Hercules Capital 2026 Q2 Earnings Call

Good afternoon, everyone, and welcome to the Hercules conference call for the second quarter of 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 were released just after today's market close and can be accessed from the 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. With that, I'll turn the call over to Scott.

Thank you, Michael, and thank you all for joining the Hercules Capital Q2 2026 earnings call. In the second quarter of 2026, Hercules delivered another strong quarter of record operating performance, strong originations, and stable credit. During the quarter, we continued to navigate through a period of general volatility, although the broader market backdrop improved relative to Q1. The three themes that guided us in Q1, disciplined and conservative new underwriting, maintaining a strong and flexible balance sheet, and being proactive in terms of managing credit, continued to be our focus in Q2. As of the end of Q2, our balance sheet and liquidity position is strong, our portfolio credit performance remains stable, and our investment portfolio continued to generate net investment income in Q2 that comfortably covered our base shareholder distribution by 125%.

Coming off a record-breaking Q1 for originations, our platform continued to see robust deal flow in Q2. For the first half of 2026, we delivered record originations of $2.74 billion, an increase of 35.6% year-over-year, and record fundings of $1.35 billion, an increase of 8.5% year-over-year. The combined business activity in the first half helped to deliver new records for total investment income and net investment income for the first six months of the year and in the second quarter. Driven by the continued growth of both the public BDC and our private capital is now managing approximately $6.1 billion of assets, an increase of 14.4% from a year ago. We are continuing to manage the 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 needed, remaining disciplined on new underwritings, staying focused on asset diversification, and maintaining our higher than normal first lien exposure, which was approximately 87% in Q2. Let me now recap some of the key highlights of our performance for Q2. In Q2, we originated total new debt and equity commitments of over $927 million and gross fundings of over $647 million. The focus of our origination efforts in Q2 was on maintaining a disciplined approach to capital deployment while emphasizing diversification across the asset base. Our Q2 new commitment activity was weighted slightly towards life sciences companies, while our fundings were weighted more towards our tech portfolio. In Q2, approximately 59% of our commitments and 45% of our fundings were to life sciences companies, while approximately 41% of our commitments and 55% of our fundings were to tech companies.

We funded debt capital to 39 different companies in Q2, of which nine 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 support our portfolio companies as they scale and expand their businesses is an important part of our model and a key differentiator of our expanded platform capabilities. Our available unfunded commitments increased slightly to $408.2 million from $397.4 million in Q1, still maintaining a more defensive positioning of the portfolio. Early loan repayments in Q2 were $572.1 million, which exceeded the upper range of our guidance for the quarter. Approximately 60% 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.

The increased level of prepayments in Q2 positions us well to be able to redeploy this capital in what we expect to continue to be a more favorable originations environment. For Q3 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. Consistent with our prior history, we expect originations to be seasonally lower in Q3 and be more back-end weighted. Since the close of Q2, and as of July 27, 2026, our investment team has closed $149.3 million of new commitments and funded $112.5 million. We have pending commitments of an additional $70 million in signed non-binding term sheets, and we expect this number to continue to grow as we progress in Q3.

Across our existing portfolio, we are continuing to see an abundance of attractive opportunities to provide new capital to existing exceeding expectations. We expect this to again be a driver of our Q3 investment activity. Recently, we have also observed that a handful of lenders, both bank and non-bank, are being very aggressive in terms of deal structures for new opportunities. This is something that we will monitor, but our decision will be to stay disciplined and not chase the market in cases where we do not believe it makes sense for our shareholders and stakeholders. Let me now provide an update on our portfolio and credit performance for Q2. 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. Our debt investments are spread across 136 different companies with a combined fair value of $4.4 billion in the BDC. In addition, we have warrants in 117 companies and equity investments in 73 companies. Combined, our warrant and equity investments make up approximately 4.5% of our investment portfolio. 98% of our debt investments are floating rate investments with a floor, and as of the end of Q2, 75% of our prime based loans are already at their contractual rate floor. Consistent with our historical experience as of the end of Q2, the average loan duration across our debt portfolio was approximately 21 months. In Q2, PIK continued to decline as a percentage of total revenue, falling to approximately 8.3% from 9.1% in Q1.

Approximately 87% of our Q2 PIK income came from PIK that was part of the original underwriting, or as we refer to it, PIK by design. More than 93% of our Q2 PIK income came from loans that were rated 1, 2, or 3. Excluding a single convertible loan, every loan with a PIK component on accrual status is also paying cash interest. We collected approximately $12 million in cash payments on accrued PIK during Q2. That same trend has continued subsequent to quarter end, where we have collected an additional $12.6 million in cash payments on accrued PIK as of July 27, 2026. Year to date through July 27, 2026, we have now collected $39.9 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 of 2.17 slightly increased compared to the 2.11 rating in Q1 and remains well within our normal historical range. Our grade 1 and 2 credits decreased to 65.4% compared to 70.5% in Q1. Grade 3 credits increased to 32.7% in Q2 versus 28.6% in Q1. Our rated 4 credits increased to 1.8% from 0.8% in Q1, and our rated 5 credits were at 0.1% for both quarters. Our rated 4 and 5 credits continue to make up less than 2% of the portfolio fair value. In Q2, the number of companies with loans on non-accrual increased by one to two loans on non-accrual with an investment cost and fair value of approximately $16 million and $5.5 million respectively, or 0.3% and 0.1% 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 are on accrual are current with respect to the payment of scheduled principal and interest. After quarter end, our teams successfully completed new non-accrual loan in Q2. The result was a cash recovery that was approximately $1 million in excess of our Q2 fair value mark, and a positive realized IRR on the investment. With respect to our broader credit book and outlook, we generally remain pleased by what we are seeing on a portfolio level. Our portfolio monitoring remains enhanced given the continued volatility we are seeing in the markets. While the exit activity that we saw in our portfolio remained strong during the quarter and through the first half of the year, we are continuing to note that in certain parts of the market, M&A valuations and process timing are less certain.

This is something that we will continue to monitor over the coming quarters. Year to date, as of today, we've had 12 M&A events and two IPOs in our portfolio. Based on current market conditions, we continue to expect M&A exit activity to continue at these levels in the second half of 2026. After quarter end, and as of July 27, 2026, we have already had three M&A events close. Venture capital investment activity in Q2 continued to demonstrate robust levels of investing. Investment activity came in at $143.9 billion for the second quarter, according to data gathered by PitchBook NVCA. The VC market in the first half of 2026 reached unprecedented levels, with $412.7 billion deployed, already exceeding the entire 2025 full year figure by nearly 30%. AI defines the venture landscape, capturing nearly 86% of all first half 2026 deal value.