Hercules Capital Inc

NYSE:HTGC

Earnings Call Analysis

Hercules Capital Reports Strong Q3 Performance Amid Market Slowdown

In Q3 2024, Hercules Capital reported a record investment income of $125.2 million, up 7.3% year-over-year, with a net investment income of $83.2 million, or $0.51 per share. Despite a slowdown in venture capital activity, they maintained a robust liquidity position with $572 million. The company expects Q4 prepayment activity between $150 million to $250 million and anticipates continued quality in deal origination post-election. They confirmed a 128% coverage of their base distribution of $0.40 per share. Looking ahead, Hercules aims for disciplined capital deployment, citing an optimistic environment for funding amid an evolving market landscape.

Strong Financial Performance in Q3 2024

Hercules Capital reported remarkable financial results for the third quarter of 2024, achieving a record total investment income of $125.2 million, which marks a 7.3% increase year-over-year. This was coupled with core net investment income of $83.2 million or $0.51 per share, showcasing an 8% increase year-over-year. The success was primarily driven by Hercules' robust positioning in the venture and growth stage lending market, with the company managing approximately $4.6 billion in assets, reflecting a 10.9% growth since last year.

Maintaining Cautious Capital Deployment Strategy

Despite the productive financial results, Hercules practiced a cautious approach in capital deployment during Q3 due to a slowdown in quality investment opportunities within the venture ecosystem. They noted that both venture capital investments and M&A activity had declined, with Q3 being particularly slow. Consequently, the team decided to curtail new originations and actively maintained a disciplined capital deployment strategy. As a result, they committed over $430 million and funded $272 million, which continued their trend of quality over quantity.

Robust Liquidity Position

The company's liquidity position remained strong, with over $570 million available by the end of Q3. This includes $70 million of liquidity added in July from retiring $105 million of institutional notes, and newly acquired access of $175 million through their fourth SBIC license. The liquidity enhances their capability to support upcoming opportunities while sustaining their conservative leverage positioning.

Guidance for Future Performance

Looking ahead, Hercules anticipates continued solid performance despite a backdrop of macroeconomic volatility due to the upcoming presidential election and recent Federal Reserve interest rate actions. For Q4, they expect core yields to hover between 13% and 13.3%, with prepayment activity projected between $150 million and $250 million. Furthermore, they aim to execute an additional $630 million in pending commitments, indicating a potential resurgence in activity post-election as interest in growth-stage debt financing increases.

Market Environment and Competitive Landscape

The broader venture capital ecosystem experienced a marked slowdown, with venture capital investment activity down 32% from Q2 to $37.5 billion in Q3, reflecting the slowest Q3 in four years. This creates a challenging marketplace for new deals. Hercules, however, focused on maintaining its competitive edge by emphasizing disciplined credit underwriting and leveraging its long-standing expertise in the sector, setting firm pricing and risk schemes.

Dividend Distributions and Shareholder Value

Hercules has announced a base distribution of $0.40 per share and a supplemental distribution of $0.08 for Q3, marking their 17th consecutive quarter of supplemental distributions. The company ended Q3 with an undistributed earnings spillover of over $152 million, or approximately $0.94 per share, which supports the commitment to returning value to shareholders. This stable dividend coverage amidst macroeconomic challenges assures investors of the company’s solid performance and commitment to shareholder returns.

Credit Quality and Portfolio Stability

Despite the challenging economic climate, Hercules displayed strong credit quality in their investment portfolio with record metrics for weighted average credit ratings. Approximately 65.2% of their investments remained classified as Grade 1 and Grade 2, emphasizing their focus on high-quality borrowers. Additionally, 52% of early loan repayments stemmed from M&A events, suggesting a favorable dynamic. Maintaining a conservative leverage profile allows Hercules to selectively capitalize on higher-quality assets.

Expectation of Market Recovery Post-Elections

Management expressed optimism for a market recovery after the presidential election, indicating that many companies have deferred financing decisions until there is greater clarity. With interest rate dynamics shifting with the Fed's actions, there is an expectation of increased activity and commitment growth in Q4 as the venture landscape stabilizes. Hercules is well-prepared, maintaining flexibility to respond to evolving market opportunities.

Earnings Call Transcript 2024-Q3

[Operator]

Good day, and thank you for standing by. Welcome to the Hercules Capital Third Quarter 2024 Financial Results and Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your first speaker today, Michael Hara, Managing Director of Investor Relations. Please go ahead.

[Michael Hara, executive]

All right. Thank you, Brianna. Good afternoon, everyone, and welcome to Hercules' conference call for the third quarter 2024. With us on the call today from Hercules are: Scott Bluestein, CEO and Chief Investment Officer; and Seth Meyer, CFO.

Hercules' financial results were released just after today's market close and can be accessed from Hercules' Investor Relations section at investor.htgc.com. An archived webcast replay will be available on the Investor Relations web page for at least 30 days following the conference call.

During this call, we may make forward-looking statements based on our own assumptions and current expectations. These forward-looking statements are not guarantees of future performance and should not be relied upon in making any investment decision.

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

And with that, I'll turn the call over to Scott.

[Scott Bluestein, executive]

Thank you, Michael, and thank you, all, for joining the Hercules Capital Q3 2024 Earnings Call. Our strong operating results for the third quarter and year-to-date through Q3 2024 reflect our leadership position in the venture and growth stage lending market as well as the benefits of operating at scale with an institutional lending platform and a seasoned, best-in-class investment team.

In Q3 2024, the company delivered record total investment income of $125.2 million, an increase of 7.3% year-over-year. Year-to-date, the company has delivered record total investment income of $371.8 million, an increase of 10% year-over-year as well as record NII of $244.7 million or $1.52 per share, an increase of 12.2% year-over-year.

As of the end of Q3, Hercules Capital is managing approximately $4.6 billion of assets an increase of 10.9% from where we were a year ago.

Hercules has delivered record year-to-date ending Q3 2024 total gross fundings of $1.34 billion, despite intentionally slowing down new originations in Q3. Q3 is typically a slower quarter in terms of equity capital investments and overall activity across the venture ecosystem, and this year was no different.

The venture and growth stage markets slowed considerably in Q3, particularly with respect to venture capital investment activity and venture capital M&A exit activity. This slowdown, combined with many quality scale borrowers putting off debt decisions until after the upcoming presidential election and waiting for the recent Fed interest rate action resulted in a new business environment that our investment teams did not believe was favorable for disciplined and prudent capital deployment, particularly early in the quarter.

Every decision that we make as a company is centered around what we believe is in the best long-term interest of our shareholders, stakeholders and borrowers, and this time was no different. As we continue to manage our balance sheet, leverage and business conservatively, we remain very well positioned to deliver another year of outstanding results and record operating performance for our shareholders.

Through the remainder of the year, we continue to expect higher-than-normal market and macro volatility, given the upcoming presidential election and the ongoing challenges taking place in the global geopolitical environment.

After the recent Fed interest rate action, we have started to see an uptick in the number of quality later-stage companies looking to secure growth-stage debt financing. And we have also seen a recent pickup in the venture capital investment activity quarter-to-date.

Our current pending commitments of approximately $630 million reflect the change in environment that we have seen post quarter end. As a result, we remain optimistic about our funding activity for the remainder of Q4, and we expect to deliver another record year of new gross fundings for fiscal year 2024.

Through year-end, we intend to continue to manage our business and balance sheet defensively, while maintaining maximum flexibility to take advantage of market opportunities. This includes continuing to enhance our liquidity position, maintaining low leverage, further tightening our credit screens on new underwritings and maintaining our higher-than-normal first lien exposure, which was at 89.5% in Q3 compared to 90.1% in Q2.

We believe that positioning ourselves to be able to take advantage of the market when it is more attractive to do so will be a key differentiator of our business going forward.

Let me now recap some of the key highlights of our performance for Q3. In Q3, we originated total gross debt and equity commitments of over $430 million and gross fundings of $272 million. Year-to-date, we have committed in excess of $2.07 billion of capital, and we have delivered record funding performance over the same period.

As a result, and as previously mentioned, in Q3 2024, we generated record total investment income of $125.2 million, up over 7% year-over-year. And net investment income of $83.2 million, up over 8% year-over-year or $0.51 per share, providing 128% coverage of our base distribution of $0.40 per share.

We were able to achieve 128% coverage of our base distribution despite ending the quarter with very conservative GAAP leverage of 94.6%. This is our sixth consecutive quarter of over $100 million of quarterly core income, which excludes the benefit of prepayment fees or fee accelerations from early repayments. This puts us in a very solid position to be able to continue to comfortably cover our quarterly base distribution despite the declining rate environment.

We also generated return on equity in Q3 of 18.9%. Our portfolio generated a GAAP effective yield of 14.4% in Q3 and a core yield of 13.3%. Our balance sheet with conservative leverage and low cost of leverage remains very well positioned to support our continued growth objectives and provides us with the ability to go lower on yield and larger in size for higher-quality assets when warranted. This again, serves as a key differentiator of our business.

The focus of our origination efforts in Q3 was on maintaining a disciplined approach to capital deployment. Our deal screening activity during the quarter was high, but we simply did not see enough quality deals to warrant aggressive deployment of capital.

As an internally managed BDC that prioritizes credit, we have the luxury of not chasing the market when we do not believe that the credit quality on new originations supports it. Our Q3 originations activity was driven by both our technology and life sciences teams once again.

In Q3, approximately 61% of our fundings were to technology companies, while approximately 56% of our new commitments were to life sciences companies. We funded debt capital to 21 different companies in Q3, of which 4 were new borrower relationships. This is reflective of our approach during the quarter to prioritize capital deployment within the portfolio, where we know the credit quality and performance history of the underlying borrowers.

We also increased our capital commitments to several portfolio companies during the quarter, which speaks to our ability to scale alongside our borrowers as they continue to grow their businesses. Our available unfunded commitments increased slightly to approximately $489 million from $479.5 million in Q2.

The quality of the growth stage companies looking for debt financing has improved following the recent Fed rate cut. And based on active conversations that our teams are having throughout the ecosystem, we expect this to improve further post the U.S. presidential election.

Since the close of Q3 and as of October 25, 2024, our deal team has closed $17 million of new commitments and funded $15.2 million. We have pending commitments of an additional $630 million in signed nonbinding term sheets, and we expect this number to continue to grow as we progress in Q4.

Similar to what we saw in Q3, our expectation is that Q4 funding activity will be back-end weighted. Our focus for Q4 will remain on asset quality and prudent underwriting.

In Q3, we had 4 total M&A events in our portfolio, which included 3 life sciences portfolio companies signing definitive agreements to be acquired and 1 technology portfolio company being acquired. Year-to-date, we've had 10 portfolio companies announced or complete an M&A event. Last year at this time, we had 13 portfolio company M&A events. So our exit activity remains healthy, but slower than last year.

Early loan repayments decreased in Q3 to approximately $230 million, which was within our guidance of $200 million to $300 million. Over 52% of our Q3 prepayments were attributable to M&A events or new equity capital events, which we view as a positive signal overall. For Q4 2024, we expect prepayments to be in the range of $150 million to $250 million, although this could change as we progress in the quarter.

Credit quality of the debt investment portfolio remained strong quarter-over-quarter. Our weighted average internal credit rating of 2.24 increased slightly from the 2.18 rating in Q2 and it remains at the lower end of our normal historical range. Our Grade 1 and Grade 2 credits decreased slightly to 65.2% compared to 67.2% in Q2. Grade 3 credits increased slightly to 31.9% in Q3 versus 31% in Q2. Our rated 4 credits increased to 2.3% from 0.9% in Q2 and our rated 5 credits decreased to 0.6%.

In Q3, the number of loans and companies on nonaccrual remain the same. We had 2 debt investments on nonaccrual with an investment cost and fair value of approximately $92.2 million and $20.7 million, respectively, or 2.6% and 0.6% as a percentage of the company's total investment portfolio at cost and value, respectively.

Based on the most recent updates that we have, we expect to largely conclude our Convoy workout efforts in Q4 as well as have a resolution to the Chorus loan before the end of the year.

With respect to our broader credit book and outlook, we generally remain pleased by what we are seeing on a portfolio level, and our portfolio monitoring remains enhanced. Our focus on credit underwriting and a diversified asset base is going to continue to serve us well.

During Q3 2024, Hercules had net realized losses of $0.6 million comprised of gross realized gains of $2.8 million, primarily due to the gain on equity investments, offset by $3.4 million, primarily driven due to losses on warrant and equity investments. Our net asset value per share in Q3 was $11.40, a very small decrease of 0.3% from Q2 2024.

We ended Q3 with strong liquidity of $572.3 million. Our liquidity position includes our fourth SBIC license, which we received in July. Our fourth license provides access to $175 million of additional growth capital and will help us to maintain our overall blended cost of capital.

Our balance sheet with excess liquidity, a low cost of debt relative to our peers and 4 investment-grade corporate credit ratings continues to position us well and afford us the ability to compete aggressively on quality transactions.

As discussed earlier, we saw a significant slowdown in the venture capital ecosystem during Q3 in terms of some of the key metrics that we monitor. Venture capital investment activity of $37.5 billion in Q3 was down 32% from Q2 levels. This was the slowest Q3 in the last 4 years in terms of venture capital equity investment activity. Year-to-date, venture capital investment activity was approximately $131.4 billion, which is largely flat from the same period a year ago, according to data gathered by PitchBook and BCA.

We also saw M&A exit activity for U.S. venture capital-backed companies pulled back considerably in Q3 to $7.4 billion, down from $18.5 billion in Q2. Year-to-date ended Q3 2024, fundraising activity was steady relative to last year at approximately $65.1 billion.

Despite the slowdown in Q3, we believe that the ecosystem remains healthy and that the recent numbers reflect a reversion back to the historical norm, the uncertainty surrounding the upcoming U.S. presidential election and a lack of clarity around near-term Fed actions.

Consistent with the aggregate data for the ecosystem during Q3, capital raising across our portfolio was down with 18 companies raising approximately $600 million in new capital, down from $1.7 billion raised in Q2 and $2.6 billion raised in Q1. Year-to-date ending Q3, we had 58 portfolio companies raised over $4.9 billion of new capital, which is nearly the same amount of equity capital that our portfolio companies raised last year through the same period.

Given our strong operating performance in Q3, we exited the quarter with undistributed earnings spillover increasing to over $152 million or $0.94 per ending shares outstanding.

For Q3, we announced our base distribution of $0.40 and a supplemental distribution of $0.08. This represents our 17th consecutive quarter of being able to provide our shareholders with a supplemental distribution on top of our regular quarterly base distribution.

In closing, our scale institutionalized lending platform and our ability to capitalize on a rapidly changing competitive and macro environment continues to drive our business forward and our operating performance to record levels. In Q3, Hercules delivered its sixth consecutive quarter of over $100 million of quarterly core income, which excludes the benefit of prepayment fees or fee accelerations from early repayments.

Our success is attributable to the tremendous dedication, efforts and capabilities of our 100-plus full-time employees and the trust that our venture capital and private equity partners place with us every day. We are thankful to the many companies, management teams and investors that continue to make Hercules Capital their partner of choice.

I will now turn the call over to Seth.

[Seth Meyer, executive]

Thank you, Scott, and good afternoon, ladies and gentlemen. Q3 marked another solid quarter of income generation and balance sheet strengthening. Record total investment income of $125.2 million was based on a solid core income of $116.1 million or core net investment income of $0.45 per share.

Early repayments of approximately $230 million were within the guidance range, generating a 4% acceleration rate in noncore income. Our cost of debt ticked up slightly to 5.1% and our SG&A expenses were just below my guidance. The net result was a solid $0.51 net investment income per share of earnings.

On the balance sheet side, we increased available liquidity by $70 million in July when we concurrently retired $105 million of institutional notes and received approval for our fourth SBIC license, unlocking another $175 million of liquidity. We ended the quarter with more than $570 million of available liquidity and more than $930 million across the platform, including the adviser funds managed by our wholly-owned subsidiary, Hercules Advisor LLC.

With all of this in mind, I'd like to review the following areas: income statement performance and highlights, NAV unrealized and realized activity, leverage and liquidity, and finally, the financial outlook.

Turning first to income statement performance and highlights. As mentioned previously, total investment income in Q3 was a record $125.2 million, driven primarily by our record first half growth in the debt portfolio. Core investment income, a non-GAAP measure was a solid $116.1 million. Core investment income excludes the benefit of income recognized as a result of loan prepayments.

Net investment increased to $83.2 million or $0.51 per share in Q3, a 1% quarter-over-quarter increase. Our effective and core yields decreased modestly in the third quarter to 114.4% -- sorry, 14.4%, and 13.3%, respectively, compared to 14.7% and 13.7% in the prior quarter. The decline in the core yield during the quarter was largely driven by the prepayment of certain legacy higher-yielding assets as well as a slightly lower onboarding yields for more recent originations.

Third quarter gross operating expenses were $44.3 million compared to $45.5 million in the prior quarter. Net of costs recharged to the RIA, our net operating expenses were $42.1 million. Interest expense and fees increased to $22.4 million from $21.5 million in the prior quarter due to greater utilization of the credit facilities as a result of the refinancing of the $105 million notes.

SG&A decreased to $21.9 million, in line with my guidance. Net of costs recharged to the RIA, the SG&A expenses were $19.7 million. Our weighted average cost of debt increased slightly to 5.1%, ROAE or NII over average equity increased -- or decreased to 18.9% for the third quarter and ROAA or NII over average total assets decreased slightly to 9.5%.

Switching to NAV unrealized and realized activity, during the quarter, our NAV per share decreased slightly by $0.03 per share to $11.40 per share. This represents a NAV per share decrease of 0.3% quarter-over-quarter. The main driver was the investment portfolio net unrealized depreciation of $13.9 million, primarily driven by a single portfolio company investment that remains on nonaccrual.

Our $13.9 million of net unrealized depreciation was the result of $15.5 million of net unrealized depreciation on the loan portfolio, offset by $3.6 million of appreciation to the privately held equity and warrant portfolio and $2.6 million of appreciation to the publicly held equity and warrant portfolio.

In addition, we had $1.6 million depreciation due to the reversal of prior unrealized appreciation, $3.6 million of depreciation attributable to other investment-related receivables offset by $0.6 million of appreciation on forward currency.

On leverage and liquidity, our GAAP and regulatory leverage decreased modestly to $94.6 million and 85.1%, respectively, compared to the prior quarter due to healthy prepayment volume in the quarter. Netting out leverage with cash on the balance sheet, our net GAAP and regulatory leverage was 92.5% and 83.0%, respectively.

We ended the quarter with over $570 million of available liquidity. As a reminder, this excludes capital raised by the funds managed by our wholly-owned RIA subsidiary. Inclusive of these amounts the Hercules platform had more than $930 million of available liquidity. The strong liquidity positions us very well to support our existing portfolio companies and source new opportunities.

On the outlook points. For the fourth quarter, we expect core yield to be between 13% to 13.3%, excluding any future benchmark interest changes. As a reminder, more than 97% of our portfolio is floating with a floor and presently, more than 1/3 of our portfolio is at the contractual floor following the September prime rate reduction.

Although very difficult to predict, as Scott communicated, we expect $150 million to $250 million in prepayment activity in the fourth quarter. We expect our fourth quarter interest expense to increase slightly on the growth of the balance sheet compared to the prior quarter.

For the fourth quarter, we expect SG&A expenses of $22 million to $23 million and an RIA expense allocation of approximately $2.7 million. Finally, we expect a quarterly dividend from the RIA of approximately $1.6 million to $1.8 million per quarter which is an increase to my prior guidance.

In closing, our balance sheet remains strong to support our existing portfolio as well as opportunistically invest in the best opportunities.

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

[Operator]

[Operator Instructions] Our first question comes from Crispin Love of Piper Sandler.

[Crispin Love, analyst]

Scott, fundings were lighter in the quarter as you discussed and you've been vocal in the past that you don't need to grow for growth's sake. But as you look out a little further beyond the election and even in the next year, can you discuss just some of your expectations for deal activity in B.C. broadly and what that could mean for Hercules?

Would you expect a big wave of deal activity in 2025? Just curious on how you're thinking about that in the intermediate to longer term here.

[Scott Bluestein, executive]

Sure. Thanks, Crispin. Look, longer term, we continue to be very optimistic about the health and vibrancy of the venture capital ecosystem. The numbers that we saw in Q3 from an industry perspective were reflective of what we saw within our own portfolio in terms of a slowdown with respect to some of the key metrics that we monitor.

We've said this very consistently, and we'll continue to say it going forward. Venture debt, growth stage debt is designed to supplement equity. It's not designed to replace equity. And so when the equity markets in terms of venture capital investment activity are slow, it's not the right time, in our opinion, to be aggressively putting capital to work.

Our team is speaking to hundreds of people within the ecosystem on a pretty consistent basis. We had numerous conversations with management teams, with venture capital investors, with Board members throughout the course of Q3. And what we heard virtually consistently across the board is that a lot of the better quality later-stage companies were hesitant to take action in terms of financing in Q3, and that they wanted to wait it out to see what would happen with the Fed rate action and waited out to see what would happen with the upcoming presidential election.

Subsequent to quarter end, we've seen a very big change in terms of mentality. You can see that in terms of our pending commitments of over $600 million. Based on active dialogue that we're having now, we expect that number to continue to grow. So we remain optimistic.

I would just caveat that by saying that when we see a period, whether it's a month or a quarter or a half a year, where the market is not conducive for prudent credit deployment, we're simply going to hold our dry powder and wait for better opportunities. And that's exactly what we did in Q3.

[Crispin Love, analyst]

Great. I appreciate that. And then you mentioned the election a few times during your prepared remarks. So just with the election less than a week away, can you just speak to some of the potential implications for venture capital as a whole? And then Hercules specifically as it relates to different potential outcomes in the election. And then just kind of how those implications could impact the near or longer term?

[Scott Bluestein, executive]

Sure. Dangerous loaded question, but I'll certainly do my best to be responsive. Look, I think there are a number of scenarios that could play out next week. I think the scenario that we're probably most concerned about that would have an impact on Hercules and have an impact, I think, on the venture capital industry as a whole is we wake up Wednesday morning, and we don't have an outcome, right? And I think that's what we are probably most concerned about.

There are pluses and minuses in either direction. And from our perspective, we think the most important thing is that we have clarity in terms of who is the winner of the election come next Tuesday. But I think the scenario that we're most concerned about that we keep hearing a lot of anxiety about is the scenario where it's a disputed election, there is no winner and we're all in sort of a period of paralysis where you're just waiting to see what's going to happen. And that's what we're managing right now the business pretty conservatively to navigate around.

[Operator]

Our next question comes from Brian Mckenna of Citizens JMP.

[Brian Mckenna, analyst]

I know you've got a bunch of questions about this really over the past 18 months, but what are you seeing in the market today from a competitive perspective? You're clearly in an industry-leading position, and it doesn't appear that there are a lot of other direct competitors in the market. But at some point, does this change at all? And then also related, have you seen any of the larger private credit players coming into the space or trying to come into this space just to go after the opportunity more broadly?

[Scott Bluestein, executive]

Sure. Thanks for the question, Brian. I'll answer this similarly to how I answered it last quarter, which is that the market is competitive. We continue to see competition on the majority of deals that we underwrite and look at. Having said that, there is no real consistent competition that we see on every transaction or in the majority of transactions that we originate and underwrite.

Our business on the asset side is very diversified. We have a distinct investment team that focuses on life sciences. We have a distinct investment team that focuses on technology. Within those 2 verticals, we have sub verticals with teams of experts that focus on particular parts of the market. So we make sure that we're touching every company. Depending on the vertical, depending on the stage, we will see sporadic competition from a variety of different players.

In terms of the larger question about larger asset managers and private equity firms coming into the space. We've seen that from time to time. It has not been consistent. There will be periods or quarters or certain types of deals where some of the larger asset managers will come in and be a little bit more aggressive.

But what we can say sort of definitively is that none of them have the consistency of being in the venture and growth stage market for the last 20 years. None of them have the track record that our team has in terms of $21 billion of deals over a 20-plus year period. And that's very hard to replicate and duplicate.

So I think we're positioned very well from a competitive perspective. When we do compete, we primarily are competing with equity. So the companies that we're talking to are either going to do a deal with us or they're going to raise equity capital. But competition is something that we watch very closely. If we see changes, we'll obviously make decisions to react appropriately, but we have a long-term outlook on this business.

[Brian Mckenna, analyst]

Yes. Super helpful. And then just a follow-up here. It's great to see such strong dividend coverage, specifically given where we are in the cycle and what will likely be a number of base rate cuts moving forward. But how should we think about the base dividend heading into next year? Is the $0.40 quarterly level a good baseline and then you'll continue to pay specials around that based on the level of excess earnings? Just any thoughts there would be helpful.

[Scott Bluestein, executive]

Sure. Brian, the dividend is ultimately a Board decision, and the Board doesn't make those decisions on a prospective basis. Given the coverage, I can tell you, just institutionally, we feel very comfortable with our ability to continue to cover the base distribution.

And as we've demonstrated now over the last 17-plus quarters, to the extent that we have excess spillover income, which we continue to have, it is our view and our belief as an organization that we have an obligation to return as much as that as we can to our shareholders. And so to the extent that, that spillover remains the same, to the extent that our business continues to perform, we have every intention to continue to deliver supplemental distributions to our shareholders on a go-forward basis.

[Operator]

Our next question comes from John Hecht of Jefferies.

[John Hecht, analyst]

If I'm thinking right, you guys have your 20th anniversary coming up, so congratulations on that. I just want to dive a little bit more into some of the factors and the macro factors impacting originations from some of the prior questions.

Number 1 is, from an interest rate uncertainty perspective, I mean how -- for your portfolio, and I'm sure there's different cohorts within the portfolio, how much flexibility do they have in terms of waiting to see what's going to happen? Do they just have a specific window of time to make a decision? Or is there a lot of time for them to wait and see and make a decision?

[Scott Bluestein, executive]

So a couple of things there, John. First, thanks for the remarks regarding the 20th year anniversary. That's a significant milestone for Hercules Capital and our ability to consistently outperform over that period is really a credit to the team that we've built. We've got the best employees in the business, and we certainly appreciate you recognizing that special event for the company.

In terms of the rate question, the challenge here is that as you probably recall, the vast majority of our deals when they're underwritten have a contractual interest rate floor that's set at the market yield as of that time. It's not the case in every transaction, but it is the case in the majority of transactions that we do.

So a lot of the quality companies that we were talking about that we were talking to in the early parts of Q3, they were looking at the rate environment. I think the consensus was pretty clear that the Fed was going to cut.

We were in discussions with those companies. We may have had initial indications of interest out, but they simply wanted to wait to receive a term sheet because they knew that the term sheet subsequent to a Fed rate action, if it reflected a cut, would potentially be more attractive.

We didn't want to force those decisions. We were seeing a slowdown in the market. So we made the decision to wait it out.

Subsequent to the Fed taking action, reducing the Fed funds rate by 50 basis points, we've seen a significant increase in terms of the number of companies that are now willing to actually pull the trigger on debt financings. And that's why you've seen our pending commitments go up to $630 million in a very short period of time.

[John Hecht, analyst]

Okay. That makes sense. And then I hope this isn't loaded at all, but assuming that we do have clarity after the day of the election, is there -- like depending on the outcome, whether it goes either way. Are there certain sectors that you think will be impacted and more vibrant and more active relative to others depending on the outcome of the election?

[Scott Bluestein, executive]

Sure. I mean there's definitely an argument that certain sectors, certain verticals will be impacted either positively or negatively depending on who will win. I'm not going to get into that on the call because we're obviously going to make decisions in terms of sector allocations. I mean, we just don't want to signal to the market what we're going to do, but we do believe that there are specific sectors that will respond favorably and then certain sectors that will be more negatively impacted depending on who wins next week.

[John Hecht, analyst]

Okay. That makes sense. And then finally, if I can, I can't remember if we've had a conversation about AI and what you're thinking in terms of -- I mean, obviously, the massive development of that in the industry. And what kind of opportunities that might present to you?

[Scott Bluestein, executive]

Yes. Look, it's a massive evolution in the technology space. Our team has been doing a lot of work on artificial intelligence, broadly speaking, we've been very selective in terms of the companies that we are pursuing within the artificial intelligence space. I would sort of describe our approach to the space right now is wanting to 10 gently be exposed.

We're looking for companies that have AI elements to them, but we've not been super aggressive with respect to pure-play AI companies because we sort of view the market like we viewed the battery market 15 to 20 years ago. There's a ton of capital going into the space. There's a ton of interest in the space. There's going to be a lot of winners, but there's also going to be a lot of losers.

And when you're an equity investor, you can afford to make those bets. When you're a secured lender that focuses on credit, you can't have a lot of losers. And so we're playing the space tangentially. We've booked transactions with a lot of very strong companies that we're excited about. But we'll continue to sort of approach pure-play artificial intelligence companies pretty selectively here.

[Operator]

Our next question comes from Finian O'Shea of WFS.

[Finian O'Shea, analyst]

Happy 20th as well. I guess I want to go back to the market or origination topic. There's a lot to sort of tie together there between the opening remarks and the Q&A. So it sounded like, Scott, Q3 is light on volume, but also the quality hasn't been great. And tying that -- does that tie to some of maybe the other comments on competition that maybe you don't view as long term consistent?

Is that the case? And if so, why would that change? Because it does feel like everybody is raising a lot of money and looking down new -- into new cabinets for yield and so forth. So just seeing if you can add to that.

[Scott Bluestein, executive]

Sure. First up, Fin, thanks for the remarks on the 20th anniversary, again, I certainly appreciate that recognition. In terms of the question, I think there's a lot there as well. I'll do my best to be responsive. And if you want additional color, obviously happy to continue to engage on it.

With respect to our view of the credit market for venture and growth stage lending in Q3, it was both slow and it was soft in terms of quality. There were a lot of companies that we saw, particularly in the early innings of Q3 that were subscale, that were thin on liquidity, that were coming to the debt market because they did not have a lot of other alternatives. That's certainly not the case in every instance, but that was the majority of what we saw coming to market, particularly in early Q3.

We chose to sit that out. We were focused on quality. We saw a lot of opportunities within our own portfolio to put capital to work. We ended up committing in excess of $400 million in the quarter. We ended up funding nearly $275 million in the quarter.

Year-to-date, we have funded a record $1.3 billion. Year-to-date, we have committed $2 billion. So our origination efforts have not slowed down year-to-date. We just pulled back in Q3 because we didn't see the quality to support aggressive capital deployment.

[Finian O'Shea, analyst]

Okay. It sounds idiosyncratic more so than a powerful force, I guess. A follow-up, if I may. Seth, can you talk about the -- why the guidance went up on the RIA?

[Seth Meyer, executive]

Yes, absolutely, Fin. So we're taking the guidance on the RIA dividend up slightly because of the performance that the portfolio is achieving as well as the growth of that portfolio. As you know, we've been allocating pretty consistently, maybe around 20%, 22% of the investments that we've been making since the inception in 2021. And that portfolio is really now at a mature stage.

It's also achieving that maturity level where it's receiving prepayments just like the BDC is. And so with that, we could see that the outlook was a little bit more positive than I had guided, and so we wanted to tick it up a little bit.

[Finian O'Shea, analyst]

And is there eventual -- is there embedded, say, potential upside from performance fees? I know it's early in the life and maybe those come later upon realizations or whatnot. Is that -- is this rate sort of lower than it would be down the line, all else equal?

[Seth Meyer, executive]

So yes is the short answer. Of course, there's the opportunity, but it is the same way that we look at the equity and warrant options that we get in the BDC portfolio. We see those as opportunistic to defray any debt losses that we may incur. And so we don't look at those as a huge equity home run opportunity for that performance side, Fin. So I would say that certainly, structurally, that is there but it's not something that we're betting on.

[Operator]

Our next question comes from Christopher Nolan of Ladenburg Thalmann & Co.

[Christopher Nolan, analyst]

Congratulations on the 20. On a broader issue, taxes on unrealized gains is something, which has sort of been proposed in all the discussions, in particular, in California. And how do you see that impacting your business?

[Seth Meyer, executive]

So we would see that as impacting our business no differently than any other investment business. And so I think that we're going to be dragged along with the tide with that. And therefore, when you look at the relative performance, Chris, I don't think that it would impact us any more negatively or positively than others.

We do enjoy the fact that we are a pass-through entity. So keeping in mind that the BDC itself is a RIC. We're passing on the earnings up into the investors. That profile could be a taxable or tax-exempt entity. But we would not see ourselves as disproportionately impacted by that.

[Christopher Nolan, analyst]

Okay. And then I guess the follow-up question is for 2025, what regulatory change affecting BDCs would you guys be at the top of your wish list?

[Seth Meyer, executive]

That's an open field question. As an industry, we have been hopeful that Congress would take up the AFFE issue for inclusion and basically excluding the expenses when calculating the total returns and disclosure to their companies. So that's certainly top of the industry list. It does not impact us directly as much. But Scott has something additional that is -- go ahead.

[Scott Bluestein, executive]

Yes. I was just going to say, I think the top of the list on the investment side would be the ineligible asset restrictions. That's something that we've been talking about for a long time. We think it disproportionately impacts negatively businesses like Hercules Capital. And if we could have our pick, we would certainly look for that to change going forward.

[Seth Meyer, executive]

Yes, the indexing of that would be great.

[Operator]

[Operator Instructions] I am showing no further questions at this time. I would now like to turn it back to Scott for closing remarks.

[Scott Bluestein, executive]

Thank you, and thanks to everyone for joining the call today.

As a final note, we will be participating in the Citizens JMP Financial Services Conference on November 12 in New York. If you are interested in meeting with us at this event, please contact Citizens JMP directly or Michael Hara. We look forward to reporting our progress on our Q4 2024 earnings call.

Thanks, and have a great rest of the day.

[Operator]

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.