Earnings Call: Q3 2018

Nov 1, 2018

Good afternoon, ladies and gentlemen, and welcome to the Hercules Capital Q3 twenty eighteen 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. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Mr. Michael Harrah, Senior Director of Investor Relations. Please go ahead, sir. Thank you, Sarah. Good afternoon, everyone, and welcome to Hercules' conference call for the third quarter twenty eighteen. With us on the call today for Hercules are Manuel Henriques, Founder, Chairman and CEO and David Lund, our Interim Chief Financial Officer. Hercules' third quarter twenty eighteen financial results were released just after today's market close and can be accessed from Hercules' Investor Relations section at htgc.com. We have 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 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 the final audit results. In addition, the statements contained in this release 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 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 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 our website, htgc.com. With that, I will turn the call over to Manuel Henriques, Hercules' Chairman and Chief Executive Officer. Thank you, Michael. Good afternoon, everyone, and thank you for joining us on the call today. I am happy to report that we continue to have a tremendous and outstanding year in 2018. With just a few months left to the year, we're on pace to set new all time records across many key indicators, especially as it relates to total new annual commitments and loan portfolio growth, which now we expect to exceed $1,100,000,000 in total new commitments for calendar year 2018. This is a level that we've never seen before and it amplifies the tremendous amount of deal flow that we're currently seeing in the marketplace. This performance has been accomplished despite in otherwise tough and volatile times in the capital markets and many ongoing geopolitical uncertainties. However, Hercules Capital nonetheless continues to thrive and has achieved another strong and outstanding quarter for our shareholders, generating net investment income of $0.31 per share and once again covering our dividend of $0.31 from NII earnings. As evidenced by our many Q3 twenty eighteen accomplishments, Hercules Capital has both achieved the necessary scale to succeed, but also has established itself as a BDC industry leader in the venture capital lending category as we continue to build our investment portfolio while many other smaller subscale BDC venture lenders are still unable to do so as evidenced in their Q3 earnings release and performances. Furthermore, driving our tremendous growth in 2018 is a strong marketplace awareness and trust the Hercules Capital brand and platform has achieved within the market. As the capital partner of choice among many of the top tier and select leading venture capital firms, as well as many of the innovative entrepreneurs, all have sought out our capital and sought us out as a capital partner. We have surpassed and set all time new records of total new commitments in a single year, which as of the October was already at over $1,000,000,000 even though our target is $1,100,000,000 for the year, again with two months remaining. I truly can't say thank you enough to these amazing and visionary and innovative entrepreneurs and our venture capital partners for entrusting Hercules Capital as one of their trustworthy capital partners of choice. No other venture focused BDC lender has the market presence, the balance sheet or capabilities that we have to offer our companies and no existing small subscale BDC venture lender in the market today, has or can publicly demonstrate their ability to originate new commitments anywhere near the level of originations or scale that Hercules has achieved in the market so far. Because of our sustained confidence in Hercules Capital and our continued strong transaction demand that we are seeing in the marketplace, I am very proud to announce and declare our additional supplemental dividend of $0.02 per share to be paid in conjunction with our regular dividend of $0.31 for a total distribution to our shareholders of $0.33 in Q3 due in no small part to the strong and continued expected growth of our investment loan portfolio and of course our growing earnings and growing earnings spillover which currently stand at $27,000,000 or approximately $0.29 per share. And this I would like to highlight excludes any harvesting of realized gains from our DocuSign and other holdings that we have in public securities. This additional earnings spillover will serve as additional potential future supplemental dividend payments or distributions to our shareholders, especially as we continue to generate ample net investment income to cover and eventually surpass our existing dividend level of $0.31 per share as we anticipate to occur later in 2019. Although we have achieved many new financial records and achievements through the first nine months of 2018, we are nonetheless entering Q4 with a revised and heightened level of caution and controlled optimism, especially given the recent market volatilities and of course with our strong year to date performance. This should not be confused that we are somehow pulling back or being more conservative in the overall marketplace. It's none of that, but rather that we're being a bit more selective and a bit more skeptical on new investment opportunities given the fact that we're already at $1,100,000,000 on track to achieve in 2018. Notwithstanding there is new level of caution or guarded optimism entering Q4 twenty eighteen, we anticipate continued growth in our investment portfolio in Q4. In fact, we expect the net new loan portfolio growth in calendar in the fourth quarter of twenty eighteen to be approximately $75,000,000 to $125,000,000 net up or growth in the portfolio in the fourth quarter representing a 5% to 8% quarter over quarter overall loan growth. To put things in better context, with a tremendous growth realized year to date, we are also on track to potentially exceed, as I indicated earlier, the $1,100,000,000 total new commitments in calendar 2018. And we also expect net with the expected new net portfolio loan growth as I previously mentioned, we now expect to end 2018 with an investment loan portfolio balance in the range of $1,700,000,000 to $1,750,000,000 which is higher than our original forecast at the beginning of the year that we expected to finish fiscal year end 2018. Given this meaningful year to date growth, I believe it is prudent to proceed cautiously in the remaining few months of the year and protect our balance sheet while also augmenting and maintaining ample liquidity to capitalize on new investments or acquisition opportunities as we are evaluating many of the same. More than ever, scale has become a critical B2C competitive advantage and Hercules has successfully achieved this level of scale as evidenced by our nearly $2,000,000,000 in total assets, $1,000,000,000 in total net assets, as well as our strong year to date capital fundraising activity of more than $450,000,000 that we have raised in calendar twenty eighteen in a combination of debt and equity capital raise during the first ten months of 2018. As we have previously shared with you during our Q2 earnings call, we had forecasted and now I'm proud to say achieved net investment income of $0.31 per share covering our dividend just on net investment income driven by the strong loan portfolio growth of 3.7 quarter over quarter and of course the sustained effective yields of over 13% realized during the quarter. With that said, as we approach year end 2018, we are increasing our year end investment portfolio target as I indicated to the $1,700,000,000 to $1,750,000,000 and we continue to anticipate generating ample net investment income or NII to cover the dividend in Q4 and beyond. This will allow us to continue to possibly distribute additional supplemental dividend from our earnings spillover given the fact that we are now anticipating covering NII from earnings alone. Much of our success and achievement would not have been possible if not for our most important human capital assets, our tremendous team of dedicated employees who have once again proven their significant importance and teamwork and strong execution allowing us to realize these great achievements on behalf of our shareholders. Thank you all very much for your continued dedication and loyalty. I take immense pride to see many of these new records and achievements being realized as a Founder and Chairman and CEO of Hercules Capital. It truly underscores the amazing depth and level of talent, discipline and diligence that origination team has put forward and all of our employees contribute towards realizing these amazing milestones among many other achievements that we have realized. I am deeply regret to you and once again I'd like to say thank you for making this all possible. Now for today's call, I will briefly discuss the following select achievements and highlights. I'll provide an overview and highlight of our outstanding financial performance and key achievements during the quarter. I will provide a brief commentary on our revised level of heightened cautions and controlled optimism as we enter Q4 and our upward revision to our outlook and forecast of NII covering our dividend moving forward as well as our anticipated growth in earnings and spillover for potential future supplemental dividend distributions and payments. I will also offer some perspective and insights into the very robust and very strong venture capital marketplace activities as it relates to fundraising investments IPO and M and A exit activities. And then of course, I will turn the call over to David Lunn for a more detailed and briefer overview of our specific financial results for the quarter ending Q3 twenty eighteen. And finally, as we always do in our calls, conclude with a Q and A session to address any of your questions. And now for some select highlights and key achievements in the third quarter. Let me begin by saying, we realized a stronger than expected seasonal third quarter than what we anticipated. With this new robust neorealization activities that we're experiencing across all sectors that we focus on, we are proud to announce the following achievements. We achieved another strong quarterly performance of net investment income of $29,300,000 or $0.31 per share, up 22% year over year. We entered into total new debt and equity commitments of $235,000,000 in the third quarter, up an impressive 52% year over year. We funded over $142,000,000 in new investments for the third quarter for a total of the first nine months of the year through Q3, we have now funded over $7.00 $6,000,000 of new capital investments representing an equally impressive showing of 45% year over year growth. We realized materially lower early prepayments or payoff activities than we hadn't expected in the third quarter. In fact, we realized $65,000,000 of early payoff activities down from the $114,000,000 we had experienced in Q2 and well below our targets of $75,000,000 and $100,000,000 per quarter. This has two implications. Number one, it allows us to generate higher interest income, but conversely it also translates into lower one time acceleration fees related to early payoff activities. So there's always a trade off between early payoffs and consistency building a loan portfolio. During the third quarter, we also took the time to also continue our pruning and selective rotating out of certain positions. And in fact during the third quarter of the $65,000,000 in early payoff, $42,000,000 in early payoff was precipitated by our own actions of selectively grooming and pruning the portfolio out of certain credit positions that we felt more comfortably should cycle off of our credit book and that's in fact what we did during the quarter. Empowered with that knowledge, this is why you'll see our revised Q4 early payoff numbers are now expected to normalize more than the $35,000,000 to $45,000,000 level. With the combination of the strong fundings occurring in the third quarter and the slowdown in early payoff activities, we experienced a net portfolio growth of approximately $54,000,000 in Q3. As I indicated just a few seconds ago, we're now forecasting our Q3 early payoff numbers to be approximately $35,000,000 to $45,000,000 With this lower expectation of early repayment activities, we also are expecting a higher interest income to be generated from our portfolio given the fact that we'll have higher intra quarter balances than we had initially anticipated in the fourth quarter. However, because that early payoff activity will also impact other sources of income during the quarter, we also anticipate lower income from accelerations on early payoff or non reoccurring fees during the fourth quarter. When combining both of those elements of higher interest income and lower fee income, we actually still expect to achieve $0.31 in NII earnings in Q4. However, because of the timing of the fundings of the new originations in the fourth quarter and the ultimate payoff of some of these loans that may occur that we anticipate early payoff, we could see a swing in NII earnings of anywhere between $0.05 to $0.015 subject to when the early path activities take place or the targeted fundings take place in the quarter. Notwithstanding that statement, we still feel very comfortable that achieving a $0.31 in NII earnings plus or minus $0.05 to $0.01 in either direction. We also anticipate early payoff activities to materially pull back and remain at these subdued revised levels as we experienced in Q4 for the next few quarters or at least until we see stabilization and evidence of a stable capital markets when we start seeing a pickup in M and A and IPO activities, at which time we expect to see an elevated early path activities as M and A and IPO activities start picking up again. Until then, we're comfortable saying that we expect early path activities to be in the $35,000,000 40 5 million dollars range on a normalized basis. As a reminder and as evidenced in Q3 results, predicting owner repayments is and shall remain a very difficult task since we do not have control or visibility much beyond thirty days from our own portfolio companies on what's going to get paid off or not. It's also subject to significant market variability and market conditions as I indicated specifically related to M and A and IPO activities. Another important indication of our market leadership position was our ability to maintain and sustain our quarterly yields quarter over quarter despite an otherwise competitive market. Both our core and effective yields were basically flat or consistent with our Q2 results of 12.713.5% respectively on our core and effective yields. More than ever, as we all face a turbulent and unpredictable market conditions, our proven controlled discipline of slow and steady growth strategy has once again demonstrated that remaining focused and willing to walk away from ill structured or badly priced transactions are critical fundamentals to building a successful and strong performing loan portfolio. To provide some context, despite our expected $1,100,000,000 plus in closed and pending new commitments in fiscal twenty eighteen and calendar twenty eighteen, we have turned down or walked away from more investment opportunities in the third quarter than I have witnessed or recall ever doing in any prior quarters since founding Hercules back in 02/2003. We are acutely focused on certain criteria of underwriting and we're more than happy to walk away from a transaction if it doesn't make sense. In fact, we remain highly selective in our underwriting and I personally would rather miss an earnings EPS forecast or consensus than sacrifice the balance to simply make a quarter in earnings. You do not achieve the level of growth that we have without that steadfast discipline and underwriting that we have achieved over the years and with the strong deal flow that we have, we're able to pick the best opportunities that come before us. We achieved many outstanding results while maintaining our historical focus and prudent credit discipline as evidenced by historical and insignificant low 20 basis points non accrual loans, while maintaining a very strong balance sheet and highly liquid position with over $137,000,000 available liquidity for new investment and continued growth in the portfolio. However, post quarter growth and as we announced this morning, I'm proud to say that we recently completed a very successful $200,000,000 new securitization making it the third securitization that we've completed, we've now secured over $200,000,000 of additional liquidity to further bolster our balance sheet as we turn our attention to the fourth quarter and the first quarter to fund additional loan growth and earnings on behalf of our shareholders. In addition to the robust new loan origination activities during the third quarter, we remain very active in enhancing our right side of the balance sheet or our liability structure as we continue to proactively manage our debt and equity capital as we look to continue to bolster our growth by augmenting our balance sheet with additional liquidity. We are also actively managing our overall cost of funds, while also managing our leverage within the targeted desired leverage range that we had indicated that we would maintain for the fourth the third and fourth quarter of 0.75 to 0.95. As an example of the activities that we completed just alone in the third quarter, we successfully completed the following capital markets. We raised approximately $31,000,000 of equity capital through our ATM just in time program, all done well above book value north of 1.2 times book making it highly accretive equity offering on behalf of our shareholders. We also completed a successful fifteen year bond offering that which I am not aware of any other BDC has successfully been able to place a fifteen year par twenty five six point two five bond offering in the marketplace to which we raised $40,000,000 We also just recently completed as I indicated just a few seconds ago a $200,000,000 securitization making it our third securitization as a single A rated by Kroll KBRA, which was well as described and a testament to our proven business model and our strong and diverse asset base that we're able to successfully underwrite and complete a new securitization at a fixed coupon rate of 4.605 with a maturity of approximately 2027. Further to that, I'd also like to remind everybody during the quarter, we also received a green light letter from the SBA, which continues to be a terrific and fantastic partner for us. We received a green light letter, which we're now in the process of completing the final application for our third SBA license. The final steps are in process and we expect to complete the final approval from the SBA sometime in the first half of twenty nineteen, allowing us to gain access to approximately $175,000,000 of new SBA debentures. As a reminder, on June 2138, President Trump signed the Small Business Investment Opportunity Act allowing a single license SBA to achieve maximum leverage of 175,000,000 which with our existing license of $150,000,000 will immediately give us access to $325,000,000 As a reminder, the total family of funds capacity under the SBIC program with the SBA is $350,000,000 in total. Lastly, as we receive investor grade corporate and credit indicative rating from DBRS as a BBB flat, which encompasses and includes the approval from our Board to reduce the asset coverage ratio to 150% under the Small Business Credit Availability Act. This is inclusive or in addition to our existing KBRA or CROLL BBB plus rating that we have today. All of these activities allow Hercules Capital to finish the third quarter and enter the fourth quarter with an enhanced and a very strong liquid balance sheet to allow us to continue to access the equity capital markets when we need to manage our leverage within the ranges that we first described and continue our portfolio growth and our portfolio growth targets that we indicated to you earlier of $1,700,000,000 to $1,750,000,000 Now let me take a few moments to share with you the activities related to new business and the robust venture capital marketplace activities that are going on. We saw a very strong demand for loan and transaction deal flow driven in no small part by the very impressive and robust performance by the venture capital investment activities realized during the third quarter. In fact, the VCs were so active, they invested over $27,000,000,000 a record pace of new investments in the third quarter, making it one of the best quarters since February according to Dow Jones VentureSource. At this level and run rate, the VC investment activities for 2018 are on pace to shatter all previous records related to new investment levels activities in a single year and are expected to now surpass $100,000,000,000 outpacing all of 02/1999 in terms of invested capital during the .com era itself. Liquidity activities realized in excess by the venture capital investments investment community were also quite active in certain areas. Our own investment portfolio has benefited from a very strong M and A marketplace and activities. We had a handful of portfolio companies complete and announce their M and A activities, which you can see listed in our earnings release that we published today in the subsequent section. IPOs on the other hand have been much more tepid. We are cautiously monitoring the IPO markets. Which saw an unexpected pullback with only 21 companies completing their IPO activities in the third quarter. This is down from the 60 companies that completed IPO activities in all of 2017. Year to date for the first nine months of 2018, we've seen 68 companies complete their IPO activities thus far, well below the 126 companies that completed IPOs in 2014. However, unlike the IPO market, the M and A market has continued to be fully resilient. We continue to deliver very strong activities with over two zero two companies completing M and A activities in the third quarter representing over sorry five seventy four in the first nine months of the year. The amount paid was over $102,000,000,000 which already surpassed all of the activities of transaction in fiscal twenty seventeen of $90,000,000,000 As a reminder, we had over five companies complete M and A activities alone in the third quarter. Now let me discuss our pipeline and new commitments and funding as we turn our attention to Q4. As I shared with you earlier during the call, in just a few months in just a few months of October alone, we've already secured or closed over $84,000,000 of new commitments well on our way to eclipsing the $1,100,000,000 target that we expect to have by year end with only with still two months to go in the year. Assuming all of these signed term sheets and commitments continue to convert into newly funded loans in the fourth quarter, we once again will reaffirm our belief in achieving an investment loan portfolio of $1,700,000,000 to $1,750,000,000 and representing a year over year loan portfolio growth of over 20% to 25% from the year end balance of 2017 of four point excuse me, of $1,440,000,000 at cost or $300,000,000 net portfolio growth alone in one calendar year. Now let me take a brief opportunity to discuss our views in our marketplace and activities as we enter the fourth quarter. Again, we remain guardedly optimistic, but cautious about what we are seeing developing in the current markets as we enter the fourth quarter. Now with Jane that new guarded conservatism that we have, we still have a pipeline over $1,200,000,000 allowing us to easily select $100,000,000 to $200,000,000 of transactions to fund and close during the remaining few months of the year. Our slow study strategy has served us very well for many, many years, in fact for over a decade. The slow study strategy is credited with our disciplined growth and focus on continuing to grow the loan book despite an otherwise competitive environment and challenging economic outlooks. By remaining focused and cautious in anticipated returns to future acceleration of loan portfolio growth, we are taking our time to methodically grow our loan book to that $1,750,000,000 You will soon see that when you run your mathematical models at $1,750,000,000 we can easily consistently generate interest income or I should say net investment income that would generate at least $0.31 in earnings or more. In closing, we had an outstanding first nine months of the year. Strong commitments and fundings. We deliver on net overall loan portfolio growth, putting us in a position to cover our dividend of 0.31 in the third quarter and beyond. Assuming sustained portfolio growth and yields, I recognize it's an important measurement for many of you. At this point, we feel confident in our continuation of seeing net investment income consistently cover our dividend at $0.31 and in fact we see later on in 2019 exceeding that with earnings of our own portfolio and this is even before adding leverage to our own portfolio. Our outlook for the fourth quarter although it remains guardedly optimistic is nonetheless positive as we navigate to our desired loan portfolio targets as I indicated. And finally, as we wrap things up, the update on Hercules Capital views related to the recently passed small business credit availability by Congress on changes to leverage or asset coverage to 150%. We have received shareholder approval on September 4 and we expect to receive shareholder approval in our special meeting on December 6. I ask all shareholders to please cast your vote, so we can reach the necessary quorum and move forward with our leverage. It's very important for us to pursue leverage, but as I indicated on multiple different commentaries, we do not anticipate leverage for the first twelve months to exceed 1.25 at any time over the next twelve months as we gradually increase our leverage to modest levels. I'd like to say thank you to our institutional bond and equity holders for your time, feedback and support and recognize the many advantages our proposed and modest gradual controlled increase in leverage could have a beneficial impact to the Hercules Capital model and generating higher ROEs for our shareholders. With that, I'll turn the call over to David. Thank you, Manuel, and good afternoon, ladies and gentlemen. Today, we are pleased to report our third quarter results. This afternoon, I will focus on the following financial areas: our Origination Platform, Income Statement performance, NAV and return performance and credit performance. With that, let's turn our attention to the Origination Platform. We continue to demonstrate our strength as the leading venture capital leading venture lending platform with total investment fundings of $142,400,000 in what is historically our slowest quarter for investment activity. These investments came from a total of 19 portfolio companies, eight of which were new portfolio companies. This investment activity brings our fundings for the first nine months of twenty eighteen to a total of $706,100,000 putting us on pace for a record year. This investment activity was offset by early repayments during the quarter of sixty four point nine million dollars and normal amortization of $20,400,000 As a result of this activity, on a cost basis, our investment portfolio balance ended at $1,610,000,000 representing an increase of 3.5% from the second quarter and 11.7 percent from the first nine months of twenty eighteen. We have recently been experiencing slowdown in early repayment activity and are projecting early repayments of $35,000,000 to $45,000,000 in Q4. Our core yields maintained a 12.7% in line with prior quarter even in this competitive market. We expect Q4 core yields to be flat with Q3 at 12.7%. With that, I'd like to discuss a few key metrics from our income statement performance for the third quarter. On a GAAP basis, our net investment income for the quarter was $29,300,000 or $0.31 per share covering our dividend of $0.31 per share from operations. Total investment income was $52,600,000 in the third quarter, an increase of 6.1% from $49,600,000 in the second quarter. The increase in total investment income is due to higher interest income of $49,100,000 on larger weighted loan portfolio. Our weighted average principal outstanding increased by $85,000,000 to $1,550,000,000 from $1,470,000,000 in the second quarter. Our fee income decreased by 4.8% to $3,500,000 during the third quarter, primarily due to lower onetime and facility expiration fees. NII margin rose to 55.7% in the third quarter from 45.9% in the second quarter. The increase in margin is due to lower interest and fee expense of approximately $2,400,000 related to the redemption of $100,000,000 of our twenty twenty four notes in the second quarter and lower compensation expense. Our SG and A decreased to $12,300,000 in the third quarter from $13,500,000 in the prior quarter, driven primarily by a decrease in variable compensation due to performance and funding objectives relative to plan, offset by higher stock based compensation. We anticipate our operating expenses to be between $13,500,000 to $14,000,000 in the fourth quarter. Now I would like to discuss our NAV performance and credit outlook. We saw our NAV increase to $1,000,000,000 in the third quarter from $963,700,000 in the second quarter, an increase of $0.16 per share or 1.6% to $10.38 per share. This 30 this $40,400,000 increase in NAV was primarily the result of our net accretive ATM activity totaling $30,900,000 We saw our return on average equity increase to 6.9% from 5.4%. Our return on average equity increased to 12.7% in the third quarter, up from 10.2% in the prior quarter. The increase in both returns was due to the higher interest income on the higher weighted average portfolio and the lower interest expense in Q3. Lastly, I would like to discuss our credit performance for the quarter. Our credit performance remains strong in the third quarter with a weighted average credit rating of 2.23 as compared to 2.21 in the second quarter. Our credit four and five rated companies, which are our primary area of focus, remained stable at just 3.1% of cost in the third quarter. And our non accruals remained at historic lows at 0.2% as a percentage of our total investment portfolio at cost and 0% on a value basis. This makes five consecutive quarters were non accruals as a percentage of total investments at cost are below 1%. Based on our remarks today and our overall financial performance, we are very pleased with our third quarter results. Thus in closing, we are well positioned at the end of the third quarter heading into the remainder of 2018. Our long term focus approach and disciplined underwriting standards and access to diversified funding sources will enable us to deliver strong results for the foreseeable future. With that report, I will now turn the call over to the operator to begin the Q and A part of our call. Operator, over to you please. Your first question comes from the line of John Hecht from Jefferies. Please go ahead. Afternoon, guys. Congratulations on a good quarter. Thank you, John. Matt, well, this is two very strong quarters of origination activity, pipeline still strong. In your opinion, what's shifted in the market? Is it better? Is it less competition? Or is it just higher demand because the addressable markets may be increased? I think it's a combination of multiple items. I think that we're seeing bank regulations have an impact. I think strong venture capital participation or investment activities is another important issue. The delay in the capital markets is forcing more companies to rethink their capitalization on bolstering up the liquidity using debt as opposed to just pure equity, given the elongated timing now of realizing an IPO event. Companies are wanting to bolster their balance sheet to engage in better valuation discussions for M and A activities. And in general, we're seeing those companies that have established themselves begin to accelerate customer acquisition costs or customer acquisitions by revenue growth by accelerating expenditures to secure more customers as they groom themselves for an M and A or an IPO event also is contributing to those factors. Okay. And along with that increase in demand, your yields have moved above where you guided us earlier in the year. Is that simply more pricing power or something else going on in the market? In fairness to the comment, I think that the pricing yields that we indicated at the beginning of the year, 11.5% to 120.5% don't reflect the increases in the overall levels of prime rate, the Fed funds increases they've done recently. So I think that's one of the factors that we probably need to realize or increase our effective yield range. And when you do that, we're probably right where we should be, which is slightly above the mean on that range. So I think that the range that we've given at the beginning of the year does not take into account that benefit of the three rate increase that taken place in the market. Notwithstanding that we have been able to sustain pricing yields as we remain very selective in the transactions that we are involved with. Despite some of the early commentary that some other BDCs have made, we're not seeing covenant like deals realizing in the venture capital marketplace. I think that that is probably more akin to dealing with sub-ten million dollars venture loan transactions where the commercial banks are there in a very strong occurrence. All right. And then final question, it looks like eight new companies in terms of investments during the quarter. Anything worth calling out in terms of the sectors you're focused on right now for incremental investments? We've now come to learn we're not going to do that anymore because as we do then we see competitors simply following us. So we're no longer unfortunately calling out where we're going to be investing in from a favorable outlook because we've now been watching some of our competitors kind of trend right behind us as we identify those sectors. So as much as I'd like to share that with you, I think it's becoming a more competitive advantage not to openly discuss that. Makes total sense. Thanks very much for the color guys. Your next question comes from the line of Ryan Lynch from Hercules Capital. Please go ahead. Hey, good afternoon guys. First question has to do with the securitization. I'm not sure if you mentioned this or not, but is there any sort of reinvestment period on the securitization before it starts amortizing? I believe the last securitization you guys did, you guys had a one year reinvestment period. Can you just talk about that? Sure. This is our third securitization and each time we do one, they improve dramatically. This one has a twenty four months reinvestment period and then it goes to Amort over three years in that process. Hence, the life of approximately 2027, if you will, when the last loan is scheduled to come off. So it has a twenty four month reinvestment period, it has approximately a 70% advance rate on the collateral that's been posted in securitization. Okay, perfect. That's helpful. And then just wanted to kind of talk about your comments when you said you were going to be more cautious or more selective going forward. It sounded like those comments were made in response to the significant amount of capital, the $1,100,000,000 commitment you guys have already deployed in 2018. And so it seemed like that was kind of the driving force behind you guys kind of, I don't know if I say pulling back, but just be more cautious, more selective. But I didn't hear anything necessarily about the competitive environment that was really causing any caution. Am I framing that right? And can you just maybe provide an update on the competitive environment? Because as you mentioned, some other BDCs have talked about it being a little challenging as far as terms, structures and covenants. Well, some of these other BDCs are only growing at maybe $30,000,000 or $40,000,000 a quarter at best. We're not. So I hate to I guess I'll say it this way. I think we're seeing a tremendous amount of the lion's share of transactions in the marketplace. So we're not seeing any significant impacts from a competitive environment in terms of our deal flow, as evidenced by the trajectory of $1,100,000,000 And I would say that my tone for caution is that I can probably easily see ourselves doing $1,300,000,000 in transaction in one fiscal year, but I think that growing to $1,100,000,000 ish is more than plenty in one year. So we are the ones Purple Sea holding back. Not because competition is because we already have achieved a tremendous amount of origination. I think that's enough growth in one fiscal year. And so that's allowed us to be even more highly selective on the transactions that we look at for the last two months of the year and allow us to really preserve and manage our yields the way we want it to be. Okay. That makes sense. And then when I'm looking at prepayments, I mean prepayments have dropped off obviously significantly from the beginning of the year and it sounds like they're going to continue to kind of trend lower in the fourth quarter. Now just kind of looking back, what really drove the big spike in prepayments and really the first two quarters of this year? And why has it tailed off so significantly in the back half? Sure. You may recall that we indicated both in Q1 and Q2 that we have embarked on a purposeful grooming and pruning of the portfolio. So in Q1, we enhanced or highlighted that we experienced about $160,000,000 of the early payoff activities in Q1 were driven by our own doing on vacating two particular credits or loans that we cycled off on the books in Q1. So that made up $160 plus million of that early payoff activities that we had saw in Q1. In Q2, we also continued the pruning, but a bit more modest levels and we saw somewhere around $40 ish million to $50,000,000 of early payoff activities in Q2. So that really adjusted. So again to give you your numbers, we had $243,000,000 of early payoff activities in Q1. About $160,000,000 of that was our own portfolio rotation and pruning that we did was included in that number. The $114,000,000 in Q2 had approximately $40 ish, 50 million dollars or so of additional portfolio rotation and pruning that we did. And then culminating in Q3 where we had $65,000,000 of payoff, dollars 42,000,000 of that was further portfolio grooming and pruning. And we're able to do that when we have such a very strong pipeline of transactions and deal flow coming in. We're able to cycle off sectors that we no longer view as favorable or we see developing longer term trends that could be adverse to our secured credit position that we felt that it's better to cycle off of that particular credit and take advantage of the competitive environment where some of our competitors may not be as astute in credit underwriting, we will more than gladly take advantage of that market. Okay. That makes sense. Those are all the questions for me. Nice quarter and I appreciate the time. Thank you very much. Your next question comes from line of Casey Alexander from Compass Point. Please go ahead. Hi, good afternoon. Can you when you talk about twenty eighteen year end portfolio balance of $1,700,000,000 to $1,750,000,000 you're talking just about the debt portion of the portfolio? Yes. That's just the investment debt portfolio, portfolio excluding warrants and the equity, which would add about another $100,000,000 to $140,000,000 to that overall balance. Yes. I just wanted to make sure that I was getting that right. And that was my only question. Thank you. Thank you. Your next question comes from the line of Aaron Deer from Sandler O'Neill Partners. Please go ahead. Hi, good afternoon guys. Hi, Aaron. How are you? I'm doing well. Thanks. I just have a couple of questions. One is with respect to the expenses. What changed in the third quarter performance relative to plan that caused the true up in the compensation line this past quarter? Well, the answer has to do with it's a variable comp plan related to origination team. And there's a natural cadence that occurred typically in the fourth in the second quarter and often recalibrates in the fourth quarter as individuals achieve certain minimum requirements. Once they achieve those certain minimum requirements, it unlocks incentive bonus payments to them. And then as they continue to trend, certain percentage is up that continuum. As they approach the fourth quarter, there can be additional benefits or overage incentive costs that can be earned as well based on their yields and their overall performance. So there's the cadence is mid year and end of year, you'll see recalibrations depending on how the overall performance is occurring. That's what drives that. Okay. That's helpful. And then the guidance on that front that I think it was $13,500,000 to $14,000,000 that includes the G and A compensation benefits and stock based compensation, but not loan fees. Is that correct? That is correct. Okay. And then just last question, just given the it continues to be a pretty strong growth outlook and the very significant capital market actions that you guys have taken on the funding and capital side year to date. What are your thoughts in terms of views in the ATM continued use of the ATM as we head into year end here? Well, obviously, the ATM has been a tremendously strategic vehicle for us because it allows us to manage our leverage ranges in that 75%, ninety five % leverage that we talked about. I think the ATM program remains an integral part of our strategy as we dial in fiscal twenty nineteen with the presumption that our shareholders approve the leverage capacity or asset coverage being lowered 150%. We have made it very clear, however, that our first twelve possibly fifteen months of the approval, we do not intend I'll make it very clear, we do not intend to rise above 125 and our new operating range will be 0.95 to 125 will be the new operating leverage range for the next twelve to fifteen months upon shoulder approval, which means that we'll have to use the ATM to ensure that we remain within those tolerances, no different than we've done in Q3 and Q4 or expected to do in Q4, excuse me. Sure. All right. Very good. Thanks for taking my questions. Your next question comes from the line of Christopher Nolan from Ladenburg Thalmann. Please go ahead. Hey, Manuel. The 125 leverage ratio, is that a change from before? Because I recall you saying that you're targeting staying at 100% and then occasionally have sort of a shock absorber where you can possibly pop up to 125 or so and then come back down. Or are you looking at $125,000,000 on a more sustained basis? No. None of our models at this point show us sustained at $125,000,000 However, the amount of demand for capital right now in the marketplace is so tremendous that we're seeing that I would say that my initial outlook on kind of having a flare up and down at 125, That range band got a little more tighter. I think it still probably will flare to 125, but I think the cadence is probably more like 105, maybe 1.1. That is if we decide to to continue to fulfill that demand that's in the marketplace and we find the attractive pricing that we like to see in structure. I think that's a very important issue to denote as I indicated in the call that when the portfolio reaches a $1,750,000,000 and consistently remains at that weighted average level of $1,750,000,000 on the loan portfolio at a 13.2 yield, effectively, we throw off more than $0.31 in earnings on a consistent basis, which means that the only way we're going to decide to pursue leverage higher than that is that the asset quality has to be very strong that we're looking for. And if we do pursue that, any incremental growth of about $17.5 in loan book is going to be further additive to driving the supplemental dividends in the loan book. But at this point, I want to just get through the midterm elections. I want to finish 2018 and then kind of reassess the marketplace before setting what our operating leverage targets specifically going to be for 2019. But we don't anticipate hitting the 125 leverage consistently in 'nineteen at this point. All right, great. Also I saw a reference to a Wall Street Journal article talking about how regulators might be easing up on capital requirements, liquidity requirements for mid cap banks. Given that your market is so strong and given their cost of capital generally is so low, you seem I mean, venture debt seems like an interesting place for banks to enter in going forward. Is that sort of part of your strategic considerations that the banks become more involved in your market? I think there are plenty of examples of banks that had weighed into the venture lending asset class and have not performed very well doing that. I don't want to disparage the names of that particular bank, but there are a couple of banks who've tried that and that worked out well. I think that venture lending is a highly specialized asset class. Silicon Valley Bank is by far a very disciplined and credible provider and frankly a good partner to have in the market. But there's only honestly maybe three or four banks that have any real true domain knowledge in this area. Many banks would like to get in this area. Many banks have tried and they've lost tens of billions of dollars relatively quickly. This is not an easy asset class to manage and it's not just underwriting, but you need to have a fairly deep bench of individuals who have expertise in the verticals. As a reminder, we are not generalists and that's a very, very important distinction amongst many of the other BDC venture lenders that are out there. Being a generalist in this asset class is pretty dangerous thing and I would not advocate being a generalist in this asset class. And that level of expertise is not easily secured by a new bank de novoing assets in this category. Great. And final question, what happened to the inter quarter portfolio update that you guys provided in the past? We a lot of folks ask us not to keep on doing it, because they wanted to have it more on the earnings call. So we listened to a lot of our shareholders and we stopped doing it about two or three quarters ago. I'm torn by that by the way, but a lot of our shareholders have asked us why do it, why get rid of the surprise, the earnings call. So we're kind of trying it out. I'm a little bit mixed on it to be honest with you. Okay. Well, I vote for bring it back. All right. Thank you for that insight. Thanks. Your next question comes from the line of Henry Coffey from Wedbush. Please go ahead. Good afternoon and congratulations. I've heard you talk like this before. It sounds like going into the fourth quarter, you're just everybody's just going to sort of take a breath and digest what you've boarded that has absolutely nothing to do with any sense of waning demand or the quality of the business that you think you can put on. Is that accurate or are there some things out there that you're really worried about? No, Henry. This team has performed exceptionally well. And given the already robust growth of 1.1 maybe it tops $1,200,000,000 in one fiscal year. It's all has to do with a tremendous year already and giving the team a little bit of a kind of a break and saying thank you very much for an outstanding performance in the year of doing $1,200,000,000 But can we do 1,400,000,000 Probably. Do I think it's the right thing to do? Not really. I think that on boarding $1,100,000,000 1 point 2 billion dollars of new commitments in one fiscal year to me feels like the appropriate level kind of just take a break. When you look into 2019, we'll refrain from any comments. But when you look at the political environment in 2019, is there any real political risk that could affect your business? Or is it just it's just kind of the general uncertainty that always surrounds an election? I mean, look, there's the China pressure exists. There are drug prices exist. There are slowdown in acquisitions related to companies on a market where Chinese are big buyers of technology. There's the HB1 Visa program. I think we should have a merit based immigration system. There are a plethora of issues that could be could represent constraint in capital deployment and growth in fiscal twenty nineteen. And clearly the midterm election has a huge implications with whichever party wins. Either party has its own challenges by winning or losing. And so we are taking the more conservative position of great year, let's wait and see what happens. Let's have liquidity available to ourselves, take advantage of any good opportunities that surface between now and then. But we've been in a strong advantageous position to take advantage of opening in the first quarter of twenty nineteen and that's exactly what we're doing. We feel great about where we're at. We have great earnings momentum. We have strong portfolio growth, outstanding credit, liquidity. I don't know what else to say other than we are sitting in a very advantageous position and we just want to see the political environment stabilize a bit. In the ancient days, a long, long time ago, gold cut, Lord, it's like ten, twelve years ago now, there were some aspects of your securitization that sort of triggered against you and you bought through that and you survived in great shape and then since then it's been nothing but up. When you looked at how you structured the new securitization, can you get is that a kind of a totally non recourse deal? Or is there any sort of risk factors that could that you might have to live with in the future? Or what is your thought around that this new funding? One of the things that I learned dearly in the credit crisis in 02/2010 was not to have a single concentrated funding source. In those days, it was either equity in commercial banks. I think that commercial banks should represent anywhere between 25% to 30% of your liquidity. And I strongly believe like some of the top tier BDCs and in stellar names like Ares, I think that having a diversified liquidity stack and laddered maturities is an absolute integral part of risk management. And we have that. We probably have one of the most diversified source of fundings than any BDC. We just did a seven year bond offering this year. We did a fifteen year bond offering this year. We did a securitization. We've renewed our bank lines. We've increased our bank lines. We've done a convert. We have just a wide variety of funding sources all that are staggered maturities in doing so. But I think it's a very, very important aspect of your question is that when you look at the securitization having done two previously securitizations both done very successfully, both paying off at full par, we learned from those two securitizations and we wanted to have additional features and benefits to that. So in this case, we have a twenty four month revolving period in the front end. We have a steady percent advance rate, which means that we bear the first risk of loss of 30%. Some BDCs have actually sold off that risk. I believe that tranche B as it refers to is mispriced. And I felt that because of the mispriced, we're better off keeping it ourselves, which is what we did in this case because we believe in our credit underwriting capabilities so strongly. So we've got we kept that. But there is no recourse from the securitization up to the parent because it's done in SPV, a special purpose vehicle. But I mean also holding the B gives you optionality in a completely different environment than the one we're living in today. David, I'm sorry I missed the number. What was the overhead guidance for the fourth quarter? '13 point '5 million dollars to $14,000,000 in SG and A is what you're talking about? Yes. That's $13,500,000 to $14,000,000 Thank you very much. Thank you, Henry. Your next question comes from Robert Dodd with Raymond James. Your line is open. Hi, guys. Just going back to your comments about the guided optimism, etcetera, as we get into the latter part of the year. I mean, on the oneone, which is a very good number and a record number, right, in terms of onboardings and commitments, etcetera. But what you seem to be saying is you could do $1,300,000,000 there's $1,300,000,000 in deals you think, obviously, haven't been through all the underwriting yet, but they would check all the boxes, they'd meet the criteria, they'd meet your underwriting standards, which are strict and you have the capital to do them, but you just don't want to. I mean, because you've had a good year already and you're going to push things out to next year. I mean, is that am I thinking about that right? I mean that just doesn't seem very consistent with your prior pattern, which is when you've got capital, don't do a bad deal even when you've got capital. And when you've got a good deal, do it. Well, people are human and you don't want to burn out your team. It's almost like the Red Sox going through the voluntary bench and leaving your last pitcher to pitch nine innings and burning his arm out as we saw in the World Series. So I think that I approach this business at a more practical level, which is I think that people deserve a break. I think they've worked exceptionally hard. And I think that ending of the year at $1,100,000,000 to $1,200,000,000 is more than fine. And like I said, I also want to wait and see what the midterm elections bring. So by the time the midterm election is casted and counted, we've already baked in what that number will be for the remainder of the year since there's only obviously forty days left in the year at that point. So I think that pricing may be different on the backside of the election and that's another reason why I'm going to wait. I think the pricing may be better on the backside. Okay. Okay. Very, very fair point. So is right now you're saying oneone to be clear, right? But depending on how things play out and whether you get the vote on maybe extended leverage as well, which I think you will get, but it's not locked in stone yet. But if you do get that and the elections play out and pricing moves, that oneone might change? I think that with the vote of leverage and the outcome in the election, whatever that may be, being a favorable environment and stabilizing of the capital markets, absolutely that number will go up. Okay. I appreciate that. That was my only question. Thank you. Thank you. Your next question comes from Fin O'Shea with Wells Fargo Securities. Your line is open. Hi. Thanks for taking my question. First on the asset sensitivity, we often see a schedule here I think of maybe $0.04 a quarter point. Looking on your yield slide, you can see the loan coupons increase presumably due to the most of the base rates, but your core yields are pretty stable. So is there another form of spread compression via perhaps loan discounts and fees kind of going away in your market? Is that the way to think about it or is there something else? No, it's really as you can see in that Slide 26 you're referring to, you saw a 30 basis points increase in the cash loan coupon rate and the overall core yields remained flat at 12.7%. I think part of that simply has to do with the recently onboarded new loans that are basically onboarded at or similar to the price of the loans that were off boarded. And so you have this net neutral portfolio, which again I'll take all day long, which means that portfolio is consistently performing to the same legacy assets that they ran off. I'm going back a couple of years though. Oh, Jesus, okay. I'll try to answer the question in a couple of years, okay? That's fine. What would you like to ask me? Oh, you mean sorry, moving on. Okay, fine. We'll take it offline. Another slide that caught me is an uptick in, I'm not sure if you addressed this on the call in the commentary, the uptick in unfunded commitments, is this just sort of one off? It's kind of popped up for a couple of quarters now to levels less seen before sort of the SEC pushed on them. Is this something is this a matter of pipeline or how would you describe it? Well, look, I think it's a very, very important question and one that I frankly invite the SEC to really re scrutinize again. I think there's some players out there that are frequently abusing the unfunded commitment category, where in some cases the unfunded commitment can almost exceed their current outstanding portfolio. We're $2,000,000,000 in size and my unfunded commitment are mere $170,000,000 versus somebody could have a $350,000,000 loan portfolio and $240,000,000 unfunded commitment. So it's a whole different world and I think that the SEC frankly should be relooking at that and policing that more diligently in the industry. That said, our unfunded commitments are mostly attributed to pharmaceutical companies that have performance based milestones that upon FDA approval and other significant milestones would unlock or expire these unfunded commitments. So ours are truly structured with milestones that come into effect. The ones that you see that are fully available, these are companies that have asked us to provide additional strategic capital for them to both pursue acquisition opportunities or accelerate sales and marketing, but they have yet decided to step on the gas to engage in those products or engage in those initiatives as of yet. And we believe that those companies have an abundance of enterprise value associated with it. So we're more than happy to extend that part of the balance sheet. But again, in context, it's still not a very large number for us. In fact, as evidenced in page 27, it has popped up, but it's 10.7%, but a big chunk of that will start running off in the first half of twenty nineteen. Sure. Makes sense. And just one more question extending, I think, Mr. Lynch was asking discussing previously the competing venture BDCs. And I think you noted that they're smaller and grow less quickly. But to my observation, the other venture BDCs are raising actively on the private side. So are you seeing those players do sort of larger deals that they can allocate internally? And do you see that trend continuing? I think that there's a matter of rhetoric in reality. I'm not aware of any private venture lender that has any significant meaningful pools of capital that they like to espouse that they have that they really do have. And so we're not seeing any competitive advantage or any competitive differentiation within those strategy. And I think it's disservice to have a public BDC that is then raising money privately at the deference of the public shareholders. So I question what's your loyalty to the public or the private shareholders you have. So I think that's more rhetoric than reality. Thanks for taking my question. Your next question comes from Tim Hayes with B. Riley FBR. Your line is open. Hey, good evening guys. And I apologize, I had to jump on late. So if I ask anything that's already been asked or covered, just tell me to shut up. But the first question is, I saw that grade one credits dropped a good amount. Just wondering how much of that was due to repayment versus them being downgraded as they approached capital raises versus a deterioration in your outlook? When the capital markets started pulling back, our rated one deals basically signify that we're going to have a realized event and the company has an abundance of access to cash flow or liquidity. And so when the capital markets did their adjustments, we prudently marked down credits that were rated one back to rated two. And that's really probably the biggest driver that kind of led to that. Okay. And then repayments were nearly half of last quarter's, but GAAP yields were the same despite core yields also being the same. So just wondering if the credits last quarter that repaid early were more seasoned credits versus newer credits this quarter or maybe that's why the benefit to GAAP yields was stronger or if there's anything else we should be aware of? No, it's actually the inverse. The a couple of statements there you may have missed. Of the $65,000,000 of really fast activities that took place in Q4 excuse me, Q3, dollars '40 '2 million of that was our owned sector rotations and select portfolio pruning that we encourage the companies to kind of refinance this out. And in a case like that, on some occasions, we may waive the prepayment penalties as a way to simulate a portfolio mitigating developing portfolio credit risks as a way of doing that. And when that happens, of course, you will see a materially lower overall income contribution from those early payoff activities when we select to do that portfolio rotation in doing so. The other element is that you saw more younger loans pay off in Q2 than you saw in Q3 where Q3 had older loans associated with it. And therefore, the older loans would typically have less than a one point acceleration benefit from that early payoff versus a younger loan that may have a 2.5 accretive benefit from early payoff. Okay. Okay. And then switching gears a little bit, what percentage of your commitments were to SaaS companies this quarter? So overall SaaS portfolio has grown to approximately, I think we're around well, total commitments, you want fundings, Christ. I have the committed number. Can you give me that? That's fine. That's fine. I don't have the funding numbers in front of me. But total commitment has risen now to approximately $390,000,000 of total commitments in the SaaS group. When we issued the press release back in, I believe it was June, we're at $3.00 $5,000,000 in commitments. So you've seen it grow by approximately $80 ish million in one quarter of SaaS activities. Got it. Okay. And as this kind of newly branded segment continues to gain traction, how do you see that flowing through G and A and also your asset yields? Because I believe these loans are a little bit lower cash or lower yielding, correct? They tend to be a bit about 100 basis points or so lower yield, but they have an abundance of enterprise value. So it's a little different underwriting methodology there. But to answer your question, I don't look at it from an SG and A point of view. I look at it from a loan portfolio or balance sheet point of view. And today my SaaS group is about 17% of the loans on a cost basis. I think it's 17% or 18% of the total loans are reflected in a SaaS model. I don't think that SaaS should go much above 25% of the overall loan book, but it's really contingent upon how the capital markets are doing and how the public multiples are looking. But I think that from a portfolio diversity point of view, probably 25% is probably the right number to kind of manage it to. Okay. That's helpful. Thanks. I'll jump back in the queue. Thank you. All right. I'm showing Go ahead, operator. I'm showing no further questions at this time. I would now like to turn the conference back to the presenters. Thank you very much and thank you everybody for joining us on the call today. As most of you may be aware, effectively next week we're on a European Jefferies European road tour for BDCs with a handful of BDCs. We'll be touring throughout Europe with meeting our European investors. They're out there as part of the BDC community in Europe. And then we expect to be further doing additional non deal roadshows in New York, Boston and Chicago in the coming months. I would encourage you to reach out to Michael Hara to schedule any future meetings that you would like to have with us. We're more than happy to accommodate you on those scheduling in those cities that we're in. With that, thank you for your time today and thank you for being a shareholder. And remember, please cast your vote. Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may now disconnect.