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Hercules Technology Growth Capital (NYSE:HTGC)
Q3 2019 Earnings Call
Oct 30, 2019, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Hercules Capital Q3 2019 earnings conference call. [Operator instructions] Please be advised that today's conference is being recorded. [Operator instructions] I would now like to hand the conference over to your speaker today, Mr. Michael Hara, managing director of investor relations.

Thank you. Please go ahead, sir.

Michael Hara -- Managing Director of Investor Relations

Thank you, Paul. Good afternoon, everyone, and welcome to Hercules' conference call for the third quarter of 2019. With us on the call today from Hercules are Scott Bluestein, chief executive officer and chief investment officer; and Seth Meyer, chief financial officer. Hercules' third-quarter 2019 financial results were released just after today's market close and can be accessed from the Hercules' Investor Relations section at htgc.com.

We have arranged for a replay of the call at Hercules' web page or by using the telephone number and passcode provided in today's earnings release. During this call, we may make forward-looking statements based on current expectations. Actual financial results filed with the Securities and Exchange Commission may differ from those contained herein due to timing delays between the date of this release and in the confirmation of the final audit results. In addition, the statements contained in this release that are not purely historical are forward-looking statements.

These forward-looking statements are not guarantees of future performance and are subject to uncertainties and other factors that could cause actual results to differ materially from those expressed in the forward-looking statements, including, and without limitation, the risks and uncertainties, including the uncertainty surrounding current market turbulence and other factors we may have identified from time to time in our filings with the SEC. Although we believe that the assumptions on which these forward-looking statements are reasonable, any of those assumptions can prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also could be incorrect. You should not place undue reliance upon these forward-looking statements. The forward-looking statements contained in this release are made as of the date hereof, and Hercules assumes no obligation to update the forward-looking statements or subsequent events.

To obtain copies of related SEC filings, again, you can visit our website. With that, I'll turn the call over to Scott.

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

Thank you, Michael, and good afternoon, everyone, and thank you all for joining us today. Q3 was another strong quarter for Hercules Capital, where we delivered record Q3 total fundings of $177 million, while continuing to deliver strong and consistent credit performance and operating results. Even though Q3 is typically our slowest originations quarter, our team was once again able to deliver a record quarter which highlights the scale and depth of our investment platform. Our overall performance in Q3 has put us in a strong position to deliver yet another record year in 2019 and, more importantly, we believe positions us well at this particular juncture of the credit and economic cycle.

Our year-to-date performance was highlighted by multiple interim records, including new commitments, total fundings, total investment income, net investment income and total portfolio investments and assets, all while maintaining our historical strong credit discipline and underwriting standards. In Q3, our originations platform delivered new debt-to-equity commitments of $241.3 million, an increase of nearly 3% from the same period last year. For the first nine months of 2019, we delivered $1.19 billion in new debt and equity commitments, an increase of nearly 24% compared to the same period last year. Since the close of Q3 and as of October 29, Hercules has already closed an additional $191 million of new commitments, and we have pending commitments of an additional $36 million in signed, nonbinding term sheets.

Year to date through October 29, our closed new debt to equity commitments are at $1.4 billion. With two full months remaining in 2019, we have already delivered a new historical record of annual commitments for 2019. In addition, our current pipeline remains strong with approximately $1 billion in potential transactions. Our investment-related activity in Q3 reflects our focus on three key themes and our views on the current market and competitive environment: first, building and maintaining a broadly diversified portfolio and avoiding concentrated risk; second, delivering controlled growth without sacrificing our credit and underwriting standards and discipline; and third, positioning the portfolio best for where we believe we are in the credit cycle.

During Q3, we were successful in each of these three areas, and I am incredibly proud of the entire Hercules investment team and broader organization for our achievements during Q3 and year to date. Our belief since inception and throughout the course of our 15-year history has been that portfolio diversification is essential to achieving long-term sustainable success in the venture and growth stage lending space. During the third quarter, we funded six new and 14 existing portfolio companies. The majority of the 14 existing portfolio companies that we funded during Q3 were situations where our portfolio companies achieved specific performance milestones or growth targets that unlocked additional capital.

We believe that this both speaks to the quality of our portfolio but also our ability to support our companies as they grow and scale. We ended the quarter with a total of 95 debt portfolio companies. The profile of the six new companies that we made debt commitments to reflects our focus on quality, diversification, and differentiation. We closed new financings with a blend of technology and life sciences companies, and the 14 portfolio companies that we completed fundings with also reflects a similar makeup.

In all, our total fundings in Q3 were split evenly between technology and life sciences companies. At the end of Q3, our top five and top 10 debt positions make up 16% and 28% of our total debt portfolio at cost, respectively. Our focus remains on being intentionally diversified by stage, sector, geography and sponsor. In the current market and macroenvironment, we believe that this will best position us for sustained success.

The $177 million that we funded in Q3 represents the most that we have funded in any Q3 since inception. For the first nine months of 2019, we have funded $785 million, an increase of over 11% from last year. As noted in our earnings release, early payoffs remained at a higher level but down quarter over quarter. In Q3, we had $140 million of early payoffs, which was down from $178 million in Q2.

Nearly 70% of the Q3 payoffs were attributable to either M&A-related events or prudent credit management where we cycled out of certain credits as part of our ongoing risk mitigation strategies. This has been and will continue to be a primary area of focus for us. We are comfortable sacrificing some short-term growth as we focus on sustainable, long-term performance and total shareholder returns. Net debt portfolio growth of $24.1 million in Q3 drove our debt investment portfolio to a record $2.1 billion at cost.

We had net debt investment growth for the first nine months of 2019 of $348.4 million. Subject to market conditions and our expected level of Q4 early payoffs, we now expect to exceed the high end of our debt investment portfolio growth targets for 2019. Credit quality on the debt investment portfolio improved slightly in Q3 with a weighted average internal credit rating of 2.17 as compared to 2.18 in Q2. Our rated one credits, as a percentage of our overall investment portfolio, went down slightly to 11.4% in Q3 from 12.4% in Q2, largely driven by payoffs of several rated one credits that we were anticipating.

Our rated two credits as a percentage of our overall investment portfolio increased to 64% in Q3 from 63.9% in Q2. And our rated four and rated five credits decreased to 1.5% in Q3 from 3.6% in Q2, making up less than 2% of our investment portfolio at fair value. Nonaccruals remained low, with three debt investments on nonaccrual with a cumulative investment cost and fair value of approximately $9.3 million and $2.2 million, respectively, or 0.4% and 0.1% as a percentage of the company's total investment portfolio at cost and value, respectively. Even with our strong capital deployment in the first nine months of 2019, we are continuing to manage GAAP leverage below our stated ceiling of 125%, with Q3 coming in at 111.5% and regulatory leverage, excluding our SBA debentures, coming in at 97.8%.

Our diverse and well-structured balance sheet is designed to provide a long-term-focused and sustainable investment platform and give us the flexibility to drive growth when we feel prudent. We ended Q3 with over $284 million of liquidity, which was strengthened by our $105 million private placement of unsecured bonds at a fixed rate of 4.77% in July. We continue to see strong loan demand and transaction deal flow, driven partly by the continued strong pace of U.S. venture capital-only investment activities which invested $23 billion and raised another $12 billion according to Dow Jones' Q3 2019 Venture Capital Report.

Through the third quarter, VCs have invested a total of $79 billion and raised over $40 billion of new capital. At this pace, 2019 could represent the second consecutive year of over $100 billion being invested by VCs into growth stage companies. The IPO market has slowed somewhat given the change in investor sentiment regarding high-profile unicorns that are considering going public. Year-to-date 2019, we have already set a new annual record with 11 of our own portfolio companies completing their IPOs.

Hercules' portfolio companies, Opportune Financial and Brickell, completed their IPOs in Q3, and we have Televio and three additional confidential filers in the pipeline. We expect the IPO market to remain volatile through year-end. Assuming market conditions remain favorable, we are anticipating M&A exit activity in our portfolio to continue at a steady pace. In Q3, 163 companies were acquired for nearly $26.9 billion in total consideration versus approximately 19 IPOs, which raised approximately $6 billion in the quarter.

I would now like to spend a few minutes discussing our shareholder distributions. With our total investment portfolio at $2.3 billion at cost and our debt investment portfolio at $2.1 billion at cost, our NII per share in Q3 generated 116% coverage above our quarterly base distribution of $0.32 per share. In addition to our quarterly base distribution of $0.32 for Q3, we also declared a supplemental distribution of $0.03 per share. In the aggregate, this brings our total distributions to shareholders for Q1, Q2 and Q3 to $1.02, representing an approximately 7% increase from the same period a year ago.

This also represents the third consecutive quarter where the company's strong performance has allowed us to deliver an increased distribution to our shareholders. In addition to our quarterly income exceeding our base distribution, we are also fortunate to have been able to grow our undistributed spillover to an estimated $62 million or $0.59 per share, subject to final tax filings in 2019. This provides us with tremendous flexibility with respect to our dividend going forward and the ability to continue to invest in our team and platform as we discussed in Q2. Subject to market conditions and sustained financial performance, we hope to be in position to potentially declare a larger supplemental distribution once we finalize year-end numbers early next year.

In closing, our performance in Q3 and throughout the first nine months of 2019 truly underscores the depth and level of talent, discipline and diligence that our organization has and the scale that we have collectively managed to achieve. I am proud to be leading this organization and very excited about the opportunities that lie ahead for us. We believe that our venture and growth stage lending model is unique and has a proven track record of growth while establishing a high watermark for credit quality that has delivered long-term top-tier shareholder returns throughout any type of credit cycle. Thank you very much, everyone, and I will now turn the call over to Seth.

Seth Meyer -- Chief Financial Officer

Thank you, Scott, and good afternoon, ladies and gentlemen. As Scott mentioned, this was another strong quarter for Hercules. In Q3, we delivered record net investment income totaling $38.9 million or $0.37 per share, providing 116% coverage of the base distribution for the quarter. Credit remained exceptionally strong, and nonaccruals continued to be less than half a percent of our total investment portfolio on a cost basis.

Our ROE or net investment income over average equity was 14.9%. Our ROAA or NII over average total assets was 7.5% for the third quarter, which continues to increase with our prudent use of leverage and portfolio growth. Today, I will focus on the following areas: income statement performance and highlights; NAV unrealized and realized activity; leverage; and finally, the outlook. With that, let's turn our attention to the income statement performance and highlights.

As I mentioned, net investment income per share was $0.37, an increase over the prior quarter of $0.36 per share. Despite two federal rate cuts during the quarter, total investment income remained flat at $69.3 million compared to the prior quarter, supported by a 4.1% increase in total interest income due to portfolio growth in the second and third quarters. Fee income decreased in the quarter due to lower early payoffs. The important point to note is that the growth that we have seen in the portfolio over the year has created a baseline at which we can cover the base dividend without depending on nonrecurring or noncore income.

For context, compared to the same quarter of 2018, total investment income has increased 31.6%. Our effective and core yields in the third quarter were 13.4% and 12.4%, respectively, compared to 14.3% and 12.7% in the second quarter. The primary driver for the decrease in the effective yield was due to the lower early payoffs, the core yield reduced due to the two fed rate cuts in the quarter, with the July cut being the main driver. Net investment income margin increased to 56.1% in the third quarter, compared to 50.9% in the prior quarter, which is the highest we have delivered in nearly three years.

The reason for the increase is primarily due to the higher levels of core income due to the portfolio growth, as well as lower operating expenses. Turning to expenses. Our total operating expenses for the third quarter reduced to $30.4 million, compared to $34 million in the second quarter. Interest expense and fees decreased again to $15 million from $15.2 million in the prior quarter, thanks to all the steps taken year to date to improve our funding sources and conditions.

SG&A expenses decreased as well to $15.4 million from $18.8 million in the prior quarter. The main drivers for the decrease were lower long-term compensation expenses and legal costs due to the settlement with our former CEO, as well as decreased discretionary and variable compensation costs. The reduced discretionary and variable compensation accruals are a direct result of the company's seasonally reduced debt fundings in the quarter compared to the prior quarter. Partially offsetting this was an increased tax provision.

Our weighted average cost of debt was 5.1%, a small reduction, compared to 5.2% in the prior quarter and a more material reduction, compared to the 5.6% in the same quarter last year. Now let's now switch the focus to the NAV unrealized and realized activity. During the quarter, our NAV decreased by $0.21 per share to $10.38 per share, largely related to unrealized depreciation attributable to market volatility impacting the fair value of our investment portfolio. We had unrealized depreciation of $25.5 million in our investments comprised of $5.8 million in our loan portfolio, $13.9 million in our equity portfolio and $5.8 million in our warranty portfolio.

In addition, we had $1.1 million in unrealized appreciation on other assets and liabilities, bringing the net unrealized depreciation for the quarter to $24.4 million. We also realized net gains of $4.8 million during the quarter. The unrealized depreciation on our loan portfolio was attributed to market yield adjustments of $7.2 million and $2.6 million of impairment adjustments primarily related to one loan, offset by $4 million of appreciation due to the reversal of unrealized depreciation arising from the successful resolution of two impaired nonaccrual loan decisions. One of the loans was resolved at our second quarter mark and the other was resolved approximately $1.2 million better than our second-quarter mark.

Our equity and warrant portfolio had an unrealized depreciation of $19.7 million. Mark-to-market adjustments of $11.4 million were driven by volatility in the market, along with $8.3 million of depreciation due to the reversal of unrealized appreciation primarily related to the monetization of two equity positions. Both resulted in realized gains that were accretive to our spillover. Next, I'd like to discuss our leverage.

At the end of the quarter, our GAAP and regulatory leverage was 111.5% and 97.8%, respectively, which increased compared to the second quarter due to the private placement in July and continued growth. We continue to manage the business to ensure that we remain below our 2019 communicated leverage ceiling of 125%. As a reminder, our early payoffs and normal amortization provide us with significant monthly inflows that we can use to de-lever when and as needed. We will closely monitor the macro, political and market conditions in determining future potential debt and equity capital timing.

Finally, let's address our expectations on outlook points. Despite the actions taken today by the fed, we maintain our core yield guidance of 12% to 13%, though, clearly, we will be at the lower half of the range. As a reminder, the majority of our loans are issued with a floor, which mitigates some of the potential downside due to rate decreases. As a result, the impact of our rate decreases is not linear to the impact of rate increases.

With the fed rate cut today of 25 basis points, the portion of loans at the contractual floor increases to approximately 60%. For the fourth quarter, we expect SG&A expenses of $16 million to $17 million. As communicated previously, the reduced expense level due to the settlement with our former CEO will partially be offset by increased investment in our team and infrastructure. Should market conditions remain favorable and origination activity exceed our expected growth, the SG&A expenses could increase based on origination activity during the quarter.

We expect our borrowing costs to increase slightly due to increased activity in Q4 and greater use of our credit facilities. Finally, although very difficult to predict, we expect $100 million in prepayment activity in Q4. In closing, we continue to see Hercules Capital well-positioned for the remainder of 2019. I will now turn the call over to the operator to begin the Q&A part of our call.

Operator, over to you.

Questions & Answers:


Operator

[Operator instructions] The first question is from Tim Hayes of B. Riley FBR. Your line is open.

Tim Hayes -- B. Riley FBR -- Analyst

Hey, good afternoon, guys. Thanks for taking my questions, and congrats on a great quarter. My first one, can you just touch on the supplemental dividend? I know you made some comments, but this is your fourth straight quarter of supplemental dividend payments. How do you think about these dividends in relation to the amount of spillover you'd like to keep on hand?

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

So first, Tim, thanks for the comments. It's the third straight quarter where we've issued the supplemental distribution. There was a gap in between Q3 and Q4 where we didn't have one. Our goal as we've stated on the last several calls is to really focus and drive total shareholder return.

And there are two ways to do that. One is obviously through the base distribution and the second is through the supplemental. Given the trajectory of the business, particularly in Q1, Q2 and Q3 of this year, we felt and the board supported our decision to declare the supplemental distributions which had increased on a quarterly basis as the performance of the business has continued to improve throughout the year. The base dividend for us is really driven primarily off of what we believe the business can generate from a core income perspective.

If you look at our business now, we're now at a point where we're covering the base distribution alone from core income, so we're not really relying, as Seth mentioned, on noncore income associated with payoffs or accelerations. The spillover is something that we look at from two different perspectives. One, we look at it as way for us to continue to invest and expand the platform and the scale and depth of our team. And we think that's an important thing to be able to do without impacting NII on a go-forward basis.

And the second point is, as we've sort of shown, we look at that as a way for us to continue to deliver supplemental dividends to our shareholders as a way to increase and drive total shareholder return. We don't have a specific dollar threshold in mind in terms of what we plan to keep from a spillover perspective, but as we get toward the end of the year, that's something that the management team and board will be evaluating. And as I mentioned in my comments, based on what we're seeing right now and based on obviously our performance quarter to date, we hope and we expect to be in a position where we can deliver a larger special distribution to shareholders once we do the true up subsequent to year end.

Tim Hayes -- B. Riley FBR -- Analyst

OK. Yeah, that makes sense. Appreciate the additional comments there. Then if I could just pick on the dividend, again, you talked about the quarterly dividend and how you've handily covered it with NII for the past two quarters irrespective of the early prepayment income you're receiving there, too.

You're very constructive around, or seem constructive around growth in the lending environment in general, so I know that Seth made some comments about where yields could shake out given the recent fed cut, but what gives you pause at the moment in raising the quarterly distributions given where your core earnings or just your earnings power is at this point?

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

Yeah, I think we're in a unique position now and I view it as sort of a position of strength where I think we have flexibility both with respect to the base distribution, as well as the supplemental distributions. And that's something that we're going to be looking at closely once we again true up the final year-end numbers. And I think that both the base distribution, as well as additional special supplemental distributions are certainly on the table for us to explore as we get into 2020. When we look at sort of the decision with respect to this quarter, there's clearly -- this is the second quarter, as you mentioned, where the core income is covering the base distribution.

We've obviously had some yield compression in the business, as Seth mentioned in his comments, from the three rate cuts that we've seen. We want to see what the rest of Q4 looks like. The markets have been more volatile than they were over the last 30 to 90 days and we really just want to sort of catch our breath a little bit and then assess things once we see where the year ends up. But we're very optimistic about what lies ahead for us and we think that we're in a unique position which is a position of strength as I mentioned where we have the ability to look at both the base distribution, as well as some increased supplemental distributions on a go-forward basis.

Tim Hayes -- B. Riley FBR -- Analyst

Got it. Makes sense, and a good position to be in, for sure. Switching gears a little bit, can you size your pipeline today and maybe talk about how much of that is attributable to some of the strategic initiatives you've undertaken over the past couple of quarters including expanding the product offering set and/or partnering with other investors?

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

Sure. So the pipeline right now is about $1 billion which is strong. I think the portfolio -- sorry, the pipeline right now is I would sort of describe it as healthy and sort of typical with where we are in the year. There is no question that our performance this year, both on the commitment side and on the funding side, is partially driven by some of the things that we've done that you mentioned.

We've done a couple of things from a product perspective, we've done a couple of things from a strategic perspective that we believe have helped us capture some additional market share. We also think that there's a lot more room for growth with respect to those things and some other things that the team and I are actively working on currently. If you look at the commitment numbers on a year-to-date basis as we mentioned, you're essentially at $1.4 billion when you include what we've already done in the month of October alone. 2018 was a record year for us where we delivered $1.2 billion in commitments.

Through 10 months, we're already at $1.4 billion. So I can't tell you exactly what percent or what dollar amount is directly attributable to those things, but we are certainly of the view that you're seeing a significant impact from a lot of those that we've been talking about and some of those things that we're continuing to work on that we hope to roll out over the next several quarters.

Tim Hayes -- B. Riley FBR -- Analyst

OK. Got it. Then just one more for me. What portfolio size can you support today given your current infrastructure? And as you prepare for the next level of record portfolio size, what type of investments do you see making and how does G&A trend? I know that's a lot of questions in one, but just from a high level would be helpful.

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

Sure, I'll take the first part and then Seth can take the second part. We talked a little bit about this on the Q2 call, but when we made the big investment in sort of the team and the platform in 2016, we talked about that we felt comfortable that that would get us to roughly the $2 billion portfolio mark. We crossed the $2 billion portfolio mark in Q2 and that's why on the call last quarter we talked about the fact that we were now going to start to reinvest once again in our team, in our systems, in our platform. And the goal there is really to position us to get to the next portfolio mark that we believe is roughly $3 billion.

In Q2, we made several investments, we've continued to make some investments again in both the team and in the platform in Q3, and we have confidence that the investments that we're making now and will probably continue to make through the end of the year will position us to be able to support a debt investment portfolio of roughly $3 billion. Once we cross that threshold, which is probably somewhere between a year and two years away, we would again then look to make some additional investments in the platform at that time.

Seth Meyer -- Chief Financial Officer

The only thing I would say, Tim, as far as managing expectations on costs, we feel that we can do this at the run rate of the $16 million to $17 million that I mentioned at least for this quarter. We'll reevaluate that in the future. We're not talking about expensive transformations, adding people here and there, making sure that our systems are leveraging the technology that is available these days, of eliminating human touch in between things as much as possible. So I've been now with the organization for I guess seven, eight months.

I'm impressed by how efficient things work. But there are certain additional steps that we can take by leveraging technology a little bit further that will enable us not to add a person every time we grow by $100 million. And that's what we're trying to achieve.

Tim Hayes -- B. Riley FBR -- Analyst

Understood. That's helpful. Thanks again, guys, for taking my questions.

Operator

The next question is from Aaron Deer of Sandler O'Neill. Your line is open.

Aaron Deer -- Sandler O'Neill + Partners, L.P. -- Analyst

Hi. Good afternoon, guys. Seth, just following up on it sounded like you were just guiding toward something in the range of $16 million, $17 million on opex. I'm guessing that that's G&A compensation and stock compensation combined?

Seth Meyer -- Chief Financial Officer

Yes.

Aaron Deer -- Sandler O'Neill + Partners, L.P. -- Analyst

OK. And then I thought I heard, too, that you're expecting around $100 million in prepays here in the fourth quarter. Any sense in terms of what the origination volumes might be or where the debt investment portfolio might be at cost when we get to year end?

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

We don't provide guidance with respect to funding activity in the quarter. What I can tell you is that Q3 is typically our slowest quarter and you saw that. Q3 was our slowest quarter, but it was also a record Q3 for us. We typically see signs of pickup in Q4 and what I can tell you is we've already started to see signs of that pickup.

If you look in our press release and if you focus on what I said in the prepared remarks, for the month of October, we've already closed new commitments of over $190 million. So we're continuing to see very strong momentum, we feel very optimistic about where Q4 will shape up. And then with respect to the prepayments, as Seth mentioned, that are very difficult for us to predict, but based on what we've seen so far in the quarter and what we're aware of, we think that the $100 million prepayment mark is appropriate for modeling purposes for Q4.

Aaron Deer -- Sandler O'Neill + Partners, L.P. -- Analyst

I appreciate that, Seth. Then lastly, given the pretty strong growth outlook here, obviously you're still below maybe your target or the ceiling leverage ratio, but with the stock price having seen some good performance of late, what are your thoughts on getting back and using the ATM at this point?

Seth Meyer -- Chief Financial Officer

We always have it as an option. We'll continue to evaluate whether that's the step we want to take. We consider that the markets are open and appreciate the ease that we had in June when we stepped out and very quickly raised capital, so no plans at the moment, but we appreciate that it's readily available thanks to the fact that we're trading well above our book value.

Aaron Deer -- Sandler O'Neill + Partners, L.P. -- Analyst

OK. Great. Thank you for taking my questions.

Operator

Our next question is from John Hecht of Jefferies. Your line is open.

John Hecht -- Jefferies -- Analyst

Good afternoon, guys, and congrats on a good quarter. You guys talked about rates. I think -- did I hear you right, as of the rate cut today 60% of the loans are through their floors or at or through their floors? Or was that number incorrect?

Seth Meyer -- Chief Financial Officer

No, no, no, that's correct. And you're correct to say that some are below at this point. But that's where we land as a result of the cut today.

John Hecht -- Jefferies -- Analyst

So in the interest rate sensitivity table where you show the benefits of rising rates and the vice versa, does that 75 basis -- for instance, in that example where you give the 75-basis-point decline, does that incorporate the floors as well in that analysis? Or is that just sort of a shock factor to the whole portfolio?

Seth Meyer -- Chief Financial Officer

No, no, that incorporates the floor. So what we can say is, annually based on that table, we'd approximately go down $0.03 per share annually again as a result of the rate cut today. But at that level, then 60% of the portfolio is at the floor end. Which is why you see that it only increases $0.02 per share when you go to 50 basis points.

John Hecht -- Jefferies -- Analyst

That's that nonlinear angle that you mentioned.

Seth Meyer -- Chief Financial Officer

Exactly. Yup.

John Hecht -- Jefferies -- Analyst

OK. And then I guess maybe talk about, Scott talked about the universe, the VC mentality. I mean given some of the big market IPOs and their post IPO performance, clearly there's a lot of demand. Maybe are there any structural changes that you see ongoing in the industry that suggest the addressable market either has like a longer duration before seeking IPO or is just larger overall?

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

Sure. There's a couple of things going on. First, and I think this is probably the most important, we are continuing to see a very robust and vibrant ecosystem. $23 billion of VC equity invested in Q3 alone.

If you sort of look at that from an aggregate year-to-date perspective, you're at nearly $80 billion of VC equity capital invested into the ecosystem. Last year was a record year with about $107 billion, $108 billion. Based on what we're seeing, assuming Q4 is sort of consistent with expectation, this would be the second consecutive year where over $100 billion is invested. You're also continuing to see tremendous strength from the fundraising perspective.

$12 billion raised by venture capital firms in Q3, roughly $40 billion raised year to date. If you look at sort of the trends in the industry over the last five years, you basically have five consecutive years where the VC firms have raised north of $40 billion in each year. So a lot of sort of momentum and a lot of sort of vibrancy with respect to those key metrics that we use sort of as a guide to speak to their overall health of the ecosystem. There is no question that there have been a couple of fairly high-profile IPO situations that either didn't work out or that have performed materially below expectations post offering.

What I would tell you is that we view those as isolated situations. We've had a record year year-to-date in terms of IPO activity with 11 of our portfolio companies completing IPOs. Certainly, some of those have underperformed post completion of the offering, but we have several that have performed very well. We don't look at what's going on with sort of the few isolated larger, later stage IPOs that either haven't gotten off or have done really poorly as indicative of anything sort of systemic with respect to the ecosystem that we play in.

And then I would just add as a closing comment, in some ways we view the noise with respect to this isolated group as potentially beneficial to us. Because it really focuses the industry and it focuses the market really back on a rationalization of business models, more of a focus sort of on unit economics and underlying KPIs. I think if anything that's where our investment team really excels from an understanding perspective, and it's our belief that some of that noise with respect to that isolated bucket could create some additional opportunities for us from a debt financing perspective.

John Hecht -- Jefferies -- Analyst

OK. Thank you very much for the update. Appreciate it.

Operator

[Operator instructions] The next question is from Ryan Lynch of KBW. Your line is open.

Ryan Lynch -- KBW -- Analyst

Good afternoon, Scott. My question, I kind of wanted to follow-up on your last comments on kind of those isolated incidents of recent struggles in the IPO market. One of the concerns with some of those recent struggles, as well as some private VC companies that have struggled recently is that the valuations in later stage companies might be inflated and there might have to be some revaluation of those companies which could put some pressure. Want to just get your thoughts and comments on how you feel some of these later stage VC backed valuations are today.

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

Sure. Look, there's no question that again, in a small I think isolated part of the market, valuations got ahead of themselves. And you've clearly seen that with a couple of high-profile situations over the last 30, 60, 90 days. And again, I don't think that's a bad thing in terms of a rerationalization of valuations and a focus on underlying business models and unit economics.

I can tell you that with respect to our portfolio, if you look at our marks from an equity perspective, in virtually every single case we are either below or well below the most recent round of financing from a valuation perspective, so I feel very good about where our book is from a fair value perspective. We had a little bit of unrealized depreciation in the quarter which Seth talked about in his comments. I think the important thing to note there is exactly what Seth said. When you really break it down, the $25.5 million of unrealized depreciation, the vast majority of that was in sort of the public book from a mark to market perspective.

Only $2.5 million of it was attributable to the unrealized piece from the credit perspective which is a pretty immaterial amount on a quarterly basis. And we really haven't seen any further degradation subsequent to the 9/30 marks that would lead us to believe that there's further erosion with subsequent to valuations in our portfolio subsequent to quarter end.

Ryan Lynch -- KBW -- Analyst

That's good color. Wanted to switch over to interest rate sensitivity. I appreciate your comments on the 60% of your portfolio is at your floor levels. I believe that's because you guys structure your loans a little bit differently than most middle market lenders.

Kind of on that point, when I think of most BDCs are doing middle market leverage buyouts, it feels like those borrowers are going to be very interest rate sensitive because they're doing a little bit of financial engineering to make the math work. Versus a VC borrower feels like to me is more looking to take on some debt so that they don't dilute their equity at stake and may not be as interest rate sensitive. So my question is, to the extent that short term rates keep going lower, how do you think your ability will be to potentially offset some of that by not only the floors you have in your portfolio, but also potentially increasing the spread or the fees you charge on those VC borrowers?

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

Sure. So I think our view is that we will be able to offset some of the degradation in rate through other means. And that's certainly something that we've seen. If you look at the fundings that we've completed quarter to date, we've been able to do that, which will certainly help us offset some of that rate degradation.

I think the important part is sort of what Seth spoke to. With the rate cuts announced today, approximately 60% of our portfolio right now is already at the contractual floor. Any new loan that we originate in Q4 from this point on will be at the contractual floor because we'll set it up off a prime floor of 4.75 which is essentially where prime is today. We also have the ability when a loan comes up for a restructuring or an amendment to sort of try to do things to either reset floors or continue to drive that number up.

And it would be our hope that irrespective of what the fed does, that certainly as we get closer to year end and to the early part of next year, that we can drive that 60% number up substantially so that we won't have any really further significant impact on the downside with respect to short term rates.

Ryan Lynch -- KBW -- Analyst

OK. Those are all my questions. I appreciate the time.

Operator

The next is from Christopher Nolan of Ladenburg Thalmann. Your line is open.

Christopher Nolan -- Ladenburg Thalmann -- Analyst

Hey, guys. Philosophically, how do you look at companies which are trying to grow at all costs? And I'm specifically thinking about the We Work situation. When you see a company like that, what is your underwriting approach?

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

Look, I think We Work is sort of one of those isolated situations that I mentioned. I don't think that's endemic to the entire venture ecosystem. And again, the way we look at that situation is we actually look at it from a positive perspective. I think a rationalization in the market, a refocus and an emphasis on unit economics, on the cost of growth, are generally good things because that's what our team does every single day.

We've always been a firm I think that's a little bit unique in this part of the market where we actually focus on underwriting to the individual credits as opposed to some others who tend not to get as deep into the weeds as we do from an underwriting credit perspective. So we view that as a positive. Every deal that we do, we are looking at the core fundamentals of that business. We're not just looking at the syndicate, we're not just looking at the post money, we're not just looking at how much capital they've raised.

We're looking at the KPIs, we're looking at the overall market, we're looking at sort of the numbers and really getting pretty deep into the weeds which we believe has led to our best in class credit performance. We are very, very, very grateful and appreciative of the fact that we have now done $9.7 billion of commitments from a cumulative perspective and we've got net losses of $26 million. Our annual loss rate right now is basically under two basis points. And that's not something that's easy to do when you are lending to growth stage, cash flow negative companies.

And I think that's directly attributable to the work that our team does from a diligence perspective and how we're able to understand what the numbers are actually telling us versus what post money gets done from a round perspective.

Christopher Nolan -- Ladenburg Thalmann -- Analyst

Scott, are you seeing the entrepreneurs for these select unicorns having more leverage over investors than before?

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

We haven't seen that. I think there's still, again, a little bit of a rationalization going on in the market. There are some companies that we are aware of that are exploring an IPO and also exploring a private round just given some of the volatility that we've seen in the market. But we haven't really seen anything specific with respect to entrepreneurs having leverage over VCs.

I think it's really specific to the individual investment rather than sort of an industry wide issue.

Christopher Nolan -- Ladenburg Thalmann -- Analyst

Got it. Thanks for the color.

Operator

The next question is from Finian O'Shea of Wells Fargo Securities. Your line is open.

Finian O'Shea -- Wells Fargo Securities -- Analyst

Hi, thanks for having me on. Just a first question, a small question on the equity vol this quarter. Just glancing at some small cap biotech indices which is usually pretty indicative of your equity portfolio, I see things slightly down but not meaningfully. So is that correct to say -- is it more concentrated or broad based on your equity markdowns?

Seth Meyer -- Chief Financial Officer

Our equity markdowns. So yeah, there's specific ones that obviously we have public marks on the equity and warrant positions of $9.6 million down. Are you looking for a concentration within that?

Finian O'Shea -- Wells Fargo Securities -- Analyst

Yeah, if it's more -- if it's three names that are way down or if it's 40 names that are slightly down.

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

A couple of things, Finn. If you look S&P biotech index in Q3, down 13.2%, so there was clearly a pretty substantial pullback with respect to some of the key indices that we used to kind of track our portfolio in Q3. If you look at our unrealized depreciation in the quarter, again, as Seth mentioned in his remarks, $11.5 million attributable directly just to mark to market volatility with respect to equity and warrant positions, there was sort of a downdraft both on the tech side and on the equity side. But there were four or five names that drove the vast majority of that, but it really wasn't specific to any one or two situations.

Finian O'Shea -- Wells Fargo Securities -- Analyst

OK, that is helpful. And then just not to make things repetitive on the larger cap headlines we're seeing and you've been answering today, but to the description of stretched valuations being isolated, can you expand a little bit on how you're defining what's isolated? Is it sort of the unicorns? Is it a specific sector? Or is it really just these couple of headlines that we've all seen?

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

Our view is that it's really a couple of headlines that we've all seen that sort of drive the narrative. We've not seen, again, a sort of systemic issue with respect to valuations or fundraising or financing with respect to the vast majority of our addressable market. The unfortunate reality of kind of the current environment from a new cycle perspective is the one or two or three very high-profile public situations get a lot of publicity. I think that's what you're really seeing from a focus perspective.

We do expect kind of the IPO market to remain volatile as a result of those situations, but again, I don't think it's systemic with respect to there's an issue across the venture landscape because we absolutely have not seen that. There are a couple of higher profile situations that have obviously been noisy, but we're not seeing that sort of trickle down to the vast majority of our addressable ecosystem.

Finian O'Shea -- Wells Fargo Securities -- Analyst

Thank you, and just one more if I may, on competition. So understanding that you've always faced some sort of in and out players in the venture lending space and there's, it's a very specialized vertical, but more broadly in private that you see a lot of larger managers really trying to diversify their pipelines. So would you say, would you agree with that and say there's more of a more meaningful commitment from some of your competitors in entering the VC space, sorry, the venture lending space?

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

Yeah, so what I would say is two things. Number one, we have seen a robust competitive environment throughout the course of 2019 and we did not see any change in that regard with respect to what we saw in Q3. The second thing, and I think this is the more important thing from our perspective, we've been doing this now for 15 years. We've done $9.7 billion of commitments, we've been very fortunate now to have financed over 500 different companies, we've partnered with over 1,000 different VC and growth stage investment firms.

And what we hear on a pretty consistent basis from the companies that we're speaking to and that we're financing, is these companies, their board members, their investors, they want to partner with someone on the debt side who they know understands the market, who they know has been in the in the market though a cycle or two. Hercules is not a lender that comes in and comes out. And when people partner with us, they understand that. And so while some of the larger asset managers have tried to come into the space over the last couple of years, some have been successful, some have not been successful, we hear pretty consistently from the companies that we associate with, concerns with where they will be in a year or two.

Because the reality is, lending to a growth stage, cash flow negative company is very different then lending to a cash flow positive company in a sort of traditional EBITDA leverage-based financing situation. And that's why we continue to be very optimistic about our market and our growth trajectory on a go-forward basis.

Finian O'Shea -- Wells Fargo Securities -- Analyst

Thank you for your comment today. That's all for me.

Operator

The next question is from Henry Coffey of Wedbush. Your line is open.

Henry Coffey -- Wedbush Securities -- Analyst

Yes, greetings, and thank you for taking my question. I'm intrigued obviously with all of this chatter about what's going on in the tech community. But if you forget the unicorns and real estate companies that think they're tech companies and all that other goofy stuff, what is the fundamental nature of where your companies are in your view compared to say a year or two ago, their ability to successfully execute on their business plans and successfully get out products there and sort of grow to the next stage? I can't imagine that We Works, which is basically a REIT, not getting its IPO done at something like $12 trillion or whatever the number was, has anything to do with that. So where we are, forgetting all the fluff, where are we in terms of the fundamental substance of the companies you're investing in?

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

Sure. I think we believe our portfolio is in great shape. And I think the numbers speak to that. For the quarter, our weighted average credit rating was 2.17.

That's essentially flat, slight improvement from where it was in Q2, 2.18% last quarter. One of the other things that we look at is what percent of our portfolio is in our rated four and rated five bucket. We just walked through that our rated four and rated five credits this time make up less than 2% of our portfolio from a fair value perspective. Our portfolio is continuing to largely perform to expectations.

Our portfolio companies are largely continuing to have success both from a public equity perspective and a private equity financing perspective. And we really have not seen a slowdown or negative impact from the few isolated situations that we talked about on this call and that you referenced again in your remarks. So we feel very good about where our portfolio is from a health perspective and from an overall credit perspective. We just announced another quarter where we had nearly $5 million of additional realized gains and we're continuing to be very optimistic based on what we're seeing so far in Q4.

Henry Coffey -- Wedbush Securities -- Analyst

How do you translate -- you are principally a lender. So how do you translate all of this into your sense of how you -- and again, your loans are performing exceptionally well, 98% of them are in really great shape. When you look at -- if I could look at each of your portfolio companies, which would take me forever, what would my fundamental assessment be of how they are performing relative to plan? How close are they to profitability? What do the companies themselves look like from your perspective?

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

I'd reiterate what I said. I think our view on a portfolio level is that our portfolio right now is in really good shape. We have not seen degradation from a credit perspective at all in Q3 or anything related to some of the higher profile situations that we just talked about.

Henry Coffey -- Wedbush Securities -- Analyst

Now I'm also looking at Slide 22 in your deck which I always find very helpful. Clearly in Q2 2018 there was sort of a stepdown in where coupons and yields were. I'm sorry, where gross and effective yields were. Actually, coupons went up.

And then since then we've had a major cut in rates and your effective, your core yield has gone from 12.7 to 12.4 which means you've only suffered a third of the cuts out there. Is that what we're likely to see going forward is a very small downward moderation in yields as rates go lower and lower? Or are we up for another stepdown? Are we going to wake up by next year and see that 11.5% is where the business should be?

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

Look, we've always said this, we manage the business based on that middle line. On Page 22 that you're referencing. We focus on core yield. The top line which dipped down in Q2 of 2018 on the effective yields, that's a direct correlation with respect to how much we have on a quarterly basis in terms of prepayments.

In Q2 of 2019 we had nearly $180 million or $185 million of prepayments, so you had the spike to 14.3% from an effective. Our prepayments were down slightly to $140 million in Q3, so the effective was down to about 13.4%. Seth in his prepared remarks just reiterated our guidance with respect to core yields and we feel very confident that we are going to be within our range but at the low end of that range which is 12% to 13%. And that's inclusive of the fed cut from today.

So we certainly do not expect to wake up at the end of Q4 and see the portfolio at 11.5%. Otherwise we wouldn't have just given the guidance that we did with respect to our ability to maintain ourselves --

Henry Coffey -- Wedbush Securities -- Analyst

Well obviously I didn't mean the fourth quarter, but next year. I mean if you're looking at the same chart I am, you can almost draw some lines through it where there's a shift that occurs periodically.

Seth Meyer -- Chief Financial Officer

Henry, I'd point to Slide 25 where you see the dynamics, the shape of the portfolio changed significantly with the dramatic paydown in Q1. We're not seeing that development.

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

We also, Henry, we also look very closely at what our onboarding yields are. So we look at the deals we were able to onboard in Q2, we look at the deals we were able to onboard in Q3. We look at the $190 million of commitments that we've already managed to onboard in Q4. And as I mentioned, we have not seen any real degradation in terms of our ability to target deals that will be able to maintain our core yield in our target ranges.

Henry Coffey -- Wedbush Securities -- Analyst

So even the newest business is being set up at levels that allows you to keep it at let's just call it 12%, that allows you to keep the business -- and you think that's where it's going to be next year?

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

That is correct.

Henry Coffey -- Wedbush Securities -- Analyst

Thank you very much.

Operator

The next question is from Chris York of JMP Securities. Your line is open.

Chris York -- JMP Securities -- Analyst

Hey, guys, thanks for taking my questions. So Scott, you produced back to back quarters of record originations, so I'm curious whether you think you are taking market share here as being a primary driver of the record growth? Because the US venture ecosystem was also very, very strong in 2018 with respect to VC investments.

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

Sure. So I think it's a combination of two things. It's our belief that we are taking some additional market share. It's also our belief, and we talked about this on the last call, that we've now gotten the portfolio to a point where we've crossed $2 billion.

We have 95 active debt portfolio companies. Our portfolio from a debt perspective is very vibrant, very growth focused. And so there are a lot of opportunities for us to demonstrate the strength and the breadth of our platform by continuing to finance our own portfolio companies on a go forward basis, either with respect to unfunded commitments that get unlocked or new commitments as they continue to achieve growth objectives. So I think it's really a combination of those two things.

With capturing some additional market share largely driven by some of the changes that we've made from a product perspective, from a strategic perspective, as well as being able to really take advantage of the fact that we are one of the only players in the space that has actually been able to achieve a portfolio of scale.

Chris York -- JMP Securities -- Analyst

Got it, that's helpful. Then following up a little bit on that and maybe a little bit on Finn's question earlier, a lot of venture capital backed companies stay in later or longer before completing their IPO. It seems that some of these rapidly growing tech companies are now changing sponsors, oftentimes from VC to PE. So I'm curious on your level of interest and then willingness to grow with the company at later stages, but potentially lending at lower yields than what is traditionally associated with venture debt.

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

There are certainly a couple of situations that we're aware of that sort of occurred in Q3 where you had sort of a situation along the lines of what you just described where a later stage sort of nontraditional VC, more like a PE or a sponsor, came into a growth stage company and sort of did a final round of financing. We have not seen a real impact when that change happens in terms of the type of debt financing that those companies are focused on. The reality for us is, if a company in our market is exploring sort of a pre-IPO debt financing, that most likely is not going to be done from us because those deals are done at much lower yields than we would be comfortable with. We are trying to find situations where we can generate from a risk adjusted return perspective a yield and a return profile that we believe makes sense for our shareholders.

And that tends not to be in those situations where you have the growth stage tech company that's six to 12 months away from an IPO because they are going out and getting much cheaper financing than we're going to provide. We do think that there's a tremendous opportunity with respect to companies that are a little bit further away from their IPO, so the company that was initially thinking about doing an IPO in 2021, maybe that company has second thoughts now. We think that's a great opportunity for us to sort of engage with those companies and we're actively speaking to a couple of them right now, where we can provide a fairly large structured financing that will enable them to be well positioned if they decide not to pursue that IPO in 18 to 24 months.

Chris York -- JMP Securities -- Analyst

Got it, so maybe -- I wasn't going to say a name but one that just came to mind that would be maybe like a Post Mates type that you could be focusing on as opposed to some others that maybe took you out this quarter from a private equity perspective.

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

I don't want to address any particular situation. Post Mates is a portfolio company of ours today.

Chris York -- JMP Securities -- Analyst

Yep, exactly. OK. And then just two housekeeping questions. So in terms of your prepay expectations of $100 million, what is the average duration of the portfolio payoff for that?

Seth Meyer -- Chief Financial Officer

It's about 15 months.

Chris York -- JMP Securities -- Analyst

OK. And then Seth, maybe this one for you as well, FTEs, full time employees at quarter end. And then what is your budget for new investment professionals, hires in 2020?

Seth Meyer -- Chief Financial Officer

So I don't have the budget yet for 2020, what we plan on putting forward to the board next month, so I don't have anything to share with you yet on that. For the current FTEs, we have about 77 employees at the moment.

Chris York -- JMP Securities -- Analyst

OK, so up a little bit quarter-over-quarter. And so if you don't have the budget, any ideas, Scott or Seth, on growing that and being strategic in hiring a couple of new investment professionals?

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

We're going to continue to be strategic in terms of our hiring decisions. We talked in Q2 about sort of reinvesting in the team and the platform. Over the course of the last two quarters we've added to our investment team at all levels. We've also added to our finance team, we've added to our legal team and we've added to our credit team.

So I think you're going to continue to see us make strategic investments in our team broadly speaking, not just the investment team. And if we can find individuals that we think will be accretive and add value and allow us to continue to expand our breadth and diversification from a platform perspective, we'll certainly be interested. This is, we talked a little bit about this historically, but Hercules is a difficult place to sort of hire into because the expectations are very high and it's unique what we do. Our investment team is very talented because they are domain experts in the areas that they focus in.

They understand how to underwrite and structure credit, but they also understand growth and equity and sort of the technology driven aspects of our business whether it be on the technology side or the life sciences side. So we can't just go out and hire someone from a commercial bank or someone from a competitive firm because we think what we do is truly differentiated in terms of how we approach the market.

Chris York -- JMP Securities -- Analyst

Makes a lot of sense. That's it for me. Thanks, Scott, thanks, Seth. Thanks, Mike.

Operator

I'm showing no further questions at this time. I would now like to turn the conference back to Scott. Please go ahead, sir.

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

Thank you, operator. And thanks to everyone for joining our call today. We look forward to reporting our progress on what has been a strong year so far on our next Q4 earnings call. In November, we will be participating at the JMP Financial Services Conference in New York and the Jefferies Fourth Annual BDC Summits in London, Zurich and Frankfort.

If you are interested in meeting with us at any of these events, please contact JMP Securities or Jefferies for their respective events or Michael Hara. Thank you and have a great day.

Operator

[Operator signoff]

Duration: 73 minutes

Call participants:

Michael Hara -- Managing Director of Investor Relations

Scott Bluestein -- Chief Executive Officer and Chief Investment Officer

Seth Meyer -- Chief Financial Officer

Tim Hayes -- B. Riley FBR -- Analyst

Aaron Deer -- Sandler O'Neill + Partners, L.P. -- Analyst

John Hecht -- Jefferies -- Analyst

Ryan Lynch -- KBW -- Analyst

Christopher Nolan -- Ladenburg Thalmann -- Analyst

Finian O'Shea -- Wells Fargo Securities -- Analyst

Henry Coffey -- Wedbush Securities -- Analyst

Chris York -- JMP Securities -- Analyst

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