Implications of Hercules Technology's New Convertible Debt Issue

by: Nicholas Marshi

Another day, another Convertible. Today, specialty lender Hercules Technology (NASDAQ:HTGC) announced plans to raise up to $90 million in Convertible Subordinated Notes in a private placement. We do not know all the details as this is Breaking News, but the press release does indicate the Convertible will mature in 5 years and cannot be redeemed prior to maturity. We don’t yet know what the interest rate on the Notes will be, nor the conversion premium.

BDC Reporter’s Two Cents: First, the big picture: today’s news underscores that the Convertible is here to stay in the BDC sector. To date, Ares Capital (NASDAQ:ARCC), Apollo Investment (NASDAQ:AINV), Fifth Street Finance (NYSE:FSC) and Kohlberg Capital (NASDAQ:KCAP) have arranged Convertible Notes in recent months, all with similar maturities. Hercules Technology makes five. We wouldn’t be surprised to see several other BDC peers join the Convertible club in the months ahead.

For Hercules, the new Notes continue its liability diversification. Today the Company has two Revolving Lines of Credit, one for $100mn (with an “accordion facility up to $300mn) and another for $20mn, both expiring in 2014. Moreover, the Company has long term SBIC financing with the SBIC, which will eventually become fully drawn at $225mn. The Convertible Notes will probably be the most expensive of its debt facilities, but will provide medium term, fixed rate financing for a sector of the BDC universe that has some difficulty attracting private term debt capital.

(By the way, in a prior post, we indicated that HTGC’s Revolver was priced at 8.5% (a 5% floor and a 3.5% margin spread). However, we were corrected by a reader and after checking with Investor Relations, we can confirm the actual rate on the Revolver is the 5.0% minimum rate. Apologies for the error).


We should note the amount being raised is relatively high, and does not seem to be needed in the short run. At the end of the year, Hercules (according to its own press release ) had $472mn in investment assets and an additional $232mn in unused liquidity. The Revolvers were not drawn, and there was ample capacity under the SBIC lending program. Management is presumably looking ahead and taking advantage of the popularity amongst some institutional investors for Convertibles while the going is good. As we’ve pointed out for other BDCs, which take on Convertibles, the short term result might be higher interest expense than before. Medium term,though, and assuming the SBIC monies (which continue to be the best game in town for lower middle market BDCs) is fully drawn, the combined term debt on the books will be $315mn. That’s equal to three quarters the equity balance at year end 2010. As we’ve said before, that suggests Hercules does not intend to rely materially on its Revolving lines of credit for permanent financing of new investments. From a credit risk standpoint that’s a positive, and is another indicator that many BDCs are rebuilding their balance sheets in the post-Great Recession era to reduce refinancing risk by relying on a mixture of debt capital sources, and laddered by expiration date.

Disclosure: I am long ARCC, FSC, KCAP, AINV.