Hercules Capital, Inc. 2026 Q3 Earnings Call

Good afternoon, everyone, and welcome to Hercules' conference call for the third quarter 2026. With us on the call today from Hercules are Scott Bluestein, CEO and Chief Investment Officer, Seth Meyer, President, and Andrew Olson, CFO. Hercules financial results released just after today's market close and can be accessed from Hercules Investor Relations section at investor.htgc.com. An archive webcast replay will be available on the investor relations webpage 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. And with that, I will turn the call.

Thank you, Michael, and thank you all for joining the Hercules Capital Q3 2026 earnings call. In the third quarter of 2026, Hercules delivered another strong quarter of operating performance, platform growth, strong seasonal originations, and stable credit. Our focus in Q3 remained consistent with what guided us during the first half of 2026. Disciplined and conservative new underwriting, maintaining a strong and flexible balance sheet, and being proactive in terms of managing credit. We were also able to further accelerate our efforts to expand the broader Hercules platform. Hercules Adviser LLC, our wholly owned registered investment adviser, surpassed $2.3 billion in investable capital during Q3. The milestone follows the closing of new commitments across several vehicles from a wide range of sophisticated global institutional investors, including insurance companies, pensions, asset managers, foundations and endowments, and family offices.

As of the end of Q3, our balance sheet and liquidity position is strong, our asset base is diversified, our credit performance remains stable, and our investment portfolio continued to generate net investment income in Q3 that comfortably covered our base shareholder distribution by 118%. Coming off a record-breaking first half for originations, our platform experienced healthy seasonal deal flow in Q3. For the first three quarters of 2026, we delivered record originations of $3.44 billion, an increase of 20% year-over-year, and record fundings of $1.93 billion, an increase of 9.9% year-over-year. The combined business activity in the first three quarters helped to deliver new records for total investment income and net investment income for the first three quarters of the year.

Driven by the continued growth of both the public BDC and our private credit funds business, Hercules Capital is now managing approximately $6.5 billion of assets, an increase of 17.7% from a year ago. We continue to manage our business and balance sheet conservatively while maintaining the flexibility to take advantage of market opportunities as they arise. This includes continuing to enhance our liquidity position as we did both during the quarter and subsequent to quarter end, remaining disciplined on new underwritings, staying focused on asset diversification, and maintaining our higher than normal first lien exposure, which was approximately 89% in Q3. Let me now recap some of the key highlights of our performance for Q3. In Q3, we originated total new debt and equity commitments of $701 million and gross fundings of over $572 million.

The focus of our origination efforts in Q3 was on maintaining a disciplined approach to capital deployment while emphasizing diversification across the asset base. Our Q3 new commitment activity was weighted slightly towards life sciences companies, while our fundings were weighted more towards our tech portfolio. In Q3, approximately 54% of our commitments and 48% of our fundings were to life sciences companies, while approximately 46% of our commitments and 52% of our fundings were to tech companies. We funded debt capital to 32 different companies in Q3, of which seven were new borrower relationships. During the quarter, we were able to opportunistically increase our commitments and fundings to several portfolio companies that have continued to demonstrate strong performance. Being able to continue to support our portfolio companies as they scale and expand their businesses is an important part of our model and a differentiator of our expanded platform capabilities.

Our available unfunded commitments decreased to $397.6 million from $408.2 million in Q2, still maintaining a more defensive positioning of the portfolio. Early loan repayments in Q3 were $148.3 million, which came in below the lower range of our guidance for the quarter. Approximately 44% of the repayments during the quarter came from M&A or balance sheet cash, which we believe speaks to the continued strength of our broader investment portfolio. Despite the market volatility this year to date through September 30, 2026, we have had over $946 million of early loan repayments, and we expect 2026 to be our strongest year on record for early loan repayments across the debt portfolio. For Q4 2026, we expect prepayments to normalize and be in the range of $200 million-$300 million, although this could change as we progress in the quarter.

Our expectation is that both total investment income and net investment income will increase in Q4, driven partly because of the expected normalization of prepayment activity during the current quarter. We anticipate strong originations in Q4, and we expect the originations to be more back-end weighted. Since the close of Q3, and as of October 26, 2026, our investment team has closed $219.6 million of new commitments and funded $89.2 million. We have pending commitments of an additional $571.7 million in signed non-binding term sheets, and we expect this number to continue to grow as we progress in Q4. Based on our performance to date and the current pipeline activity, 2026 is on pace to be another record year for the company in terms of both new commitments and new fundings, exceeding the previous records that we achieved in 2025.

In the current environment where cost of capital is higher than it has been in several years, capital is more difficult to raise and originations are larger and more complex. Scale, experience, and platform strength matter more than ever. Hercules Capital is benefiting from this dynamic. Across our existing portfolio, we are still seeing an abundance of attractive opportunities to provide new capital to existing portfolio companies that are meeting or exceeding expectations, and we expect this to again be a driver of our Q4 investment activity. We are also continuing to observe that a handful of lenders, both bank and non-bank, remain aggressive in terms of deal structure and pricing for new opportunities. We will remain disciplined and not chase the market in cases where we do not believe it makes sense for our shareholders. This strategy has always served us well.

Let me now provide an update on our portfolio and credit performance for Q3. Our asset base remains intentionally diversified with approximately 50% of our assets in our life sciences vertical and approximately 50% of our assets in our technology vertical. No single sub-sector makes up more than 25% of our total investment portfolio, and our debt investments are spread across 137 different companies with a combined fair value of $4.65 billion. In addition, we have warrants in 114 companies and equity investments in 73 companies. Combined, our warrant and equity investments make up approximately 4% of our investment portfolio. Approximately 98% of our debt investments are floating rate investments with a floor, and as of the end of Q3, nearly 60% of our prime base loans are at their contractual rate floor.

The decrease in the percentage of loans at their contractual floor was driven by the most recent Fed rate increase, which will be accretive to total investment income. Consistent with our historical experience, as of the end of Q3, the average loan duration across our debt portfolio was approximately 22 months. There has been a recent focus on loan vintages across the private credit space, so we wanted to provide some additional color on how that looks at Hercules Capital. Approximately 60% of our active loan book was funded between 2025 and 2026. Approximately 82% of our active loan book was funded between 2024 and 2026. That number rises to 90% if you include 2023 originations. In other words, the vast majority of our portfolio was underwritten and funded after the 2021/2022 peak in market valuations.

In Q3, PIK continued to decline as a percentage of total revenue, falling to approximately 7.5% from 8.3% in Q2. Approximately 85% of our Q3 PIK income came from PIK that was part of the original underwriting or PIK by design, where the PIK income came from loans that were rated 1, 2, or 3. We collected approximately $18.5 million in cash payments on accrued PIK during Q3. Year to date, as of September 30, 2026, we have collected $45.8 million in cash payments on accrued PIK income. Credit quality of the debt investment portfolio was stable quarter-over-quarter. Our weighted average internal credit rating in Q3 improved to 2.12, compared to the 2.17 rating in Q2, and remains well within our normal historical range. Our grade 1 and 2 credits increased to 68.6%, compared to 65.4% in Q2.

Grade 3 credits decreased to 30% in Q3 versus 32.7% in Q2. Our rated 4 credits decreased to 1.1% from 1.8% in Q2, and our rated 5 credits were at 0.3% versus 0.1% in Q2. Our rated 4 and 5 credits continue to make up less than 2%. In Q3, the number of companies with loans on non-accrual remained the same, with two loans on non-accrual with an investment cost and fair value of approximately $18.8 million and $13.2 million respectively, or 0.4% and 0.3% as a percentage of our total investment portfolio at cost and value, respectively. As of the most recent reporting that we have, 100% of our debt investments that were on accrual are current with respect to the payment of scheduled principal and interest.