Good day, and thank you for standing by. Welcome to the Hercules Q1 2023 Earnings Conference Call. At this time, all participants are in listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand over the conference to today's speaker, Michael Hara, Managing Director of Investor Relations. Please go ahead, Michael.

Thank you, Mark. Good afternoon, everyone, and welcome to Hercules' conference call for the first quarter 2023. 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 when making investment decisions. 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. And with that, I'll turn the call over to Scott.

Thank you, Michael, and thank you all for joining the Hercules Capital Q1 2023 Earnings Call. Following our record operating performance in 2022 and despite a volatile market backdrop, partially driven by the failure of our largest competitor in the asset class, Hercules Capital delivered another quarter of record operating performance in Q1. Our ability to consistently deliver strong results speaks to the quality of our employees, the strength of the platform that we have built and our 18-plus year history of operating with an emphasis on prudent underwriting, asset and liability diversification, and an unwavering commitment to the venture and growth stage ecosystem that we service. Building a venture and growth stage lending business that operates at scale and consistently delivers strong credit and financial performance does not come easily or by accident. Since inception in 2003 and throughout our history, we have focused on sticking with our steadfast core principles: steady, patient and disciplined underwriting, diversifying and strengthening both sides of our balance sheet, maintaining strong liquidity and continuously investing in our team and systems. From the beginning of 2021, our platform has raised more than $2.5 billion in new capital and significantly increased our credit facilities with better flexibility and terms. We further enhanced and expanded our reach and capabilities with the creation of our wholly-owned RIA, which manages our three private funds. And now with the unexpected changes in our competitive environment in Q1, we are presented with a tremendous opportunity that we believe will grow our presence and further strengthen our leadership position in the venture and growth stage lending landscape. The current market requires a combination of playing skillfully and selectively on offense in terms of new business and a disciplined and tight defense on credit. We intend to do both, and we believe that we are uniquely positioned to be able to do so successfully. Q1 was another quarter of investment in the company where we took additional steps to strengthen our platform, originations capabilities, back office functionality, and sophistication. We added talent across the organization and now have an excess of 105 full-time employees. During the quarter, we also established a new private credit fund vehicle and raised additional capital to enhance liquidity in the BDC. As of the end of Q1, we manage more than $3.9 billion of assets across our platform, an increase of 33.2% year-over-year. The investments that we have made provide us with continuing optimism and confidence in the trajectory of our business for the remainder of 2023. Let me recap some of the key highlights of our performance for Q1. We started out 2023 with record gross fundings for our first quarter with over $476 million, which led to strong net debt investment portfolio growth of over $153 million. This is the fifth consecutive quarter that we have been able to deliver in excess of $100 million of quarterly net debt investment portfolio growth, which positions us favorably to be able to continue to drive earnings momentum in 2023. Our Q1 originations activity was driven by both our technology and life sciences teams, delivering strong funding performance during the quarter. Our funding activity demonstrated balance between our two core verticals, while our new commitments were weighted slightly more towards technology companies. We funded debt capital to 31 different companies in Q1, of which nine were new borrower relationships. Consistent with what we saw throughout 2022, we were again able to expand our funding relationship with numerous portfolio companies that continued to show strength and achieve performance milestones during the quarter. In Q1, we were also able to provide new commitments to six current borrowers, which strengthens our incumbency position in several strong companies. We expect this trend of increased follow-on fundings to existing portfolio companies to continue in 2023. The momentum that we saw throughout 2022 in terms of originations accelerated in Q1 following the failure of SVB and general turmoil across the regional bank landscape. We intend to use our experience and best-in-class underwriting acumen to selectively target the best opportunities that present themselves and avoid the many marginal deals that we are currently seeing. Given our strong funding performance in Q1, we expect funding activity to be weighted towards the second half of Q2. Since the close of Q1 and as of May 02, 2023, our deal team has closed one million of new commitments and funded 3.9 million. We have pending commitments of an additional $510 million in signed non-binding term sheets. We expect deal quality and terms to continue to get better as the year plays out, and our balance sheet and liquidity is positioned favorably to be able to benefit from this. Volatility across the equity and credit markets increased in Q1, particularly in the financial markets, due to the SVB situation. Valuations for both public and private companies remain under pressure and the capital markets have stayed more selective on the equity side. Given the dislocation created, we recently established a new credit lending program to provide capital to help the disrupted companies navigate the challenges from the recent market events. Consistent with our historical approach to underwriting credit, we will remain patient and disciplined on these new opportunities and we will always prioritize credit quality over chasing higher risk transactions with a yield premium. Hercules has always maintained a credit-first culture, and we expect this to continue to serve us well, particularly in periods of volatility. During Q1, portfolio company exits and liquidity events for the industry continued to reflect the ongoing pressure in the equity and broader financial markets. Having said that, during Q1, our investment portfolio continued to exhibit strong M&A activity, with eight M&A transactions closing in the first quarter. We had one additional new M&A transaction in Q1, which was Sanofi's announced acquisition of Provention Bio, which was announced in March and subsequently closed on April 27. The previously announced acquisition of Oak Street also closed on May 01. In addition, this week Iveric Bio announced that they have entered into a definitive agreement to be acquired by Astellas Pharma and we added one new confidential IPO submission, giving us two in the current pipeline. We continue to expect to see strong M&A activity across our portfolio in the quarters to come, which validates the great work and selective underwriting that our investment teams do. As we anticipated, early loan repayments increased further in Q1 to approximately $202 million, slightly above our guidance of $150 million to $200 million, and an increase from $131 million in Q4 2022. For Q2 2023, driven in large part by M&A, we expect prepayments to increase further to between $225 million and $320 million, although this could change as we progress in the quarter. The increasing levels of prepayments over the last several quarters, despite the market volatility, reflect the quality of our loan portfolio as well as our team's ability to continue to identify and target the most promising growth-stage companies in the market. In Q1, we generated record total investment income of $105.1 million and record net investment income of $65.5 million or $0.48 per share, providing 123% coverage of our base distribution of $0.39 per share. This is our second consecutive quarter of delivering record net investment income, and we expect that trend to continue in Q2. Our portfolio generated a GAAP effective yield of 15.1% in Q1 and a core yield of 14%, which is indicative of the recent rate increases and higher onboarding yields for certain new loans. With net regulatory leverage at a very conservative 99.2% and continued robust liquidity across our platform, our balance sheet remains very well positioned. Credit quality of the debt investment portfolio remains strong and stable. Our weighted average internal credit rating of 2.26 was slightly higher than the 2.23 rating in Q4 but still at the low end of our normal historical range. Our grade one and grade two credits slightly decreased to 59.8% compared to 61.5% in Q4. Grade three credits were slightly higher at 37.1% in Q1 versus 36.3% in Q4. Our rated four credits made up 3.1% of the portfolio and rated five credits were 0% in Q1. As of the end of Q1, we have the same two debt investments on non-accrual with an investment cost and fair value of approximately $17.9 million and $1.2 million respectively, or 0.6% and 0.0% as a percentage of the company's total investment portfolio at cost and value respectively. Our consistent and strong credit performance is a result of our emphasis on diversification and credit discipline as key cornerstones of our investment strategy. We have increased and enhanced our portfolio-level monitoring as a result of the banking turmoil witnessed in Q1, and we continue to be pleased by what we are seeing on the credit side of our business. As of the end of Q1, approximately 82% of our debt investment portfolio is in senior secured first lien positions, up from approximately 73% a year ago. Despite the decline in valuations for many growth-stage companies over the last 12-plus months, as of the end of Q1, the median loan-to-value across our debt investment portfolio was approximately 8%, and the weighted average loan-to-value across our debt investment portfolio was approximately 18%. This defensive portfolio positioning gives us confidence in our ability to continue to deliver strong credit performance. For our portfolio companies, having ample liquidity and the ability to raise additional capital when needed are two important factors that we closely monitor. Despite more selectivity and valuation sensitivity from venture capital investors, capital raising across our portfolio remained strong in Q1, with 23 companies raising nearly $1 billion in new capital in the first quarter. As a result of the recent market volatility, we wanted to provide a brief update on what we are seeing across our portfolio in terms of liquidity. When looking at our entire outstanding debt investment portfolio, inclusive of contractually committed funding facilities from existing equity investors, we estimate that approximately 71% of our portfolio currently has 12-plus months of liquidity with another 18% with six to 12 months of current liquidity on balance sheet. Loans that have three months or less of liquidity make up approximately 0.3% of our outstanding debt portfolio, while approximately 41% of our outstanding debt portfolio currently has 18-plus months of liquidity. During Q1, Hercules had net realized gains of $8 million. This was comprised of net realized gains of $8.4 million due to the sale of equity investments and gains on foreign exchange, offset by $400,000 due to the write-off of warrant positions. We ended Q1 with strong liquidity of over $553 million. Inclusive of available liquidity in our private funds, we have approximately $1 billion of liquidity as of the end of Q1. During the first quarter, we increased our letter of credit facility with SMBC from $100 million to $175 million. This was done to best position us to take advantage of the better quality later-stage transactions with potentially higher unfunded commitments that we are currently seeing as a result of the banking market turmoil. The turmoil in the venture capital ecosystem during the quarter affected both fundraising and investment activity at more muted levels at $11.7 billion and investment activity at $37 billion, respectively. With the amount of capital available to invest at historic highs, exceeding $0.5 trillion entering 2023, we expect fundraising to stay at much lower levels than prior years and investment activity to pick up as the year goes on. We exited Q1 with undistributed earnings spillover of over $133 million or $0.96 per share. The undistributed earnings spillover continues to provide us with the added flexibility with respect to our shareholder distributions going forward and the ability to continue to invest in our team and platform. For Q1, we maintained our base distribution at $0.39 and declared a supplemental distribution of $0.08 for a total of $0.47 of shareholder distributions. This was our 11th consecutive quarter of being able to pay out a supplemental distribution to our shareholders. In closing, our strong growth and performance continued in Q1 and has elevated our earnings power to historic highs. We remain optimistic about our business opportunities given how well we are competitively positioned to take advantage of market conditions and grow our core income-generating assets, and as a result, the earnings power of the business. Our core themes for 2023 will largely remain consistent with 2022, and they reflect maintaining a strong balance sheet and liquidity position and staying selective and disciplined on new underwritings while continuing to invest in our teams and our platform. 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.

Thank you, Scott, and good afternoon, ladies and gentlemen. Hercules' first quarter performance was a great way to kick off 2023. The portfolio growth was complemented by strengthening our balance sheet to support our current and anticipated growth. In the first quarter, we renewed the $400 million MUFG credit facility, executed and subsequently increased the SMBC letter of credit facility from $100 million to a total of $175 million, and took advantage of the ATM by raising $65 million of accretive capital. We continue to maintain strong available liquidity of $553 million as of the quarter end, more than $120 million higher than what we maintained just a year ago. Despite the increase in our ready-to-access credit facilities, more than 80% of our leverage is fixed rate and 73% is unsecured, helping us keep financing costs low and optionality high. We continue to explore more cost-effective ways to manage our liquidity needs as the opportunities to invest increase while maintaining our consistent credit and return standards. We've positioned ourselves well to continue scaling our platform, most recently by adding additional capital managed by our wholly owned RIA. As previously communicated, we expect the RIA to move beyond expense relief for the BDC and start delivering dividends to the BDC later this year and further enhance our returns to our shareholders. With these points in mind, let's review the following areas: the income statement performance and highlights, NAV unrealized and realized activity, leverage and liquidity, and the financial outlook. Starting with the income statement performance and highlights. This was the second quarter in a row that total investment income exceeded $100 million at $105.1 million, driven by the prior year and current quarter growth in the debt portfolio on solid new business underwriting and an increase in benchmark rates. Net investment income was another record at $65.5 million, a 5.4% quarter-over-quarter increase or a record $0.48 per share NII in Q1. Our effective and core yields in the first quarter were 15.1% and 14%, respectively, compared to 14.7% and 13.8% in the prior quarter. The increase in the core yield was due to an increase in coupon interest as a result of benchmark rate increases. We're forecasting a leveling of our core yield hereafter due to expected little to no movement from the Fed in the coming quarters. Turning to expenses. Our gross operating expenses for the quarter increased to $42.3 million compared to $40 million in the prior quarter. Net of costs recharged to the RIA, our operating expenses were $39.6 million. Interest expense and fees increased to $19 million from $18 million in the prior quarter due to the growth of the investment portfolio and slightly higher weighted average cost of debt. SG&A expenses increased to $23.3 million from $22 million in the prior quarter, slightly above my guidance on higher funding for the quarter versus our forecast. Net of cost recharge to the RIA, the SG&A expenses were at $20.6 million. Our weighted average cost of debt was 4.7%, a slight increase compared to the prior quarter, reflecting a greater utilization of the credit facilities due to the growth of the investment portfolio. Our ROAE or NII over average equity increased to 18.8% for the first quarter. And our ROAA or NII over average total assets was 8.9%. Switching to NAV unrealized and realized activity. During the quarter, our NAV increased $0.29 per share to $10.82 per share. This represented an NAV per share increase of 2.8% quarter-over-quarter. The main drivers for the increase were the net change in unrealized appreciation of $21.1 million, net of reversals of prior unrealized appreciation of $8.1 million, mainly due to investments disposed or written off, net investment income, and accretion due to the ATM sales offset by dividends paid in the quarter, including the supplemental distribution. Our $21.1 million of unrealized appreciation was primarily driven by $22 million of appreciation to the loan portfolio, approximately half of which relates to valuing certain investments at expected proceeds due to the portfolio company's intention to prepay the loans before maturity. This correlates with our increased prepayment guidance for Q2. The reversal of prior unrealized appreciation resulted in a net realized gain of $8 million comprised of net realized gains of $8.4 million due to the sale of equity investments and gains on foreign exchange, offset by $0.4 million due to the write-off and other realizations of warrants. Moving to leverage and liquidity. Our GAAP and regulatory leverage were 115.6% and 103.9%, respectively, which slightly increased compared to the prior quarter due to maintaining a higher cash balance over the quarter end. Netting out leverage with cash on the balance sheet, our net GAAP and regulatory leverage positions decreased to 110.9% and 99.2%, respectively. As mentioned, we ended the quarter with $553 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 has nearly $1 billion of available liquidity. We believe our strong and flexible liquidity positions us well in the current operating environment. With the Q1 renewal of the MUFG facility and the increase in the SMBC letter of credit facility, we have no near-term debt maturities, giving us the ability to be opportunistic should we decide to raise additional capital to support the business. We continue to opportunistically access the ATM market during the quarter and raised approximately $65 million, resulting in an $0.11 accretion to NAV. Following the quarter end, we have raised another $48 million, further strengthening our liquidity position to support very strong new business demand and ensuring our leverage remains within the target range. Finally, the outlook points: For the remainder of 2023, we expect our core yield range to be at 13.8% to 14.2%. As a reminder, 95% of our debt portfolio is floating with a floor, so the recent interest rate hike and any additional in 2023 will benefit our core yield going forward. Although very difficult to predict, as communicated by Scott, we expect $225 million to $325 million in prepayment activity in the second quarter. We expect our second quarter interest expense to increase compared to the prior quarter due to the balance sheet growth experienced in the first quarter. For the second quarter, we expect our SG&A expenses to be $22 million to $23 million and RIA expense allocation of approximately $2 million to $2.5 million. In closing, the steps we have taken to strengthen our balance sheet and continuing to scale our platform ensure that we're well positioned for the remainder of 2023. I will now turn the call over to the operator to begin the Q&A part of our call. Mark, over to you.

Our question will come from John Hecht from Jefferies.

Congratulations on achieving a solid and stable quarter in such an uncertain environment. Scott, you mentioned the sale of SVB to First Citizens and the resulting opportunities and disruptions in the market. I would like to take a step back and ask how First Citizens plans to operate SVB moving forward from your perspective. If there are any changes, how will that impact the ecosystem you operate in? Additionally, what does that mean in terms of opportunities or challenges for your portfolio companies, and how could this create opportunities for Hercules in the long run?

Sure. Thanks, John. A couple of things. We can't speak to what First Citizens will or won't do, but certainly I want to take a minute to maybe make a couple of comments on the SVB situation. The first thing that I want to say is that what happened to SVB in Q1 certainly from our perspective had absolutely nothing to do with the health or vibrancy of the venture ecosystem. And it certainly had nothing to do with the credit quality of their venture lending book. What happened to Silicon Valley Bank in the first quarter was a result of a mismatch in terms of their asset and liability management, which created significant pressure from a deposit perspective. We as an organization have tremendous respect for that team and for the SVB business. SVB was an instrumental part of the ecosystem for the last 40 years. As a firm, we are saddened by the failure of the bank, and we obviously feel terribly for the approximately 10,000 employees of the bank. Having said that, we view what happened to SVB in the first quarter as a tremendous opportunity for HTGC. You saw some of the early impact of that positivity in terms of our Q1 numbers. You're seeing more of that impact now in our pipeline numbers that were publicly reported in our press release, where we have over $500 million of signed term sheets. The quality of our pipeline since the SVB failure has continued to grow both in terms of size and in terms of quality. We look at the opportunity realistically, and we also view it as an opportunity for us to honor our 18-plus year commitment to helping fund the companies that make up the venture and growth stage ecosystem. We are very well positioned. We believe we are the only lender in the venture lending space positioned to be able to aggressively take advantage of the opportunity that has been created by SVB's exit from the market.

I know there are some smaller venture lenders out there, but I'm not very familiar with their liquidity positions since I'm not closely monitoring them. However, I believe they are experiencing strained liquidity, especially compared to your situation. So the question is, aside from SVB, is the competitive market also improving? Are other market participants weakened by the current circumstances while you are gaining strength?

We are definitely observing some signs of stress in the venture lending market, not only regarding SVB but also involving other players. I can only share insights about our own position, and I assure you that we are in a strong position. Our business has always been managed with a conservative balance sheet. At the end of Q1, we had a net regulatory leverage of less than 100%. We finished Q1 with more than $550 million in liquidity in the BDC and over $1 billion in available liquidity across the HTGC platform. We have made significant investments in our team, systems, and infrastructure over the past couple of years, and we currently employ over 105 full-time staff. We brought in considerable new talent in Q1 and plan to continue taking necessary actions to ensure we can seize opportunities left by SVB and possibly others.

And our next question will come from Crispin Love with Piper Sandler.

Scott, you said early in the prepared remarks that you're avoiding marginal deals that you're currently seeing. Can you just expand a little bit on that, on what you're seeing currently? And then just also speak to your confidence on closed funding accelerating in the back half of the second quarter.

Sure. I'm not going to say too much, Crispin, with respect to what exactly we're seeing on the marginal deal front because obviously, we're avoiding those deals. I'll make a general comment, which is that our pipeline right now continues to be at record levels. Our investment team, which is now comprised of about 56 to 57 full-time employees, is screening, seeing, evaluating and looking at a record number of transactions. The vast majority of the transactions that we are seeing are simply not transactions that meet our credit underwriting screens, and we're passing on those. And I will tell you, we continue to see many of those deals get done in the market, and we'll have to see over the next couple of quarters how that plays out. We are being very selective in terms of new business. We have the balance sheet to be able to be aggressive on new business when and where we want to be. But the single most important part of our new business effort right now is on making sure that the credit quality is strong and that it meets our very tight underwriting parameters.

And then just on credit, and specifically, one of your portfolio companies, Codiak BioSciences. So they filed for bankruptcy in late March, which is out there publicly. So I'm just curious on what type of recovery you might expect there. Just looking at their balance sheet, they had a little over $50 million of cash as the third quarter, and that compared to your $25 million loan, which looks to be about a $17.5 million principal now. So unclear what their cash burn has been since the third quarter just given disclosures. But curious if you're confident on a full recovery there based on their cash position or anything else worth pointing out?

Sure. Thanks, Crispin. As you pointed out, we do have one company out of about 120 debt positions that did file for bankruptcy at the end of Q1. Bankruptcy for us as a senior secured first lien creditor does not mean that we are going to have a loss on that position. When the company filed, we had $25 million of principal outstanding. Subsequent to the filing, we have worked cooperatively and constructively with the company, with the advisers and with the investors. We have already received $10 million of cash paydowns. So that $25 million principal loan has been reduced to $15 million. The company remains 100% current through the May 1 date on all payments of principal and interest to Hercules. The company has a vast pool of assets that they are currently looking to monetize, obviously in consultation with Hercules and their advisers. While there are no guarantees in any of these situations, we feel very good about the ultimate recovery of that position. I would also say that for us, what we just said is not just words. We have a very long track record of being able to navigate through challenging workouts and bankruptcy situations. If you look at the last several workouts and bankruptcies that we, as an organization, have had, we have had very strong recoveries, and we're not seeing anything with respect to Codiak specifically that we believe will lead to a different outcome.

And our next question will come from Kevin Fultz, JMP Securities.

My first question might sound familiar from another BDC earnings call, but I wanted to get your point of view as well. I know you closely review the PitchBook NBCA venture monitor, and there is a figure in the 1Q '23 report that highlights the funding gap that has recently accelerated within late-stage VC. Essentially, the figure shows that the late-stage capital demand to supply ratio has reached a decade high in the first quarter of 2023 at just above 3.2x, which compares to 0.9x in the first quarter. I'm just curious what your view is on the shift in capital availability for late-stage companies, both what you're seeing in the market and within your own portfolio, and also what that could mean in terms of venture stage companies' ability to raise additional capital.

Sure. Thanks for the comment and the question, Kevin. A couple of comments there. There absolutely remains a significant amount of capital on the sidelines, which is available for late-stage companies. What we are seeing, and what I think equity investors are seeing, is that there continues to be a disconnect from a valuation perspective with respect to where the venture capital firms want to be on valuation and where management teams and entrepreneurs want to be on valuation. The capital that is sitting on the sidelines for the most part is not going away. That capital will be there in Q2. It will be there in Q3. It will be there in Q4. What typically happens during these periods is there's a period of sort of a slow delicate dance. At some point, the valuations will meet and these deals will start to get done. The other comment that I would make with respect to sort of the broader data that we're seeing from NBCA and PitchBook is, although the Q1 data with respect to VC equity investments was down materially, I think sort of the folks that are out there thinking that this is a sort of a dark winter and the worst period that we've seen, at least it doesn't add up with our view of the market. In Q1 of 2023, there were approximately 2,856 companies that received venture funding, and the venture funding in Q1 totaled approximately $37 billion. When you compare that to what the market was able to achieve between 2020 and 2022, so during the COVID period, the numbers are down materially. But if you compare that to the numbers between 2012 and 2019, which we view as sort of the steady state of the market, those numbers were approximately 3,900 deals per year and approximately $70 billion invested. So on a comparative basis to what we view as the normal market, the numbers in Q1, although down materially, were still fairly healthy. And that's the way that we are currently viewing the market.

And then just one more, if I can. I'm curious if current market conditions are presenting the opportunity to scale the private funds in RIA at a more accelerated rate than you initially anticipated?

Absolutely. And I would reiterate what we said on the last call, which is we continue to expect to be able to begin the dividend distributions from the RIA up to the BDC in the second half of this year. So not only will the shareholders of HTGC be benefiting from the expense reimbursement, but we expect in the second half of this year for our shareholders to begin to benefit from distributions from the RIA business up to the BDC. There is tremendous momentum for us, not just in the BDC, but also in the private fund business. If you look at what we announced most recently, we did launch a new private vehicle, which is specifically designed to take advantage of the market dislocation that we're currently seeing. We deployed a significant amount of capital in the private funds in Q1; that was about $121 million of fundings and that's on top of about $400 million that we funded in the private fund business last year alone.

Our next question will come from Christopher Nolan with Ladenburg Thalmann.

Scott, strategically, two things and just a follow-up on the earlier question. Would you consider participating in a new bank targeting the venture capital space?

The answer to that is no. We're not in the banking business. We think that our business works better without being tied into relying on deposits. And so the answer would be no.

Second question is how do you think AI is going to affect the VC lending business?

AI is something that we're obviously watching very closely. We think that there are positive scenarios and then, of course, negative scenarios as well. We're looking at it pretty optimistically. We think that AI has the ability to further accelerate innovation across the technology and life sciences landscape. Every few years, there's new innovation that is disruptive. AI is sort of the current phenomenon. While we do have some concerns about the impact that AI could have on certain businesses, overall, we're actually pretty optimistic about what AI will mean for the overall health of the innovative economy.

Our next question will come from Casey Alexander Compass Point Research & Trading.

Scott, you described SVB, Silicon Valley Bank, as a competitor. But in many ways, they were also a partner to you and you guys had joint positions with companies. I'm curious from your seat, what opportunities does that create for you to take a more senior position in the lending stack with those companies and also hammer down your incumbency position with those companies? And then secondly, with Silicon Valley Bank, there's been a lot of migration of talent that has gone around. Has Hercules been able to make any key hires that have been able to take advantage of some of the dispersion of that talent?

Sure. A couple of great questions, Casey, and thanks for your questions there. First thing, with respect to the partnership, I mentioned a collaborative and competitive relationship. I would tell you that over the years, Silicon Valley Bank was a great partner of ours in helping us finance many great companies across the venture capital ecosystem. We have a pretty high bar in terms of who we will partner with, and SVB was one of the few firms that we were comfortable partnering with in terms of the market, both on the life sciences and technology side. Having said that, as you just pointed out, that creates a tremendous opportunity for us given that we do have a handful of partner deals with the bank to be able to do something strategically to help lock down our incumbency position. I will also say that with respect to those partner deals, to date, First Citizens has honored 100% of the commitments across our portfolio. First Citizens continues to fund those companies that we are partnered on, and we don't expect any negative disruption in that regard, but there is certainly an opportunity for us to continue to take some added market share with respect to not just those deals that we were partnered on currently but that we were contemplating partnering with them prior to the situation that developed in Q1. With respect to talent, in my opening remarks, I made the comment that we have tremendous respect for the SVB business and that team. There were a handful of employees that we identified that we thought would fit in very well with the Hercules culture and team. We have made a handful of hires from SVB over the course of the last 30 to 60 days, and we're very pleased with what we've seen to date from that group of employees.

My other follow-on question is there were gross fundings of $476 million, and you called out 9 new borrowers out of 31 companies, so 22 borrowers were existing borrowers. Out of that $476 million, can you tell us how much was drawn down off of the unfunded commitments as opposed to being direct originations?

Sure. I can give you the breakdown. Roughly $476 million of fundings in the quarter, about $185 million of the fundings were new fundings to new companies. Approximately $150 million of the fundings were new fundings as part of new commitments to existing portfolio companies, and approximately $140 million were fundings from unfunded commitments.

Our next question will come from Finian O'Shea of Wells Fargo.

Can you provide us any detail on what the new private fund means for Hercules' economics and if it's part of the RIA or a separate vehicle?

So the new fund will, in the same way as the first two funds, provide a management fee and performance fee to the RIA. So yes, to answer your second part of your question, it is part of the existing RIA fund. It will provide expense relief in the immediate term. As it builds up the portfolio, it will start to generate those revenues from the management and performance fees, which will then eventually turn into additional dividends that come up to the BDC.

And Fin, I'll just add to that. When we launched the private fund business about two and a half years ago, we made a commitment publicly and privately that 100% of the benefit from that private fund business would accrete to the benefit of HTGC's public shareholders, and we remain committed to that commitment. Anything that we do in the private fund business will be under the RIA, which is a wholly owned subsidiary of the public BDC.

Our next question comes from Ryan Lynch with KBW.

First one I had is you mentioned a lot of the details around the SVB collapse and kind of the aftermath on that as far as the opportunity set goes. I was just curious if you could talk about post the collapse of SVB, has there been any sort of shift in investor sentiment or action from the DC equity investors and their willingness to support the existing companies, just broadly in the VC marketplace? Obviously, the trends have been getting worse as far as the level of investment activity has been kind of going lower for the last several quarters. But I just wasn't sure if you've seen any sort of acceleration of those trends post SVB or not.

Thanks, Ryan. I don't think we've seen any acceleration necessarily. Obviously, what happened with Silicon Valley Bank was a surprise to the vast majority of the ecosystem. I think for the first couple of weeks post-failure, a lot of people on the equity side and on the credit side were sort of just taking a step back to catch their breath and figure out what just happened. Obviously, subsequent to SVB, there has been some additional turmoil, First Republic, and obviously some additional regional banks that are currently exploring strategic options. So I don't think there's anything specific in terms of an acceleration that we saw post-SVB. The equity markets right now and the credit markets continue to be volatile. There's a lot of uncertainty. We continue to focus on what we can control, and that is ensuring that our credit portfolio continues to outperform, that our BDC continues to be incredibly well positioned and conservatively managed. We believe that puts us in a great position to be able to benefit and take advantage of whatever the opportunity set is over the next couple of quarters.

And the other question I had, you mentioned repair account is about $22 million of appreciation in your loan book. I think you said half of it was due to companies expected to prepay. Can you talk about what drove the other half of the appreciation? And then also in your press release, you talked about $4.7 million of unrealized depreciation related to privately held equity warrants and investment funds. Can you talk about what was the driver behind there? Were some of your portfolio companies doing up rounds in this marketplace that revalued some of those equity warrant positions or what drove that $5 million?

Sure. Thanks. As you know, each quarter we revalue our entire portfolio. We make individual adjustments for our portfolio companies based on how they perform against our original underwriting plan. For companies that are doing better—perhaps they are raising capital more quickly or advancing faster through the FDA approval process—we will slightly adjust their valuations, including both debt and equity positions if they are private. We also conduct a market yield analysis against a benchmark portfolio, specifically the SMI index, to see how we should adjust the overall portfolio considering benchmark interest rates. The appreciation you mentioned, related to the early repayments, is mainly driven by that performance. The impairments have remained quite stable, as we only have two non-accrual loans with minimal adjustments in valuation. Overall, the portfolio is performing better than our market-adjusted writing thesis. It's important to note that 95% of our portfolio is floating with a floor, so we are not seeing reductions in value despite rising benchmark interest rates. That addresses the debt portfolio. Scott, would you like to discuss the private equities?

Sure. Ryan, with respect to the $4.7 million of unrealized appreciation on the private equity and warrant positions, the substantial majority of that appreciation came from an up valuation with respect to Hercules Advisor, which is the wholly owned registered investment adviser. That was a result of two things: one, we raised and we launched the new fund and we continued growth with respect to the AUM in the first two private funds.

At this time, I would like to turn it back over to Scott for closing remarks.

Thank you, Mark, and thanks to everyone for joining our call today. We look forward to reporting our progress on our Q2 2023 earnings call. Thank you all, and have a great day.

Thank you, everybody, for your participation in today's conference. This concludes the program. You may now disconnect.