Hercules Capital's (HTGC) CEO Manuel Henriquez on Q2 2016 Results - Earnings Call Transcript

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Hercules Capital, Inc. (NASDAQ:HTGC) Q2 2016 Earnings Call August 4, 2016 5:00 PM ET


Michael Hara – Senior Director of Investor Relations

Manuel Henriquez – Founder, Chairman and Chief Executive Officer

Mark Harris – Chief Financial Officer


Jonathan Bock – Wells Fargo Securities

John Hecht – Jefferies

Ryan Lynch – KBW

Aaron Deer – Sandler O'Neill & Partners

Robert Dodd – Raymond James


Good afternoon, ladies and gentlemen, and welcome to the Hercules Capital Q2 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduction 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 turn the conference over to your host, Mr. Michael Hara, Senior Director of Investor Relations.

Michael Hara

Thank you, Sharon. Good afternoon, everyone, and welcome to Hercules' conference call for the second quarter 2016. With us on the call today from Hercules are Manuel Henriquez, Founder, Chairman and CEO; and Mark Harris, Chief Financial Officer.

Hercules' second quarter 2016 financial results released just after today's market close and can be accessed from Hercules' Investor Relations section at htgc.com. We've arranged for a replay of the call at Hercules' webpage or by using the telephone number and passcode provided in today's earnings 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 then the confirmation of the final audit results. In addition, the statements contained in this release that are not purely historical are forward-looking statements.

These forward-looking statements are not guarantees of future performance and are subject to uncertainties and other factors that could cause actual results to differ materially from those expressed in the forward-looking statements, including, without limitation, the risks and uncertainties, including the uncertainty surrounding the current market turbulence and other factors we 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 on 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 thereof. And Hercules assumes no obligation to update the forward-looking statements for subsequent events. To obtain copies of related SEC filings, please visit sec.gov or visit our website, htgc.com.

For today's agenda, Manuel will begin with a brief overview of our second quarter business highlights, followed by an overview of the competitive environment and venture capital markets, and our perspective and outlook for the third quarter of 2016. Mark will follow with a summary of our financial performance results for the second quarter of 2016. And following the conclusion of our prepared remarks, we will open up the call for question-and-answers.

With that, I will turn the call over the Manuel Henriquez, Hercules Chairman & Chief Executive Officer.

Manuel Henriquez

Thank you, Michael. And good afternoon, everyone, and thank you for joining us today for Hercules Capital second quarter 2016 earnings call. First and foremost, I am very pleased and proud to announce another outstanding and very, very busy second quarter for Hercules Capital which culminated and not only delivering $0.32 in net investment income, but also exceeding our dividend of $0.31 as well as exceeding that strict consensus by $0.02. This is a very important achievement for Hercules. Just one year ago, we made a conscious decision to invest in our organization – in our infrastructure to ensure our platform was capable and ready to support future additional portfolio of growth.

We made that investment consciously expecting a portfolio over time to grow to $2 billion to $2.5 billion. By doing so, we made the decision not only to merely focus – we made the decision not to merely focus on short term performance, but to ensure that we're making long-term investments for the greater good of our shareholders long term. By doing so, we caused a dip in earnings in the early part of 2015.

However, since then, we have steadily risen our quarterly earnings each quarter thereafter, culminating in second quarter of 2016 of achieving $0.32 in earnings for our shareholders. Our decision to invest in our future has begun to generate significant and expected dividends and returns on behalf of our shareholders as evidenced by our continuation of earnings growth as well as our achievement in the second quarter.

In just one year, we have successfully grown earnings from $0.23 in Q2 2015 to over $0.32 NII in Q2 2016, representing nearly a 40% earnings growth year-over-year. While this earnings growth in itself is impressive achievement, it was, nonetheless, overshadowed by an equally important achievement and that is mitigating the continuous questions we have received as to when will we achieve dividend coverage over – earnings coverage of our dividend through NII. Now, we're seeing the effect, however, that our dividend has been covered by taxable income throughout the period of time, which also has produced, for two years in a row consecutively, earnings spilled over to that point.

What is important to emphasize is that we had projected achieving this coverage in the midpoint of 2016, and in fact, we have done just that. Although it's only the midpoint of the year and assuming our existing portfolio performance and origination trends continue, we are well on our way towards achieving our expected total investment loan portfolio targets of $1.3 billion to $1.35 billion.

Interesting to note, however, was the abundance of liquidity, some of which we recently added to our balance sheet. We were actually in a fortuitous position to actually exceed those targeted $1.3 billion in loan portfolio growth with the liquidity that we have on hand. Mark will be covering that point in greater details during his segment of the presentation.

Ii hope to share with you as the year comes to a close that as we continue to perform as expected, it is high likely that we should have and may have a third consecutive earning spillover from 2016 to 2017. Although it is only midpoint of the year, I hope that by the time we have our third quarter earnings call, we should be able to provide much greater clarity as to what are the potential ranges of those earnings spillovers may be. That allows you to see the confidence that we have in our platform, our organization and our ability to continue to not only cover the dividend but continuing now to grow our earnings as we approach the fourth quarter and 2017.

Today, we find ourselves in a very advantageous position as turn and enter to the second half of the year. We are continuing to grow our debt invested portfolio. We expect to achieve our targeted portfolio loan growth of $1.3 billion to $1.35 billion by early fourth quarter of 2016 or because of U.S. election, mainly by the first quarter of 2017. I want to point out that we are taking a conservative stance in the mid third quarter through the election until we have greater visibility as to which candidate may or may not win and the outcomes of the impact of the debt and equity capital markets post the election. Because of that, we will have a more controlled growth of our portfolio in the third quarter. It's also our slowest quarter during the year. So it happens to coincide a very good time that we're actually going to stand back slightly and allow this election process to clear up the marketplace.

With that said, we continue to be enjoying nice increasing yields and widening spreads across our entire portfolio, while also lowering our overall cost of borrowings as we continue to actively manage our right-hand side of the balance sheet and assessing the debt capital markets as we've done during the quarter. Mark will elaborate on that further in his section.

Because our stock continues to perform at significant premium, we continue to have access to both the debt and equity capital markets, however, we continue to choose not to access the equity capital markets other than or beyond simply using an ATM program which we'll talk about later on in the presentation.

And finally, we ended the quarter with an exceptionally strong and liquid balance sheet with nearly $255 million of liquidity, affording us the ability to comfortably grow our portfolio well beyond the $1.35 billion target that we've been discussing with the currently liquidity we have on hand. You'll see later on in my discussion we ended the quarter with $1.256 billion in investment or loan portfolio outstanding.

At the end of the quarter, Hercules reached an important inflection point. This inflection point is something I will discuss quite a bit on this call and is important to understand. What we mean by the inflection point is that the portfolio has reached an interesting equilibrium by which if we do not have early payouts and the natural origination activities, it will automatically allow us to rise to the $1.35 billion. Conversely, if we find ourselves receiving early payout activities, those early payout activities will translate into increase in earnings simply while the prepayment activities of those early investments.

Said differently, we are indifferent at this point whether we grow organically without early payouts or early payout contribute to earnings. We are very fortuitous place right now in our portfolio at the inflection point that we're at today. Not many companies have this luxury to see rising rates, widening spreads, continuation of a strong pipeline and deal activity, and selectively seeing early payout activities to further bolster our earnings for the benefit of our shareholders.

Again, I'd like to point out that many companies and many investors view early payout as a bad item. We actually now view them as both favorably or indifferent. If they happen, it's fantastic; if they don't happen, it's fantastic either way because we will grow the portfolio if we're not seeing the early payout and achieve the critical mass which allows us to have a portfolio at which point is fully covering our dividend earnings or dividends by the earnings just by reaching that critical mass of the investment portfolio.

This inflection point was achieved, as I said, at the end of the quarter at $1.256 billion. We continue to cycle off older credits in our portfolio, which means that as we term out older loans in our portfolio that are lower yield, the current remaining portfolio overall yields are rising, meaning our interest rates are increasing, and so our yields. We are continuing to groom and prune our portfolio and ensure that we have the appropriate mix within industries, stages, and yield composition within the portfolio itself.

That said, and with an abundance of liquidity, we are still adopting a slow and steady strategy of investing, especially through the third quarter and through the election year. We prefer to maintain liquidity and take advantage of wider yield spreads as more and more of our competitors are struggling to access capital or liquidity in the marketplace, and we are continuing to see the widening yields and better terms and conditions being realized in the market today.

We expect Q4 to be a very robust quarter for us, and we expect Q4 to return back historical levels of seeing anywhere between $50 million to $100 million of net portfolio growth and potentially even larger. However, I want to handicap that because of the election coming in November itself.

That said, we are quickly approaching our significant milestone of $1.35 billion. We find ourselves just shy of that mark with literally $1.256 billion, or literally $50 million to $100 million short of achieving that mark. Well within our reach and grasp. Because of that, as we achieve the velocity of earnings growth from that investment portfolio growing, we find ourselves in a fortuitous position that as we enter 2017, it's highly likely that our earnings portfolio will begin rise. Because of our BDC reg, it is highly likely that we'll find ourselves having to increase our dividend some time in 2017 as reflected with our continuation of earnings growth.

It has been quite some time we feel to have the confidence to share this with you in terms of our continuation and belief in our portfolio's ability to continue generate ever increasing earnings. We are at that position and we feel quite comfortable about that. This [indiscernible] market condition is not changing or some unforeseen black swan event that would cause us to pull back from origination and liquidity in the marketplace today.

We are very grateful to our partners in the venture capital community and entrepreneurs for continuation of high quality deal flow and continuation of a strong deal pipeline that we have and expect to convert for the benefit of our shareholders and yield the originations. I will share with you now that size does matter. Having a large liquid balance sheet, and having access to multiple forms or sources of liquidity have made and continued to make significant difference in the Hercules business model unlike many of our competitors. Because of that, we're able to structure and pursue the appropriate transactions where we have strong credit expertise and the ability to underwrite those credits. Unlike many of the players in the venture lending market place, we are not generalists. We have four uniquely distinct origination groups, a technology group, a life sciences group, a renewals group and a special situation. Those groups are really different from each other and had different credit paradigms within each other and that allows us to be much more focused in our underwriting capabilities in translating to much stronger deal because our team knows what they're talking about in the industry verticals which they invested. That has manifested itself over the course of the last 12 years plus with over $6 billion of origination activity and just under $11 million of net credit losses.

We are very proud of the fact we are now covering our dividend and expect to continue to cover dividend from NII as I've said previously in the quarter. It's an important goal to achieve, as I've said. But we remain steadfast towards stated mission of steadily building our debt investor portfolio in a matter which maintains our historical credit performance and yields. We refuse to simply chase yields and refuse to simply get distracted by fatty or cool companies that are out there. We have a fundamental credit standard, and we adhere to that credit standard in respect to the impact they may have on earnings.

We are a fundamental credit shop, and we expect to continue that as evidenced in our historical performance. That abundance of liquidity, $265 million, we will expect to deploy. But I assure our investors we have a steady hand on the tiller and we expect to navigate through the next few months as we go through the multiple different changes in the marketplace ensuing in this election period of time. We remain quite confident and believers in the market opportunity we see before us and the abundance of liquidity we have on hand to achieve that goal.

To help give you a range of projects, we are extremely close to this targeted goal. As I said just a minute ago, we're merely $1.5 billion away as we ended the quarter. However, more impressive than that is that we began the third quarter alone, we've already began to take investments towards that goal. We closed $60 million of new investments already in the third quarter and we funded approximately just under $45 million, $50 million of new investments in third quarter already, ostensibly telling you we're already at $1.35 billion.

However, we do expect to see early payout activities in the third quarter. And in fact, we are giving guidance that we believe that we'll see $50 million to $75 million of early cap activities during the quarter. However, I want to caution everybody that early payout activity is entirely out of our control. It is extremely difficult to ever pinpoint an absolute number of early payouts. So even though we are now guiding towards a range of $50 million to $75 million in the third quarter, I would caution that that could swing $25 million lower or $25 million higher in the quarter. It's extremely difficult to have a very precise pinpoint of that.

However, assuming a $50 million to $75 million early payout in the third quarter, we expect our loan portfolio net growth to be approximately $20 million to $40 million of net portfolio growth in the quarter meaning we'd basically be achieving close to the $1.3 billion at the end of the quarter of Q3, well on our way to that early goal that we talked about.

As we turn our attention to the fourth quarter, you can certainly expect to see a pick-up in early payout activities. We expect to see some early pick-up of activities in the fourth quarter. However, at this point it is so early in the fourth quarter for us to have a good insight that we are forecasting very light early repayment activities in the fourth quarter. Said differently, at this point, we are forecasting a $50 million to $100 million net portfolio of growth in the fourth quarter potentially even topping us up to the $1.4 billion.

However, I'd like to remain conservative. I think by the end of the fourth quarter we should be constantly at the $1.35 billion and could be as high as $1.4 billion which assuming a 13.2% or 13.4% interest rate, you will see that we more than cover the dividend income at that point and actually exceed that. However, I would caution of late that a lot of that on-boarding will be occurring late in the fourth quarter because of prior election comments that I made and, therefore, we would not receive the full impact on earnings in the portfolio from that origination activity in the fourth quarter.

Finally, keeping a pragmatic and cautious credit background and outlook, let's not forget that we're coming off to an unpredictable third quarter. We're seeing activities that uncertainly is driven by the Brexit and now we have our own acrimonious U.S. election whose outcome is anybody's name or a tossup.

Because of that, we've taken a very conservative stance, turning our attention into that election period of time. We will be modulating our investment activity that's now said on various – many times in this call. However, that modulated growth should not impact our earnings growth capabilities because we have such a large base already of interest-earning assets at attractive yields that should in itself generate near or close to all the NII income that we need.

Finally, I am equally proud of a major achievement of our team and our organization. As original founder of this company, achieving $6 billion in new cumulative debt commitments over 350 companies is an amazing and astonishing achievement in the short order of 12 years. That speaks to the premier position that Hercules has achieved as a lender of choice to the venture capital industry and to the venture capital partners.

[Indiscernible] of less than 13 years represents an outstanding achievement and more importantly an annual compounded growth rate of nearly 58% of new commitment activity. It's a testament to the strong brand recognition of our team's and investment team's professional capabilities and our unrelenting and uncompromising standards in our origination activities. I am deeply grateful to the continuous support and confidence our innovative entrepreneurs and venture capital partners continue to place upon Hercules Capital and for the continuous support now and the future as we continue to grow our portfolio together. Thank you to them and thank you for the continued support.

Over the course of the past 12 years, we remain true to our mission and serve the need of our portfolio companies. Achieving the largest venture capital lender within the B2C industry landscape, having had more than 350 companies choose us as an innovative partner, witnessing the continuation of our loan portfolio growth is a testament to that brand and that recognition from the venture capital industry. We have a high diversified portfolio within multiple different industries including technology, life sciences, healthcare, variety of technology, sustainable and renewable technology. We are highly diversified. We do not have exposure to oil and gas or we do not have exposures to CLO.

Now, let me turn your attention quickly to some of the achievements that Hercules done in the quarter. Mark Harris will gain the specifics of the financial achievements during the quarter. Once again, Hercules demonstrated a very strong new originations with nearly $203 million of new origination activities during the second quarter to 16 new companies. For the first half of the year, we originated $425 million from new commitments. Putting us on a pace to exceed total new commitments of $745 million achieved in 2015. This, of course, is subject to market condition remaining favorable.

The funding front equally is strong. We also achieved an impressive result of over $330 million of growth in fundings during the first half of 2016. This has allowed us to achieve net portfolio growth for the first half of the year of $104 million, notwithstanding nearly $173 million of early payoffs in the first half of the year. That speaks of the robust pipeline and the capabilities of our investment professionals and our ability to generate and continue to see quality deal flow as we continue to build the loan portfolio.

As I've said briefly a minute ago, we continue to have great results during the quarter. We saw widening yields. We saw lowering of overall interest rates. We saw increase in our interest rates, NOIs and our overall effective yields. During the quarter, we witnessed a nice steady rise in our effective yields of 14.4%, up from 13.2% the prior quarter. Not being left behind, our core yields are equally strong, rising to 13.4%, up from 12.9% the prior quarter. Overall, we now anticipate and expect our core investment yields to stabilize. We're expecting our core investment yields to stabilize at 13.25% to 13.5% overall. We do not forecast our effective yields because it's very hard to determine them. However, we do forecast and believe that this is a good level for our core yields which at $13.5 billion, you will see that we more than generate an abundance of yield or income from our portfolio to cover our dividend.

As I've been saying throughout this presentation, deal flow remains very robust and steady, with over $1.1 billion in potential deals in our current pipeline. We are exceptionally well positioned entering the second half of 2016. However, we remain highly selective in our underwriting, especially as we look to deploy selectively our $255 million of capital into new investments.

In addition, as I said previously in this call, at the commencement of Q3, we have already closed $60 million of new deals and funded $50 million, giving a perspective of our confidence in our earnings growth and outlook. That omits $60 million in existing signed term sheets that we're in the midst or in the process of closing sometime in mid- to late-August, further adding to our investment portfolio growth.

As I said, we do not do oil and gas, and we do not do any CLO exposure in our portfolio. We continue to assemble a highly diversified investment loan book and promising new innovative venture capital-backed company across multiple industries.

Now, quickly for an overview of the venture capital marketplace. Our data is provided by Dow Jones VentureSource. Venture capital fundraising and investments continue at a much higher level than we have been expecting and continues to show a higher level of resiliency than what many had been expecting in the first half of the year.

Specifically, in the first half of the year, the venture capitalists invested $25 billion, nearly $50 million run rate at this point, putting them on a pace to exceed the fundraising levels in 2015 and 2014 of $35 billion and $34 billion, respectively. This high level of new investment – of new fundraising activities by the venture capitalists provide us some perspective and confidence in their ability to continue to invest in subsequent future quarters.

Venture capital investors were equally as strong with $15.8 billion invested in the second quarter alone to over 845 companies, or $29 billion invested in the first half for a $60 billion run rate of investment activities. Much, much ahead of what we expected. However, upon closer look, the venture capital activities, although appear strong, had then backed out nearly a third in the investments or $4.8 billion that was concentrated into two companies specifically, Snapchat and Uber, disproportionally received the wide share of the benefit of that $15.8 billion of investments in the second quarter. Obsessively, you would see that we adjust for that. The second quarter was much more in line with our expectations of the $10 billion level, giving you a run rate to that $45 billion to $50 billion investment activities that we are expecting to see in the venture capital marketplace in 2016 albeit down from the $35 billion in 2015.

As you'll see in the slide deck available on our website, Hercules Capital invested between $1.2 billion to $1.5 billion of the annual equity dollars that venture capitals put out to work are generally matched by Hercules debt investments into new technology and life sciences companies. In terms of stage of development, we all continue to see a very strong correlation in what the venture capitals are investing and what we invest in ourselves. And that is late-stage venture growth companies. Nearly 60% of the capital invested by venture capitals went into later-stage companies which still happens to be what we focused on and have been doing for quite some time. We also saw a benefit of those dollar [indiscernible] to many of our portfolio of companies during the quarter which gives us further stability and confidence in their ability to continue to amortize and pay out our debt investments.

In terms of IPO activities or exit activities between the venture capital investments, we saw a fairly modest growth in the IPO market, a whopping 10 companies. Not a very impressive number but nonetheless 10 is greater than zero. This compares favorably to the same activities that we saw in Q1. So although it's not a very attractive trend, it is still a trend upward.

As the second quarter draw to a close and the third quarter began, we also saw some good high quality IPO companies take place. Most notably, Twilio, which nearly tripled since its IPO offering and [indiscernible] which also saw an aggressive 42% increase in its IPO.

We also continue to see high concentration of liquidity events in the IPO market coming from biotechnology companies which still happens to be nearly 50% of our portfolio, and we'll continue to witness a very strong performance in that marketplace as well. I'm also happy to report that in July, we finally had our first IPO of the year. And now, with TPI Composites completed their IPO in late July, marking our first IPO for the year. We still have four companies in IPO registration currently under the JOBS Act. In contrast to the IPO market, the M&A events in our portfolio were quite strong, if not, extremely robust.

M&A event continues to be very strong than the IPO in the venture capital marketplace. And also you saw IPO – M&A activities also robust in our portfolio with currently six current and former portfolio companies completing or announcing M&A events during the quarter.

In closing, outlook on the second half to 2016 and early 2017 as I've stated earlier, we are reaching an important inflection point in delivering sustained earnings and increased earnings from our investment portfolio. We expect to continue to see dividend coverage and if not an increase as well in our earnings for dividend later on in 2017. We continue to focus on growing a balanced, investment loan portfolio. We're focusing on core yields and we expect to see a tapering off of early payout activities with what we know today going into the fourth quarter.

This should continue to help drive earnings in Q3 and in Q4 and certainly drive earnings even higher in Q1 2017. We're extremely well-positioned entering the quarter with $255 million of liquidity with no need to access the equity capital markets and continued access to an ATM program as well as to additional bond capacity if so we choose to that which Mark will cover in this section.

We do not expect much early payout activities in Q4 at this point. I was seeing a modest $20 million or $40 million maybe occurring in Q4. That means that we can expect to see a growth in the investment loan portfolio as I indicated earlier to outdo potentially $100 in loan portfolio growth next in the fourth quarter, putting as well in position for that $1.35 billion, $1.4 billion. I'm quite excited about the results of our organization. I'm very proud of the achievement of the organization. And more importantly I am very happy to report to our shareholders a solid Q2 earnings as well as dividend coverage.


Mark Harris

Thank you, Manuel, and good afternoon or evening, ladies and gentlemen. I'll now briefly discuss the financial results for the second quarter of 2016 and add some detail and direction to the reported numbers. With regards to portfolio growth, we had a strong total investment fundings of $159.8 million in the second quarter including the addition of eight new portfolio companies. While we had $117.6 million of unscheduled early payoffs and normal amortization of $24.1 million, we were still able to grow our debt investment book accordingly. This resulted in our debt investment portfolio increasing to a cost basis of $1.26 billion at the end of the second quarter.

The unscheduled early payoffs drove our effective yield to 14.4% in the second quarter, which was up significantly from the 13.2% in the first quarter. As we have early unscheduled payoffs of $117.6 million in the second quarter compared to that of $55 million in the first quarter, that's an increase of 114%. As Manuel stated, we expect to see $50 million to $75 million of unscheduled early payoffs in the third quarter of 2016 with our effective yields to maintain between 13.5% and 14% given the age of our debt investment book.

Our core yield which exclude the effect of prepayment penalty season accelerations from our payoffs was 13.4% in the second quarter, which was up nearly 4% from the first quarter. Our core yields continue to maintain their increasing momentum within the portfolio, which is driven by the addition of new debt investments at more favorable terms, offset by older payoffs in the period. As Manuel discussed, we expect our core yields to maintain around 13.25% to 13.5% on a going forward basis.

Net investment income was up to $23.4 million in the second quarter or 16.4% from the $20.1 million in the first quarter. On a per share basis, net investment income in the second quarter was $0.32 per share, which is a 103% coverage of our dividend and a 14.3% increase from the first quarter or up 39% year-on-year. From the beginning of 2015, that's a cumulative annual growth rate of approximately 46%. This coupled with our earnings spillover from 2015 and our potential equity in warrant portfolio gains provides us with sufficient ability to cover our annual dividend and potentially distribute excess earnings in the future.

Our NII margin improved to 53.6% in the second quarter from 51.6% in the first quarter and up from 44% this time last year. We expect our NII margin to stabilize between 51% and 52.5% in the following quarters with more normalized prepayment activity.

Our return on average equity was 12.8% in the second quarter, up from 10.9% in the first quarter. This is in line with our expectations of return on average equity to be between 10% and 12% on a normalized basis. We derived this from investment income which was up 12% to $43.5 million in the second quarter from $38.9 million in the first quarter. This increase is primarily attributable both to growth of our debt investment portfolio as well as one-time accelerations and prepayment income in the second quarter.

Interest and fee expense increased to $8.9 million on the second quarter from $8 million on the first quarter. This increase is attributable to our efforts to increase our liquidity. We successfully completed two note issuances in the second quarter for a total raise of $141.9 million of our 6.25% 2024 notes. We expect to see interest and fee expense stabilize between the $9.5 million and $10 million in each of the following quarters subject to private facility usage.

Weighted average cost of debt was 5.8% in the second quarter, up from the 5.5% in the first quarter, and we expect the weighted average cost of debt to remain consistently around 5.8% in the following quarters of 2016.

Our net interest margin expanded to $34.7 million in the second quarter, an increase of 12.3% from the $30.9 million we had in the first quarter. Further, our net interest margin, which is a percentage of our average yielding assets, was 11% in the second quarter, up from 10.1% in the first quarter.

Operating expenses, excluding interest expense and fees, modestly increased $11.3 million in the second quarter compared to that of $10.8 million in the first quarter or a change of just 4.6%. We expect our operating expenses, including – excluding interest and fees, to maintain around $10.5 million to $11.5 million for the quarter in 2016 or approximately 25% to 27% of our investment income.

Our G&A in the second quarter was $4.4 million compared to the first quarter of $3.6 million, and again, we expect G&A to maintain between $4 million and $4.5 million on a quarterly basis in Q3 and Q4. Employee compensation decreased slightly to $6.9 million in the second quarter compared to that of $7.3 million in the first quarter due to changes in variable performance compensation and lower employee stock-based compensation. We expect employee compensation to be between $6.5 million and $7.5 million in 2016 on a quarterly basis.

We had a net change in unrealized depreciation of $13.9 million or a reduction of $0.19 NAV per share in the second quarter. During the period, our debt investment portfolio had net unrealized depreciation of $8 million, where in the first quarter, we had appreciation of $6 million in the first quarter or net in the first half of the year $2 million of net unrealized depreciation year-to-date. This net unrealized depreciation during the second quarter was primarily a result of additional impairments taken on debt investments, partially offset by the reversal of prior impairments.

We believe we may have the opportunity to cover $10 million, $20 million in the second half of 2016 on our net unrealized depreciation, which would give rise to $0.10 to $0.30 of accretion to our NAV per share. As many of those companies are looking to complete ongoing M&A events thereby facilitating potential recovery.

Our equity and warrants portfolio had a net change in unrealized appreciation of $5.6 million in the second quarter compared to net appreciate of $7.4 million in the first quarter. Approximately 87% of the unrealized depreciation was concentrated in our public company portfolio. Since the end of the second quarter, we have noted that many of the indices and [indiscernible] stocks have rebounded. For example, the Russell 2000 Biotech Index is up 14% since the end of the second quarter through today. The Russell 2000 Technology Index is up 8% and a Box shares that we own is up 15% which is approximately $2 million of value or $0.03 of NAV per share accretion.

Now, let's turn to credit. We continue our focus on credit discipline. In the second quarter, our weighted average loan rating was 2.11 improving from the first quarter weighted average loan rating of 2.17. Our grades 1 and 2 debt investments remain consistent within the second quarter of 74.3% our graded 1 and 2 compared to that of 74.5% in the first quarter.

Our cumulative net losses since inception, which consist of debt investment losses offset by equity and warrants gains, was $11.3 million, which is consistent with the prior quarter. This is an outstanding number given the approximately $6.1 billion of commitments made since inception or a loss of only 2 basis points annualized. We view our warrant and equity portfolio as a risk magnet as we have realized gains from inception of $83 million.

Today, we're sitting on 139 different warrant positions with nominal exercise value of $101 million of which we expect 50% to expire [indiscernible] and the remaining 50% to be exercised between two to four times of value, which means this has a potential to generate realized gains of approximately $100 million to $200 million further offsetting any future losses.

Liquidity. We had $254.7 million of liquidity at the end of the second quarter, which consists of $59.7 million of unrestricted cash and $195 million of undrawn availability under our revolving credit facilities, subject to borrowing base leverage and other restrictions. Our liquidity was enhanced in the second quarter through three capital market transactions. The $141.9 million issuance of our 6.25% 2024 notes. We added our bank to the Wells Fargo credit facility for $25 million which gives us a $120 million availability under a $300 million accordion, and we closed $11.3 million of net proceeds from HCM.

We continue to optimize our capital structure and engage in our ATM program. Subsequent to the quarter end, we issued approximately 529,000 shares with gross proceeds of approximately $6.6 million. Again, this just in time financing tool is working very well to further enhance our liquidity efficiency without causing significant cash drag and further increasing our NAV per share by $0.02 due to issuing the shares well above our net asset value.

We further expect to enhance our liquidity by leveraging a third SBA license which we are expecting to begin the process in the second half of 2016 with the expected completion within the first quarter to the end of the first quarter of 2017. Our total available unfunded commitment was $71.2 million at the end of the second quarter or only 5.1% of our total assets, which was down considerably from the $159.1 million or 11.4% total assets one year ago. That's a reduction of 55%.

In terms of our leverage, our regulatory leverage excluding SBA debentures as we have an exemptive release from the SEC, was 57.5% at the end of the second quarter. This is 58.6% at the end of the first quarter, which gives us ample room to grow our portfolio to $1.55 billion without raising additional equity. Our GAAP leverage with SBA debentures with 94% at the end of the second quarter versus 85.1% at the end of the first quarter. With our cash position at the end of the quarter, and self-imposed 1:1 to 1.1:1 GAAP leverage, this will enable us to grow our debt investments to $1.36 billion to $1.43 billion without raising additional equity.

Finally, we expect net assets to typically 1%, plus or minus, 1% to 2% per quarter due to normal market movements. Our net assets were $717.8 million at the end of the second quarter, representing $9.66 NAV per share or decline of approximately 1.5%. This is within our expected range and the decreased NAV per share this quarter to see the fair value adjustments in the period.

With the previously discussed debt investment recoveries that could generate to $0.10 to $0.30 NAV per share accretion, the $0.03 of Box recovery and an ATM of $0.02 of accretion, we have the ability to see substantial uplift in our NAV per share in the near term.

Finally, we are pleased to declare our 44th consecutive dividend of $0.31 per share that will be paid on August 22, as approved by our board of directors, with a record date of August 15.

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

Question-and-Answer Session


[Operator Instructions] And your first question comes from Jonathan Bock from Wells Fargo Securities. Your line is open.

Jonathan Bock

Good afternoon, and thank you for taking my question. Manuel, your comment about reaching that equilibrium was very interesting and fascinating point. And so, we do understand that the math can work where if you keep the assets on the balance sheet, you're going to effectively be at the same earnings level to the extent that you would proceed with early payoff. I'm curious, if you look at the asset that is Sungevity, just because of its size at roughly $70 million and $68 million, to the extent – and it's also in a definitive merger agreement and do they keep the debt? Do they not? Do we receive a significant back-end fee as a result of that repayment that would effectively allow us to go into that equilibrium that you suggest, or not? I'm interested in that one in specific just because it is so large.

Manuel Henriquez

So, I mean the good news is like you speak about is that tripping up any confidential information that we have on behalf of Sungevity, which is a company that we actually have a very solid position in. Sungevity actually has a publicly filed S-4, and you'll see in their publicly filed S-4 with the SEC that they specifically do not mention or discuss the repayment of Hercules debt

So, we do not anticipate nor do they anticipate from what we know today and they know today of any intention of paying off that debt at all. We are perfectly happy to remain a very strong partner of theirs. We are delighted to see the mergers that they're involved in and further bolstering their liquidity position.

But at this juncture, there is no expectations of any early payoff activities from Sungevity, merely with the confirmation of the mergers that they're contemplating right now. So, I hope that is responsive to your question.

Jonathan Bock

Yes. I appreciate that. And then, also talking about the ability to fund new investment growth using leverage, but of course, we also see the small and also prudent issuance of equity via the ATM. Manuel, it's the $64,000 question I always gets asked in the BDC space as it relates to need for additional equity capital to fund opportunity without sacrificing substantial growth. So as you look through your modeled plans, do you happen to see any additional need for equity outside of the small dribs and drabs as you're able to issue through the ATM program?

Manuel Henriquez

Well, having to run a publicly company for nearly 12 years, the answer is that I'm not going to answer that question. The issue on equity rates is one that is evaluated by us and our board of directors. We continue to trade above book and we recognized that that privilege that we have and that premium and we are very, very cognizant as me being one of the largest shareholders on the impact of any dilutive capital raise. Even though it will be highly accretive to book, so the response to that question is in the near term, we were not under any pressure or needed to raise equity capital.

We prefer to continue to deploy our available headroom that we have in our leverage. Continue to drive even higher ROEs that we're already generating nearly 12.5% ROEs and drive that higher. And then once reached the $1.4 billion loan book or so, we will then take a pause at that point and reevaluate the March conditions and whether or not we believe we continue to take any new equity capital raise that we do. And put it to work in relatively short order that doesn't at all threaten the possibility of a dividend cut which – dividend adjustment [indiscernible] dividend.

So one of the things I will not do is sacrifice the earnings on behalf of the dividend itself. So there is no immediate need for us to raise equity. But we reserve the right to evaluate that especially post the election of what we want to do. But at this point ATM is more than adequate and it doesn't raise that much money, but it's a nice tool to have. This is accretive to shareholders.

Jonathan Bock

Got it. And as we continue to look at the venture space in particular, venture leaders such as yourselves, we're starting to see effectively to, we'll call it, distinct pathways or thoughts in terms of how one underwrites. One can be an extremely credit-focused shop and great at – everyone is credit focused, I want to try to be clear, but one where you can take more episodic investments that allow you to earn above average returns or perhaps a more sponsor-oriented pathway where you're focusing on a subset of individual venture sponsors in an environment and have multiple deals, right? And those high-quality sponsors could effectively support those deals going forward. As we look at where we sit in this stage today where – and I understand that both sponsor and credit, they kind of weave together but you can see some venture lenders on one side or the other of the aisle. Where do you see more opportunity between focusing specifically on a subgroup of sponsors versus always trying to focus on more episodic credits across the wide variety of industry? Where do you see more opportunity between the two and more importantly, why?

Manuel Henriquez

Okay. No disrespect to you but that comment that you may have been fed is completely, as Ryan said, malarkey. This pretense that somehow dealing with a privileged group of venture capitalists that somehow we don't think that access to you is completely ridiculous. You don't do $425 million of new commitments in the first six months of the year without having a broad access to all the top-edged capital firms in the country. So this pretense that somehow another venture lender may have a privileged relation with the venture capital firm is completely idiotic. So, that's non-existent.

On the episodic thing, I think that investing in episodic events can in itself be very dangerous. I think that you have to first be a prudent leader and use a credit discipline. So whether it's sponsored or not is important but it's not the end or deal. When you [indiscernible] simply relying on sponsors, you're actually deriving very low yields or you're being forced into a subordinated secondary credit position [indiscernible] behind a bank which you have no credit control. So, we don't ascribe to that either. I think that our testament of our performance speaks for itself and I think that you cannot just invest in trendy value deals and you cannot simply invest in a subset of venture capital firms because somehow they have the golden keys of the kingdom. I think that is not existent.

I think fundamental underwriting of credit and understanding industry trend is far by most important part of the underwriting process. And having four specialized uniquely structured lending teams or groups is what really makes us different and allow us to have a deal flow and the access to capital that we do. But I don't ascribe to that rhetoric, with that ideology. I think it's baseless.

Jonathan Bock

I appreciate it, Manuel. And you're correct; the performance does speak for itself. So, thank you for taking my questions.


Your next question comes from John Hecht from Jefferies. Your line is open.

John Hecht

Thanks very much, and Manuel, congratulations on covering the dividend in the timeframe you told us you would. The first question is for Mark. Mark, just clarification, did you say we should expect the combined interest expense and fees on the debt to be about $9.5 million a quarter or is it just the interest?

Mark Harris

No. Sorry. It's interest expense and fees. I combined those to be between $9.5 million and $10 million on a going forward basis.

John Hecht

And then you guys detailed the – I guess you took some small impairments across a few different assets. I mean, any detail you might recapture some of that but is there any, – was that just market pricing that drove that, was there any kind of characteristic of things that turned in the market that you saw that you wanted to address evaluation?

Mark Harris

No. My overall comment on that would be that, first of all, is deal-specific. So each one has its own story. But again, being pretty conservative [indiscernible] we look at each one. We make a determination based on events that have happened, they're tracking, et cetera, and then we make the appropriate adjustments to those. So it's not really specific in the sense that it would be one, certain vertical but the specifics for example [indiscernible] to an M&A event, or what's going in terms of their activity. Manuel, I guess I'll turn it over to you as well if you want to add anything to that?

Manuel Henriquez

I think it's fine.

Mark Harris


John Hecht

Okay. And then I know Manuel, you talked about [indiscernible] there in Q4 to kind of figure out the specific repayment pattern debt in Q4. But I guess just more generically, at what point – how far in advance do you get indications of prepayments in order you'll get some bit of forecasting available to us?

Mark Harris

So, on an M&A event, if the company's is in the process of M&A event, typically, we'll have an indication that can be as much as 45 days out. On a refinancing, by commercial bank for example, you may have two weeks’ notice if that. So it varies dramatically.

Obviously, an IPO, it's a long lead time because these are filed and they state in the prospectus S1 or S4 that an event of refinancing would take place. So generically speaking, 30 days is probably the most you have visibility to, with a confidence level and that's about it. And that could change quite a bit. As you saw in our own portfolio and rolling from Q1 to Q2, we had two events of M&A that were to take place in Q2, that – one fell apart and one slid. It's just the nature of [indiscernible] when you acquire innovative companies that the M&A that are announced not all the time close as well.

John Hecht

Okay. Appreciate the color. Thanks, guys.

Mark Harris

Thank you.


Your next question comes from Ryan Lynch from KBW. Your line is open.

Ryan Lynch

Hey. Good afternoon, guys. Just the first question relates to you guys' public equity portfolio. You guys experienced some pretty big depreciation from that portfolio in the quarter. So, can you just maybe talk a little bit about your exit philosophy on some of your public equity positions? How long – what is your philosophy on how long you guys plan on typically keeping those in the portfolio after you guys – those companies IPO and go public and maybe particularly with the Box situation?

Manuel Henriquez

Sure. So specific to your question, oftentimes, we're still subject to a lock up that can range 180 days or more post the IPO. But typically, 180 days is what we see. Oftentimes, our public portfolio may have cost bases which you could see in our [indiscernible] investment that even though the company may have gone public, it may have experienced a downdraft as a sector or specific to that company, which means that selling equities at that point would be a capital loss, a realized capital loss event.

And so, we're not necessarily interested in doing that because we still believe this confidently in the company's ability to achieve what we expect to achieve. So we'll be long on that position. Specifically on Box, it's one that – I think it's safe to say it's been frustrating for a lot of people including ourselves. We think the company continues to execute extremely well. I think we continue to be a leader in the category and I think that they more than us but I think together we're all frustrated that stock is still at $12 and not a $20 a share for example. But that said, I think that our holding of box is kind of running against its timeframe. So our philosophy the answer to your question more specifically, once we achieve a strike price on the underlying securities, meaning for appreciation, we will sell the position. Because unlike an external manager, we're not being paid more or less by AUMs asset under management. So we have no [indiscernible] incentive to keep the stock on our books unless it makes a prudent sense to actually sell it or realize the gain.

So in that context we're fully aligned with our shareholders in that point of view. Because incentive for us and only unless it make sense to hold it.

Ryan Lynch

Sure. Okay. And then next is kind of following up on your commentary you made around pulling back a little bit or being a little more conservative around the election. It feels like at least in the second quarter certainly is you'll think it was a pretty good time to deploy capital in the markets you guys core yields increase nicely. Feels like a competitive standpoint some of the competitors may have pulled back being low in capital allowed you guys to put out some really good loans, have some really higher yields.

So just how were you guys balancing the election risk that you guys see in the third quarter with the potential risk of losing out on maybe some high quality transactions to competitors?

Mark Harris

Well, I'm not sure we're losing high quality transaction to competitors. I can pretty much assure you that. And again, I didn't say we're not in the market, I didn't say we're not doing deals. We've already done $120 million in the first 40 days [indiscernible] 40 days – first 37 days of the quarter already. So we're active and remember what I said, we're expecting up to $75 million in early payoff, and we're growing the loan book by $20 million to $40 million. So, that's essentially funding $100 million in transactions growth in the quarter, which means that you're probably originating $150 million or more in new commitments.

So, we are quite active in the third quarter. We're just not stepping on the gas because I believe strongly that once you go into the mid- to late-September timeframe, so October and early part of November are going to be hold on to liquidity because who the hell knows what's going to happen in this election?

And the capital markets may be adversely impacted. I want to be in a position fortuitously to take advantage of strong liquidity in the fourth quarter while others may not have access to the equity and capital markets at that point where I could actually capitalize on exactly your point on wider yield spreads and better credit quality in the fourth quarter.

Ryan Lynch

Okay. That's all the questions for me. Thanks, guys.

Mark Harris

Thank you.


Your next question comes from Aaron Deer from Sandler O'Neill & Partners. Your line is open.

Aaron Deer

Hi, guys.

Manuel Henriquez

Hey. How are you, Aaron?

Aaron Deer

Good. Say, Mark, I guess following -up on the earlier credit question, you talked a little bit about the impairments taken in the quarter. Looking specifically at the non-accruals, those were down sharply. I was wondering if you can just give some color in terms of what were the inflows and what were the outflows and kind of what drove those trends.

Mark Harris

Sure. So, basically we had one big transaction that we had on non-accrual that came off. We've restructured that. It also kind of goes back to one of the earlier questions that was asked under the impairment side which, when I first got here, we had an impairment, but it's done a great job in turning [indiscernible] around and we restructured accordingly, and now it's producing quite well.

And then we added two other loans that were put on non-accrual if you will, too, to mix. So, it really is just a net outflow of cost bases over non-accruals which again over the loan net cost kind of drove that down for us.

Manuel Henriquez

Maybe specific, we have basically four transactions they can isolate the variance attributed to all the non-accruals and the credit impairments that we took. Three of those transactions are absolutely earmarked and actively engaged in some form of an M&A transaction one way or the other with respect to the companies.

Two of which we have a high confidence levels of where are they in the process and definitive agreements. They're at or about to sign to conclude those events that may lead to, in some cases, full recovery of the impairments meaning full recovery of the initial investment itself. So as Mark, indicated in his opening comments, there's a possibility of seeing recovery of anywhere between $5 million, $10 million, $20 million of recovery just by the consummation or completion of some of these pending M&A events that these companies are contemplating on right now.

And then third example, we had a company that was engaged in an M&A event but that transaction fell through. However, the underlying in terms of property of the company is quite valuable, and so we expect to see monetization of the intellectual property value in that company. However, that monetization in that particular company will not be fully recovering of our initial investment which is why we're taking a more aggressive markdown on that investment itself.

Aaron Deer

Okay. That's helpful. Thank you, guys. And then I also just wanted to inquire on the yields. Manuel, you made a couple of comments regarding the – you're getting higher rates on your new debt originations. A lot of conversations that I've had with other lenders over the past quarter, really the past couple of years has been just continuous [indiscernible] of more pressures on rates due to the rate environment and competitive pressures. What's unique about what you're doing that's allowing you to get even better rates on your originations?

Manuel Henriquez

Well, [indiscernible] it’s really wide timeframe there, a couple of years. I mean the way market has changed dramatically only in the past honestly, three to five months. I would now sit here and tell you that we saw a great rate in Q4 2015. I think we didn't see – not great rates in the January and February timeframe. I think what has happened subsequent to that is that, you've seen many commercial banks reporting credit stresses and credit issues, you're seeing some commercial banks vacating [indiscernible] lighting. So the answer to your question broadly speaking is, over the course of the last three to five months, we've seen a dramatic shift in competition, and we've seen a pullback in various sectors of – by commercial banks and certain types of asset classes that we are involved with, and having that revert back to more of an ABL revolver type structure and less in the term loan area.

Aaron Deer

Okay. That's right. Thanks.

Manuel Henriquez

[Indiscernible] occurring in the short-term not over again, greater than three or five months ago, no. It's just in near term, that's what's happening.

Aaron Deer

Yeah. I understand. Okay. Thank you.

Manuel Henriquez

You're welcome.


[Operator Instructions] And your next question comes from Robert Dodd from Raymond James. Your line is open.

Robert Dodd

Hi, guys. On the kind of the election question, following up [indiscernible] I mean, if you're hesitant or your commentary there related to an expectations that the market is going to slow heading into – slow is relative, obviously everybody put out a lot of money, slow heading into the election or is it a decision by you at Hercules to not want to risk shareholders' capital ahead of such an uncertain event? So is it a market issue or is it your particular choice separate from the market?

Manuel Henriquez

I honestly can answer the question, it's our choice. I think that to serve as a witness to what happened with the Brexit, I think that you have total opposite, and I'm not taking any political view on this call nor expressing any political view, but I think that if you use Brexit as a proxy as to what may happen when you go one way or the other, the ramifications or the repercussions to which, are now self-evident with the outcome of Brexit. I think that when you look at Canada, whichever camp that you want to be in, and you exercise your judgment as to one channel over the other, there are material implication on the victory of one candidate over the other on the implication in the equity and debt capital markets. Because of that, election is so tight and because of its inability to make that prediction, I rather be long liquidity than short liquidity going into this election.

And since I'm talking about a 60-day window here between sometime in mid-September to November something, once we have that outcome behind us, I think that that point will decide – judge it whether to go back in the market or not. And depending on the outcome, you may see a very favorable capital market or you may see a very challenged capital market thereafter. And so rather than speculate – just like we did by the way, when I executed the bond trade that we went out as an organization and end up raising $142 million ahead of the Brexit vote, I think that tells you what we thought about the Brexit vote and where we came out and how well we feel today like holding on liquidity. So we're thinking the same view, that same pragmatic view going to this election that I don't know who's going to win. I'm not calling who's going to win. But I do know is that not being long liquidities, probably the wrong side of trade.

Robert Dodd

Okay. That's very fair, very fair.. Going back to the collateral base, impairments on the debt. In the past, you told us how – I mean, obviously, you tend to mark down portfolio as they come up to a funding need just to be conservative. I mean, is that a factor in play there when you talk about obviously the M&A maybe being obviously forced in those situations by company needing capital in that? Is that being a source of where you can get the recoveries from, or is it just struggling companies right there?

Manuel Henriquez

Well, no. I mean, there's some plethora of source of repaying our debt that takes place. I mean, here's a good example. Post the second quarter, BIND, one of our biopharmaceutical companies we have investment in prior to quarter went into bankruptcy. I'm happy to report and disclose in our earnings release that BIND successfully was able to sell its intellectual property [indiscernible] our pharmaceutical for nearly $40 million and was able to successfully fully repaid our debt as an example.

Further occurring is a company called [indiscernible] in our portfolio also publicly traded and also publicly filed for bankruptcy. And subsequent to that, we have a mark on our book at the end of the second quarter about $1.75 million on our mark. And I'm happy to report that subsequent to that, even though the company is [indiscernible] liquidation, we have received just a few weeks ago $1.6 billion in cash payments already paying down their obligations. So just because the company is an M&A, and just because the company is in bankruptcy Hercules because of our historical experience and working with our companies and our financial partners, we structure and know what is the right level as best as we can on that loan to debt ratio or capital into that company.

It is not an exact, it's more of an art and therefore it's a very difficult thing to do. But we have enormous amount of experience in this area in doing this. And just like I said and Mark has reiterated in his commentary, even though because we are very much in line with shareholders, we will take markdowns as evidence of historic performance because we feel that is the appropriate thing to do under fair value accounting. In difference to what impact it may have on assets under management or incentive fees. We will do markdown because we think that's the appropriate thing to do.

And we hope as we continue to work with those companies as Mark said, and many of those companies we markdown during the quarter, we are still very optimistic that if the M&A engagement that they are currently underway on come to fruition, we see $10 million, $20 million, $15 million of principal recovery for loans that we have previously marked down not to mention full recover of those investments just like we've done in the past. But fair value accounting requires us to do what's right actually what is the value of that asset at that time. And that is what we do without any shame we will mark the assets appropriately down.

Robert Dodd

Yeah. I appreciate that, great color. One last question particular if your loan liquidity going into the end of the year. Obviously you got $103 million bond, 7% materially higher cost to capital than any of the other debt you can probably expand the 6.25% again, any thoughts to refinancing that towards the end of the year?

Mark Harris

Well, you said – various important points there. Number one, my actual loan liquidity related to the bonds at the end of the quarter is just merely $50 million. And that $50 million will be invested here very shortly which means that I have no negative spread at that point because I don't have cash that's not earning much interest. So at which point you can be confident that we'll be tapping our bank lines which are undrawn that serves from the abundance of that liquidity of $55 million. So, I have $195 million of undrawn bank liquidity available to me that's not burning a hole in our pockets from the negative spread.

As to the second part of your question, the seven-year bonds, we feel that the short-term range of the curve is completely mispriced. When short-term rates are demanding much higher credit spreads than are wanted, we are not very actively looking to do a refinancing under five years given the right spreads that we're seeing on the five-year end of the curve versus the 10, 20, or even 30-year end of the curve which are much more attractive. As you know, the yield curve is flatting dramatically when you go further out.

So, I think that the short term of the curve is mispriced. We're hoping that as the market stabilized, that we'll see tightened yield spreads over the five-year rates. And once that occurs, I think that you'll definitely see us actively go out and refinance those 7% bonds you've been referring to which as I'm sure you'll realize in the event of refinancing those 7% bonds, that alone can be a 1 to 3 – sorry, $0.01 to $0.015 in quarterly earnings and prove it by resizing those bonds. But we'll make sure people understand this comment. The five-year treasury rate is acting like an Internet stock. Today alone, the five-year rate dropped nearly 4% to 1.03%. This is a five-year treasury rate. It's not supposed to be that volatile. That tells you what is going on. The 10-year rate is only 47 basis points wider than the five-year rate. That means I can borrow 10-year at 47 basis points higher plus the spread. That tells you that there's no incentive to the short-term borrowing in the capital markets right now.

Robert Dodd

Okay. I appreciate that. Thanks a lot.


At this time, I would like to turn it back to the speakers for any further remarks.

Manuel Henriquez

Thank you, operator, and thanks, everyone, for joining us on the call today. We will be attending the JMP conference in New York City on September 27th. If you have any interest in attending, please contact JMP Securities or Mike O'Hara in our Investor Relations department.

Again, thank you very much, and thank you for being our investors.


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

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