PALO ALTO, Calif.--(BUSINESS WIRE)--Aug 2, 2018--Hercules Capital, Inc. (NYSE: HTGC) (“Hercules” or the “Company”), the leading specialty financing provider to innovative venture growth stage companies backed by leading venture capital firms, today announced its financial results for the second quarter ended June 30, 2018.
The Company announced that its Board of Directors has declared a second quarter cash distribution of $0.31 per share, that will be payable on August 20, 2018, to shareholders of record as of August 13, 2018.
“Our industry-leading platform and leadership position delivered another historical record for both total debt and equity commitments of $462.7 million and total gross fundings $327.5 million in Q2 - while maintaining our stringent underwriting standards and average funding spreads,” stated Manuel A. Henriquez, chairman and chief executive officer of Hercules. “The Company continued its significant origination momentum with $728.7 million in new commitments for the first half of 2018, strongly putting Hercules on pace to achieve another potential record year and surpass $1 billion in total new commitments for the full year.”
Henriquez continued, “As expected, early loan pay-offs have started to abate in Q2, which in turn helped to amplify our debt investment portfolio growth. In addition, we also realized strong improvement in core yields returning to higher normalized levels at 12.7% and an increasing record debt investment portfolio balance of $1.55 billion. We finished Q2 2018 with a strong liquidity position of $221.2 million, and we remain well positioned to fund our expected loan portfolio growth in the second half of the year. And finally, we were also very active in the capital markets, completing several initiatives to further optimize and strengthen our financial position. These initiatives included successfully raising a new bond offering of $75.0 million 5.25% notes due 2025, a successful equity offering of $81.3 million accretive to NAV, continued effective utilization of our accretive equity ATM program raising $25.4 million, and culminating with the increase in our Union Bank Credit Facility to $100.0 million. As we enter the second half of 2018, we continue to maintain a highly flexible, low-leverage and highly asset sensitive balance sheet that will benefit from future rate increases, as we monitor the rapidly evolving broader market conditions.”
Henriquez concluded, “Our exceptional performance reflects the hard work and diligent execution of our origination team. Their ability to reach more than $728.7 million in new commitments in the first half of 2018 is a testament to the strength and leadership position of the Hercules Capital brand which is increasingly recognized as the growth capital partner of choice to many of the leading venture capital-backed companies in the U.S.”
Q2 2018 Review and Operating Results
Debt Investment Portfolio
Hercules achieved another strong and record-breaking quarter, having successfully extended new debt and equity commitments to 15 new companies and 14 existing companies, totaling $462.7 million, and gross fundings of $327.5 million.
During the quarter, Hercules realized early loan pay-offs of $114.3 million, which along with normal scheduled amortization of $16.7 million, totaled $131.0 million in debt repayments. Approximately $37.2 million of the early loan repayments were received from prior portfolio companies that had previous credit ratings in the 3-5 range.
Our strong new debt investment origination and funding activities lead to net debt investment portfolio growth of $185.6 million during the second quarter, on a cost basis.
The Company’s total investment portfolio, (at cost and fair value) by category, quarter-over-quarter and year-over-year are highlighted below:
Total Investment Portfolio: Q1 2018 to Q2 2018
Debt Investment Portfolio Balances by Quarter
As of June 30, 2018, 85.9% of the Company’s debt investments were in a senior secured first lien position.
Effective Portfolio Yield and Growing Core Portfolio Yield (“Core Yield”)
Effective yields on our debt investment portfolio were 13.5% during Q2 2018, a decrease from the previous quarter of 14.3%, primarily due to a significantly lower level of early loan pay-offs during the quarter. We realized $114.3 million of early loan pay-offs in Q2 2018 compared to $243.5 million in Q1 2018, or a decrease of 53.1%. Our effective portfolio yields generally include the effects of fees and income accelerations attributed to early loan payoffs, and other one-time events. Our effective yields are materially impacted by elevated levels of early loan pay-offs and derived by dividing total investment income by the weighted average earning investment portfolio assets outstanding during the quarter, which excludes non-interest earning assets such as warrants and equity investments.
Core yields rose to 12.7% during Q2 2018, exceeding the upper end of our 2018 expected range of 11.5% to 12.5%, and materially higher than Q1 2018 core yields of 11.9%. Hercules defines core yield as yields that generally exclude any benefit from income related to early pay-offs attributed to the acceleration of unamortized income and prepayment fees and includes income from expired commitments.
Total investment income increased to $49.6 million for Q2 2018, compared to $48.5 million in Q2 2017. The increase is primarily attributable to a higher level of loan origination activity occurring early in the quarter along with an overall increase in the core yield from 12.1% in Q2 2017 to 12.7% in Q2 2018.
Non-interest and fee expenses increased to $13.5 million in Q2 2018 versus $12.6 million for Q2 2017. The increase was primarily due to an increase in variable compensation related to a record level of new origination activities.
Interest expense and fees were $13.2 million in Q2 2018, compared to $10.6 million in Q2 2017. The increase was due to the one-time non-cash acceleration of unamortized fees associated with the 2024 Notes Redemption, along with the higher weighted average borrowings from the issuance of our 4.625% Notes due 2022 in October 2017, and 5.25% Notes due 2025 (the “2025 Notes”) in April 2018, and interest related to our credit facilities during the period.
The Company had a weighted average cost of borrowings comprised of interest and fees, of 6.4% in Q2 2018 versus 5.5% during Q2 2017. The increase was primarily due to the one-time non-cash acceleration of unamortized fees associated with the 2024 Notes Redemption.
NII – Net Investment Income
NII for Q2 2018 was $22.8 million, or $0.26 per share, based on 87.1 million basic weighted average shares outstanding, which includes the one-time expense of $2.4 million, or $0.03 per share, associated with the 2024 Notes Redemption, compared to $25.3 million, or $0.31 per share, based on 82.3 million basic weighted average shares outstanding in Q2 2017.
Adjusted NII was $25.2 million, or $0.29 per share, adding back the one-time non-cash expense of $0.03 per share associated with the 2024 Notes Redemption.
DNOI - Distributable Net Operating Income
DNOI, a non-GAAP measure, for Q2 2018 was $25.6 million or $0.29 per share, compared to $27.2 million, or $0.33 per share, in Q2 2017. The decrease in DNOI is primarily attributable to the increase in variable compensation related to a record level of origination activities and to the one-time non-cash acceleration of unamortized fees associated with the 2024 Notes Redemption.
DNOI is a non-GAAP financial measure. The Company believes that DNOI provides useful information to investors and management because it measures Hercules’ operating performance, exclusive of employee stock compensation, which represents expense to the Company, but does not require settlement in cash. DNOI includes income from payment-in-kind, or “PIK”, and back-end fees that are generally not payable in cash on a regular basis, but rather at investment maturity. Hercules believes disclosing DNOI and the related per share measures are useful and appropriate supplements and not alternatives to GAAP measures for net operating income, net income, earnings per share and cash flows from operating activities.
Continued Credit Discipline and Strong Credit Performance
Hercules’ net cumulative realized gain/(loss) position, since its first origination activities in October 2004 through June 30, 2018, (including net loan, warrant and equity activity) on investments, totaled ($42.8) million, on a GAAP basis, spanning nearly 14 years of investment activities.
When compared to total new debt investment commitments during the same period of over $8.0 billion, the total realized gain/(loss) since inception of ($42.8) million represents approximately 54 basis points “bps,” or 0.54%, of cumulative debt commitments, or an effective annualized loss rate of 4 bps, or 0.04%.
During Q2 2018, Hercules had gross realized gains/(losses) of ($15.8) million primarily from the liquidation or write-off of our warrant and equity investments in seven (7) portfolio companies and our debt investments in two (2) portfolio companies, which were offset by gross realized gains of $6.9 million, resulting in net realized losses of ($8.9) million.
During Q2 2018, we recognized valuation gains from our venture capital related investments and equity and warrant assets that helped drive $38.2 million of net unrealized appreciation, of which $37.1 million was net unrealized depreciation from our debt, equity, and warrant investments. We recorded $24.2 million of net unrealized appreciation on our debt investments which was attributable to $20.1 million of unrealized appreciation primarily due to the reversal of unrealized depreciation upon write-off of one portfolio company and loan repayments from three portfolio companies, along with $4.1 million of unrealized appreciation on the debt portfolio, including $1.8 million of unrealized appreciation on collateral-based impairments on one (1) portfolio company.
Portfolio Asset Quality
As of June 30, 2018, the weighted average grade of the debt investment portfolio materially improved to 2.21, on a cost basis, compared to 2.43 as of March 31, 2018, based on a scale of 1 to 5, with 1 being the highest quality. Hercules’ policy is to generally adjust the credit grading down on its portfolio companies as they approach their expected additional growth equity capital to fund their respective operations for the next 9-14 months.
Additionally, we may selectively downgrade our portfolio companies, from time to time, if they are not meeting our financing criteria, underperforming relative to their respective business plans, or approaching an additional round of new equity capital investment. It is expected that venture growth stage companies typically require multiple additional rounds of equity capital, generally every 9-14 months, since they are not generating positive cash flows for their operations. Various companies in our portfolio will require additional rounds of funding from time to time to maintain their operations.
As of June 30, 2018, grading of the debt investment portfolio at fair value, excluding warrants and equity investments, was as follows:
Non-accruals decreased slightly for the second quarter of 2018. As of June 30, 2018, the Company had two (2) debt investments on non-accrual with a cumulative investment cost and fair value of approximately $2.8 million and $0.0 million, respectively, or 0.2% and 0.0% as a percentage of our total investment portfolio at cost and value, respectively.
Compared to March 31, 2018, the Company had four (4) debt investments on non-accrual with cumulative investment cost and fair value of approximately $12.3 million and $0.0 million, respectively, or 0.8% and 0.0% as a percentage of our total investment portfolio at cost and value, respectively. The decrease in the cumulative cost of debt investments on non-accrual between June 30, 2018 and March 31, 2018 is the result of the write-off of one debt investment that was on non-accrual and one previously written down company fully paying off and representing a full recovery to our cost basis at March 31, 2018.
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