Hercules Technology Growth Capital's (HTGC) CEO Manuel Henriquez on Q3 2015 Results - Earnings Call Transcript

| About: Hercules Capital, (HTGC)

Hercules Technology Growth Capital (NASDAQ:HTGC)

Q3 2015 Earnings Conference Call

November 5, 2015 5:00 PM ET

Executives

Michael Hara - Senior Director, Investor Relations and Corporate Communications

Manuel Henriquez - Co-Founder Chairman & Chief Executive Officer

Mark Harris - Chief Financial Officer

Analysts

John Hecht - Jefferies

Vernon Plack - BB&T Capital Markets

Chris York - JMP Securities

Sam Choe - Credit Suisse

Fin O’Shea - Wells Fargo Securities

Ryan Lynch - Keefe, Bruyette & Woods

Aaron Deer - Sandler O’Neill & Partners, L.P.

Operator

Good day, ladies and gentlemen, and welcome to the Hercules Technology Growth Capital Q3 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder this conference call is being recorded.

I would now like to introduce your host for today’s conference, Michael Hara, Senior Director of Investor Relations. Please go ahead, sir.

Michael Hara

Thank you, Charla, and thank you, everyone. Good afternoon and welcome to Hercules conference call for the third quarter 2015. With us on the call today from Hercules are Manuel Henriquez, Founder, Chairman and Chief Executive Officer; and Mark Harris, Chief Financial Officer.

Hercules third quarter 2015 financial results were released just after today’s market close and can be accessed on the Hercules Investor Relations section at www.htgc.com. We’ve arranged for a replay of the call at Hercules webpage or by using the telephone number and pass code provided in today’s release.

During the course of this call, we may make forward-looking statements based on current expectations. Actual financial results filed with the Securities and Exchange Commission may differ from those contained herein due to timing delays between the date of this release and in the confirmation and final audit results. In addition, the statements contained in this release that are not purely historical are forward-looking statements.

These forward-looking statements are not guarantees of future performance and are subject to uncertainties and other factors that could cause actual results to differ materially from those expressed in the forward-looking statements, including without limitation the risks and uncertainties, including the uncertainties surrounding the current market turbulence and other factors that are identified from time-to-time in our filings with the Securities and Exchange Commission.

Although, we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions can prove to be inaccurate and as a result, the forward-looking statements based on those assumptions also can be incorrect. You should not place undue reliance on these forward-looking statements. The forward-looking statements contained in this release are made as of the date hereof, and Hercules assumes no obligation to update the forward-looking statements or subsequent events. To obtain copies of related SEC filings, please visit sec.gov or visit our web page htgc.com.

For today’s agenda, Manuel will begin the call with an overview of our Q3 2015 financial highlights, followed by a business overview and an overview of the current market conditions and our perspective and outlook for Q4 2016. Mark will follow with a broader summary of our Q3 financial performance and results. And following the conclusion of our prepared remarks, we will open the call for Q&A.

With that, I’ll turn the call over to Manuel, Hercules’ Chairman and Chief Executive Officer.

Manuel Henriquez

Thank you, Michael, and good afternoon, everyone, and welcome to the Hercules Technology Growth Capital Q3 2015 earnings call. Today, I’m delighted to share with you that Hercules delivered another outstanding and impressive quarter, delivering net investment income of $0.33 per share and effective yield of 16.4%. Thanks to our outstanding and driven team of investor professionals who are executing exceptionally well on all fronts. The quarter exemplifies the achievement and the capabilities of Hercules by its results and the new origination commitments and fundings that occurred during the quarter.

Our Q3 results serve to highlight Hercules strong technology position within the market, market leadership position, as well as our continued unprecedented access to some of the leading, most innovative and disruptive technology and life sciences companies financially back and supported by some of the industry top tier venture capital firms.

These outstanding and visionary venture capital firms are a tremendous source of deal flow to Hercules and we’d like to say thank you and acknowledge their continued trust and support and confidence in Hercules, as a critical source of growth capital for the respective portfolio companies. Thank you very much for that continued support, as evidenced with a deal flow that we witnessed in Q3.

In addition, Hercules third quarter results demonstrated our high brand awareness, our market leadership position, and overall differentiation for qualities that separate Hercules from the rest of the venture lenders. In addition, let’s not forget one very important designation of differentiation within the BDC industry as well, and that is that Hercules is an internally managed BDC, meaning that we are directly aligned with shareholders and more interested in generating total returns on behalf of our shareholders that merely focused on increasing AUMs for additional fees or asset management fees.

Now, with respect to Hercules performance in Q3 and business and financial highlights. Q3 was an extremely busy and strong earnings performance quarter for Hercules on all fronts. If there’s any doubt on our dividend coverage capability, I think that Q3 exemplifies that capabilities with $0.33 and earnings on a $0.31 dividend. DNOI and NII were $0.36 and $0.33 respectively in the quarter, representing an increase for DNOI of approximately 33% and an increase for net investment income of 44%. This clearly was helped by the exceptionally strong early repayment activities that we witnessed in the quarter of nearly $190 million, representing a record for Hercules never achieved before with early prepayment activities taking place in one quarter.

On that, Hercules effective or realized yields or effective yields during the quarter also increased due to an impressive 16.4% marketing and major step forward towards returning to our near-term historical effective yield levels of 14% to 16% as you witnessed we generated over the last eight to 10 quarters trailing.

Clearly, increases in our effective yield above the core yields are directly impacted by increase in early loan repayment levels generally occurring above the $60 million to $70 million level. Why is that the case? Because typically, Hercules tries to forecast and factor into some form of early repayment activities above and beyond the normal amortization of portfolio. We typically tend to model anywhere between $40 million to $60 million and in later quarters $60 million to $70 million in the second-half of any year.

As many of you may recall, we had been expecting and forecast an increase in effective yields principally driven by our anticipated increase in early repayment activities to be taking place in the second-half of 2015. Clearly, that occurred. However, it occurred even sooner than we anticipated since we were anticipating that early repayment activities to actually begin in the early fourth quarter and, in fact, begin three weeks earlier than we anticipated in the third quarter.

Nonetheless, those effective yields were influenced by the increased early repayment activities, which allow us to also rebalance our portfolio and grow our portfolio in the areas that we like to as well as divesting ourselves from certain industries or exposure to geographic regions, such as we did in Q3 with exposure to China, as an example. That said, I’m very proud and like to point out the fact that once again the Hercules investment team delivered an exceptional performance for the benefit of our shareholders.

Our team was able to successfully originate and absorb nearly all of the unexpected early repayments of $190 million, providing once again and so much of what we achieved in 2014, proving our assets to unprecedented deal flow tells them the on-slot of early repayment activities take place and yet containing and materially reduce the reduction at portfolio by a contraction otherwise would have been fairly large with $190 million.

Further, Hercules performance also amplifies the industry leadership position and the origination platform that we have in place. For example, in Q3 typically our slowest quarter of the year, but certainly not the case this year. In Q3 2015, total commitments represented approximately $113 million. However, total new fundings during the quarter, a record level represented $158 million of which $155 million of that was debt investments in new companies.

In addition, during the third quarter, we continue to mange down our unfunded commitments. We work diligently during the quarter to begin the reduction of unfunded commitments as we indicated that we would do in our second quarter earnings call. I’m proud to announce today that we’ve seen a major accomplishment and achievement in that area. Unfunded commitments decreased from approximately $159 million in Q2 to $110 million in Q2, excuse me in Q3, representing a 31% decline quarter-over-quarter.

Unfunded commitments related to milestone decreased even more impressively declining from $255 million level in Q2 to a mere $130 million in Q3, representing nearly a 50% reduction in the unfunded commitments and once again proving that Hercules execute into what it says and working diligently to reduce unfunded commitment as we indicated that we would. As to achievement for the nine months ending September 30 on a year-to-date basis for Hercules, we originated over $630 million of total new commitments, putting us on pace to hit or exceed the record level of new commitments achieved in fiscal 2014. Equally as remarkable was Hercules total new fundings during the quarter of approximately $532 million of which $518 million of that went to brand new debt investment activities on a year-to-date basis, put us on pace to exceed all of 2014 record levels at the time of approximately $611 million of new fundings during that year.

So far 2015 is shaping to up to be an extremely strong year for Hercules and we’re expecting an equally strong fourth quarter, which I’ll talk to you and elaborate later on in my opening remarks.

As of the end of the third quarter, our total invested portfolio ended at approximately $1.2 billion, representing a 16% increase over that of the year-end 2014, and certainly putting us on pace to achieve our portfolio growth targets of, at least, $1.3 billion or greater. Of course, that is subject to and continued upon market conditions remaining favorable.

That said, despite in otherwise choppy and volatile stock market and concerns over Chinese growth rates and clearly uncertainty about the French direction interest rates, over the last few weeks and months, Hercules nonetheless continues to achieve a strong performance on executing on liquidity events during the quarter. We saw liquidity events in the quarter with two IPOs being completed in Q3.

On a year-to-date basis, we’ve generated $8.4 million of realized gains for our shareholders, representing approximately $0.12 and future earnings that are distributable to our shareholders. I would like to remind our investors that Hercules still has approximately 130 unique and different warrant positions in various privately funded life science and technology companies that are progressing towards an M&A or an IPO event sometime in their near future.

The $8.4 million of realized gains, or $0.12 per share excludes any impact of realized gains that we still hold in Box. We currently hold approximately unrealized gains in Box of approximately $10 million to $11 million, or representing anywhere between $0.12 to $0.14 per share, based on last night’s close of $3.17. Hercules currently hold approximately 1.4 million shares in Box to-date.

As we continue to resonate new loans, especially new loans of warrants, you can expect us continue to grow and add additional warrant positions in our already growing and impressive warrant portfolio. As a reminder, this warrant portfolio serves as a backdrop for additional capital gains for Hercules to harvest on behalf of our shareholders and generate an incremental higher total return to the majority of BDCs because of the ability for us to monetize those warrant positions that we have in various privately funded life science and technology companies.

However, I want to remind our shareholders that we do not expect all of our companies to mature and ever reach an IPO or an M&A event. It would be nice if that’s the case, but clearly in this business that is not the expected outcome of all of our warrant positions. With the majority of Hercules now approaching nearly 12 years since its founding and having many of our investments now begin to mature above this seven or eight years of maturity, we can expect to see a normal cadence of realized warrant gains over the proceeding few fiscal years on the forward basis that we expect to see from warrant monetizations.

As to liquidity in excess so far realized this year, 15 portfolio companies have completed our analysis, IPO or M&A event so far this year. As I said a minute ago, two of those companies competed IPO events in Q3 alone; ViewRay and Neos. In addition to that post completion of Q3, we also saw two additional companies completed IPO events so far in Q4; Edge Therapeutics and Cerecor. Unlike many were fighting to get IPO events, Hercules portfolio companies continue to execute and deliver nice liquidity outcomes with M&A and IPO events.

We ended the quarter with approximately four remaining companies in IPO registration originally as you’ll see in our earnings release, it’s six, but two of them went public in the first month of October in the fourth quarter, leaving us a net four companies in IPO registration. On the M&A front, equally as busy, Hercules saw two companies complete M&A events or announcements in Q3, [indiscernible] and Good Technology, both completed our announced M&A events. Subsequent to quarter end like we had in our IPO, we also had two additional companies announced pending IPO, excuse me, pending M&A events such as nContact and Gazelle those recently announced as well that are expected to close here shortly.

We also have an additional four companies, who made us aware on actively engaged M&A discussion. But as always I want to caution everyone, as I have seen over the years many, many M&A events fall apart to last minute and never get completed. We remain hopeful that our four pending M&A events that we were aware off, we’ll complete and close in Q4, which should be another positive and great events on behalf of our shareholders.

We’re assuming well positioning entering Q4 2015 with an exceptionally strong balance sheet having additional leverage to pass the available coupled with an ample amount of liquidity or our balance sheet. Banks and another small part to early repayment activities, we’re able to recycle those early repayment activity into a available dry powder or liquidity, representing nearly $300 million of dry powder in order to grow our portfolio and continue to generate additional interest income and earnings growth for our shareholders.

Although, it was a painful process, we would like to thank the SEC for their hard work during the third quarter, working diligently with Hercules and its legal staff, and finding a resolution that I’m sure BDCs were equally as thankful to the SEC achieving this endpoint. We’re very grateful to the SEC for its filing, reconciling, and understanding the unfunded commitments phenomena that’s associated, so simply eventual lending and now to the broader BDC industry. And with that we were halfway through the warrant – the declaration of warrant shelf effective, allowing us to finally pursue the refinancing of our 2019 bond. I would like to assure investors that we’re not as someone has been advocating, we’re not interested in raising equity at these levels.

Despite some of the rumors that I have heard since our shelf became effective, Hercules has no intent to raising equity at these current prices. We do, in fact, intend to use our shelf to refinancing our existing 7% bonds that are due and mature on 2019. And in fact just earlier this week, we made an announcement in our press release and 8-K announced the intent to redeem approximately $40 million of those 7% bonds that we expect to take place in mid-to late December.

I expect to retire in those bonds as I’m sure you were to cause a one-time non-cash impact to earnings in Q4 2015, and then thereafter represent an accretion towards shareholders on increase in earnings of approximately one penny per share per quarter in fiscal 2016 with the retirement of those $40 million in bond.

Lastly, during the quarter, it was also a very busy quarter, where Hercules also received affirmation of this investment grade rating from both S&P and Kroll. We received a BBB- from S&P and also from Kroll a BBB+ once again reaffirming our investment grade rating to which we’re grateful to and recognition of the hard work of our credit performance and managing of our credit loan book throughout the many years we have.

Finally and being true to our word. Hurcules committed to execute its stock buyback program if and when the stock approach levels what we found to be undervalued. I’m happy to say in defense to our shareholders that we’re true to our words and Hurcules committed and executed approximately $4.5 million of stock open-market purchases, representing $4.5 million against our $50 million stock buyback program.

We stand ready and willing to reenter the market if and when our stock approaches levels near net asset value, or we believe do not reflect the proper value of our company. We stand committed as an internally managed BDC to ensure that we look out to the best interest of our shareholders and continue to monetize the total return potential of our company and our stock on behalf of our shareholders.

Now, let me quickly turn to – my attention to the venture capital industry, which experienced a fairly vibrant activities. Fundraising, approximately 67 funds raised approximately $4.7 billion in Q3 an impressive number, however, the year-to-date number even more impressive. $18.7 billion was raised by the venture capitalists in the first three quarters of fiscal 2015 against the backdrop on the same period of 2014 of $15.5 billion. Even more impressive if not eye-opening was their new investment activities. The venture capital has invested $19 billion in Q3, representing a 68% increase over the same period of 2014. Even more impressive was the year-to-date number, and even this one surprised me.

On a year-to-date basis, the venture capital has invested $54.6 billion for the first nine months of 2015 compared to only $39.5 billion for the same period of 2014. This is important, because that is the source of refinancing for many of our companies and also allows us to see continued appreciation in our warrant portfolio. As the business sectors or investment allocations, business and financial services also Fintech has received the largest investments during the quarter of $5.3 billion. Consumer, which includes gaming and social media sites was the second recipient of capital at $5 billion.

Hardware on investment and information technology companies received $4 billion and healthcare continues to draw precipitously to approximately $3.7 billion in the quarter, which we believe will represent a stabilization and outlook into healthcare and healthcare investments on a go-forward basis.

IPOs as we all now know has dried up fairly significantly. However, we saw 12 companies complete IPOs that are ventured back in Q3. However, I’m very proud to point to the fact that 12 – two of the 12 companies that went public happened to be Hercules companies, Cerecor and Edge Therapeutics. Those companies – those 12 companies raised a total of $1.6 billion in the process.

Yes, the IPO numbers have dropped precipitously, representing a 56% drop from Q2, but we actually think there is a bit distress and we think we’ll see some pickup in Q4. M&A on the other hand, which typically the case when IPOs tend to dry up, M&A on the other hand picked up the activities having a robust quarter. We saw 127 companies completed M&A events, representing $17 billion in value. This compares to 98 M&A events completed in Q2 2015, representing $12 billion or so.

And finally, turning my attention to Q4 as well as beginning to layout our strategy for 2016. As you look to 2016, we expect to actively and continue to deploy our $300 million in liquidity that we have in our balance sheet. With that, we’re going to expect to see continuation in growth in earnings, as we had forecasted in Q2 and that growth in earnings will continue in Q1 and Q2 2016 and beyond.

We absolutely still expect to see coverage of our dividend absolutely by net of investment income, but even today, I’m happy to report with early indications on our Q4 activities and what we saw in Q3 that we now will see and expect to see a earning spillover in fiscal 2015 and 2016. Although, I’m reluctant to share now at this point until the end of the year, we are now seeing the ability to see a spillover, which means that any questions in dividend coverage should be off the table.

In addition, we’re also keeping a very watchful eye on the M&A activities or M&A floating activities going on in the BDC sector. We’re solely very interested to see consolidation in the BDC industry and we remain very watchful for key developments that may transpire in the M&A sector within the BDC themselves and we ourselves remain interested and potentially flooring M&A activities on some players that exist within the marketplace today.

We’re clearly monitoring these developments very, very closely. We hope to see the first wave the consolidation begin and we will report back as those activities begin to take shape. In the meantime, we are continuing to focus on our core business and our core activities. Our business has never been stronger. Our liquidity has never been better. And the continued execution of our Investor Relation team has ever been stronger or better that I see in quite sometime.

I’m very proud of the execution of our team. I’m also welcome and thank the venture capital community from acknowledging the Hercules capabilities. It has become clear in business that large balance sheets and large access to liquidity make you a stronger and better financial partner for many of the venture-backed companies in the marketplace.

Hercules is extremely well-positioned to take advantage of the opportunity, as others are struggling for liquidity or trading below book value. We have the luxury of having both liquidity and trading and premiums book value. Thanks and no spot to our – thanks and no small part to our investors acknowledging the positioning that Hercules has in its marketplace today.

With that, I’ll turn the call over to Mark Harris. Mark?

Mark Harris

Thank you, Manuel. What I’d like to do is try to give some context for the numbers that Manuel covered earlier in the conversion. Starting off of net invest income, which increased to $23.6 million in the third quarter versus $16.8 million in the second quarter, an increase of 41%. On a per share basis, NII increased to $0.33 per share compared to the $0.23 per share in the second quarter, another increase of 44%. We saw our return on average assets on an NII basis increased to 7.5% in the third quarter from 5.3% in the previous quarter with our return on average equity on an NII basis materially increase of 13.7% in the third quarter from 7.5% in the second quarter.

Investment income drove a lot of this, which increased to $47.1 million in the third quarter of 2015 versus $37 million in the third quarter 2014, an increase of 27% over the same period in the previous year. Our loan portfolio decreased on a cost basis to $1.109 billion in the third quarter compared to that of $1.171 billion in the second quarter, or a decrease of approximately 5%.

As Manuel discussed, while we had new fundings of approximately $157 million, which was a record third quarter for Hercules, this was offset by the decrease led to the $190 million of unscheduled paydowns in a quarter, which was not fully anticipated. The GAAP effective yields increased to 16.4% in the third quarter from 13.8% in the second quarter, an increase of 260 basis points. The increase was primarily related to the acceleration of interest and fees pertaining to early loan paydowns and payoffs.

We expect our prepayment activity to return to rate of $50 million to $70 million in the fourth quarter. The weighted average age or a loan portfolio at the end of the third quarter is young, given the velocity of prepayment we experienced in the third quarter. As such, we would expect to see retention in our portfolio over the next couple of quarters, leading to loan growth in the fourth quarter and into 2016.

Core yields, which exclude the effect of fee accelerations that occurred from our early past and one-time events was 12.6% in the third quarter compared to 13.2% in the second quarter, a decrease again of approximately 5%. However, in the second quarter we did have higher than average expired on price commitments. Therefore, backing that out and on a like-for-like basis, we would have been flat in two comparative periods.

Interest and fee expenses decreased by 3% to $8.9 million in the third quarter compared to $9.2 million in the second quarter, a decrease of approximately $300,000. We had interest and fee expense related to redemption of our $20 million of redemptions of our 2019 7% notes of approximately $500,000 in the second quarter and this was offset by the increase of $200,000 in interest, due to dropdown on our Wells Fargo facility, which was outstanding for most of the quarter. This had a coupon rate of LIBOR plus 325 basis points.

As we disclosed in our press release yesterday, we intend to buyback $40 million of our 2019 7% notes and expect that to have a forward interest and fee savings of approximately $800,000, or $0.01 EPS accretion fourth quarter. In the fourth quarter, we anticipate a one-time non-cash charge of approximately $125,000 pertaining to this potential buyback.

Future interest rate hikes and their impact to prime and LIBOR rates are accretive to Hercules. First, our outstanding levers at the end of the third quarter is a 100% fixed interest rate facilities. Second, 98% of our loans, our variable interest loans were floors, that’s a 50 basis points increase in prime rates, which most of our loans are – agreements are based on will be accretive to interest income by approximately $4.4 million on an annualized basis or an increase of NII per share of $0.06.

Our weighted average cost of debt reduced to 5.6% in the third quarter of 2015 from 6.1% in the second quarter of 2015, primarily due to the second quarter fees being higher, because of the paydown of our 2019 7% notes related to acceleration of fee expenses in that quarter. Backing out accretion of non-cash fee expenses in the second quarter, our weighted average cost of debt would have been consistent with the third quarter of 5.6%.

In an effort to reduce our weighted average cost of debt, we would like to be 75%, we’re exploring numerous alternatives in the market. As Manuel mentioned with our effective self-registration for our press release yesterday as well, which was achieved a meaning discussion with the SEC without limiting our ability to continue our business as previously conducted. This has opened up further options for us in the public debt markets.

Net interest margin increased to $38.2 million in the third quarter from $29 million in the second quarter, or an increase of 32%. Net interest margin as a percentage of average yielding assets further improved to 13.4% in the third quarter compared to 10.2% in the second quarter. Much of this increase is due to favorable impact of NII previously discussed.

Operating expenses including interest – excluding, excuse me, interest and fees increased in the third quarter of $14.7 million from $12.2 million in the second quarter, an increase of 20%. This wasn’t a surprise given 20% increase in interest income and 41% increase in NII. G&A, excuse me, went up by 11%, mainly driven by continued growth of the company. Employee compensation increased 25% with much of this being around bonuses, given our stellar performance for the first three quarters of the year, followed by an increase in head count.

We had unrealized appreciation on our investments of $25.9 million in the third quarter compared to depreciation of $12.8 million in the second quarter. However, our loan portfolio had unrealized appreciation of $1.4 million, we did have $27.3 million of unrealized depreciation pertaining to our equity and warrants.

To put our equity and warrant depreciation into context, like knowing the conversion of unrealized gain to unrealized losses, the true deprecation was $22.3 million in the third quarter. With 53% of our company is being public and 47% being private, we had to do mark-to-market fair value accounting.

Fair value from the beginning equity and warrant balances was actually down 22%. However, this is entirely consistent with the capital markets performance. The Russell 2000 biotech index was down 24% in the same period and the Russell 2000 technology index was down 11% in the same period. Both of those are up 12% and a 11% from their quarter end position to today, so the technology is actually rallied back and half of the biotech index has also rallied.

I turn my attention now over to the balance sheet. Overall, our loan portfolio decreased to 87 companies in the third quarter from 96 companies at the end of the second. We had five new companies and funded 10 of our existing portfolio companies in the third quarter, but we also had 14 companies paying after-tax as well. The number of non-accrual loans increased by one from the previous quarter. Our non-accrual as a percentage of debt investment on a cost basis rose from 3.9% in the second quarter to 4.4% in the third quarter. However, approximately half of this increase just relates to the drop of our debt investment on a cost basis, while the other half just led to the addition of the one company to the non-accrual bucket.

We would also further note that we have seen some improvements to the companies that have been on non-accrual before the third quarter and expect to see this come down from the current 4.4% non-accrual rate we are experiencing today. We are very pleased with our net loses through inception, which include equity and warrant gains decreased to $3.6 million, which is an outstanding number go into $5.6 billion of commitments we’ve had to-date since inception or a loss of only 1 basis point on an annualized basis.

Liquidity went to $297.3 million in the third quarter from $216.4 million in the second quarter. Cash increased by $31.3 million, and we also paid off our Wells Fargo facility of another $49.6 million. Our debt to equity ratio remain strong. Our regulatory leverage, which excluding SBA as we have an exempt of relief from the SEC reduced to 55.4% at the end of September versus 60.5% at the end of June.

Total leverage with the SBA reduced to 81.7% at the end of the third quarter versus 86% at the end of the second quarter. Based on our regulatory leverage ratio, we have the ability to add another 322.7 million of debt without bridging our debt equity ratio requirements.

Our asset coverage ratio increased to 281% from 265%, primarily from the path of the Wells Fargo facility in the third quarter. This is well above the required 200% coverage threshold. Net assets fell by $20.9 million to $722.8 million at the end of the third quarter, or NAV per share fell to $10.02 versus $10.26 last quarter. This was primarily driven by the unrealized depreciation in our equity and warrants, offset by our realized gains in the period as discussed previously.

Finally, we are pleased to declare our 40th consecutive dividend of $0.31 per share that will be paid on November 23, as approved by our Board of Directors with a record date of November 16. Based on our current projections, we expect our 2015 dividends to be covered through a combination of our operational performance and spillover that we had in 2014.

With that report, I now return the call over to the operator to begin our Q&A period.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question will be coming from the line of John Hecht from Jefferies. Your line is now open.

John Hecht

Thanks very much. Active quarter for your guys. Just considering the repayments – the elevated repayments in the commentary that you expect these to come down in Q4, so you get back to portfolio growth. A couple of questions and that is, in the near-term what drives unexpected repayment activity and what kind of visibility do you have in the 4Q that you wouldn’t experience that spike over the remaining part of the year?

Manuel Henriquez

John, thanks. Good question. As we’ve tried to share with investors over the 10 years that I’ve been on this earnings call is that, it’s very difficult for us to have visibility. A full quarter out, I almost like to say that we probably have visibility and confidence probably on a 45 or so ruling basis. And a lot of the takeouts are early repayments are often times driven by pending M&A events that may or may not replace, or as we saw in the third quarter by some commercial bank refinancing some of our loans, because it’s a natural progression of our companies that we’re working with them, they’re young and experiencing growth.

And eventually they will mature to a level that in commercial bank, they offer some of the resources that we do not provide like deposits or operating accounts what have you. But during the early stage of growth, it’s an area where we actually work with our companies very diligently and work with them.

That said, in the third quarter, we proactively took the approach of also reducing expose in certain area, i.e., China was one of the areas that we – mean it, fairly a strong push to reduce exposure in that area. So we kind of help deliver that portfolio turnover by encouraging some of these companies to seek financing elsewhere as you want to reduce that Chinese exposure.

So the last part of your question visibility in Q4, as of right now, I think, our confidence level for, I’m going to say in a very odd way unanticipated, but now predicted early payoffs somewhere in the neighborhood around $50 million to $70 million. That could change materially up or down by $20 million only because I’m aware of four companies that are actively engaged in M&A discussions. But if they do occur, that will make the number in the higher-end of the range and if they don’t occur, they will put it down on the lower-end of the range. So that’s one of the problems that we always have, it’s trying to handicap where exactly are we in the continuum of these early past activities.

John Hecht

Okay. That’s helpful. So if I just – I guess to clarify, I hear correct, Q4 based on your margin commentary that you kind of hit the core level of margin that you’d expect to be at, I guess, resume in a stable level for May or and that Q4 we see us return to the kind of portfolio growth that you experienced in the first-half of the year, is that kind of a fair way to think about the near-term view?

Manuel Henriquez

Absolutely. I think that you will see portfolio growth in Q4 in the neighborhood of maybe $100 million to $120 million net bluff that were forecasting in the portfolio in Q4. You then – I don’t expect to see our yields – our effective yields to sustain the level of 16% because of the early past activity that took place in Q3.

So we do expect the more modest early same activities by more mature companies being later-stage companies that are now and probably months saw 20 or beyond. So you’re not going to see the large impact from both fee acceleration, as well as prepayment in penalties kicking in. So you’ll see a continued separation of core yields to effective yields. But I think effective yields modulate downward a bit in Q4 to the level that’s unclear right now as we’re still actually trying to figure out, which loan the ones you’re going to pay off again certainly, they’re paying off or not. And so I think that we’re certainly looking at yield at the 13.5% to 14.5% is probably the right range to look at.

John Hecht

Okay. Thanks very much. And then final question, you gave us a lot of updates on the competitive environment and yes, there has been volatility in the equity markets that certainly flat over to some of the high yield markets. How do you view the competitive market, I guess, maybe particularly your ability to capture some decent warrants and and maybe deployments, because I know you had mentioned was, yes, the equity guys were getting higher, are they changing or they’re giving you guys more opportunity?

Mark Harris

Well, I think that the equity evaluations in the private sector will remain at elevated levels. I do expect sometime in the first-half of 2015 to probably see some gradual pullback on private company valuations. And clearly with $300 million of available liquidity to invest, we certainly expect to take advantage of that and bring on Board more attractively the price warrants that may offer better upside than you otherwise would see in the near-term. And so I think that the portfolio will benefit from the eventuality of valuation adjustments, because we’re coming in with debt – with warrants, so we can actually reprice those warrants different metrics there just to give us advantage of that upside total return potential.

John Hecht

Great. Thanks very much, guys.

Mark Harris

Thank you.

Operator

Thank you. Our next question comes from the line of Vernon Plack from BB&T Capital Markets. Your line is now open.

Vernon Plack

Thanks very much. And, Manuel, you addressed most of my prior question and your response to John just a second ago. But looking at the – I’m curious in terms of, should we see any further reduction in your available and encumbered commitments from the $110 million range that you just reported?

Manuel Henriquez

You’ll continue to see a lesser of an extreme reduction in Q4, but a continued reduction in Q4, as we both convert unfunded commitments to new funded assets, as well as we or the company doesn’t achieve expected milestones in Q4 that in itself naturally will cause some of those unfunded commitments to last and not be available. So the combination of those two, yes, we do expect continued contraction in unfunded commitments, but not to the extreme that we saw in Q3 to – Q2 to Q3.

Vernon Plack

Okay, great. And the G&A line in the P&L, I know that this quarter it was about $4.5 million, I think, is that a good run rate going forward?

Mark Harris

Yes, I can address that. This is Mark.

Vernon Plack

Okay. Hi, Mark.

Mark Harris

It’s a run rate that we currently have based on the activity that was going on within the quarter the growth, et cetera. I would tell you that that number probably would decrease a little bit in Q4 and that would probably be more of a normalized rate. But I do want to kind of caution that clearly as we continue to grow making that assumption through 2016, et cetera, then yes, the answer would be, it should grow in line with revenue.

Vernon Plack

Sure. I understand. Okay.

Mark Harris

It’s very – a lot of the G&A in Q3 had final payments on executive search fronts that we were using that running, of course, we’ve made – we’ve been making some higher, some of which we would be announcing here, hopefully, next week or two. But we have been very active also and adding to our organization.

As you may realize, we also just recently opened an office in Huawei. We’re expanding in other areas and other markets. And we’re also augmenting both our East Coast and West Coast team with some extremely high caliber and new investment professionals that we just added or soon be added to the organization further driving further growth of earnings and assets for our shareholders.

Vernon Plack

Okay, great. And just one quick follow-up. What is your FTE account right now, and what are you trying to grow there too in the short-term?

Mark Harris

We’re at approximately – we’re approximately at 62.

Vernon Plack

62, okay.

Mark Harris

And that will probably grow to mid-70s by most likely second-half of 2016.

Vernon Plack

Okay.

Mark Harris

We’re slow to higher, because it’s just like we invest. We take time to make sure we understand the people.

Vernon Plack

Okay, great. Thank you very much.

Operator

Chris York. Your line is open form JMP Securities.

Chris York

Good afternoon. So my first question kind of ducktails with Vernon’s question. So, Manuel, you recently opened up and you talked about your LA office, some other remote offices. So I would like to hear about the production and how it’s been at some of those offices and then more specifically your origination activity away from the Valley?

Manuel Henriquez

Well, it’s on the way from the Valley. We’re extremely visiting the Valley. But what we realized is that, we were spending too much time in airplanes, servicing the calls and the needs of those new emerging markets that have venture capital activity. LA is actually representing a very strong social media, gaming marketplace that we are quite optimistic about. And so we’re seeing a growing demand of capital in that market. And as we always prefer to do at Hercules, we actually prefer to have physical presence in the market that we’re involved in.

And I think Hercules down has offices in – and actually larger than any other venture lender out there. But we have offices in Boston, obviously, Palo Alto, LA, Washington DC, McLean, Virginia, Philadelphia and New York and Chicago. And that really gives us a very strong footprint into canvassing all the trickle venture capital centers in the country. So we’re well positioned in that area.

As to productivity, we think that an office over time should generate over $100 and new loan origination on an annual basis, if not more as we add more staff to it. But that’s typically what we look to.

Chris York

So since some of those remote offices aren’t new, I would suspect that they’re not at that level.

Manuel Henriquez

No.

Chris York

So should we expect a greater contribution maybe in the first-half of 2016?

Manuel Henriquez

It typically takes us nine months to a year to have a new hire be conditioned to the Hercules underwriting paradigm. And we prefer it not to rush, because we don’t make. We make investments and we care about the outcome of those investments, not market share. And so we’re very much focused on the fundamentals of underwriting and identifying the right companies then we simply are rushing to put money to work. So that’s what we give our individuals new hires anywhere between six to nine months to get condition and become productive. And so that is exactly the timeframe you referred to is sometime in the second-half of 2016, you start seeing that productivity really starts kicking in.

Chris York

Got it. It makes sense. And then last one here. So I would like to have you elaborate potentially more on your prepared comments for support and interest in BDC M&A. So if you found a target that you are interested in, would you consider taking a strategy similar to another BDC that has involved in potential M&A by acquiring shares in the open market or what other route would you consider?

Manuel Henriquez

It’s hard for reference to always do transactions on a friendly basis and partner together as opposed to also transaction. But as we’re seeing in the marketplace, I think that there is a two different approaches going on right now, and I think we just want to watchfully wait what is going on. We’re not in any urgency to do anything, and it’s something that’s probably more of a tertiary strategy than a primary strategy or say differently opportunistic than anything else. I think that we are successfully enough in our business and busy enough in our business that if an opportunity present itself as attractive and it’s really friendly, I think, we will pursue it. And that’s my first choice of doing any transaction.

Chris York

Got it. That’s it from me. Thanks, guys.

Manuel Henriquez

Thank you.

Operator

Thank you. And our next question comes from the line of Douglas Harter from Credit Suisse. Your line is now open.

Sam Choe

Hi. This is Sam Choe filling in for Doug Harter. Our questions have been answered. Thank you.

Manuel Henriquez

All right.

Operator

Thank you. [Operator Instructions] Our next question will be coming from the line of Jonathan Bock from Wells Fargo. Your line is now open.

Manuel Henriquez

Hi, Jonathan.

Fin O’Shea

Hi, guys. Thank you. It’s actually Fin O’Shea here for Jon Bock, sorry about that. First question you mentioned you’re going to take down more of the – I believe that was 7% 2019 notes. How should we look at your liability that’s also going forward as a split between revolver and term debt? Is this going to be replaced with a cheaper term debt or the bank facility?

Mark Harris

Sure, let me try to answer that for you. Obviously, one is without thought and the other in the sense that when we reduced the 2019 7% notes by $40 million, as I articulated into the conversation there is good savings involved and that’s accretive obviously over to the P&L. We’re always trying to get sub-5% on our weighted average cost of debt. So now that we have an effective shop registration we will be looking externally to seeing what options we have there in the public debt markets. As it pertains to the credit facilities that we have, we use those as you can imagine to assist us with our cash drag that is right now you can see the liquidity we had at the end of the quarter as we found new investments, we will start drawing back down on to the facility, when the facility sizes start to aggregate in value then we will look back into the debt markets and replace that with another long-term debt product and then keep recycling as we see fit to minimize cash drag as much as possible.

Manuel Henriquez

As I said historically, I don’t like having more than 20%, 25% of our capitalization be on short-term bank lines. And I think that will [indiscernible] manage the business to some of that level, it is clear my preference who continues to leg out maturities of bonds and mitigate any mature – debt maturity walls that come up and that’s one of the reason why we’re proactively also looking to push out and restructure some of our credit liabilities. Also reminder, that our convertible bonds, the last remaining tail of that matures is in April of 2016. And now we’ll clean up any remaining legacy convertible bond as well.

Fin O’Shea

Very well thank you and on fundings this quarter, do you have a number or even a ballpark number, fundings that were new at the time of originations versus prior commitments?

Mark Harris

I don’t think we have that allocation in front of us, but I think that you’re safe to assume that Q4 you probably look at gross fundings allocated probably, you are talking about Q3 or Q4, I’m sorry.

Fin O’Shea

Q3.

Manuel Henriquez

I’m sorry, Q3 I think that Mark will actually have Q3 data.

Mark Harris

Yes, I think the easiest way to described that is the – of the $157 million we had it’s about a 50-50 in terms between the new loans and existing loans. So, it’s still pretty consistent in terms of what we’re discussing on the new companies, which is funding the existing companies.

Fin O’Shea

Okay very well that’s all from me. Thank you.

Manuel Henriquez

Thank you.

Operator

Thank you. Our next question will be coming from the line of Ryan Lynch from KBW. Your line is now open.

Ryan Lynch

Hey, good afternoon. Thanks for taking my questions. It looks like you guys had about $35 million uptick in investments that are listed as grade five in the quarter and also looks like you guys had about $1 million of collateral base impairment write downs in the quarter. I just would have expected more collateral write downs in the quarter given the move significant or the decent size of new grade five investments, so can you just help me understand why there are so little collateral based write downs in the quarter?

Manuel Henriquez

Sure, as I said, I have four companies that have signed – four companies who are in the midst and throws of the completed M&A event, without getting into specific names some of those names maybe reflective in a rated 4 or rated 5, and we do that, because until such time as our companies have secured subsequent amount of financing that will fund the operation of the business for next 12 – 9 to 12 months until that is completed we take the cautionary approach to merely market down to signal that we’re monitoring situation closely. And often times the case is because there’s an abundance of enterprise value that cover our loan and that will mitigate any need or necessity to then markdown the credit or markdown the loan in that context.

So just because of the rated five did not directly correlate that there has to be an impairment of principal or loan value against the credit. If the credit were to deteriorate further, meaning, that in M&A event that is personally not completed and subsequently not followed up by an equity infusion by the venture capital firms that would re-merit or revisit the credit rating on that credit or the impairment on that credit. But at this juncture, given that many of our companies are very actively involved in M&A discussion to which we are very much aware of. We don’t see at this juncture any necessity to enter principal risk.

Ryan Lynch

Okay, great. And then you guys have done a nice job of producing unfunded commitments over the past few quarters. You also talked about reducing – actively reducing some specific exposures like your exposure to China in the most recent quarter. I was just curious if any other repayments in the current quarter were initiated by new guys in an effort to reduce any associated unfunded commitments with a specific portfolio company?

Manuel Henriquez

So the answer to that question is obviously, yes. As Hercules has done throughout its many years in history and monitoring credit, we take very proactive approach to looking at credit, not necessarily in the current quarter, but what is the occurrence of a credit situation two or three quarters out. And that has served us well over the years. Yes, they may hurt than I may gave up some current interest income, but I also mitigate the possibility of principal risk two or three quarters later on down the road.

So we actually took a proactive approach in the portfolio valuation in Q3 and we identified those companies that we felt had a disproportionate risk to China pullback. And we have taken the efforts to reduce that risk and part of that risk is manifested itself in the $190 million of really loan payoffs. So, yes, we do that from time to time. China is one of those issues. We also have another sector, I don’t want to disclose. So I don’t give some of our competitors, the clue. But there is another sector that we have made a conscious effort to pullback some as well, while some of our competitors are leave fully looking to wait in and we’re fine with that.

Ryan Lynch

All right, great. That’s all from me.

Manuel Henriquez

Thank you.

Operator

Thank you. Our next question comes from the line of Aaron Deer from Sandler O’Neill & Partners. Your line is now open.

Aaron Deer

Hey, good afternoon, everyone.

Manuel Henriquez

Hi, Aaron.

Aaron Deer

Just one quick follow-up question from me on the unfunded commitments. I’m just curious if there has been any shift in the and how you’re underwriting credits or the structure of the credits that’s bringing down the level of unfunded commitments or contributing to anyone?

Mark Harris

So obviously new credit origination will not impact legacy unfunded commitments, but the answer to your question is, yes. We have made material changes to our business that would absolutely ensure that the unfunded commitments continues to decline every time. As you saw that our ability to risen in Q3, we’re not seeing any impact to our business, because thankfully the SEC has applied the methodology system-wide, so others will have to calibrate if there’s anything that we’re doing anyways.

So we see no impact to our business on a go-forward basis. And we’re actively, as we said in the beginning of the call, a lot of the unfunded commitments convert into funded assets, as well as a portion of those unfunded commitments expired merely they passed this time or the milestones that the company expatiating we are not achieved. And those two factors certainly helped relieve or reduce the unfunded commitments that we expect to see further decline in Q4.

Aaron Deer

All right. And so what are the material changes that were made on new credits versus the legacy stuff?

Manuel Henriquez

I’m sorry that we’re not going to disclose, because that’s competitive advantage. But the answer is that we are and we were not going to get into the specificity – this specifics as to how we conduct our business and divorce straight secrets on these calls.

Aaron Deer

All right. Fair enough. Thanks for taking my questions.

Operator

Thank you. Our next question comes from the line of Leslie [indiscernible] from Raymond James. Your line is now open.

Unidentified Analyst

Hey, guys, it’s Leslie Vandegrift. [How are you doing there] [ph]?

Manuel Henriquez

Good. Thank you. How are you.

Unidentified Analyst

Doing well, thanks. So I got a couple of just kind of tied together questions. First of all, you are talking about possible BDC M&A interest, I know right now we are all kind of watching to see how that kind of new story goes, but if you were interested in looking any sort of qualities or looking for an expansion of our current, the same kind of loans you guys currently do expansion into maybe a different area in the market, any color on that would be good?

Manuel Henriquez

No, I’m sure you’ll like color on that. Today, we’re not going to disclose that I think that like you we’re watching the developments in the BDC industry. There are certainly larger BDCs than us that I’m very much aware, who are closely scrutinizing and monitoring the business. I think this gives managers the opportunity to readjust our management fees [indiscernible], but I think that right now we’re all watching and waiting the current development, if that saga that’s taking place in a market. And see how that kind of comes out and see, which processes tend to be viewed more favorable and what tend to be viewed less favorable. And I think that we’re patient and like I said it is a tertiary part of our strategy, not primary and if we don’t do anything for six months or year that’s fine as well, it’s much more opportunistic and as I said at the beginning of the call, I prefer to have it done in a friendly basis in a very collaborative basis than a hostile basis.

Unidentified Analyst

Of course yes. And then on [indiscernible] I know we talked about a lot in this called and you guys have been taking it down. Any response in the SEC, I know that obviously your mix shift got filed and was effective before filling your 10-Q, so that’s through. But I have seen a lot of other BDCs have correspondent come out publicly, were they’re responding back and forth with the SEC have you guys said that and if so color on the response to your differentiation between milestone versus not milestone?

Manuel Henriquez

Sure, I’ll let Mark answer that, but you’re absolutely right. I think the first wave of BDCs we’re eager to put this situation behind them who are engaged and very open, open comment letters back and forth of the SEC, we certainly opted to go and engage proactively with SEC on a more private basis, which Mark can kind of open and give you color on the current development and prior conclusions from the SEC, Mark?

Mark Harris

Sure, I mean look the SEC as I’ve discussed before when we first began this process we had some come out as go back and forth. I think one of the more interesting parts that we did was really sit down with the Securities and Exchange Commission on a phone call for about an hour an half walking them through not just the BDC space, which I think everybody generalizes a bit too much, but that were ventured debt however on funded commitments are potentially different to mid-and-low market lenders, et cetera, et cetera and it was a very meaningful discussion. We followed that up, kind of with a letter just this is rearticulating the points that we made. We had some good conversations back and forth.

And again, we weren’t surprised at all in terms of how it all came out that was what we were expecting at least hoping and expecting. So, it all worked out very well, it was very proactive and was very meaningful discussions. In terms of your first point, which is the available and unavailable milestone basis. Yes we had discussions around that they I think had a much better appreciation of one being openly contractually obligation versus one is not. The hurdle rates for those that were not achieving the milestones yet. And the way that we manage our balance sheet is incredibly consistent. And our ability, which is why I was personally very pleased with the representation and essence basically saying that we’ll be careful and monitor unfunded ways to our balance sheet, which of course we would do. So, I hope that helps you in terms of where we got to with them.

Unidentified Analyst

Yes, certainly, okay. And the last question I know you guys are talking about the market outlets seems pretty positive on your end kind of all around for fourth quarter, but we’ve heard other peers either in some of the bank, and the Silicon Valley bank had issues in the third quarter talking about the DC market maybe they will be a little slower over the next two quarters and obviously you guys aren’t seeing that do you know any reason why there we got to see better deals more deals coming through any differentiation there?

Manuel Henriquez

Well, Silicon Valley banks is a good quality name, and they’re very large in the asset class but they’re a bank they focus on customers and deposit, we focus on making investment in prudent later stage companies that are approaching greater liquidity events. So, I think that we basically fish in two different types of areas and with a pullback in valuations that we expect to see occurring in Q4 and the first half of 2015, first half of 2016, I think debt is a natural product to kind of helps stem the dilutive impact on a lower evaluation and that requires you to be able to do larger transaction sizes to which Hercules balance sheet lends itself very favorable to, while others don’t have the wherewithal and the balance sheet to do it $30 million, $40 million, $50 million transaction as we can.

So, I think that the differentiation of market will become very clear. And in Q4 and our first half of 2015 those with capital, those without capital to be able to benefit themselves on those larger transactions that we think will come to the table, which is why we’re pretty excited of our liquidity position where we’re at and the opportunities that we see before us, with $300 million of available dry powder to invest. So, we actually think Q4 and first half of 2016 are going to be great quite attractive periods.

Unidentified Analyst

Okay perfect, that’s it from me. Thank you.

Manuel Henriquez

Thank you very much.

Operator

Thank you. And at this time I’m not showing any further questions. And I would like to turn the call back over to Manuel Henriquez, you may proceed.

Manuel Henriquez

Thank you operator, and thanks everyone for joining on the call today. As most of you maybe aware of we’re attending the Wells Fargo BDC Conference in New York on November 7, through the 18th. We have a very, very busy schedule already on that date with many investor meetings. But clearly if you want to put your name on that list and have a meeting with management, I would encourage you to reach out please to our Investor Relations department, Michael Hara and he will help coordinating a time slot if available or a meeting if you are in New York, while we are there as well. Thank you everybody and operator that concludes the call.

Operator

Thank you. Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. And you may all disconnect. Everyone have a great day.

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