of the SEC pushed on them? Is this something, is this a matter of pipeline or how would you describe it?

Well look, I think it's a very, very important question and one that I frankly invite the SEC to really re-scrutinize again. I think there's some players out there that are flagrantly abusing the unfunded commitment category where in some cases the unfunded commitment can almost exceed their current outstanding portfolio. We're $2 billion in size and my unfunded commitments are a mere $170 million. Versus somebody could have a $350 million loan portfolio and $240 million of unfunded commitments. So it's a whole different world and I think that the SEC frankly should be relooking at that and policing that more diligently in the industry. That said, our unfunded commitments are mostly attribute to pharmaceutical companies that have performance-based milestone that upon FDA approval and other significant milestones would unlock or expire these unfunded commitments. So ours are truly structured with milestones that come into effect. The ones that you see that are fully available, these are companies who have asked us to provide additional strategic capital for them to both pursue acquisition opportunities or accelerate sales and marketing, but they have yet decided to step on the gas to engage in those products or engage in those initiatives as of yet. And we believe that those companies have an abundance of enterprise value associated with them, so we're more than happy to extend that part of the balance sheet. But again, in context, it's still not a very large number for us. In fact, as evidenced on page 27, it has pumped up, it's 10.7%, but a big chunk of that will start running off in the first half of 2019.

Sure. Makes sense. And just one more question, extending I think Mr. Lynch was asking, discussing previously the competing venture BDCs, and I think you noted that they are smaller and grow less quickly. But to my observation, the other venture BDCs are raising actively on the private side. So are you seeing those players do sort of larger deals that they can allocate internally? And do you see that trend continuing?

I think that there's a matter of rhetoric and reality. I'm not aware of any private venture lender that has any significant meaningful pools of capital that they like to extol that they have but they really do have. So we're not seeing any competitive advantage or any competitive differentiation with any of those strategies. And I think it's a disservice to have a public BDC that is then raising money privately at the deference of the public shareholders. So I question what's your loyalty to, the public or the private shareholders you have? So I think that's more rhetoric than reality.

Your next question comes from Tim Hayes with B. Riley FBR.

I apologize, I had to jump on late, so if I ask anything that's already been asked or covered, just tell me to shut up. But the first question is, I saw the grade 1 credits dropped a good amount and just wondering how much of that was due to repayment versus them being downgraded as they approached capital raises versus a deterioration in your outlook.

When the capital market started pulling back, our rated-1 deals basically signified that we were going to have a released event. And the company has an abundance of access to cash flow or liquidity. And so when the capital markets did their adjustments, we prudently marked down credits that were rated-1 back to rated-2. And that's really probably the biggest driver that kind of led to that.

Okay, and then repayments were nearly half of last quarter's, but GAAP yields were the same despite core yields also being the same. So just wondering if the credits last quarter that repaid early were more seasoned credits versus newer credits this quarter and maybe that's why the benefit to GAAP yields was stronger or if there is anything else we should be aware of.

No, it's actually the inverse. There's a couple of statements there you might have missed. Of the $65 million of early payoff activities that took place in Q4, excuse me, Q3, $42 million of that was our own sector rotations and select portfolio pruning that we encouraged the companies to kind of refinance us out. And in a case like that, on some occasions we may waive the prepayment penalties as a way to stimulate a portfolio mitigating developing portfolio credit risk as a way of doing that. And when that happens of course you will see a materially lower overall income contribution from those early payoff activities when we select to do that portfolio rotation in doing so. The other element is that you saw more younger loans pay off in Q2 then you saw in Q3 where Q3 had older loans associated with it, and therefore the older loans have typically less than a one-point acceleration benefit from that early payoff versus a younger loan that may have a 2 point to 2.5-point accretive benefit from early payoff.

Okay. And then switching gears a little bit, what percentage of your commitments were to SAS companies this quarter?

Overall SAS portfolio has grown to approximately, I think we're around -- well total commitments, excuse me, you want fundings. Christ, I have the committed number.

That's fine.

I don't have the funding numbers in front of me, but total commitment has risen now to approximately $390 million of total commitments in the SAS group. When we issued the press release back in I believe it was June, we were at $305 million in commitments, so you've seen it grow by approximately $80 million-ish in one quarter of SAS activities.

Got it. Okay. And as this kind of newly brained segment continues to gain traction, how do you see that flowing through G&A and also your asset yields? Because I believe these loans are a little bit lower yielding, correct?

They tend to be a bit, about 100 basis points or so lower yield, but they have an abundance of enterprise value, so it's a little different underwriting methodology there. But to answer your question, I don't look at from an SG&A point of view, I look at from a loan portfolio or balance sheet point of view. Today my SAS group is about 17% of the loans on a cost basis. I think it's either 17% or 18% of the total loans are reflected in a SAS model. I don't think that SAS should go much above 25% of the overall loan book, but it's really contingent upon how the capital markets are doing and how the public multiples are looking. But I think that from a portfolio diversity point of view, probably 25% is probably the right number to kind of manage it to.

I'm showing no further questions at this time. I would now like to turn the conference back to the presenters.

Thank you very much. And thank you, everybody, for joining us on the call today. As most of you may be aware, effectively next week we are on a European Jefferies European road tour for BDCs, with a handful of BDCs. We'll be touring throughout Europe meeting our European investors that are out there as part of the BDC community in Europe. And then we expect to be further doing additional non-deal roadshows in New York, Boston and Chicago in the coming months. I would encourage you to reach out to Michael Hara to schedule any future meetings that you would like to have with us. We're more than happy to accommodate you in this scheduling in those cities that we're in. With that, thank you for your time today and thank you for being a shareholder and remember, please cast your vote. Thank you.

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