Good day, ladies and gentlemen and welcome to the Q1 2010 Hercules Technology Growth Capital conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this conference maybe recorded.
I would now like to turn this conference over to your host today Mr. Jason Gold. You may begin sir.
Thank you, Regina and good afternoon everyone. On today’s call are Manuel Henriquez, Hercules Co-Founder, Chairman and CEO; and David Lund, our CFO. Our first quarter 2010 results were released just after today's market closed. That can be accessed from the company's website at www.herculestech.com or www.htgc.com. We’ve arranged for a taped replay of today's call, which will be available through our website or by using the telephone numbers and pass code provided in today's earnings release.
I would like to call your attention to the Safe Harbor disclosure in our earnings release regarding forward-looking information. Today's conference call may include forward-looking statements and projections. We ask that you refer to our most recent filings with the SEC for important risk factors that could cause actual results to differ materially from these projections. We do not take any obligations to update our forward-looking statements unless required to do so by law. To obtain copies of our latest SEC filings, please visit sec.gov or visit our website at herculestech.com.
I would now like to turn the call over to Manuel Henriquez, Hercules Co-Founder, Chairman and CEO. Manuel.
Thank you Jason and let me first start of, thank you for everybody being on the call after today’s one crazy volatile day. So I hope that we have a lot of folks on the call today and looking forward to answering lot of questions after this. Today is quite an interesting day, being a financial services company and the technology company like we are.
So Let me first start of by saying that I am very happy about everything that’s been going on in our organization and the continued transition as we go from a capital preservation mode to now a new and growing portfolio mode and I’ll be speaking to you about this in quite significant details throughout this call and certainly look forward to expanding upon those issues at the Q-and-A session.
Let me first start of by saying that once again we did a fantastic job reporting $5.6 million GAAP earnings or $0.16 a share that also matched our taxable income at $0.16 per share as we turn the portfolio from a harvesting mode to a growth mode and I’ll be talking a lot about that as I go along. We also did $90 million of new commitments in the quarter that is a fantastic turnaround from going from zero or mature origination in 2009 to certainly coming out in Q1 with $90 million of commitments in an extremely strong pipeline.
A pipeline I have not seen this robust in over two years versus sales, a year and half, this level of a pipeline over billion dollar in opportunity. So I’m extremely optimistic and bullish about the future ahead despite today’s fairly volatile stock market, our business looks and remains fairly robust. And our concern as we go along is not overloading our liquidity, as we try to fill this growing backlog that we have today of demand.
Our credit performance has improved dramatically from Q4. David will start getting into the specifics of the credit performance. So you’ll see in our detailed financial release that we saw significant credit improvement in portfolio, which is also indicative on how our business in growing and improving as well and better than that is also non-accruals. Non-accruals basically have become almost a non-issue, a non-item, they are insignificant at this point compared to Q4 and I believe we have one loan only in non-accrual which David our CFO will also speak more to that situation.
I’m also happy to report to our shareholders that earlier this month, we received notice from the SBA that we were approved by the Divisional Committee level, which is where the most difficult committees to go through, and we have our final committee approval for second license expected to be on Monday, May 10. From what we believe, we expect that license to be approved granting at secured abilities have additional $75 million of leverage from the SBA giving us more importantly long-term 10 year capital of fixed interest rate, which Dave will talk about further during his presentation as well.
Now, let me turn to some of the more specific issues related to our new business activity, pipeline and continued growth of signed term sheets that we are receiving every week, almost every day in the organization. Yesterday, you saw us report that even after the close of Q1, we closed an additional $35 million of term sheets that were converted into contractual loan obligations or commitments from us.
Its important, that we start segregating as I used to do in 2007 the difference between a non-binding term sheet of commitment in our funding and I will talk about a lot more on the call, it is important to understanding the uniqueness of Hercules, which focus on the venture industry as opposed to other BDCs that rely primarily in the lower level market or middle market industries when the companies fully drawn down to the capital.
Now, continuing on that thread, we saw also $35 million of deals in Q2 so far leaving by the way another $125 billion of outstanding term sheet that we expect to convert in the next 30 to 45 days into obligations. What this means is, that it gives me an incredible comfort on being able to see over $220 million of new investment activities that will close in the first half of 2010. So we’re certainly on track to our pace that we expected.
Now, where the differences is it’s important to talk about is a close commitment doesn’t necessarily equate to the immediate funding, because venture stage companies oftentimes have three to six months to draw down the capital from our commitments, which then become performing loans for us. So you’ll see a lag from closed commitments to actual funding and you’ll see how that will take place in the second half of 2010 as those commitments turn into fully funded transactions.
Going further, our portfolio is positioned for growth. We have hired over the course of the last four to five months, five to six new originators as I said at the beginning of our fourth quarter earnings call, it generally takes between five to six months to get a new originator conditioned to the Hercules underwriting criteria and also have them understand the profile of the underlying companies we look for; and you’ll see those individuals start becoming productive at the end of the second quarter and see that asset growth happened in the second half of the year as new hires begin to become very accretive to us.
Asset quality, as I said earlier; our asset quality has improved from a rating of 2.7 weighted credit score average to 2.35 in Q1; and for those who may not recall, our rated two happens to be a very good rating. So you are seeing us continue to increase the performance of our portfolio.
Now, I just joined and I recall, it is important to really understand that Hercules has a high reliance on the venture capital industry, any earnings call that we do not provide color to the venture capital industry, we do at the service to understanding on how Hercules operates as a BDC when compared to other BDCs out there, who don't have much exposure to a venture industry.
With that said, let me spend a few seconds here in talking about the venture capital environment and the industry itself. In the first quarter of 2010, we saw eight IPOs raise $711 million, you may think this is a small number. However, those eight companies in Q1 represent the total number of venture capital companies that went public in 2009 that in itself is a significant achievement. I’m happy to report, Hercules currently had two companies in IPO registration, one of which can play in IPO in Q1 called Avail, today we have both [Next] and we have Everyday Health currently in registration.
Further to that point, M&A. The M&A activity is an important part of our established companies gaining access to emerging technologies from properly funded venture stage companies. In the first quarter, we saw 77 transactions completed from $4 billion in value, which worth the same amount of deal completed in the first quarter of 2009. We currently have as an industry to 44 venture stage companies in IPO registration. That is the most companies seen in IPO registration since the fourth quarter of 2007. This should give you some indication on the design of the venture capital marketplace and pursuing liquidity to the IPO market.
Now, let’s talk about the inflows, meaning the venture capitals’ investments into technology and life sciences companies. So very interesting developments are [afford] in the venture industry and some results highlight right now, which are indicative of our own portfolio marketing to match that of the venture industry.
First on the numbers, the venture capitals invested $4.7 billion in the first quarter of 2009 to 597 deferred transactions or companies that is up by the way 12% from the same period last year, which did $4.2 billion, so a very good indication. Now, the interesting observation which I concluded by looking at these most recent capital outflows by the venture capital, was the industry shifts that are going.
IT remains and continues to be the largest recipient of venture capital dollars receiving approximately 32% of the venture capital dollars or about processing $1.5 billion to 192 companies. That coincides quite nicely with Hercules’s loan portfolio, which has about a 45% to 50% IT exposure to it. Health care on the other hand received about $1.2 billion entry of about 141 companies.
Now, the industry shift was in the industry specifically where we saw consumer goods and services received 75% growth year-over-year or as you say receiving $288 million of venture capital dollars over the same period last year, while energy and utilities, a description I generally hate, it’s more referred to as renewal energy areas received $351 million of capital or 69% increase over the same period last year. Business services in churn up 33% to the prior year received $808 million of venture capital dollars. So it’s an interesting shift going on that you see in our own portfolio that emulate out in the venture industry.
Now let me finish off by two critical stages, two critical products of the venture industry further. First, it is the stage of companies. Of the $4 billion plus that was invested, 59% of that capital floating to later stage companies, so having to be our core focused and has been the core focus for a period of three and half years.
The early stage side, received 17% of the capital, but as I indicated in the fourth quarter, Hercules made conscious decision to commence investing albeit $2 into earlier stage companies, because we think that representing a very interesting growth area, but I’ll caution everybody that our investment in early stage companies may aggregate to $25 million to $50 million it will not be a significant size today, but it’s an important size in securing additional warrants in our portfolio which I’ll talk about further in a moment.
Lastly, to fully understand the venture industry we have to understand the venture capital source of financing, which are from limited partners and [down with venture plans, or whatever]. The venture industry itself continues to contract, that contraction in itself is not bad, because what is happening is as a venture capital industry contracts, venture investors find themselves competing more and more for better deals, and companies are now being more selective by the venture capitals, which means there is less competition, which means only the better companies are getting finance.
Now to bring it all together, the venture capitals raised $3.6 billion in the first quarter of 2010 to 32 points that is down 31% on a year-over-year basis. These statistics all come from either Dow Jones VentureSource or NVCA Thomson Reuters, which are good source of revenues in venture industry itself.
Now, let me turn to the overall understanding of our environment from a competitive point of view. The contraction that took place in the market from a liquidity point of view, the other competitors who do not have the credit discipline such as Hercules has in its business model or the conservative nature of Hercules has seen their portfolios contract dramatically and have seen their access to liquidity dissipate. That means that we are seeing a growing pipeline of opportunities as our competitors continue to shrink or focus into other segments of the market.
Understanding the disciplines, the subtleties, the technology and life sciences know how of how the venture industry operate is the key competitive advantage for Hercules and one that I think that will lead us to significant portfolio growth over the coming years as we see that focus became a valuable asset for us.
Growth incentives, we are well positioned for growth in 2010. With over a $195 million of liquidity, $106 million of debt in cash, we are actively engaged in negotiations and discussions with various other credit warehouse providers to get access to additional growth capital in a form of leverage in our portfolio, which today by the way is unleaverged. We have no leveraging in our portfolio outside of the SBA, which Dave will talk about.
We are extremely well positioned for growth. Our robust pipeline and currently signed term sheets give us confidence and our ability to see our dividend grow over the pursuing quarter in 2010 as we convert successfully those commitments into fundings and those fundings end up becoming working access for us, earning interest and yield in our portfolio.
Lastly and in closing, let me please go back and help our investors and analyst to recall the conversation that we’ve had in 2007, 2006 on how to think about Hercules on it’s origination efforts because we are slightly different from middle market the lower middle market companies. Again, a term sheet becomes a pledge of capital to a company. Once the term sheet is successfully executed by us and becomes a signed commitment.
We issued press release every time, we secure project commitments. However, I want to caution everybody that for example $100 million of growth commitments does not translate into a $100 million of fundings right away, it may take us one or two quarters or I prefer to think about it three to six months period of time, when those commitments will then fund over a period of time and become working assets.
So when you look at Hercules, you use to be looking at the continued phase of close commitments and that will lag into fundings over the next three to five months, or six months at those commitments become fundings. So you will see a 30 significant upward slope in the second half of the year as these commitments end up becoming close financings or assets that are working for us a very, very important part of our model.
Lastly, one of the thing that surprises a bit was early payoffs. It is extremely difficult for us to predict or anticipate early payoffs. As an example of that in the first quarter, we received approximately $32 million of early payoffs. A payoff of that nature that would happen at the beginning of the quarter could have an affect on earnings as much as $0.01 to $0.04 depending on the yields of our critical assets.
So we have this volatility in our earnings, which is extremely hard for us to predict of any between $0.01 to $0.04 on these early payoff that may occur. Because of that surprise we had in the first quarter, I have personally gone through and scrub line by line as best possibly we can 130 payoffs maker in the second quarter. I am happy to say that from our analysis it appears and that we could have $20 billion to $25 billion of possible early payoffs.
However, I need to caution everybody. We have no true indications for underlying portfolio companies if that effect may occur this often time these payoff are attributed to milestones that the company itself is working towards that could trigger these payoffs, but because of this potential early payoff exist, I feel strongly that it’s important for our shareholders that our analyst who have a better indications of these potential early payoff that could occur that could cause a swing in our earnings of $0.01 to $0.03, when $0.04 is depending on the yield itself.
Now, I’ll be happy to answer more questions about this in our Q-and-A session. With that, I’ll turn the call over to David Lund, our CFO to speak about the specific results for the quarter and Dave and I, both look forward to answering questions in Q-and-A. David.
Thank you, Manuel. Between our new loan pipeline, credit quality and liquidity position, we believe we remain in a strong position to grow our portfolio during the reminder of 2010. Today, I’d like to focus on three key areas, summary of first quarter results, liquidity and capital resources, and portfolio highlights. As Manuel well indicated during the Q-and-A, we look more than happy to answer any questions that I do not specifically address during my presentation.
To begin, I will touch on first quarter results. We achieved approximately $5.6 million of investment income for the quarter, while significantly improving our portfolio credit quality, which improve to weighted-average rating of 2.35 from 2.71 in the prior quarter. As we anticipated and indicated last quarter, our investment income was lower in the first quarter as a transition to growth more with the portfolio and as a result of credit quality of the portfolio improving.
The lower income compared to the fourth quarter of 2009 was driven particularly by lower one-time fees of approximately $1.7 million and lower interest income, which was accelerated at approximately $1.3 million due to restructurings, which occurred in the fourth quarter. We anticipate the income from these types of activities will continue to be lower in the coming quarters, as the credit quality of the portfolio has improved significantly.
To that point, I would like to note that we have only one loan on non-accrual as Manuel mentioned at the end of the first quarter. This one loan represented less than 1% of our loan investment on a cost basis. Our net interest margin graphed to 9.34% in the quarter from 12.82% in the last quarter, due to unplanned early payoff of $32 million during the quarter and a decline investment income from restructuring as I just described.
We anticipate that it will return to more normal range between 10% to 11% as we build the portfolio in the coming months and quarters and grow our investment income. Our effective yield on our debt investments during the quarter was 14.5% compared to 13.3% in the fourth quarter of 2009. It was attributed to unanticipated early payoff of $30 million and normal amortization resulting in a lower average asset base relative to the income that we’re in.
We expect the yield to be between 12% and 13% as we build the portfolio, which excludes the impact of any possible early payoffs. Compared to the same quarter last year our interest expense declined from $4.1 million to $2.3 million as the only debt we had outstanding during the quarter is the SBA debentures of approximately $131 [billion].
As a reminder, we incurred non-use fees on our Wells Fargo and Union Bank credit facilities of approximately 25 basis points and amortized origination fees associated with these facilities ratably over their availability periods. Our interest expenses will increase in the coming quarters as we drop on these facilities as well as, our SBA debentures to facilitate the funding of new and existing portfolio companies.
Operating expenses for the quarter excluding interest expense and loan fees were $4.6 million as compared to $4.8 million through the same period last year. This decrease was primarily attributable to a decrease in variable compensation expense. Both our Q1 net investment income and distributable taxable income was $5.6 million or $0.16 per share per quarter.
Note that unlike in Q4 ’09, the $32 million of loans which were paid off early in the first quarter of 2010, did not have significant fees related to Original Issue Discount or OID, and un earned fees that were accelerated, which are recognized as ordinary income on a GAAP basis, but are recognized as a capital gains for tax purposes.
Turning to liquidity, our solid liquidity and capital resources position us for portfolio growth on that note, I’d like to discuss Hercules liquidity and capital resources. As of March 31, we have over $195 million of liquidity comprised of $106 million in cash, access to $50 million of borrowings under the facility with Wells Fargo, and approximately $20 million of borrowing capacity with Union Bank subject to advance rate. And approximately $20 million of capacity under the SBIC programs subject to regulatory limitation.
In addition, as I pointed out earlier our only debt outstanding was approximately $131 million under our SBA debentures. I am also pleased to announce that, we were approved at the Division Committee level of the SBA for our second SBIC license that would provide up to an additional $75 million of borrowings.
We believe this facility will be approved later this month, the second license will require that we contribute $37.5 million to the SBI subsidiary, which will be used for investment purposes along with the available borrowings under the debenture program. The combined access to capital from these potential sources our cash on hand at the end of the quarter would be in excess of $217 million.
Now I would like to discuss the run up of our portfolio, we have normal principle collections of approximately $20 million to $25 million a quarter. Additionally, as Manuel indicated, we are unable to forecast what earlier repayments are, as a reminder, we have unintended anticipated pay off of $32 million in the first quarter.
Potentially, based on preliminary notifications from two portfolio companies, we could receive $20 million on early pay offs, but that collection is uncertain at this story point in time and still the companies resolved their financing situations. The impact of early pay-offs could be $0.01 to $0.03 per share on NII, depending on the pay-off amount and the timing of the pay-off within a quarter.
We believe our liquidity position as I have just discussed places us in a very advantageous position to invest in 2010. Turning to our dividends, we distributed a dividend of $0.20 per share during the first quarter, and announced today, that we have declared $0.20 dividend payable in the second quarter. And also further note, we had our stock repurchase plant program $35 million that was approved by our Board of Director in February, and under that program during the quarter, we pre-purchased 25,125 common shares of our common stock at a total cost of approximately $234,000.
In conclusion, we believe, we have laid a very solid foundation for growth in 2010, we have the most robust pipeline in the company’s history, high credit quality, an enviable liquidity position, which we will continue to leverage as a competitive advantage, and will be ready to discuss the pace of our new commitments in 2010.
Operator, we are now ready to open the call for questions, Regina.
(Operator Instructions) Our first question comes from John Hack, Mr. Hack.
John Hecht - JMP Securities
One question, is trying to compare interest income versus a couple of quarters ago when you were accruing from Spa Chakra and InfoLogix, can you tell me first how much interest income you were at the peak of those investments getting from those investments and the second, I know that both provided income during the quarter how are you recognizing that income right now?
Answer to the interest income, we going to make sure that we’ll be very careful, because Spa Chakra went through a previously through a bankruptcy process all the prior debt was converted to equity, so, the new debt issued in the company $2.3 million to $2.4 million of debt is all new revolver based credit facility. So all the old prior debt was first converted, was probably credited into the full equity ownership of the company itself. So that’s a very important point there as I’ll make sure you understand. As to the specific, David
Yeah, John it was roughly about a $100,000 on a monthly basis for Spa Chakra that we had from that entity.
John Hecht - JMP Securities
Do you recall InfoLogix?
No, we’ll get that here for you a moment though.
John Hecht - JMP Securities
You’re recognizing income from both of these entities now, is that through recognized your P&L or just with adjustments of the cost or value of the companies at this point?
No, we recognized that through the company itself through interest income.
Hold on John the Spa Chakra component, again all the old debt no longer accrues or recognize any interest, so that is now gone. So the only interest that you are accruing in Spa Chakra beyond a $2.3 million to $2.4 million new outstanding that’s out there. The InfoLogix itself continues to incur interest as it did in the fourth quarter.
We can see it will be actively supporting the company and as we indicated in our press release the company is currently has a [developing] notice and we kind of look it through those challenges there and the company has continued working capital challenges as it migrates from an old product line to new product line itself so, we do not anticipate any material on the interest paying, for that entity right now
With regards InfoLogix, we were earning about $450,000 a quarter on that particular entity, during this quarter we earned about $820,000 on InfoLogix and about a $156,000 on our Spa Chakra, for the quarter, for both interest as well as the amortization.
John Hecht - JMP Securities
The other question on sort of the modeling side is there going to be any fees associated with your second SBA line and then, if you can just remain me how you finance those before you fix I guess the 10 year?
We will pay a 1% fee for the SBA borrowings 1% on $75 million; so we’re going to be paying approximately $750,000. And that will get amortized over the course of 10 years facility.
John Hecht - JMP Securities
And then, when you kind of warehouse since before you fix them what’s the rate?
During this, before, there was actually a fixed rate at March and September of every year its 30 basis points, over our LIBOR; and so that will then be fixed on every March and every September, and that’s generally been running about 6.5% on an interest rate basis.
John Hecht - JMP Securities
And then the last question, clearly, the role of demand the environment for borrowing in your segments is beginning up pretty quickly. What do you expect will happen to pricing as demand parquets up with may be some others to attempt to enter the market?
Well as I indicated in our fourth quarter earnings call, I don’t think historically yield are3 sustainable, I think that you’ll see a gradual yield compression as I guess alluded to in the fourth quarter earnings call; and I’ll do further here now. Then I think that, today you mainly realizing yields in a 12% to 13% range for the venture stage companies it’s a little higher for the longer term market. I think that you’ll see that yield compress back to the norms of 2007, early to May 2008, when you’ll see those yields probably give up a 100 base points in [year end and between now and year end, we will see that further tightening right now.
It is although as there are not a lot of competition that is, an interesting competitor is rising, which already venture capital themselves looking to put more equity capital in the companies. So it’s an interesting competitor that you otherwise will not have had four years ago.
Our next question comes from Troy Ward with Stifel Nicolaus.
Troy Ward - Stifel Nicolaus
Can you speak to the comp expense line and kind of the run rate expected there with the new hires, and how much of that 30 baked in?
Yes, I think the expenses line itself is probably pretty well baked at this level. You probably have I would say anywhere between $200,000 to $400,000 that maybe added on a quarterly basis, all consistent upon performance milestones of the individual themselves. The lines obviously just led it to dramatically increase from here, unless we do some significant new hires I mean we are still looking to hire averaging three to five additional people, but we are just very selective in that process and that happens obviously that will cause it to go up, and I don’t think organically if you haven’t got much more than it is right now.
Troy Ward - Stifel Nicolaus
And then on the non-accruals, I know you said you had one non-accruals like rather small company, I think in the previous quarters you had two or three and I know probably spot shots what was in there and now of course with restructuring there are not. Can you give us any more color on what’s gone on in the non-accrual line in the last couple of quarters?
Clearly as the quarters have improved, the economies have improved. We’re seeing significant improvement that portfolio companies themselves with regards for their operations and we’ve seen funding just coming into these companies from venture capital and private equity. So you are seeing a much more stable portfolio of companies and as you indicated, we do only have one company transmatics, which is a non-accrual. It’s about $2.8 million low in that cost and represent less than 1% portfolio of cost. Its [galleasses] not transmatic
This is (inaudible) it just mean a lot of equity, so it’s knocked out. Those are fantastic and [JOSIS] by the way, although its non-accrual. The company has without company theologies the company has some very strict technology that they are working on that could have a significant break through here sometime in the end of the fourth quarter.
They have some promising developments, they just recently achieved with some of their product development and you can learn more about JOSIS from their website. I’d rather not get in to specific what the work we have due to confidentiality issues, but it is something that we currently hold on a zero fair value basis meanings fully written down by us, but there could be some reversal of that sometime the fourth quarter is the continued progress of the company is still going on by then.
Troy Ward - Stifel Nicolaus
And then Manuel, can you just speak broadly about your leverage capacity. I mean you said you are still speaking with potential new lenders in the marketplace. You have wells, you have union, I think if we look relative to others in the space, your leverage looks pretty expensive. How do you think about leverage going forward on the portfolio and do you think that cost of leverage can comedown?
I certainly don’t think our leverage looks expensive. I think that were maybe expensive as when you look at the SBA cost of capital that’s only [JOSIS] expensive the 6.5%, 6.7% from a cost point of view, but that said, if you believe like I do you are facing a rising environment I’ll take by 6.5% cost of capital locked in for ten years any day of the week. So it is expensive right now, but over the course of next nine and ten years down the road, I’ll take it, it’s a creative from me on a spread basis.
As the Wells Fargo line, I actually don’t think its anymore expensive in fact might historical line that we have right now is actually cheaper, certainly ever be seasonal out there. I believe our Wells Fargo lines are 5% of floor and our Union Bank has a 4% of floor. So those are pretty damn good rates and I’m seeing renewals from other BDCs out there are little higher than that.
Troy Ward - Stifel Nicolaus
You are right I was reading that incorrectly I am sorry.
That’s okay. That’s what we’re trying to do better job right now, I think it’s creating a lot better transparency of our cost of capital our cost of leverage as well as understanding the subtleties season of our business model to other BDC. So if I jump majority, I apologize I’m just trying to make sure that people really understand on how to derive interest income, how to derive what the right yield use are and what the right assets to focus on and how to think about originations, commitments, funding and assets growth, all of which are just looking and going in the right direction.
Our next question comes from Jason Deleeuw with Piper Jaffray.
Jason Deleeuw - Piper Jaffray
My first question is on the percentage of commitments that typically turn in the fundings, I understand the timing issue and the lag, but typically historically, I am assuming a very high percentage of those commitments turned into funding?
Sure, let me talk about that. The best way I can give an indication of how you should look at it, is (Inaudible) I look at it. If you have $100 million of commitment we expect 35% of that will convert into a loan, a working asset for us. So for every $100 million, $75 million to that will become invested asset that commitment of $100 million would generally be dribbled out in pieces of loans up to $75 million or the preceding three to six month period of time. Its probably draw down period the company has.
Unlike middle market companies, when you sign a $100 million commitment they’ll jog down almost immediately is a tangible use for it right away. A recapitalization, a dividend recap and acquisition or what have you, venture stage company tend to use it more as a credit line to fund their business and use as adjusted times towards the financing, so it’s a little bit different and as to why and how they drive down.
Jason Deleeuw - Piper Jaffray
And then with asset values across the board, really improving, I guess except for today, but generally with this IPO activity picking up M&A activity picking up, I’m trying to understand a little bit better what value could be embedded with the loan portfolio. Seeing that there would be more value than what, a lot more value potentially than what you guys are carrying to that.
Absolutely, that is a fantastic question and I appreciate Jason asking, because we’ve tend to forgotten over last two years why Hercules is such a different BDC than the rest of the BDCs out there and it is fact this hidden value that we have probably as warrants. However, and to put a little caution into that because we’re public companies, our earnings should people understandable the both sides of equation.
So today we approximately have warrants and I think 77 portfolio company that have a, as you said, value. We take the warrants strike price of all of our warrants in aggregate, we equate approximately $49 million in aggregate value if we were to excise those warrants in difference to whether they are in the money or out of the money.
So to make this illustration easier for me was to fill the $50 million warrant for. However we’re cautious all along. We do not expect that more than 50% of those warrants will ever monetize into value, giving you $25 million of that $50 million in aggregate will become in the money warrant.
On our website, we have posted the historical performance of 16 or 18 of our realized warrants gains, that range from one multiples as low as 1.7 to as high as 8.9. We don’t believe you should use 1.9 and we don’t believe this is eight times worth multiple. This in fact is somewhere in the neighborhood of either 2 -3 -4 or 5 or 6 time warrant multiple in your example to kind of drive this value. So for this illustration purposes lets assume we use the four time warrant multiple on the $25 million that I said that may become in the money.
That means that the $50 million in warrant value today gets haircutted by 50% of those who will not monetize giving you a base of the 25 million, take a 25 billion in this example assume a Forex multiple will give you $100 million in fair value of those warrants. Those warrants at $100 million we carry on our books today at $13.7 million in fair value accounting using Black-Scholes, which means that sometime in the next 12, 24, 36 month or sometimes I mean thereafter, you have the opportunity with the existing assets that you have in-house today, if they were to monetize, you could have a potential of recognizing $87 million in value or somewhere near to that $2.20, $2.40 in net asset value growth today.
Because of the tax loss that we have, we actually think all of those gains or a significant part of those gains insulated from having to payout our shareholder pay taxes on it to first absorb our cash on carry forward allow us to retain that $87 million or solid value to continue grow our net asset value organically. So it's a highly accretive vehicle and with the IPO market opening up again, I am certainly now happy with the [old talking about] something that we have not spoken about that was two years.
Jason Deleeuw - Piper Jaffray
That's great. It's very helpful. And then just lastly when you do get to assume you get the final round for the financing of the SBA financing, when will you have access to their money and can you just if am I understanding correctly would the rate be 6.5% on this financing too?
So we’re going to final committee next week for approval we think that will happen without any issue, then all their course the next 30 days we would be putting in our leverage request and so on to borrow against those funds, and we’ll point out we do need the downstream $37.5 million to access the fund. So over the course of the next six to nine months I believe we’ll be accessing the $75 million from the SBA it's not going to be immediately and it’ll be dependent upon the funding that we do out of the SBA.
The whole growth of the SBA is looking to [build on] our continued acceleration of our pipeline. If we continue to see in growing assets to additional liquidity through the SBA and the other credit line negotiations that we are truly actively involved in that would further potentially accelerate our asset growth right now. We have good liquidity, but I don't want to over run by liquidity that we have today if I had the higher confidence level of additional liquidity opening up you will certainly see a thick advantage of that and accelerate our pace of growth of our assets and that will translate to earnings growth.
And to your other question the rates with the fees everything being fully amortized and it's running about 650 basis points on a fully amortized basis.
(Operator Instructions). Our next question comes from Vernon Plack with BB&T Capital.
Vernon Plack - BB&T Capital
The 95 million in commitment, how many companies was that to?
I believe it was eight.
Vernon Plack - BB&T Capital
Eight companies, okay and is that eight in total new plus existing?
No that’s eight new credits, new companies forming. We don’t credit companies’ portfolio companies. Those are the eight new unique relationships.
Vernon Plack - BB&T Capital
Just try to help me with the math here, looks like the portfolio grew on a net basis and on a fir value basis about $9.5 million for the quarter?
The problem is as I said the commitments will lag fundings, you’ll see that funding growth is not happening in Q2 you’ll see it really circuiting in by Q3 as you start to seeing all these commitment now I’ll translate into working assets funded assets.
Vernon Plack - BB&T Capital
Right. The findings I thought saw somewhere where fundings for the quarter was that $87 million?
The fundings for the quarter.
But that included restructuring and amendments on some existing credits I think we foot noted that about $26 million.
Yes, it was $68 million of cash out and then we had some re-fundings, restructurings and re-fundings for the balance.
Vernon Plack - BB&T Capital
Okay. So basically 68 million and then if you look at repayments I think it was 59 that's basically gets does the math to get to a net growth of around $9 million?
With the $32 million as I said earlier that kind of that Bluebird very difficult for us to anticipate, but it was what it was
And next question comes from the line of (Inaudible)
With the SBA facility in place the new access to cash those ones going to have a specific characteristic and will you be able to get lending facilities in today's kind with a similar the level of durability for our prolong, if they don’t fit the SBA model?
The second license of the SBA has the same kind of underwriting attribute or characteristics required by the first license. The only challenge would be the single credit obligor limit our new second license is a bit smaller; it's generally 30% of the regulatory contributed capitals. So you limit it some where in neighbor of $10.5 million to $11 million on a single obligor under the SBA program, under the second license while the first license is more enabled of $21.5 million or so. So we go to balance the underlying new credit, new company that kind of can form into the size in the SBA itself.
But beyond that it doesn't change much characteristic in the first and the second license, the same kind of underwriting attributes. Now, the second part of your question is actually very good one, because what we are seeing right now as we engage the renegotiation with potential credit warehouse provider is an interesting phenomena that I did not witness as well as 18 to 24 months ago and that is down to new warehouse credit providers are having this notion that they essentially re-underwrite the credits the potential portfolio can be used so have met under the credit facility, their own underwriting groups are now embarking on re-underwriting it as a further risk mitigation assessment of a collateral value that they are doing.
But you need an approval every time you put something into it?
They will never say that word, I wish they would but they don’t say that, they simply call it a re-review process of the underlying collateral. But yes, we can call what it is, it’s an approval. Now, the other element of the that that's different from it was a couple of years ago is that they are indented to describe their own obituary credit rating and then that would translate into some form of an advanced rate against this unofficial realistic wherever credit rating describe to it, they are starting different levels of advance rate for a credit facility. So for example, let's say you believe in the 30% advance rate under your credit facility, but the underlying new bank may deem it to be a 50% advance rate, because they think it's a lower credit rating than you have for example. So its an interesting evolution that is going on in the market...
Do you think this would be once they take you through all this, do you think you end up with a more durable credit line?
Right now, the good news about that is we’re seeing that terms are actually being pushed out more to the two to three year levels as opposed to the one to two year level. So I think that's encouraging in itself.
So it’s still a work in process the SBA still your best money?
The SBA is certainly the most reliable cornerstone of the Hercules liquidity strategy of continuing to build the organization. With the reliance on the SBA, it’s 10 year cost of money, fixed rate of interest rate and a rising interest rate environment with all of our deals are fully rated straight, we get to maintain and have a growing spread on our deals.
And could you grow the business just around the opportunities within SBIC or do you need really both to have a meaningful future growth. And how do you build the earnings back up to that $0.30 to $0.40 level that we have seen you moving towards in the past and can do or just the SBA as a partner or do you need to bring in one of those other people?
I think the answer to your question the optimal asset growth would be a portfolio that has SBA fully leveraged at about 50% leverage on its core regulatory assets to leverage on the BDC side. So having $200 million of credit facilities outstanding outside the SBA as fully drive SBA, I’ll take that business any day or week.
How quickly do you think the business kind of rebuild to where it was in the last say 12 to 18 months ago?
Given the pipeline in opportunities that I’m seeing right now, if I’ve add just real assets to liquidity, I think then you see us returning to that run rate at $0.30 sometime in the fourth quarter and the first quarter next year.
I know this will upset you, but you will recognize the name of the trading firm implicated into today’s fat finger that to curve the market down, but it’s formal associate of yours?
We are not associated with that.
I don’t know former vendors.
I won’t be surprised I mean the rumors are we are seeing on the web was that former vendor you are referring who gave us a credit facility our Leslie (Inaudible)
Well maybe next time it will be on your loan, this actually gave you billion to loan facility and then take it from there. Well, thank you for answering my questions congratulations on the progress.
Our next question comes from Jason Arnold with RBC Capital Markets.
Jason Arnold - RBC Capital Markets
Manuel, I was curious if could expand upon the comment you made earlier about the VC sponsors putting more equity in the deals?
Sure, I can do that for 25 years and you have a phenomena right now where the venture capitalist are sitting on portfolios that maybe down 40%, 50% and has some dry power and they have settled the wagons on their better deals and suddenly when the IPO markets starts opening up, they’re seeing opportunity to quickly monetize and get quick return or multiple on their money.
So certainly debt, which is still a very attractive alternative for them from a dilution point of view, they were ignoring and the place more equity capital in this company or advertising if you well because of the ability to arbitrage the prior valuation to the public valuation and see higher multiple on their companies.
The last time we saw it’s phenomenal by the way, it was 1998, 1999, where you’re investing in a $100 million private round and the company was pricing in IPO six months later and $500 million in valuation. So I’m little surprised to see that phenomenon now, but that phenomenon is now driven for other reasons then it was driven in ‘98, ’99. This time it’s driven by trying to lift the overall funds.
The venture funds performance back into the 75% trial, 80% trail in order to secure the next capital rising of the fund itself. Its shortly lived game, I think that will run it core to very shortly because the venture capital all the times have structural difficulties taking new capital to advances for all the investments in all the funds so that’s a difficult thing trying to do for extended period of time, but I have seen it and seen a lift bit more of that over the last two or three months with the IPO opening up the way it is.
Jason Arnold - RBC Capital Markets
Yes interesting so from a competitive perspective it seem like short term it might crowd out a little bit on the new lending side, but intermediate to longer term as these company is growing and put this new business on loan demand certainly seems to coming time?
Despite into capital money is doing both, they are putting more equity in and still taking debt in and demand, so to say $50 million debt piece and they take $10 million debt piece over equities it, but the smart more money is still putting more layers of debt into it which is why we’re seeing the demand that we’re seeing
Our next question comes from Douglas Harter with Credit Suisse.
Douglas Harter - Credit Suisse
Thanks. My questions have been asked and answered.
Our next question comes from Matthew Howlett with Macquarie.
Matthew Howlett - Macquarie
Just on the bringing of the other parties, the other vendors into the facility, the wells facility, I know you are in negation. Any more color you can give us and may well on where you are and you suiting for the three year pushing out to three years, did I hear you right?
Well, first of all, I didn’t say that we’re bringing them into the Wells Fargo facility. If I infer that I apologize that was not my intent. I think the intent is to bring new credit facilities period. If it just forms at Wells Fargo that’s fantastic wells is a great partner and continue to be a great partner, but as I learned the large money centered banks on our (Inaudible) and they don’t want to collaborate with each other on a common credit facility and so I think that it is highly likely that will probably have this new credit provider that we are speaking to probably an independent standalone credit facility that’s out of the wells. In terms of their progress we have had now four or five conversation with them.
We expect to be entering into some form of that more of an LOI. We have been sorting through what their underlying parameters are, if will like getting a better assessment as to what are the mechanics that would be associated with tendering the loans for them to consider the (Inaudible) forms I need make sure, I understand that quite well to ensure that there’s a lag time issue that I don’t commit funding to a company that credit facility may not confirm to (Inaudible) being longer, a credit that I want to.
So, we’re spending a lot of time in the front end really working through what the mechanics of that would look like and I believe that should give results here in the next week or two, and then once we have that bill go to their committees to get a soft circle kind of get commitment more or less and our special term interest and then we go into documentation if there it seems to workout. So, it encouraging but it’s not something I want to bank on in the next 31 days. I think that it’s certainly, one and half with the pulse that has ways to closed in 69 days potentially.
Matthew Howlett - Macquarie
And then just coming back to I mean, you’ll see a ramping up you could put a lot of money to work really the next 12 to 18 months. How back the range for while, what are you seeing now in terms of quality deals, I know there is roughly more equity, but is it just your better outlook on the tech and healthcare space, or better quality companies coming to, maybe elaborate on that little more like now sort of the tonne really look forward, with the investor?
You’re being nice to me, I’ve been yelled at, I have been two conservative and overly tied on the range and I though will take as compliments, because being conservative and holding back the range for 2009 I still strongly believe it was the right thing to do; and revenue growth will happen. I am as optimistic again as bullish as I have been in the last two years. Our team is kicking butt, our team is seeing strong deals. Our team is being hardened through the credit storm of 2009.
They know what we like know, we look forward, if we will decide it for example, three of our credit underwriting parameters are keeping double originations in closing deals, I don’t think it’s a right thing to do. I do believe strongly and controlled growth, I think that you deployed capital as you see your liquidity arising to match your funding and you’ll see us do that, and because of the nature of a venture industry, the lagging of a close commitment to funding, I have built in six month window to when I commit the fund the company, to allow additional progress in the marketplace to get the funding needed to getting as to fill that backlog and most people may not recall in 2009, ’07, and 2008 we’re running sometimes with the $100 million, $120 million of unfunded commitments of drawn downs that were pending with our company.
So, I look forward to returning of the days, and having a $500 million and $700 million portfolio and having a $100 million of unfunded commitments behind me. That gives me very stronger visibility into asset that I can deploy over preceding three to six months. And all that we are doing right now, is we are rebuilding the whole backlog of those signed term sheet and commitments that we expect to fund over the next three to six months and today, this team has done a fantastic job from zero to May of having over $228 million of term sheets that we have in house or we converted to transaction. Most people don’t remember that in January [may be like] today the sky was falling. We held back in January we are very conservative in January.
We were extremely apprehensive in February during the February conference call on earnings for the fourth quarter, we still look at. We want to go slow, because we’re not sure that everything is in the right direction. Today I have eight IPO completing Q1. I have 12% increase year-over-year eventual capital deployment of capitals. M&A activity remains very robust and strong; IBM record quarter earning, Intel record quarter earnings. You’ve had continued capital deployment by institutions Microsoft deployment of Windows 7 is currently incorporations to rebuilt the capital expenditure and upgrade the hardware infrastructure. We’re in a good place right now, but we want to make sure that we control with growth and not just growth to grow earnings for the wrong reason.
After going through the pains of 2009, the last thing I want to do is let go the range and originate $400 million without taking into account credit quality and maybe I am being a old dog here, but on conservative I’d like the growth that we’re on, I like the earnings growth for Q4 that that I’m seeing and it will all come together in the second half of the year without hopefully sacrificing credit quality and I’m very, very happy with our strong pipeline and strong deal further we’re seeing today
Sir, I’m showing no more questions in queue.
Thank you, operator and thank you everyone for your continued interest and support of Hercules, especially in today’s marketing volatility that we saw today. We will be attending a conference on Monday at the JMP conference to presents as part of their financial conference we will be taking needs of investors on that day as well and as we do and say in every earnings call Dave and I will be on the road over the next two to three weeks. Meeting with investors if you will like to have a meeting with us, we are happy to coordinate that with this in our schedule and the cities that we’re in. Feel free to contact David Lund at 650-289-3060 or myself and we’ll be happy to coordinate a time to meet with you. Thank you very much and thank you again for being our shareholders and have a good day.
Ladies and gentlemen, this does conclude today's conference call. Thank you for your participation and have a wonderful day.
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