Hercules Capital Inc

NYSE:HTGC

Earnings Call Transcript 2022-Q4

[Operator]

Good day, and thank you for standing by. Welcome to the Hercules Capital Fourth Quarter 2022 Earnings 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 speaker today, Michael Hara, Managing Director of Investor Relations.

[Michael Hara, MD, IR & Corporate Communications]

Thank you, Josh. Good afternoon, everyone, and welcome to Hercules Conference Call for the Fourth Quarter and Full Year 2022. 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, CEO, CIO, President & Director]

Thank you, Michael, and thank you all for joining the Hercules Capital Q4 2022 Earnings Call. Following our record operating performance in 2021, Hercules Capital raised the bar higher and once again delivered record performance in 2022. 2022 was a historic year for Hercules Capital. And I am incredibly proud of what our talented and growing team accomplished. Our record-setting performance in 2022 culminated with the strongest total and net investment income quarter in the company's history. And the recent declaration of an increased quarterly base distribution and a new supplemental distribution program for our shareholders.

Hercules Capital delivered another strong year of record originations performance, record financial results and continued strong credit performance. Our performance in 2022 reflects the benefits of being able to achieve and operate at scale, maintain robust liquidity and a strong balance sheet and working with the best-in-class team that is highly experienced in this asset class.

Thanks to the growth of both the BDC and our private credit funds business, Hercules Capital is now managing in excess of $3.6 billion of assets, an increase of over 38% from where we were at the end of 2021. Despite continued market and macro volatility, the continued strength and expansion of our originations platform, robust liquidity position and strong balance sheet put us in a position to deliver achievements on multiple fronts in 2022, including record total gross debt and equity commitments of $3.12 billion, up 18% year-over-year and the first time in our 18-year history where we have been able to deliver over $3 billion of new commitments in a year.

Record debt investment portfolio growth of nearly $600 million; record total investment income of $322 million, up 14% year-over-year; record net investment income of $188 million, up 25% year-over-year; increased our base distribution 3x in 2022 with our most recent increase to $0.39 per share in Q4. Record cash distributions of $1.96 declared for 2022, an 18% increase year-over-year, 3 consecutive years of delivering supplemental distributions to our shareholders. And finally, over $330 million of investments assigned to and/or funded directly out of the adviser funds that we manage through our wholly-owned RIA.

2022 was also another year of investment in the company, where we took additional steps to strengthen our platform, originations capabilities and back office functionality and sophistication. These investments provide us with continuing optimism and confidence in the trajectory of our business heading into 2023. Our results in Q4 can be summarized by record earnings strong portfolio growth and momentum, improving yields and stable credit.

Let me recap some of the key highlights of our performance for Q4. Our record originations performance in the first 3 quarters of 2022 continued with strong Q4 gross debt and equity commitments of $645 million. Our gross fundings continued to be strong during the quarter with over $367 million, which led to strong net debt investment portfolio growth of over $133 million during the fourth quarter and a record $598.5 million for 2022.

The net debt investment portfolio growth that we achieved in 2022, combined with the current yield environment puts us in a strong position to be able to deliver strong net investment income growth in fiscal year 2023. Our Q4 originations activity was driven by both our technology and life sciences teams, delivering strong performance during the fourth quarter. Our commitments and funding activity demonstrated balance between our 2 core verticals, and this continues to provide us with the unique ability to actively target both verticals depending on where we are seeing better opportunities and risk-adjusted returns.

We funded capital to 25 different companies in Q4, of which 9 were new borrower relationships. For 2022, we added 52 new borrower relationships, which further expands our scale in the market and reputation as the lender of choice for growth-stage companies looking for a long-term and stable financing partner that has been active in the market through several cycles.

Consistent with what we saw throughout the first 3 quarters of 2022, we were again able to expand our funding relationship with numerous portfolio companies that continue to show strength and achieve performance milestones during the fourth quarter. With over $3 billion of new commitments in 2022 and a lower-than-typical funding-to-commitment ratio driven by conservative credit underwriting, we expect this trend of increased follow-on fundings to existing portfolio companies to continue in 2023.

The momentum that we saw throughout 2022 has carried into 2023, and we are pleased by our performance on originations quarter-to-date. Since the close of Q4 and as of February 13, 2023, our deal team has already closed $189 million of new commitments and funded over $192 million. We have pending commitments of an additional $263 million in signed, nonbinding term sheets. Volatility across the equity markets, particularly for growth-stage companies continued to stabilize in Q4. Valuations for both public and private companies remain under pressure, and the capital markets have stayed more selective on the equity side. This is continuing to drive strong demand for our capital and why we expect our pipeline to continue to be healthy near and medium term.

We believe that Hercules is best positioned in the asset class for continued and sustained success. Consistent with our historical approach to underwriting credit, we are remaining patient and disciplined on new originations, and we will prioritize credit quality over chasing higher risk transactions with a yield premium. We believe that we are incredibly well positioned in the current market and that our scale and portfolio and VC diversification afford us the ability to say no on new credits that do not meet our underwriting parameters. This is particularly important in today's market with a number of growth-stage companies looking for structured debt has increased dramatically.

Hercules has always maintained a credit-first culture, and we expect this to continue to serve us well, particularly in periods of volatility. During Q4, portfolio company exits and liquidity events for the industry continue to reflect the ongoing pressure in the equity markets as well as the trends in M&A that we anticipated on our Q3 earnings call.

For 2022, we had 19 total exits comprised of 5 IPOs and 14 companies announced or complete M&A transactions. Although the exit environment in 2022 was suppressed relative to 2021, our 19 exits were consistent with our historical average. As the IPO market remains uncertain, we continue to expect to see an acceleration of M&A transactions over the next several quarters.

Since our last earnings call on November 2, we have had 9 portfolio companies announced or complete M&A transactions. This includes Ouster announcing a merger with Velodyne in Q4 and completing it in Q1. And Evernote announcing its acquisition by Bending Spoons also in Q4. During Q1 quarter-to-date, we have had 7 additional portfolio companies announced or complete M&A transactions. This includes Fungible being acquired by Microsoft. Albireo Pharma being acquired by Ipsen; Agrivida being acquired by Novus; Concert Pharmaceuticals being acquired by Sun Pharma; Logicworks being acquired by Cox Communications; AVEO being acquired by LG Chem; and Oak Street's recent announcement that it is being acquired by CBS.

This reflects the quality of our loan portfolio as well as our team's ability to continue to identify and target the most promising growth stage companies in the market. Early loan repayments were approximately $131 million in Q4, close to the midpoint of our guidance of $100 million to $150 million and a modest increase from $125 million in Q3 2022.

For Q1 2023, driven in large part by M&A, we expect prepayments to be between $150 million and $200 million, although this could change as we progress in the quarter. In Q4, we generated a record total investment income of $100.2 million and record net investment income of $62.1 million or $0.47 per share, providing 121% coverage of our recently increased base distribution of $0.39 per share.

Our portfolio generated a GAAP effective yield of 14.7% in Q4 and a core yield of 13.8%, which exceeded our guidance for the quarter and is indicative of the recent rate increases and higher onboarding yields for certain new loans. With net regulatory leverage at a very conservative 100.1% and continued robust liquidity across our platform, our balance sheet remains very well positioned.

Additionally, we have no long-term debt maturing in 2023, which affords us the ability to be opportunistic and selective on raising new capital. Credit quality on the debt investment portfolio remained strong and stable. Our weighted average internal credit rating of 2.23 was slightly higher than the 2.20 rating in Q3, but it remains at the low end of our normal historical range.

Our Grade 1 and 2 credits decreased to 61.5% compared to 67.4% in Q3. Grade 3 credits were higher at 36.3% in Q4 versus 31.1% in Q3. Our rated 4 credits made up 2.1% of the portfolio and rated 5 credits were 0.1% in Q4. As of our most recent reporting, 100% of our debt portfolio companies are current with respect to contractual payments of principal and interest. As of the end of Q4, we had only 2 debt investments on nonaccrual with an investment cost and fair value of approximately $18 million and $1.7 million, respectively or 0.6% and 0.1% as a percentage of the company's total investment portfolio at cost and value, respectively.

We ended Q4 with strong liquidity of over $606 million. Subsequent to year-end, we signed a new letter of credit agreement with SMBC, which provides for a letter of credit facility of up to $100 million. In addition, we amended and extended our MUFG led facility. The venture capital ecosystem finished 2022 with fundraising activity at a record $163 billion and investment activity at $238 billion according to data gathered by PitchBook and the National Venture Capital Association.

With the amount of available capital to invest at historic highs, we remain optimistic that venture capital activity will accelerate in 2023. Despite more selectivity and valuation sensitivity from venture capital investors, capital raising across our portfolio remained strong throughout 2022, with 58 companies or more than half of our portfolio companies raising over $5.6 billion of new capital.

In Q4 alone, we had 20 different companies raised over $1.6 billion of new capital. We exited Q4 with undistributed earnings spillover of nearly $125 million or $0.94 per share. The undistributed earnings spillover continues to provide us with the added flexibility with respect to our shareholder distributions going forward and the ability to continue to invest in our team and platform.

For Q4, we increased our base distribution to $0.39 from $0.36 and declared a new annual supplemental distribution of $0.32, which will be paid equally over the next 4 quarters beginning in March 2023. This was our third increase to our quarterly base distribution in 2022 and our third consecutive year of being able to pay out supplemental distributions to our shareholders. We will continue to evaluate the quarterly, variable base distribution with a particular focus on the debt portfolio growth and NII growth that we are expecting to materialize.

In closing, our momentum remained strong throughout 2022, and we remain well positioned in 2023 from all aspects to take advantage of market conditions and grow our core income generating assets, and as a result, the earnings power of the business. Our core themes for 2023 will largely remain consistent with 2022, and they reflect maintaining a strong balance sheet and liquidity position and staying disciplined on new underwritings, while continuing to invest in our investment teams and platform.

We are thankful to the many companies, management teams and investors that continue to make Hercules their partner of choice. I will now turn the call over to Seth.

[Seth Meyer, CFO & CAO]

Thank you, Scott, and good afternoon, ladies and gentlemen. As Scott mentioned, this was another record quarter for Hercules Capital, capping off a record-breaking 2022. In addition to record investment activity in 2022, we continue to strengthen our team, expand and enhance our balance sheet and ensure our cost of leverage was optimized in a rising interest rate environment.

Throughout the year, we were able to further validate the benefits of operating at scale by demonstrating meaningful operating leverage as we grew AUM to record levels. This allowed us to deliver an NII margin of 62% in Q4, the highest that we have achieved since 2007. During 2022, our weighted average cost of debt remained below 4.6%, putting us in a very strong position relative to others in our asset class.

We were able to do this by refinancing more expensive legacy instruments in 2021 and into early 2022. And then focusing our balance sheet flexibility once the markets became more challenging from a rate perspective. As a recap, in June, we completed 2 institutional debt financings and expanded our capacity on both credit facilities to support the continued growth of the portfolio.

In total, $470 million of additional debt financing and credit facility capacity was made available to Hercules Capital, demonstrating our ability to raise significant amounts of capital at attractive rates in a period of significant volatility for the capital markets. We've started 2023 with the same success, amending and renewing early, our largest credit facility led by MUFG and putting in place a new letter of credit facility with SMBC to cover $100 million of our available, unfunded commitment in a more cost-effective manner.

The consequence of these steps is greater flexibility, lower financing costs and consistently strong liquidity to support our business and portfolio companies. We will continue to focus on these themes in 2023 as well as focus on other operational efficiencies and scale of the platform. With that in mind, let's review the following areas: number one, income statement performance and highlights, number two, NAV, unrealized and realized activity; number three, leverage and liquidity; and then finally, number four, the financial outlook.

Focusing first on the income statement performance and highlights. Total investment income was another record at $100.2 million driven by 27% growth in the debt portfolio over the year on strong new business underwriting combined with lower prepayments and an increase in benchmark rates.

Net investment income was a record $62.1 million, a 24% quarter-over-quarter increase or a record of $0.47 per share in Q4. Our effective and core yields in the fourth quarter were 14.7% and 13.8%, respectively, compared to 12.9% and 12.4% in the third quarter.

The increase in the core yield was due to an increase in coupon interest as a result of base rate interest increases. While we expect this trend to continue in the first quarter with the full quarterly impact of the fourth quarter Fed policy interest rate changes and the partial impact of the most recent rate change, we are forecasting a leveling of core yield thereafter due to expected loan onboarding yields and less movement from the Fed.

Turning to expenses. Our gross operating expenses for the quarter increased to $40 million compared to $36.1 million in the prior quarter. Net of costs recharged to the RIA, our operating expenses were $38 million. Interest expense and fees increased to $18 million from $16.7 million in the prior quarter due to the growth of the investment portfolio and slightly higher weighted average cost of debt.

SG&A expenses increased to $22 million from $19.4 million in the prior quarter, above my guidance on higher funding for the quarter versus our forecast. Net of cost recharge to the RIA, the SG&A expenses were at $20.1 million. Our weighted average cost of debt was 4.6%, a slight percent increase compared to the prior quarter, reflecting greater utilization of the credit facilities due to growth of the investment portfolio.

Our ROAE or NII over average equity increased another 350 basis points to 18.2% for the fourth quarter and ROAA or NII over average total assets was 8.8%. Switching to NAV and unrealized and realized activity. During the quarter, our NAV increased $0.06 per share to $10.53 per share. This represented an NAV per share increase of 0.6% quarter-over-quarter.

Net investment income accretion due to modest use of the ATM was offset by the dividends paid in the quarter, including the $0.15 per share spillover distribution of 2021 earnings. Net realized loss of $1.7 million related to the write-off of the legacy equity and warrant positions.

Moving on to leverage and liquidity. Our GAAP and regulatory leverage were 113.7% and 101.3%, respectively, which slightly increased compared to the prior quarter due to the net growth of the investments, offset by the modest use of the ATM. Netting out leverage with cash on the balance sheet, our GAAP and regulatory leverage was 112.6% and 100.1%, respectively. We ended the quarter with more than $600 million of available liquidity.

As a reminder, this excludes capital raised by the funds managed by our wholly-owned RIA subsidiary. We believe our strong and flexible liquidity positions us very well in the current rate environment. With the renewal of the MUFG credit facility and the addition of the SMBC letter of credit facility, we have no near-term debt maturities, giving us the ability to be opportunistic should we decide to raise additional capital to support the business.

We continued to opportunistically access the ATM market during the quarter and raised approximately $40 million, resulting in an $0.08 per share accretion to NAV. For the year, we raised approximately $230 million from the ATM program. Finally, on the outlook points, for the first quarter, we're increasing our core yield guidance range to 13.5% to 14%, excluding any future benchmark interest changes.

As a reminder, approximately 95% of our debt portfolio is floating with a floor, so the recent interest rate hike and any additional in 2023 will benefit our core yield going forward. Although very difficult to predict, as communicated by Scott, we expect $150 million to $200 million in prepayment activity for the first quarter. We expect our first quarter interest expense to increase compared to the prior quarter due to the balance sheet growth experienced in the fourth quarter and anticipated in the first quarter.

For the first quarter, we expect gross SG&A expenses of $21 million to $22 million in a similar level of RIA expense allocation compared to the fourth quarter. As a reminder, the first quarter always has higher payroll taxes and benefit costs. In closing, as we reflect on the achievements of 2022 and our ability to deliver both record AUM and record NII per share, we remain optimistic about 2023 and our ability to continue to drive growth across the platform while remaining focused on delivering best-in-class total shareholder returns.

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

[Operator]

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

[Crispin Love, Piper Sandler & Co.]

In your prepared remarks, you talked about how half of your companies -- portfolio companies raise equity capital in 2022 for, I think, you said about $5.6 billion and that's with -- as the industry activity fell off meaningfully. So can you just speak to why you believe that your portfolio companies were in a position to raise significant capital while the industry as a whole wasn't able to?

[Scott Bluestein, CEO, CIO, President & Director]

Sure. Thanks, Crispin. I think a lot of it really has to be attributable to the quality of our team. We have over 55 professionals on the investment team. This is an incredibly experienced investment team. The average industry experience across that investment team is approximately 10-plus years, and they have a long track record of working successfully together to identify and then win transactions with some of the best quality companies in the market.

So I think a lot of the credit has to go to the team. The second thing that I would point out is that at least from what we're seeing, there has certainly been some pressure in terms of valuation. But the companies that remain strong companies are able to raise new equity capital, and that's really what we saw across our portfolio in 2022. And those numbers that you cited were exactly where they came out for us. In Q4, we had 20 different companies raised over $1.6 billion of new capital. And for the year, we had approximately 58 companies raised approximately $5.6 billion of new capital.

[Crispin Love, Piper Sandler & Co.]

And Scott, how does that $5.6 billion compared to 2021? .

[Scott Bluestein, CEO, CIO, President & Director]

I don't have the data for you for 2021. So I'd have to get back to you on that. .

[Crispin Love, Piper Sandler & Co.]

Okay. Not a problem. And then, Scott, you also mentioned during the prepared remarks about being patient and disciplined on new originations. Are you able to drill into that a little bit deeper and what that might mean for your expectations for new debt fundings or debt fundings growth in 2023 or at least what you're seeing over the near term?

[Scott Bluestein, CEO, CIO, President & Director]

Sure. So as a firm, we are incredibly optimistic about what the environment will look like for us in 2023. We're off to a great start in Q1, and I provided some quarter-to-date closed commitments and quarter-to-date pending commitment numbers, and we're off to a great start in regards to both of those numbers. The team is continuing to look at and evaluate a record number of transactions.

So when we look at our pipeline activity, it is as large as it's been in a long time. Having said that, and this was also part of the prepared remarks, because of the turbulence that we're seeing in the equity markets, both public and private, we're seeing a tremendous increase in the number of companies that are looking for venture debt or growth-stage debt funding solutions. And as you know, having followed this business for a long period of time, you simply can't hit the bid for every company that's looking for debt financing.

So our team is being very thorough in terms of our screening, very diligent with respect to the number of companies that we are progressing along in our pipeline activity. And we believe that we are closing transactions with the best qualified companies that we are seeing on a quarterly basis.

I would also reference, last year, we did $3 billion of commitments. When you look at our funding-to-commitment ratio, last year was approximately 55% to 60%. So there are a lot of funding that we anticipate taking place from the existing portfolio over the course of the next 6 to 12 months.

[Operator]

Our next question comes from Kevin Fultz with JMP Securities.

[Kevin Fultz, JMP Securities]

Congratulations on a great year. Clearly, the portfolio credit quality is in excellent shape. I'm just curious if you've seen an increase in amendment requests at all. And if you could discuss your expectations that potentially pick up in the near term.

[Scott Bluestein, CEO, CIO, President & Director]

Sure. Thanks, Kevin. We have not -- and we actually -- we just looked at this -- we look at it every quarter. But over the course of Q4, we really did not see any uptick in amendment requests broadly. And specifically, we did not see any amendment requests that were related to stress or liquidity-related situations. So I think overall, we're continuing to see a stable and strong credit environment across our portfolio.

We have 2 loans on nonaccrual. It makes up less than 0.1% of the portfolio from a fair value perspective. We're certainly increasing our monitoring. We're tightening our underwriting screens given the volatility that we have seen over the course of the last several quarters and that we expect to see on a go-forward basis. But overall, we have not seen any uptick with respect to amendment requests from our portfolio companies.

[Kevin Fultz, JMP Securities]

Okay. That's great to hear. And I guess just to continue on that line of question. You mentioned nonaccruals obviously in great shape, with only 2 investments on nonaccrual. I was just curious if you could provide some high-level color on the one new investment that was added this quarter. .

[Scott Bluestein, CEO, CIO, President & Director]

Sure. It's a small loan. It's about a $5 million loan to a small tech company that is private. That company remains current with respect to its contractual payments to Hercules, but it does have stressed liquidity. They're currently exploring a variety of options, and we're working closely with the team. We did make the decision in Q4 out of an abundance of caution to put that loan on nonaccrual and we did take a fair value adjustment on that position as well. But it's a very small position relative to, obviously, a $3 billion portfolio. .

[Operator]

Our next question comes from Christopher Nolan with Ladenburg Thalmann.

[Christopher Nolan, Ladenburg Thalmann & Co.]

Scott, unfunded commitments for $645 million, 20% of the portfolio, down slightly quarter-over-quarter. Are you -- given the volatility of the broader environment, are you seeing companies having a tougher time meeting their milestones to tap those commitments? .

[Scott Bluestein, CEO, CIO, President & Director]

We're not. We've actually had a tremendous run of success with respect to companies of being able to unlock unfunded commitments. If you -- it's hard to sort of see the quarter-over-quarter movements because there's sort of a combination of 2 things. Number one, in any given quarter, we're funding a large portion of those available, unfunded commitments and then new unfunded commitments are being unlocked.

So what you essentially saw in Q4 was we were able to fund a lot of capital to existing portfolio companies. But on top of that, we had several of our sort of larger, later-stage companies, both on the tech side and life sciences side achieve specific performance milestones during the quarter, which unlocked new tranches from an availability perspective.

[Christopher Nolan, Ladenburg Thalmann & Co.]

And my follow-up question is, in your prepared remarks, you mentioned, if I heard correctly, $3.6 billion in investment assets. The balance sheet has $3 billion at cost. Should we assume that, that incremental $600 million is assets in the RIA?

[Scott Bluestein, CEO, CIO, President & Director]

Yes.

[Christopher Nolan, Ladenburg Thalmann & Co.]

And what -- how do you -- I know it's , but do you see the RIAs being even a faster growth vehicle than the publicly traded BDC for 2023?

[Scott Bluestein, CEO, CIO, President & Director]

It's hard to say. We think that both vehicles are obviously growth-oriented vehicles, and we demonstrated and we delivered very strong growth in the public BDC and in the private credit fund business last year. We expect that to continue to be the case based on what we're seeing right now for 2023. I would point out that because of the unique structure that we've deployed here where the RIA business is operated as a wholly-owned subsidiary of the public BDC, the more successful that private credit fund business is, the better it is for the shareholders and stakeholders of HTGC.

[Operator]

Our next question comes from Casey Alexander with Compass Point.

[Casey Alexander, Compass Point]

Yes. I'm trying to wrap my head a little bit around the cadence of the way things look like they're going to flow here in the first quarter. And you discussed the $150 million to $200 million of repayments as your estimate. I understand that. you had commitments in the first quarter already of $190 million, but you've already funded $193 million. I'm assuming that, that is some of those loans that are coming off of the unfunded commitment schedule. It would suggest, especially given that most of the time, fundings are back-ended that you would be looking at a fairly robust quarter in terms of net originations. And would that, in part, explain why you've already sold 2.6 million shares under the equity ATM program this quarter.

[Scott Bluestein, CEO, CIO, President & Director]

Sure. Thanks, Casey. So first, with respect to Q1, as you know, we do not provide a gross funding projection with respect to what we expect to do. We did provide the commitment numbers. I think the way you're looking at it, though, is the right way to think about it. The reason why the funding numbers so far quarter-to-date exceed the commitment numbers is, we've been able to fund a lot of capital to existing portfolio companies who hit performance milestones in the second half of last year. And those tranches were either expiring or the company has made the decision to draw that capital.

I mean in the case that what we typically see happen with the companies are achieving those milestones, we're obviously happy to fund that additional capital to borrowers where we already have the relationships. We're also seeing strong demand from a new business perspective, and that's evidenced by the new commitment number and the pending commitment number. So we're confident and we're optimistic with respect to what that Q1 funding number is going to look like. And that does lead to, a, why we've been not aggressive, but why we've been active on the ATM quarter-to-date. And I would also tell you that, that should serve as a pretty strong signal about how we feel about portfolio growth over the course of the first half of this year.

[Casey Alexander, Compass Point]

Okay. My other question is what's different and precipitates the usage of a letter of credit as opposed to a credit facility? Is there something different about that? Is it securitized that allows for it to be cheaper capital? Or why go in that direction? I'm not sure I ever remember a BDC actually using a letter of credit as opposed to a credit facility.

[Seth Meyer, CFO & CAO]

Yes. Thanks, Casey. It's Seth here. We think it's a pretty smart addition to our toolbox based on the fact that it's a lot cheaper facility to put in place. We're very grateful for SMBC working with us to put in place what we think is probably the first, unrelated letter of credit that's been put in place. And it covers the tail end of the exposure on the available unfunded commitment. That portion, which is unlikely in any single quarter ever to be drawn down. Historically, the range has been 5% to 15% of the prior quarter's available unfunded commitment is drawn down. So covering all of it with a higher cost credit facility doesn't seem smart to us in the long term.

[Casey Alexander, Compass Point]

Okay. I think I get it. .

[Operator]

Our next question comes from John Hecht with Jefferies.

[John Hecht, Jefferies]

Congratulations on a good year and a good quarter, and I appreciate you taking my questions. First 1 is, I mean, it's very clear that the public markets have gone from a kind of hard landing to softer landing kind of valuation and narrative and expectation that I'm wondering, Scott, maybe how does the feel in the venture capital world in terms of their viewpoint on the climate. And what does that mean for kind of the demand for your product and the opportunity set?

[Scott Bluestein, CEO, CIO, President & Director]

Sure. Thanks, John. What we're seeing across the ecosystem is, I would say, caution, but also optimism. The VC firms have record amounts of liquidity available to invest. When you look at the investment activity numbers for 2022, you can look at it 1 of 2 ways. You can look at it relative to 2021, which was the best year on record, and you can say that it was down year-over-year, which is absolutely factual.

But you can also look at it and say that the 2022 investment numbers represented the second strongest year in the history of venture capital activity. And so we chose to sort of look at it somewhere in the middle. We think the fundraising activity that was a record level in 2022 is a very strong signal of what we expect to be an acceleration of VC investment activity over the next 12 to 24 months. We're also continuing to see the same trends that we saw throughout 2022.

Good companies are able to raise money. The valuation discussions are a little bit more difficult. The VC firms are more valuation sensitive. But deals are still getting done for the companies that deserve to be funded. And whether it's on the equity side or the debt side, there have always been and there will continue to be a handful of companies that probably should not be getting financed.

And until all of that sort of works its way through the system, and that will take some time, you're going to continue to have this sort of volatility that we're seeing both in the public markets and in the private markets as well.

[John Hecht, Jefferies]

Okay. That's great color. And then the second question is, look, I mean, you've had a history of extraordinarily low losses. And obviously, your current credit book is still really strong. I know you have regulatory restrictions on leverage. But given your kind of loss content and your credit book, is there any potential appetite to kind of move towards the higher end of your leverage target over time? Or how do we just think about the application of leverage you've -- given your -- again, that terribly low loss ratio over time?

[Scott Bluestein, CEO, CIO, President & Director]

Thanks, John, for the question. Two things. One, and we've talked about this publicly before. In the venture lending or growth-stage lending asset class, driving leverage up is really challenging. And the reason for that is the duration of our assets. Throughout 2022 on a quarterly basis, our average duration was somewhere between 12 and 16 months.

Right now, our average duration is roughly 15 months. And so when your portfolio is turning that rapidly, it's very difficult to drive leverage up on a consistent and sustained basis. As of the end of Q4, we were operating at roughly 113.7% from a GAAP leverage perspective. Our guidance or our ceiling as publicly indicated is about 125%. So there is some room for us to drive that up.

And if the portfolio growth is as strong as we expect it to be in 2023, it would not surprise us if that number gets driven up slightly, but we're not a firm that has traditionally or will, on a go-forward basis, push the envelope with respect to leverage because even though it might help generate some additional return. We don't think in our asset class, it's the most prudent thing to do.

[Operator]

[Operator Instructions]. Our next question comes from Ryan Lynch with KBW.

[Ryan Lynch, KBW]

First question I had was, I think you kind of sort of touched on it earlier. But can you just explain why your -- why both your debt and your equity warrant portfolio valuation held up so well this quarter, kind of just in the face of kind of a challenging venture capital marketplace.

[Seth Meyer, CFO & CAO]

Yes. So thanks a lot, Ryan. I think that when you dig into the detail of our movement, you'll see that the public equity positions moved up. So that's just driven by the public markets where they landed at 12/31 whereas the private positions move down by almost an equal amount. That was obviously a coincidence.

There's different quantums of those positions. And what we've always seen is that the private positions typically trail about a quarter behind the public positions. And so it's not uncommon that we have those move in different directions or differing quantums because of that delay of the impact to the private markets.

[Scott Bluestein, CEO, CIO, President & Director]

And Ryan, I would just add, as Seth mentioned, the biggest driver on the upside was the public equity position. And if you just look at some of our larger public equity positions quarter-over-quarter from where they started Q4 to where they ended, the vast majority of those larger positions were up, and that was the largest driver of the overall movement in unrealized depreciation.

[Ryan Lynch, KBW]

Okay. That's helpful. And then going back to just the overall environment. You guys talked about on the call, there's been a lot of venture capital fundraising in 2022. I think it was a record year. But if you look at the venture capital investment, while it was healthy in 2022, there was a pretty sharp decline throughout 2022, bottoming with the fourth quarter, I think, of like $36 billion.

And then also, when you look at venture capital exits, they have really kind of dropped off a cliff, and I think they were down to about $5 billion in the fourth quarter. And so my question is, while there's been a lot of capital raised in venture capital firms in 2022. How do you feel -- how active do you feel they'll be if exits and they're not receiving their money back if exits stay kind of at these very low levels.

[Scott Bluestein, CEO, CIO, President & Director]

Sure. Thanks for the question, Ryan. So a couple of things. And I had mentioned this in response to one of the earlier questions. You can look at the 2022 investment data one of two ways. We chose to look at it as very strong and healthy, $238 billion invested by VC firms throughout the course of 2022, down year-over-year from the record in 2021 but the second strongest year on record.

And for us, despite the fact that it's down year-over-year, that still reflects what we saw in our own portfolio in 2022. With respect to funds raised, that was a record number, about $163 billion raised by venture capital firms in 2022. When VC firms make investments, they're not anticipating an exit in 3 months, 6 months or 12 months. These tend to be longer-term investments. We are very optimistic about the future of the venture capital ecosystem. And based on the conversations that we're having with our portfolio companies, with the venture capital firms that back our portfolio companies, we believe that 2023 will represent an uptick with respect to VC investment activity across the ecosystem.

[Ryan Lynch, KBW]

Well, I guess my question was more on the trends that we're seeing because while there was a record number of capital raised in 2022, the trend from investing on a quarterly basis decelerated significantly throughout 2022. Fourth quarter was very weak. And then when you look at the exit activity, that really dropped throughout the year significantly.

So my question is really, do you expect these trends to turn around or to continue in 2023? And what does that mean for your business, even kind of forgetting about 2021, but I know those were kind of years or maybe somewhat exacerbated by kind of the frothy mix of the interest rates. But do you see these trends sort of turning around that we saw in the second half of 2022? And if not, what does that mean for the venture capital landscape?

[Scott Bluestein, CEO, CIO, President & Director]

Sure. So Q4, both with respect to funds raised and dollars invested was down if you look at it relative to Q3. We do expect that to turn around. I'm not going to predict whether that happens in Q1 or Q2. We look at things on a 6- to 12-month basis. And based on everything that we're seeing, conversations that we're having, we believe that you will see an uptick over the course of 2023. With respect to exit activity, which was another comment that you made in terms of trends, again, I would sort of distinguish between some of the overall industry data and just the empirical evidence that we see in our own portfolio.

Quarter-to-date, we've had 7 companies out of 105 companies announced or closed M&A transactions. We certainly are not seeing any uptick with respect to IPO activity. But as we've been indicating publicly over the course of the last several quarters, we expect and we are seeing a tremendous uptick in M&A activity. And again, based on conversations we're having across the portfolio, we actually expect that trend to continue to accelerate into the first half of 2023.

[Operator]

Thank you. This concludes the Q&A session. I'd now like to turn the call back over to Scott for any closing remarks.

[Scott Bluestein, CEO, CIO, President & Director]

Thank you, Josh, and thanks to everyone for joining our call today. As a final note, we will be participating in the RBC 2023 Financial Institutions Conference in New York on March 7. If you would like to arrange a meeting with the Hercules management team, please contact RBC or Michael Hara. We look forward to reporting our progress on our Q1 2023 earnings call. Thank you. .

[Operator]

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.