Hercules Capital, Inc. (NYSE:HTGC) Q2 2024 Earnings Call Transcript

Hercules Capital, Inc. (NYSE:HTGC) Q2 2024 Earnings Call Transcript August 1, 2024

Hercules Capital, Inc. reports earnings inline with expectations. Reported EPS is $0.51 EPS, expectations were $0.51.

Operator: Good day, everyone, and thank you for standing by. Welcome to Hercules Capital Second Quarter 2024 Financial Results and Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] And please be advised that today’s conference is being recorded. I will hand the call over to the Managing Director of Investor Relations, Michael Hara. Please go ahead.

Michael Hara: Thank you, Carmen. Good afternoon, everyone, and welcome to Hercules conference call for the second quarter 2024. With us on the call today from Hercules are Scott Bluestein, CEO and Chief Investment Officer; and Seth Meyer, CFO. Hercules’ financial results were released just after today’s market close, and can be accessed from Hercules’ Investor Relations section at investor.htgc.com. An archived webcast replay will be available on the Investor Relations webpage for at least 30 days following the conference call. During this call, we may make forward-looking statements based on our own assumptions and current expectations. These forward-looking statements are not guarantees of future performance, and should not be relied upon in making any investment decision.

Actual financial results may differ from the forward-looking statements made during this call for a number of reasons, including but not limited to the risks identified in our annual report on Form 10-K and other filings that are publicly available on the SEC’s website. Any forward-looking statements made during this call are made only as of today’s date, and Hercules assumes no obligation to update any such statements in the future. With that, I’ll turn the call over to Scott.

Scott Bluestein: Thank you, Michael. And thank you all for joining the Hercules Capital Q2 2024 earnings call. Following our record funding activity in Q1 2024, we followed-up with a record second quarter of total gross fundings of $461.5 million, which led to record total gross fundings of $1.07 billion for the first half of 2024. This is the first time in our 20 years history where we have delivered more than $1 billion of gross fundings in the first half of a calendar year. Our origination and funding performance in the first half continues to reflect the benefits of being able to operate an institutional venture and growth-stage lending platform at scale, and being the clear market leader in the asset class. Our ability to again deliver creative solutions for our new borrowers and strong results for our shareholders in Q2, while managing our balance sheet and business conservatively, positions us well heading into the second half of 2024.

Hercules’ strong performance continues to be driven by our committed employees, our team-first culture that emphasizes internal and external collaboration, and a balance sheet that is liquid, long-term oriented, and institutional. As of the end of Q2, Hercules Capital is now managing approximately $4.6 billion of assets, an increase of 14.7% from where we were a year ago. We continue to expect the second half of 2024 to experience higher than normal market and macro volatility, given the Presidential Election and potential changes in the global geopolitical environment. As we discussed on our last call, we expected the market environment for new originations to improve throughout 2024, and we have certainly witnessed this in the first half of the year.

While Q3 is typically a seasonally slow quarter for new originations, we remain optimistic about our funding activity over the second half of the year. We intend to continue to manage our business and our balance sheet defensively, while maintaining maximum flexibility to take advantage of market opportunities. This includes continuing to enhance our liquidity position, maintaining low leverage, tightening our credit screens for new underwritings, and maintaining our higher-than-normal first lien exposure, which increased again in Q2 to 90.1%, up from 88.4% in Q1. Let me now recap some of the key highlights of our performance for Q2. Given the strength of the technology markets and the moderate improvement in valuations, we continue to see a steady volume of quality later-stage companies looking to add new capital to their balance sheets.

We are enthusiastic about the profile of the companies that we have been able to partner with over the last several quarters, and our primary focus remains on quality credits. In Q2, we originated total gross debt and equity commitments of over $686 million, and record Q2 gross fundings of nearly $462 million. Given the strong funding start for the first half, for Q2, we generated record total investment income of $125 million, up nearly 8% year-over-year, and net investment income of $82.4 million, up nearly 9% year-over-year, or $0.51 per share, and providing 128% coverage of our base distribution of $0.40 per share. We were able to achieve 128% coverage of our base distribution despite ending the quarter with very conservative GAAP leverage of 94.8%.

This is our fifth consecutive quarter of over $100 million of quarterly core income, which excludes the benefit of prepayment fees or fee accelerations from early repayments. We also generated a return on equity in Q2 of 19.2%. Our portfolio generated a GAAP effective yield of 14.7% in Q2, and a core yield of 13.7%. The small decrease in core yield in Q2 was largely attributable to more first lien exposure, and emphasis on later-stage transactions, and heavier payoffs from legacy higher-yielding assets. Our balance sheet, with conservative leverage and low cost of capital, remains very well positioned to support our continued growth objectives, and provides us with the ability to go lower on yield for higher-quality assets when warranted. This serves as a key differentiator of our business relative to our closest competition.

The focus of our origination efforts in Q2 was once again on quality and diversification. Our Q2 origination activity was driven by both our technology and life sciences teams, delivering record funding performance during the quarter. Although new business activity was weighted slightly more towards technology companies. In Q2, approximately 63% of our fundings were to technology companies, while approximately 55% of our commitments during the quarter were to technology companies. Our new commitments in Q2 reflect our more optimistic view on the technology sector, and an increase in the number of later-stage quality technology transactions that our team is currently seeing in the market. The equity markets have been particularly robust for public life sciences companies, which has caused some life sciences companies to push out decisions on debt financings by a quarter or two.

We funded debt capital to 25 different companies in Q2, of which 10 were new borrower relationships. Consistent with what we saw in previous quarters, we expanded our funding relationship with numerous portfolio companies that continued to show strength and achieve performance milestones during the second quarter. Our available unfunded commitments decreased slightly to approximately $479.5 million from $483.4 million in Q1. Since the close of Q2, and as of July 29, 2024, our deal team has closed $28.1 million of new commitments and funded $45.4 million. We have pending commitments of an additional $210 million in signed non-binding term sheets, and we expect this number to continue to grow as we progress in Q3. Similar to what we saw in Q2, our expectation is that Q3 funding activity will be back-end weighted.

Consistent with our historical approach to underwriting credit, we will remain disciplined on new originations, and we will continue to prioritize asset quality over chasing high-risk transactions with a slight yield premium. Our portfolio exit activity moderated a bit in Q2. In Q2, we had two technology portfolio companies complete acquisitions. We continue to have two portfolio companies that have previously filed registration statements for an IPO. As we anticipated, early loan repayments increased in Q2 to approximately $306 million, which was at the upper range of our guidance of $200 million to $300 million. Over 44% of our Q2 prepayments were attributable to M&A events or new equity capital events, which we view as a positive signal overall.

For Q3 2024, we expect prepayments to remain similar to Q2 levels, and be in the range again of $200 million to $300 million, although this could change as we progress in the quarter. We also anticipate that the majority of payoffs will come in the first half of the quarter, which will likely lead to a lower weighted average debt balance for the third quarter. Credit quality of the debt investment portfolio remained steady quarter-over-quarter. Our weighted average internal credit rating of 2.18 increased slightly from the 2.16 rating in Q1, and remained at the lower end of our normal historical range. Our Grade 1 and 2 credits decreased slightly to 67.2% compared to 68% in Q1. Grade 3 credits increased slightly to 31% in Q2 versus 29.2% in Q1.

Our Rated 4 credits decreased modestly to 0.9% from 2.6% in Q1 and Rated 5 credits were 0.9%. In Q2, the number of loans on non-accrual remained the same, with the write-off of one loan and the addition of a new one. We had two debt investments on non-accrual with an investment cost and fair value of approximately $91.8 million and $32.1 million, respectively, or 2.5% and 0.9% as a percentage of the company’s total investment portfolio at cost and value, respectively. With respect to our broader credit book and outlook, we generally remain pleased by what we are seeing on a portfolio level, and our monitoring remains enhanced. Our focus on credit underwriting and a diversified asset base is continuing to serve us well. We are continuing to see general outperformance and positive momentum in terms of capital raising, M&A activity, and milestone achievement throughout our life sciences book, while things are beginning to improve on the technology side with respect to the same metrics.

Companies with slower growth rates and thin liquidity positions continue to struggle broadly throughout the ecosystem, and we are seeing some indications that the higher for longer rate environment is beginning to have an impact on certain sponsor-backed companies. During Q2, capital raising across our portfolio was very strong, with 24 companies raising approximately $1.7 billion in new capital, which was again heavily weighted towards our life sciences portfolio. For the first half of the year, we had 56 portfolio companies raise over $4.3 billion of new capital. During Q2, 2024, Hercules had net realized losses of $5.8 million, comprised of gross realized gains of $5.8 million, primarily due to the gain on warrant and equity investments, offset by $11.6 million due to the loss on debt investments, warrant and equity investments, and losses resulting from fluctuations in foreign exchange rates.

Our net asset value per share in Q2 was $11.43, a decrease of 1.7% from Q1 2024. We ended Q2 with strong liquidity of $482 million. Our balance sheet puts us in a strong position to be able to benefit from a new business environment that we believe is as strong as we have seen in several years. We further strengthened our balance sheet with the approval of our fourth SBIC license, which we received in July. This fourth license will provide access to $175 million of additional growth capital and help us to maintain our overall blended cost of capital. Also, subsequent to Q2, we retired our July 2024 unsecured notes, which Seth will discuss in more detail. Venture capital ecosystem fundraising and investment activity moderately picked up in Q2, with year-to-date fundraising activity at approximately $37.4 billion and investment activity at approximately $93.4 billion, according to data gathered by PitchBook-NVCA.

Both fundraising and investment activity are on pace with 2023 levels. We expect investment activity to remain at these levels, driven by more selectivity in terms of the profile of the companies receiving equity funding. Given our strong operating performance in Q2, we exited the quarter with undistributed earnings spillover increasing to approximately $145 million or $0.89 per ending shares outstanding. For Q2, we are maintaining our base… [Technical Difficulty]

Operator: Please stand by. Please stand by, ladies and gentlemen, we have some technical audio difficulties. Please, Scott, continue.

Scott Bluestein: In Q2, Hercules delivered its fifth consecutive quarter of over $100 million of quarterly core income, which excludes the benefit of prepayment fees or fee accelerations from early repayments. Our success is attributable to the tremendous dedication, efforts and capabilities of our 100-plus employees, and the trust that our venture capital and private equity partners place with us every day. We are thankful to the many companies, management teams and investors that continue to make Hercules their partner of choice. I will now turn the call over to Seth.

Seth Meyer: Thank you, Scott. And good afternoon, ladies and gentlemen. Q2 marked another quarter of solid execution, record financial performance, and conservative balance sheet management for Hercules Capital. We continued to see the benefits of operating at scale and the diversity of our balance sheet with no near-term material maturities. In Q2, we had record total investment income of $125 million and record net interest margin of $103.5 million, thanks to our year-to-date portfolio growth and low average borrowing cost. We continue to maintain strong available liquidity of approximately $0.5 billion as of quarter-end, and more than $750 million across the platform, including the advisor funds managed by our wholly-owned subsidiary, Hercules Advisor, LLC.

Post quarter-end, we repaid at maturity $105 million of institutional notes issued in July 2019, and received approval for our fourth SBIC license, unlocking another $175 million of liquidity to help us maintain our very competitive low cost of capital. With all this in mind, let’s review the income statement performance and highlights, NAV, unrealized and realized activity, leverage and liquidity, and then finally the financial outlook. On the income statement performance and highlights, total investment income, as I mentioned, was a record of $125 million, driven by the record first quarter growth in the debt portfolio. Core investment income, a non-GAAP measure, increased to a record of $116.4 million. Core investment income excludes the benefit of income recognized as a result of loan prepayments.

Net investment income increased to $82.4 million or $0.51 per share in Q2, a 4% quarter-over-quarter increase, driven by the increase in total investment income on the portfolio growth in the first half of 2024. Our effective and core yields decreased modestly in the second quarter to 14.7% and 13.7%, respectively, compared to 14.9% and 14% in the prior quarter. The second quarter gross operating expenses were $45.5 million compared to $45.3 million in the prior quarter. Net of cost recharged to the RIA, our net operating expenses were $42.6 million. Interest expense and fees increased to $21.5 million from $20 million in the prior quarter due to greater utilization of the credit facilities as a result of the investment portfolio growth in the first half of 2024.

SG&A expenses decreased to $24 million, in line with my guidance. Net of cost recharged to the RIA, the SG&A expenses were $21.1 million. Our weighted average cost of debt increased slightly to 5%. Our ROAE, or NII over average equity, increased to 19.2% for the second quarter, and our ROAA, or NII over average total assets, increased to 9.6%. Switching to NAV realized and unrealized activity, during the quarter, our NAV per share decreased $0.20 per share to $11.43 per share. This represents an NAV per share decrease of 1.7% quarter-over-quarter. The main driver was the investment portfolio net unrealized depreciation of $34.7 million. Our $34.7 million of net unrealized depreciation was the result of $19.8 million of net unrealized depreciation on the loan portfolio, $9.8 million of depreciation to the private equity and warrant portfolio, and $5.5 million of depreciation to the publicly-held equity and warrant portfolio.

In addition, we had 2.5 million of depreciation on the overall portfolio due to the reversal of prior unrealized appreciation. These were partially offset by $2.2 million of appreciation attributable to other investment-related receivables, and $0.7 million of appreciation on the foreign forward currency derivative. Moving to leverage and liquidity, our GAAP and regulatory leverage increased modestly to 94.8% and 85.4%, respectively, compared to the prior quarter due to greater utilization of the leverage facilities on the first half portfolio growth. Netting out leverage with cash on the balance sheet, our net GAAP and regulatory leverage was 93.3% and 83.9%, respectively. We ended the quarter with nearly $500 million of available liquidity.

As a reminder, this excludes capital raised by the funds managed by our wholly-owned RIA subsidiary. Inclusive of these amounts, the Hercules platform had more than $750 million of available liquidity. The strong liquidity positions us very well to support our existing portfolio companies and source new opportunities. As a final point, in mid-July, we secured our fourth SBIC license, adding to an additional $175 million of leverage availability to support future growth of the portfolio. Finally, on the outlook points, for the third quarter, we expect core yield to be between 13.3% and 13.5%, excluding any future benchmark interest rate changes. As a reminder, more than 97% of our portfolio is floating with a floor, so any Fed decreases in interest rate may not have an equal reduction in our core yield.

Although very difficult to predict, as communicated by Scott, we expect $200 million to $300 million in prepayment activity in the third quarter. We expect our third quarter interest expense to increase slightly on the growth of the balance sheet compared to the prior quarter. For the third quarter, we expect SG&A expenses of $22 million to $23 million, and RIA expense allocation of approximately $2.5 million. Consistent with previous guidance, we expect a quarterly dividend from the IRA, though we’re increasing the range to $1.25 million to $1.5 million per quarter. In closing, we are very proud of the tremendous start we have reported for the first half of 2024, and look forward to working together with our financial partners during the remainder of the year to continue to find efficient ways to finance our business.

I will now turn the call over to Carmen to begin the Q&A portion of our call. Carmen, over to you.

Q&A Session

Operator: Thank you so much. [Operator Instructions] One moment for our first question. And it comes from the line of Crispin Love with Piper Sandler. Please proceed.

Crispin Love: Thanks. Good afternoon. Appreciate taking my questions. First off, just a big picture question on rate cuts. We seem to be getting closer to rate cuts from the Fed. So, can you just discuss how you expect how lower rates might impact VC deal activity? And how you think that could impact you on a funding and activity basis going forward as we get to the end of ’24 and probably more likely in 2025?

Scott Bluestein: Thanks, Crispin. I think our expectation internally is that we will see demand activity pick up in a declining rate environment. I think one of the things that our team has consistently been hearing over the last several quarters from some quality late-stage companies that they’re holding off just given the current rate environment. And so, I think our operating assumption is that as rates do start to come down, which we expect to happen in the second half of the year, and then potentially throughout the course of next year, that if anything, demand will likely increase in terms of the amount of quality venture-stage companies that are looking for secure debt solutions.

Crispin Love: Great. Thank you, Scott. And then just on credit quality, Scott, I believe you mentioned a write-off on one loan in the quarter. Just first, is that the $6 million realized loss? And just any other color that you can provide there? And then just credit broadly, any leading indicators that you’re looking at that makes you confident going forward, or are there just any pockets of stress that you want to call out?

Scott Bluestein: Sure. So overall, continue to be optimistic about credit. Broadly speaking, when looking at our portfolio, there are certain key metrics that we evaluate and track on a quarterly basis. Our weighted average credit rating maintains at 2.18, that’s just a slight uptick from 2.16. So that continues to show strength and stability. Second metric that we look at pretty closely is what percentage of our entire portfolio do our Grade 4 and Grade 5 credits make up. As of the end of Q2, that was approximately 1.8% of the portfolio, that was actually down from 2.8% of the portfolio in Q1, and down from 3.4% of the portfolio in Q4 of last year. So that shows a pretty optimistic trend in terms of Rated 4 and Rated 5 credits as a percentage of our total investment portfolio.

As I mentioned in my remarks, we do have two loans on non-accrual. From a fair value perspective, that makes up less than 1% of our debt investment portfolio. With respect to the one particular write-off that we spoke about and that you just referenced in your question, that was a small loan that was placed on non-accrual. We took action in cooperation with the company and Board and ended up selling the assets of that company, which culminated and completed in Q2, then resulted in a small net realized loss in the quarter. So, nothing more to add on that one unless you have additional questions on it.

Crispin Love: No. I appreciate the color, and thanks for taking my questions.

Scott Bluestein: Sure. Thanks, Crispin.

Operator: Thank you. Our next question comes from the line of Casey Alexander with Compass Point Research. Please proceed.

Casey Alexander: Yeah, hi, good afternoon. Thanks for taking my questions. Seth, you mentioned that you expect interest expense to be up slightly, but you have a debt repayment in July. Are you funding that with the credit facility, because that comes at a reasonably higher rate? And is your strategy to let that sit in the credit facility for a while until hopefully rates come down and maybe you can refinance in the unsecured market at a better rate than you can right now?

Seth Meyer: Yeah, let me take that in pieces, Casey. Thanks for your question. So, we did utilize the credit facilities to repay the $105 million. We had ample availability in those to cover that. Certainly, as we see the interest rates move in the direction for that opportunity, we’ll take advantage of it on an opportunistic basis. But we did as well add to our liquidity availability with the SBIC license, which obviously is more attractive than what we could get in the open market at the moment. So, it was a takeout that was liquidity and leverage neutral, because we used the credit facilities. And we will be opportunistically looking at the market. But at the moment, we still — as Scott mentioned, we have very strong liquidity and the balance sheet is in great shape for a continuing growth.

Casey Alexander: Okay. Thank you. Scott, this is for you. It kind of strikes me that, is Hercules becoming sort of a hybrid lender? And what I mean by that is, sort of, you’ve moved up-market to a lot of big companies and many times public companies. Kind of what percentage of your originations or portfolio, however you would like to characterize it, don’t really involve direct interface with a venture capital company, but are more direct lending to a technology or life science company where it’s your core competency, but maybe it’s not really what you would call a traditional venture capital loan anymore?

Scott Bluestein: Yeah. Casey, a great observation and great question. Our business has really transformed itself over the course of our 20 years operating history. In the early years, Hercules was exclusively focused primarily on private venture-backed companies in the two verticals that we cover, technology and life sciences. And then, if you look at the business sort of 10 years in, as we started to mature, as we started to scale, as we started to develop our own capabilities, the business began to transition away from that traditional sort of venture-backed model into more institutionally-backed companies that still continue to be growth stage. If you look at the business today, 20 years in and $20 billion later, we no longer sort of describe the business as a venture-lending firm, we describe it as a venture and growth stage-lending firm.

The vast majority of companies in our portfolio continue to be institutionally backed by venture capital firms, but the reality is these are later-stage companies. Many of these companies are now publicly traded. Just because they are publicly traded does not mean that the venture capital firms no longer have equity at risk or an investment in these companies, but that certainly has been a change that we’ve seen over the last several years. We also look at the technology business differently than we look at the life sciences business. On the life sciences side, and this is just a virtue of the way the life sciences ecosystem works, about 80% to 85% of our investments are in publicly-traded companies. On the technology side of our business, about 90% of our investments are in privately-held companies.

So, it really depends on which part of the business we’re speaking about. But in broad terms, we have transitioned away from that early-stage venture model that we had 20 years ago into more of an institutionally-backed growth-stage lender.

Casey Alexander: Thank you. That’s all my questions. I appreciate that answer very much. Thanks.

Operator: Thank you. Our next question comes from the line of Christopher Nolan with Ladenburg Thalmann. Please go ahead.

Christopher Nolan: Hey, guys. Two quick questions. Scott, the comments you made on the increase in activity for the life science — excuse me, tech area, is there a particular focus on that such as AI? Any color you can give in terms of specifics?

Scott Bluestein: Pretty broad based, Chris. Our investment team on the technology side has been very active over the last quarter or two, both from a closed deal perspective and from a pipeline perspective. And there’s really no specific sectors or subsectors that we’re focused on. We’re focused on overall quality credit underwriting, and there’s a number of different profiles from a sector perspective within technology that we’ve been aggressive in.

Christopher Nolan: Great. And then, a follow-up for Seth. The interest rate sensitivity on the press release shows if 25 bps cut impacts NII by $0.03. Would that likely be offset by just higher investment volumes pursuant to your earlier comments?

Seth Meyer: Yeah, that’s a good question. So, I think what’s interesting is when you look at that on the 100 basis points movement, the big difference it really shows are floating with a floor structure because there’s a 20% difference. But you’re absolutely correct, we could grow away that $0.03 NII hit, and it’s an annual basis, it’s not a quarterly basis. And so, that could be covered by the growth over time. But as we’re standing today without additional growth or any other change, that would be the impact.

Christopher Nolan: Great. That’s it for me. Thanks, guys.

Scott Bluestein: Thanks, Chris.

Operator: Thank you. And our next question comes from the line of Douglas Harter with UBS. Please proceed.

Douglas Harter: Thanks. Just sticking with the growth thought, how are you thinking about the outlook for growth in the coming quarters? And how that mix might be between third-party capital and on-balance sheet?

Seth Meyer: We’re optimistic about what the second half of the year is going to look like in terms of new commitments and gross fundings. We don’t give growth guidance on a quarterly basis, just given the unpredictability associated with the early repayments. In Q2, we had $306 million of prepayments. Our guidance for Q3 is that we expect to have $200 million to $300 million again, so that’s two healthy quarters in a row of expected prepayments. And how much ultimate growth there is in terms of the BDC balance sheet will largely be driven by the level of prepayments. We’re not cautious at all in terms of our ability to deliver in terms of new commitments and new fundings. With respect to the private fund business, the business continues to operate above our initial expectations.

We do disclose in our press release the allocations that are going to the private fund business on a quarterly basis. If you look at that just in terms of aggregate numbers, in 2022, for example, we funded about $400 million out of the private funds. In 2023, we funded about $350 million out of the private funds. In Q1, we funded about $113 million out of the private funds. And then, in Q2, we just funded about another $117 million. So, the pace of fundings out of our private fund business continues to be fairly robust.

Douglas Harter: Great. Thank you.

Operator: Thank you. Our next question comes from the line of Finian O’Shea with Wells Fargo Securities. Please proceed.

Finian O’Shea: Hey, everyone. Good afternoon. A quick follow there on the private fund discussion. What was the input that led to — I think, Seth gave higher go-forward guidance on that. think at least our impression last quarter was that it was — the economics weren’t in place for the lot for a while. If you could touch on that and, like, how likely that is to happen going forward? Thanks.

Seth Meyer: Thanks, Fin, for the question. What we did was kind of narrow the range. We’ve been a little bit over my guidance or at the top end of the guidance for each of the past two quarters. And so, all we did was narrowed it a little bit. Rather than $1 million to $1.5 million, I just shortened it up to $1.25 million to $1.5 million. As I said, just because we’ve been at the top end or over for the last two quarters.

Finian O’Shea: Okay, helpful. Thank you. I guess one for Scott. There’s been a bit reported in the financial community, at least, about the comeback of Silicon Valley Bank. And seeing what your views are or what your observations are on that front? Thanks.

Scott Bluestein: Thanks, Fin. I think our observations with respect to SVB, First Citizens would be very consistent with respect to what we’ve said now several quarters in a row. They continue to be active. We continue to see them in the market. We don’t see them to the same extent that we did a year, year and a half, two years ago, but they continue to be active. We have continued to partner with them on a select number of transactions. And so, I would sort of characterize them as a viable competitor in the market that we both compete with from time to time, and partner with from time to time. Nothing else to add outside of what I just said.

Finian O’Shea: Great. Thanks so much.

Operator: Thank you. Our next question comes from the line of Paul Johnson with KBW. Please proceed.

Paul Johnson: Yeah, good evening. Thanks for taking my questions. Most of mine have been asked, but one I did want to ask is, over the last few quarters, it seems that PIK income as a percent of interest income has been increasing. I was wondering if there was anything specific that’s been driving that, or have we just been seeing more of that as you move up market and some of these borrowers are getting that option within their structure. But just wondering what’s been driving that over the last few quarters.

Seth Meyer: Sure. Thanks, Paul. I’d say a couple of things. First and foremost, PIK income on a relative basis, when you look at our entire income, continues to be a really small part of the overall income or top-line from Hercules Capital. With respect to why it has been increasing slightly over the last couple of quarters, there’s really three things contributing to that. Number one, that focus on stage again, we’re going after larger, later stage, more quality companies. The competitive environment for those deals tends to be a little bit more PIK-centric. So, we are utilizing a small amount of PIK in some of these later-stage transactions. That’s the first thing. Second thing, in a lot of our straight down the fairway deals, we do give some of our companies an option to toggle between cash and PIK to a small degree.

And so, as rates have stayed higher for longer, some companies are choosing to pay, for example, 1% of cash by transitioning that to 1.1% or 1.2% of PIK. And that’s really the second driver. And then, the third piece is just, we have selectively been utilizing PIK for a certain profile of transaction. I really don’t want to speak to what that is just from a competitive perspective, but on a small number of transactions, we’ve been utilizing PIK a little bit more aggressively. But we have limits and we do not intend to go above it.

Scott Bluestein: Yeah, I would just add one thing. From a balance sheet perspective, it’s less than 1% on our balance sheet, so it’s completely insignificant as far as the profile of the balance sheet.

Paul Johnson: Got it. Thanks. That’s very helpful. And then, just one more. But just, again, I think you’ve talked about this on your remarks, but the overall compression on just the core yields and the coupon rate on the portfolio, I assume that’s been driven by these same things we’re talking about, moving up the market, moving up higher in the cap structure, more first lien. But should investors just overall be expecting this to continue, tighter spreads, lower core yield on the portfolio as you continue to do so? Or kind of where would you expect that to trend here given the kind of compression over the last one to two quarters or so?

Scott Bluestein: Yeah. Thanks, Paul. So, a couple of things with respect to yield. First, each of those things that you just mentioned in the question have certainly contributed to some of that, but the biggest driver is actually the mix between prepayments and fundings. If you look at the prepayment activity that we’ve had over the last three to four quarters, the mix is largely centered around older legacy assets, where the core yield on those deals tends to be 14% to 16%. The new fundings that we’re putting on the books right now tend to be in the range of 13% to 14% core. And so, just that shift in mix in terms of the higher-yielding assets paying off, being replaced by new deals in that 13% to 14% core, are causing some of that slight degradation in terms of core yield.

The thing that we’re really managing to is solving for the ultimate GAAP yield that we can deliver. And if you look at the effective yield in the portfolio today at 14.7%, it is identical, just by way of example, to the 14.7% effective yield that we delivered in Q4 of 2022. And so, the goal for us is to make sure that we are delivering an above-market acceptable yield with appropriate spreads. And that’s what we’ve been able to do. Our expectation, per Seth’s updated guidance is that we will continue to see some small incremental degradation in terms of core yield, but we certainly don’t expect any material changes or decrease in core yield, obviously, barring any activity from the Fed.

Paul Johnson: Thank you very much. It’s very helpful. It’s all for me.

Operator: Thank you. And we have a follow-up from the line of Casey Alexander from Compass Point Research. Please proceed.

Casey Alexander: Yeah. I’m sorry, maybe I missed this, or maybe it was in the technical blackout, but can you discuss and give us an idea of what the situation is surrounding [Khoros] (ph), the company that was put on non-accrual this quarter?

Scott Bluestein: Sure. So, that is an ongoing active situation. Can’t provide a ton of color because it is a private company and we have certain confidentiality provisions. That is a loan that we have participated in with several other large BDCs and investment firms. We made the decision this quarter to impair that loan. So, Khoros has a cost basis of roughly $60 million, and we’ve impaired that down to about $32 million. And per your observation, we did also make the decision to put that loan on non-accrual this quarter. That’s largely based on two factors. Number one, we did believe that it warranted a significant collateral-based impairment, which means that our expectation, based on what we know today is that we will not have a full recovery on principal.

And then, the second component is that the cash coupon in that transaction has now transitioned to PIK, and so that investment is no longer paying cash income, which in our model, turns that into a non-accrual loan.

Casey Alexander: All right. Thanks. Very helpful.

Operator: Thank you. And I see no further questions in the queue. I will turn the call back to Scott Bluestein for closing remarks.

Scott Bluestein: Thank you, Carmen, and thanks to everyone for joining our call today. As a final note, we will be participating in the KBW BDC conference on October 2nd in New York. If you’re interested in meeting with us at this event, please contact KBW directly or Michael Hara. We look forward to reporting our progress on our Q3 2024 earnings call. Thanks, everybody, and have a great rest of the day.

Operator: And thank you all for participating in today’s conference. You may now disconnect.