Aug 6, 2009
Hercules Technology Growth Capital, Inc. (HTGC)
Executives
DeDe Sheel – IR, FD Ashton Partners Manuel Henriquez – Co-Founder, Chairman and CEO David Lund – CFO
Analysts
John Hecht – JMP Securities Troy Ward – Stifel Nicolaus Jason Deleeuw – Piper Jaffray Jon Arfstrom – RBC Capital Markets Douglas Harter – Credit Suisse Vernon Plack – BB&T Capital Markets
Operator
Good day and welcome to the Hercules Technology Growth Capital Q2 2009 Conference. Today's call is being recorded.
At this time, for opening remarks and introductions I would like to turn the call over to Ms. DeDe Sheel.
Please go ahead.
DeDe Sheel
Thank you, operator, and good afternoon everyone. On the call today are Manuel Henriquez, Hercules Co-Founder, Chairman and CEO; and David Lund, CFO.
Our second quarter 2009 financial results were released just after today's market close. They can be accessed from the Company's web site at www.herculestech.com or htgc.com.
We have arranged for a tape replay of today's call, which will be available through our web site or by using the telephone numbers and pass code provided in today's earnings release. I would like to call your attention to the Safe Harbor disclosure in our earnings release regarding forward-looking information.
Today's conference call may include forward-looking statements and projections. We ask that you refer to our most recent filings with the SEC for important risk factors that could cause actual results to differ materially from these projections.
We do not take any obligations to update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings, please visit sec.gov or visit our web site.
I would now like to turn the call over to Manuel Henriquez, Hercules Co-Founder, Chairman and CEO. Manuel?
Manuel Henriquez
Thank you, DeDe, and good afternoon and thank you everybody for joining us today. As you most realize after the market close we released our Q2 2009 earnings release and financial performance for the second quarter of 2009.
I'm proud to say that once again we, Hercules, produced another strong quarter in otherwise difficult and challenging credit environment as most of you are fully aware of as listening to the many earnings calls over the last few weeks. I like to start off by giving you a quick overview of the quarter, then some specific on the venture capital industry, some specifics on the balance sheet and outlook that we have for the second half of 2009, and then have David Lund, our CFO provide you more detailed internal overview of the financial performance in the quarter and of course, finish off with a question and answer session for our investors to ask questions and get better oriented in our performance.
In terms of the quarter we once again produced record net investment income of $11.8 million and producing earnings on a NII basis that are $0.04 above street consensus of $0.30. We reported $0.34 in net investment income earnings for the quarter.
On top of that we also reported record net interest margin of 14.35%. We also experienced a 3.4% income growth year-over-year as compared to the same period of 2008.
We also improved and dramatically increased our liquidity position and further solidifying our cash position in our balance sheet by delevering our balance sheet further and increasing the cash position which David will elaborate further. This is part of our ongoing strategy of maintaining high liquidity position as we position Hercules for the fourth quarter and beyond for new originations.
During the quarter we also saw the beginning and improvement of the venture capital industry by seeing an increased investment activities compared to Q1 but I like to caution everybody although the data is certainly encouraging one quarter does not make a trend yet. And I will stand upon that as I go through more details of the venture capital industry.
Another important achievement during the quarter was our ability to secure a $20 million credit facility by Union Bank, California that was expected to close in the third quarter, providing us even more liquidity to continue make investments in the fourth quarter and beyond. As to the asset quality, as many of you have seen today, we experienced a $4.2 million realized loss for the quarter, primarily attributed to two investments.
However, I remain optimistic in keeping with Hercules credit position that I expect to see over the proceeding few quarters some recovery of those realized losses that we experience as we look to monetize or liquidate some of the fixed assets, intangible assets we may have received as part of the liquidation of those companies. We have opted to take a more controlled sale of the intellectual properties, and look to monetize some portion of those, some recovery on that $4.2 million realized loss in the quarter.
A testimony to Hercules continued credit performance is that our investment professionals. Hercules credit performance would not have been and would not sustain itself without the incredible dedication and hard work of our employees as a company.
To that end we may extremely vigilant, tenacious, and aggressive, and ensuring that we attack and address the first signs of credit concern in our portfolio. During the quarter we have also experienced a $20.7 million of unrealized depreciation and in keeping with Hercules historical credit performance in underwriting and fair value standards, a significant portion of that is attributed to the companies that either in the process of closing the next round financing or expect to close round of financing in the near-term.
And to that end we have fair value of the investments in the event of those companies do not successfully secure our next round of equity capital. Say differently, we expect to see in future quarters some reversal of that unrealized depreciation subject to those companies successfully either raising additional rounds of equity capital or continuing to achieve developmental milestones when it comes to specifically the life sciences companies, which I spoke to, during the first quarter earnings call, with some of the companies are in the process of completing critical FDA milestone to transition for Phase 2 or Phase 3 clinical trial process.
And more on that as we go through the process of today’s call. Today, I like to point out another important fact that differentiates Hercules from a significant part of the financial services industry and certainly that of other specialty finance companies.
I am extremely proud to say that Hercules inception of date promote funding and fresh origination back in October 2004 to the present quarter of 2009 we've experienced a loan loss of less than 1% of total committed capital since inception. That has been achieved because of our ability to also harvest realized gains from our warrant portfolio that since inception we've now realized approximately $15.8 million of realized warrant gains down offset some of the realized losses in our loan, and equity portfolio since inception.
Frankly, I found that statistics to be outstanding in the wake of its very difficult and challenging environment. However, in keeping with our conservative stature I also like to point out that as we disclosed in our earnings release that we expect to see two additional realized losses that should materialize in the third quarter that represent approximately $14 million of realized losses.
However, we would like to caution of that $14 million of realized losses that we disclosed as a subsequent event for the third quarter we certainly expect that some portion of that should go down as we also look to monetize some of the intellectual property and other assets of those companies. Now, in keeping with venture capital marketplace, it is certainly encouraging to see the venture capitalists invest $5.2 billion in the second quarter.
It is certainly keeping with our expectations that our 5 billion investment capacity in the second quarter, however, we will continue to remain cautious and we ensure that this is not what is more commonly called a debt cap balance. We want to make sure that venture capitalists are in fact continue to support and sustain their investment activity.
We are encouraged and we are certainly optimistic and remain optimistic as we look to Q3 and more importantly, Q4 investment activity. To that end we saw 595 transactions completed by the venture capitalists in the second quarter according to Dow Jones VentureSource.
On the capital raising activity that is venture capitalists or more commonly known as general partners raise the capital from their limited investors or limited partners we also see some mix but encouraging news as well. In the second quarter we saw 25 venture capital funds raise approximately $1.7 billion.
Although the number is quite low in a lowest it has been since the first quarter 2003 it is nonetheless encouraging that the venture capitalists are still able to raise and continue to raise capital. But more importantly, during the first half of 2009 the venture capitalists in the first two quarters have raised approximately $6.3 billion of additional capital to invest in technology life sciences companies.
Frankly I view that to be a very encouraging sign and an indication that the tide maybe turning and we are certainly coming off the bottom. In terms of liquidity, again, although the numbers are dramatically lower, they are still nonetheless positive.
What I mean by that? The venture capitalists realize approximately $2.6 billion in M&A activities completed during the second quarter of 67 companies being acquired.
We also saw extremely encouraging although anemic [ph] asset IPO activities of three companies successfully completing IPOs and approximately 45 companies currently registration that are venture capital back. This by the way breaks a 13-month drought in IPO activity.
The reason why I am so encouraged by that is that even Hercules portfolio saw one of its portfolio of companies also file for public offering and that company is ancestry.com who just recently filed for an IPO and we currently have another company Gomez also in registration to-date for IPO. The other source of data the venture capitalist industry is a National Venture Capital Association and they report five IPOs that has been completed versus the Dow Jones of three.
The activities show strong liquidity in the information technology sector and a consumer-related sector well positioning the Hercules portfolio as they are currently sitting on over 51 positions in various technology life sciences companies which David will elaborate during his presentation as well. Now let me speak to the overall landscape.
The current credit environment has further reduced if not almost all of the eliminated are competitors in the marketplace. We are seeing dramatic shift in a competitive landscape as its credit cycles continue.
As many of our competitors are either unable to secure additional follow-on capital or experiencing extreme difficulties in credit challenges in portfolio. We continue to remain disciplined, focused, and extremely hawkish in monitoring and pursuing our credit portfolio to ensure that we manage through this successful challenging current credit environment, something unfortunately I cannot say a lot of our competitors.
This bodes well for Hercules as we position ourselves for Q4 and beyond investment activities given our increased liquidity position. This will allow us to continue to harvest broader spread in our underwriting, allow us to continue to sustain high effective yield in net interest margins in our portfolio as we continue to pursue our business model for the remainder of 2009.
Strategic direction, given our high liquidity position we remain actively interested and have evaluated other BEC portfolio assets to buy, other portfolio to invest in, and other strategic initiatives that we're constantly and continuing to looking at to ensure our ability to continue to unlock value for our shareholders. The landscape is related with opportunities, but we are also highly cautious that that opportunities that initially translating to monetization for our shareholders.
With that end we remain cautiously interested in evaluating portfolios, making acquisitions, or other strategic initiatives that will unlock value for shareholders, but we remain very cautious in pursuing with opportunities unless we see the appropriate returns for our shareholders. We expect to see improvements in both the broader capital, credit, and venture capital marketplace which is why we have chosen to continue to our slow and steady strategy of investment activities to ensure that we have ample liquidity to harvest new investment opportunities leading into the fourth quarter.
There is no question that we are positioning ourselves for a much more heavily oriented fourth quarter origination activities, assuming that all the leading and lighting indictors that we look through the marketplace point to and continue support the direction that we expect to see for the fourth quarter. Until then you can expect us to maintain a high cash position, low leverage of our balance sheet and extremely aggressive monitoring of our credit situation to ensure the continued long-term viability of Hercules in these recent challenging times.
With that I turn the call over to David Lund to provide you a more detailed overview of our financial performance and then of course we will open it up for questions. David?
David Lund
Thank you, Manuel. Despite the current challenging market we believe our results from operations for the quarter were outstanding.
Today, I like to focus on a couple of things. Continued strong NII achievement and the liquidity and capital resources.
During Q&A Manuel and I will be more than happy to respond to questions you have on other operating results that I do not specifically address during my discussion. First I will touch on Q2 operating results.
Year-over-year we had growth in net investment income, NII and net interest margin; we achieved approximately $19.5 million of investment income for the quarter and 14.35% net interest margin. The effective yield on our debt investments during the quarter was 16.1% compared to 15.6% in the preceding quarter, primarily due to higher income from acceleration of fees and interest from early loan repayments and loan amendment as our team continues to renegotiate higher terms.
We like to note that fee income is often composed of one-time event driven fees and we currently anticipate that our Q3 fee income will not be as high as Q2. Compared to same quarter last year we were able to reduce our cost of debt from $3.5 million to $2.4 million by decreasing our average debt balance outstanding from $180.9 million to $135.8 million primarily due to the repayment of the Citibank credit facility in March of this year.
All of these factors improving effective yield reducing our cost of debt and managing operating expenses contributed to our record Q2 net investment income of $11.8 million or $0.34 per share and taxable distributable income of $10.6 million or $0.30 per share. Turning to credit performance; we continue to be vigilant in monitoring our portfolio and mitigating losses by identifying trouble credits early.
The weighted average loan rating of our portfolio moved up slightly to 2.70 compared to 2.43 at the end of last quarter. This change in rating was primarily attributable to the increase in company's rated four and five from approximately 6.5% to 21.7% of the total debt portfolio on a cost basis.
We downgraded a select group of companies based on their need to raise additional capital and accordingly posted unrealized depreciation for the quarter of approximately $20.7 million. We anticipate that some of these companies made secure financing in the remainder of 2009 and as a result we will reverse the unrealized depreciation.
As of the end of the quarter we had four companies that are non-accrual with the combined carrying value of approximately $6 million or less than 1.5% of the fair value of our loan portfolio and less than 6.2% on a cost basis. We in our portfolio are not impervious to the vagaries of the current financial markets.
In the quarter, we had two portfolio of companies cease operations and consequently we took realized losses of $4.2 million. Since inception net realized losses total approximately $1 million.
This represents less than 1/10 of 1% of total commitment since inception of greater than $1.5 billion. As the economy is showing signs of improvement by no means is what we consider healthy we anticipate that we will have additional realized losses as disclosed in the press release today.
As we have indicated before liquidity remains one of our top priorities. On that note I like to discuss Hercules liquidity and capital resources.
Our strategy for the last few quarters has been and is to remain as liquid as possible until we are comfortable that we see investment activities have normalized. We anticipate this will begin to occur in the fourth quarter of this year.
With our cash low leverage and steady cash flows from loan repayments we believe we will be in a strong position to increase the pace of our investing when the market improves. I am pleased to announce that on July 31st in this tight credit market we received a commitment letter from Union Bank of California for a $20 million credit facility further showing confidence in our operating performance.
This commitment is subject to due diligence completion and legal documentation. As of June 30th we have $37.4 million in cash and are only debt with $130.6 million on our SBA loan and less than half a million dollars on our credit facility.
We have since paid down the amount outstanding balance with Wells Fargo allowing excess to a $50 million of borrowing under the facility. The $150 million maximum available under the SBA program provides us with additional borrowing capacity of 19.4 million subject to regulatory limitation.
The combined excess to capital from these potential sources and our cash on hand as of quarter end totaled approximately $127 million combined with future principal collection, this excess to capital places us in an advantageous position to invest as we enter the fourth quarter. In addition, I like to note that we have been advised to meet with the SBA continued the application process for a second license that would allow us to borrow up to a combined total of $225 million.
Finally we are pleased to announce that our board of directors has authorized a cash dividend of $0.30 per share payable on September 14th for shareholders of record on August 14th. At the end of the year we may also pay a fifth dividend such that we may distribute approximately 98% of our annual taxable income in the year was earned instead of spilling over our excess taxable income.
In closing, we believe we are in a strong financial position and will be ready to increase pace of our new investments as the market turns. Operator, we are now ready to open the call for questions.
Operator
Thank you. (Operator instructions) The first question comes from John Hecht with JMP Securities.
John Hecht – JMP Securities
Good afternoon, guys. Thanks for taking my question, and congratulations on another good quarter.
My first question is related to really your position of excess liquidity, strong position of cash right now. And with that one is that you announced the potential buyback program last quarter, so you could apply some of the capital using that.
And then the second is how the venture capital market ramping up in the second part of the year and both of those factors I'm wondering as when do you expect to ramp up the investment activity and when might you pursue some of the buyback?
Manuel Henriquez
The latter first and then I'll expand on the former. Clearly, signaling on what our criteria would be to commence our buyback program will be silly for me to get into the specifics of that program.
We have ample liquidity to in fact do a buyback as you rightly point out, I think that to temper that statement I think you have to look at what the dividend yield of Hercules is today versus its ability to originate new assets and new activities and look at that spread and make a determination. Clearly today was a 16% or so, effective yield, 14% net interest margin, our ability to originate new assets of for exchange that of the dividend yield on our stock.
So that is the criteria there that we look to. Obviously maintain ample liquidity is also being done for strategic purposes as we look at different opportunities to potentially buy other portfolios, some of which we've looked at, some of which we pass, but liquidity remained a very important issue for us.
As to the first part of your question of the venture capital marketplace liquidity is the reason why we are doing what we are doing. Clearly, the first quarter of almost $4 billion of venture activity extrapolating to a 16 billion investment activity of venture capitalist was of concern.
We have always said that we expect that venture capital industry to be about $20 billion to $22 billion in 2009 and then we subsequently lower that threshold that what Hercules is expected for achieving about $18 billion to $20 billion. Clearly right now we are at $18 billion run rate or so.
However, I want to caution and remind everybody just like Hercules the third quarter for the venture capital marketplace is traditionally the slowest and is so has been what always will be the slowest for Hercules. The fourth quarter always represents the strongest quarter.
I'm expecting to see that venture capital marketplace investing $6 billion to $7.5 billion in the fourth quarter with probably 4 billion or so invested in the third quarter. If whatever reason we see the third quarter venture capital activity drop off below 3 billion is highly likely that we are going continue to take a slower set of strategy in our investment processes.
And the reason being is I want to ensure that the venture capitalist and the private equity and more importantly the limited partners for the venture capital community are continuing there to support their venture capital sponsors who in turn support the underlying portfolio of companies that we invest in. This goes further into our continuing shifting that we have now been doing for almost eight quarters away from early, early stage investing, to more established stage companies and that process will continue as we remain in this credit cycle.
John Hecht – JMP Securities
Okay. So sounds like a little bit of wait and see program and that is ever.
The second question can you refresh as to where your dividend kind of carry over is from last year and what the status of that might be in the strategy for payment there might be?
David Lund
So we've had many things in carryover from the end of last year. We will obviously monitoring the performance of the campy as we go through each one of the quarters, but we would anticipate like I had mentioned earlier that we are going to try to pay out about 98% or better of our taxable income within the year by doing a special or fifth dividend in the fourth quarter.
So we really wanted to return the capital to our shareholders during the year.
Manuel Henriquez
Hey, John, to expand upon that, we are clearly one of the CVPDCs [ph] that are certainly more than amply earning its dividend or covering its dividend for both taxable income and GAAP NII. And you are absolutely correct.
Our continued profitability in fact is positioning us showed to the Board of Directors' final approval and vote on this for clearly a fifth dividend based on our continued profitability throughout 2009 and clearly with the spill over of 2008 to 2009 of $0.18 or so of the dividend. So we are well-positioned at this point for highly likely a fifth dividend we paid out as David said, but that's we revisit by the fourth quarter and make determination or a board will make that determination.
But we are clearly on that track.
John Hecht – JMP Securities
Great. Thanks very much.
Last question is related to the expected revised losses actually you talked about in Q3; I guess what level that was already booked in an unrealized loss thus far?
David Lund
All of it. Yes.
Manuel Henriquez
It is again I strongly believe in having transparency for our shareholders, and I think it is important in subsequent events that if you have something that is so well-known and so well-defined that I believe, maybe we are minority in this issue, that is prudent for our shareholders to have that understanding as they look at the company, but yes, the good news is that all that realized loss will happen in the third quarter has been booked as unrealized in the second quarter. But again, I want to cautious everybody that I remain fairly optimistic that some portion of those anticipated realized losses in the third quarter will be reversed as we continue to engage in discussions with perspective buyers for some of the intellectual property or some of these companies that we are actively engaged in right now.
However, because of the uncertainty of seeing an acquisition fully be consummated on a fair value accounting we had to book the unrealized depreciation to its force.
John Hecht – JMP Securities
Great. Thanks very much for that color.
Thanks for answering all the questions.
Manuel Henriquez
You're very welcome.
Operator
Our next question will come from Troy Ward with Stifel Nicolaus.
Troy Ward – Stifel Nicolaus
Good afternoon. Thanks, guys.
Quickly let’s start with the taxable income, with respect to the dividend, Manuel, we have seen several other BDCs in the last six months to nine months, when you take a loss on a debt piece that they originated, they offset that against taxable income so the loss you took in the current quarter and expected losses in Q3 should lower your taxable income by quite a bit….
Manuel Henriquez
I will let David explain on that, but let me tell you that we were spending large amount of time with both our accountants and our attorneys on the subject and that application is not correct.
David Lund
What happens, Troy, with regards to the taxable distribution is that capital gains cannot be offset against ordinary income, losses of these nature can only be offset against future capital gains. As a result while we may show a taxable loss for a loan loss or something, or even on a piece of equity, that will be offset in future periods against gain.
So that's why you're seeing the taxable gain that we've got.
Troy Ward – Stifel Nicolaus
Right. I guess interesting that, but you are being advised that you can’t use even if it’s a self-originated debt piece, you cannot use the loss to offset taxable income?
Manuel Henriquez
Let me tell you I have been maturely involved in each discussion on getting that potential confusion within the BDC landscape are corrected. And according to our tax accounts and our attorneys’ tax experts is very important to make sure we all understand we're saying.
Investment capital, loan capital or equity capital that translates to realized losses cannot be used to offset income, and it’s an interesting thing because our profitability continues to be so profitable, that we are not able to offset ordinary income against capital losses. It’s no different than we as individual tax payers that if we have a capital loss, whether short-term or long-term you cannot offset your debit to income against that, you are limited to 3,000 for example.
Troy Ward – Stifel Nicolaus
Right. Manuel, I know you watch the space fairly closely.
Would you characterize what a few of the other BDCs have done, your advisors would not tell you to do. Is it apples-to-apples?
Manuel Henriquez
Let me put it this way, not to dodge the question. I cannot prefer to understand what other BDCs do.
I have been often surprised on fair value on some BDCs and how they hold investments; I'm always surprised on the confusion that surrounds taxable income, which in itself is fairly complex calculations derive on taxable income which as you probably well know, differ substantially from that of GAAP and II income. And so I cannot venture as to what other BDCs are doing with their advisors, I can only tell you that what we have done and clearly spending a fairly significant amount of time with our advisors and once again, maybe we are the few that are doing it right, I'm not opining us whether we are doing it wrong or not, but I feel now fairly strongly after spending so much time with our accountants and lawyers that offsetting capital losses ordinary income cannot be done.
Troy Ward – Stifel Nicolaus
Okay. That’s good.
And nine months ago, we never seen anybody do it. So that’s fine.
Manuel Henriquez
Let me clarify one more thing is important to know, that’s a footnote to that. Now, believe it or not there is actually taking advanced situation you could actually help make it good over time.
What does that mean? It means that a BDC, who is a Rick, is more of a Rick, I just spoke a minute ago, and so it’s a Rick should not be the issue, that’s my hair on that one.
It's an IRS Rick issue, not a BDC issue. Rick, as we all know cannot take net operating losses and spill it over year over year as a Rick, you lose, you have to decide either lose your Rick status or maintain your net operating losses.
However, it’s an important footnote, however, a BDC Rick, is in fact able to carry over its capital loss to offset against future realized gains. Now, why I say that is important because Hercules more so than not compared to other BDCs has a significant warrant position in over 70-plus companies that has a face value if we would (inaudible) other warrants of $50 million.
I said at the beginning of this conversation that Hercules has so far inception of date realized over $15.8 million in realized gains of those types of securities. So, it’s our expectation over the proceeding one to four years whatever that maybe especially the IPO market opens up that some monetization of that one pool will clearly offset any capital loss that we have rendering those gains that we have, in essence, tax rate, because we apply to offsetting those capital losses that we have.
Troy Ward – Stifel Nicolaus
Yes. That makes sense.
And how many years can you carry those forward?
David Lund
Those carry forward for eight year.
Troy Ward – Stifel Nicolaus
Okay. Great.
Real quickly on the FDIC, Manuel, the way I read it, I think this is correct. You are at 130 now; you can go to 150 without anything.
You just draw down the capital, correct?
Manuel Henriquez
The answer is almost correct. Because of the remaining loss tranche we had to do with mainly file a submission letter or a funding request and then SBA has its normal course, it can be one week to four weeks on simply saying “Okay, we approved the job the final cap, we now have the capital available for you.”
It’s fairly perfunctory, but we technically have to file the drawdown request.
Troy Ward – Stifel Nicolaus
And then, second license would enable you to get 75 million an additional debt, I assume you need to have $37.5 million of equity to fund that?
Manuel Henriquez
That’s correct. Even that's why we are keeping high liquidity position, because unlike some of the other BDCs out there because of the ample liquidity, because we continue to be a well managed FDIC and we’ve been advised by SBIC to move fairly expeditiously by our second license which David and I will be flying out to the SBA to meet with their panel, either end of this month or early next month.
That process is moving about fairly quickly. In fact, even more faster that I was anticipating which are encouraged by the SBA inviting us to come in.
Troy Ward – Stifel Nicolaus
And with the $37.5 million of equity would it have to be funded first before you draw down additional 75?
David Lund
We can drop down increments and then borrow against essentially 2:1 ratio, I guess what we've invested capital.
Troy Ward – Stifel Nicolaus
Okay, great. And then, just one final topic on credit quality.
And we don't have to have this conversation very happen, Manuel, but clearly, active response group were being marked 98% of par on the Q1, 10Q and now currently when we see the next 10Q, it’s going to be marked down substantially, can you just give us a little color on kind of what happened there and why we shouldn’t expect something like that again?
Manuel Henriquez
Yes, the answer is that that situation is quite unique; the situation is not entirely over. There are some practices that transpired at the company level that has caused us significant concerns on corporate governance that may have existed at the company level, that we are looking further into it, and expect to pursue to mitigate the capital loss.
In a situation that is precipitated by a decline in their business segment of the market, customers they had moved away from them, and the nature of the business is such that it has a fairly high fixed operating cost that has the revenue contribution margins as they expect to have materialized either it did not materialize or materialize in a materially lower margins, the management are expected coupled with management did not rapidly and adequately adjust its business model to take into account, in the changing environment that they were faced in.
Troy Ward – Stifel Nicolaus
Okay. Like I said, there is not some very often in the portfolio so, just wanted a little color.
Thank you, guys.
Manuel Henriquez
Thanks, Troy.
Operator
Our next question will come from Jason Deleeuw with Piper Jaffray.
Jason Deleeuw – Piper Jaffray
Good afternoon, everyone. Just wondering on the competitive front lot of your competition fell off the map with the credit crisis, now that the world looking at little bit better, are you guys seeing any of the animal spears [ph] in your competitors be revived at all?
Manuel Henriquez
No, I think it’s fair to live on in this sky. I think that the competitive landscape has materially and dramatically are changed.
I do not expect any material change in a competitive landscape for probably a year or more out. Although the overall flow of opportunities on the venture capital side may have shrunk, the competitors that existed have all but gone.
That means that although the pool is slavered the opportunity remain no different than they were a year or two years ago. I think it will be extremely hard for a lot of our competitors to successfully show that their portfolio is remain as resilient as ours, and is profitable as ours has been.
We make a very strong statement to the marketplace with our balance sheet position and showing the strength in the balance sheet and our continued willingness and support of our portfolio of companies to ensure that they along with the venture capitalist sponsors work through the difficult environment and survive. A lot of our competitors do not have any excess liquidity and aren't able to work with their companies, later on support their companies through challenging times.
I think that Hercules liquidity position, the investment professionals that we have here to work through difficult and challenging times is a testimony to the Hercules credit performance and our ability to identify the right investments to begin with it also works through the challenging times with our companies. A lot of our competitors do not have their expertise, and do not have their excess of additional capital, and their portfolios are dramatically impaired in this current environment.
Jason Deleeuw – Piper Jaffray
Great. And appreciate the color.
And I'm just wondering on the investment growth, the third quarter seasonally slow, you guys are still targeting the fourth quarter, so I'm wondering if the VC activity is at healthy enough if you guys expect to ramp up the growth rather quickly or is still going to be rather controlled and you're just going to build the growth as we get into 2010?
Manuel Henriquez
As I said earlier the fourth quarter is a leading indictor, is quite important one for us in the venture capital marketplace. Clearly, public investors are now clamoring for and seeking growth capital type of investments.
I remain fairly optimistic we’ll see some good liquidity events though IPOs and certainly I'm seeing very good liquidity so far in the third quarter through M&A. So I'm expecting a fairly robust M&A and probably 3 to 5 IPOs in the third quarter.
As the venture capital activity I think the venture capital probably invest in 4 billion to 5 billion only in the third quarter which should be very good from what we're looking for. If that is the case, you will probably see Hercules originate between $50 million to $80 million in the fourth quarter, assuming all those indications continue to point to that direction.
If for whatever reason we don’t see that activity going in that direction you probably see it sustain a $20 million, $30 million investment space in the period of fourth quarter or so. But I want to caution everybody this is not our intent to giving guidance; it’s more speaking of what we think the market may in fact translate into.
We are more interested in not chasing as our yield on investments; we're more interested in sustaining credit performance and not sacrifice credit performance for yield. I think there is a confusion in the marketplace, that just because you get high yield you should originate a transaction.
We prefer to see strong credit qualities and strong collateral coverage as much as possibly can expect to see with intellectual property as we originate your loans and transactions.
Jason Deleeuw – Piper Jaffray
Great. And also, I'm just wondering on that growth, are you thinking of doing it more organically or would you, I mean, whether or maybe possibly acquire some of these portfolios that you guys have looked at, I mean, what can we think of in terms of the components of your growth?
Manuel Henriquez
I think it’s safe to assume that we'll continue to stick to our real house and do what we know how to do. I think that we spend sometime looking at some portfolios out there and quickly realize what we don’t know or what we don’t like is probably a better description.
Not all middle market or low middle market companies are created equal, some are more susceptible to recessionary periods, some of which make (inaudible) uncomfortable. We will originate the numbers that I spoke to you on organic self-origination as opposed to looking for growth by buying a portfolio under those numbers.
It will be self-originated as we feel more comfortable handling a credit process, cradles to grave, when we first involve the credit and make you that investment decision on our own as opposed to doing it on a secondary market buying an asset within three weeks to four weeks of as we're doing this process.
Jason Deleeuw – Piper Jaffray
Thanks, I appreciate that color. And just lastly on the SBA looking to upsize it, what would be the timing on that, it sounds like end of Q3, I mean, could that be in place by the fourth quarter?
David Lund
We are waiting to see exactly what the application process is going to look like from the SBA, we will be going in and presenting the merits of Hercules and getting the second license here in the third quarter and we've been indicated there could be a three months to five months process so we are kind of laying up that timeline.
Manuel Henriquez
I think that Jason from modeling point of view we're not modeling, the additional $75 million on the SBA in the fourth quarter, we're looking at more of a Q1 event. I think that our government is quite busy these days and I think that prudence will really govern you that I think that expecting it to occur in the first quarter is probably the safe assumption and if we get lucky in the fourth quarter that's accretive clearly, but we are treating as a Q1 event to be conservative.
Jason Deleeuw – Piper Jaffray
Thanks, guys.
Operator
Our next question will come from Jon Arfstrom with RBC Capital Markets.
Jon Arfstrom – RBC Capital Markets
Thanks. Good afternoon, guys.
David Lund
Hi, Jon.
Jon Arfstrom – RBC Capital Markets
Manuel, question for you on the loan portfolio, something you have won potential gain assuming that I feel occurred but how many other potential IPO candidates you think you have in that portfolio?
Manuel Henriquez
Well, Jon, not to be dismissive, if I had that knowledge, the overall expectation on liquidity, everybody would like to know that I mean it's extremely hard. Public investors as you know are extremely demanding right now in terms of rightfully so of what to expect.
The company's registration to look like from a revenue composition and even the performance to cash flow performance. The market (inaudible) was a clear example of the successful IPO, OpenTable has been a very good successful IPO so far and that’s a cash from negative company at the time, I'm going to be cautious here because ancestry is in registration so I don’t want anything to compromise that so other than saying that they are file and people should look at the F1 and it’s all I could say, I cannot point out to the likely outcome of that company or other than our portfolio.
I think that however safe to say that you can expect for the near-term probably next 18 months or so that the majority liquidity in the loan portfolio will still be driven mostly by M&A as opposed to IPO activity. I think that’s the safe assumption.
As to what that means is specific numbers I'm not dodging the question I have no idea. There are so many factors that go into companies’ registration process and or M&A activity.
That’s a very, very hard to any guess.
Jon Arfstrom – RBC Capital Markets
What I'm trying to get at it is, is it a handful, and I think that’s what you're saying, it's a handful of companies that are potential standalone IPO candidates, but I know you drive the bulk of your cans from M&A.
Manuel Henriquez
I think over the next 12 months handful is probably the right number from an IPO point of view. I think on the other hand next 12 months M&A is probably more of two handfuls.
That’s there. I am very much aware that we have certain companies that are in the middle of completing material milestones that would automatically trigger an M&A activity, for example.
But those milestones some of which are contingent upon successful SBA events, some of which are contingent upon continued execution on the revenue model to further get the company to a cash flow neutral, cash flow breakeven were some of the potential targets, larger targets would look to acquire that company for either its technology or its customer base. So what I'm trying to say is on certain words here the M&A events or more event-driven by the company’s successful achievements of milestones, which is entirely out of our control.
Jon Arfstrom – RBC Capital Markets
Another question here maybe a little bigger question, can you give us some more comfort on how we can get comfortable that the loan grading will improve in the second half and I just let me step a little bit you said that there will be some reversal of the unrealized depreciation and then maybe I'm thinking too much into this, but you talk a little bit about the capital loss carry forward discussion and you're saying that eventual warrant gains will offset losses and I just I want to make sure I'm understanding this correctly. Are you saying that some will reverse and we're going to see higher and more realized losses that will eventually be offset or am I reading at the wrong way?
Manuel Henriquez
No, I think you have been too liberal and going the wrong way of the comment, I apologize for my lack of clarity here, so let me take another shot of it. Of the approximate $21 million an unrealized depreciation in the second quarter, we have stated in our earnings release under subsequent event the narrative or descriptive explanation on two of that large credit representing approximately $14 million or so million.
We're engaged right now in meaningful negotiations with one of those companies intellectual property that has a high probability of seeing a deal consummated here in the third quarter. Now, here is a little dodge at this business.
I mean it is a 20-plus years and until the deal is done a deal is never done. In fair value accounting triumphs [ph] whatever manual or (inaudible) process seems to believe fair value accounting mandates that we mark down those assets to what the liquidation or value of that could be in an orderly sale, for example.
And because we are in the midst of that and discussions can move away and they have and they start over again, until that uncertainty is fully reconciled we have opted to be more conservative and fully write-off the remaining residual value of that asset that we foreclose upon until we have a sale has fully been consummated or completed I should say. If that was the case you would certainly see a recovery of that $20 million anywhere between $1 million to $10 million in possibility.
And the reason why that is, is that the other component of that unrealized depreciation and in keeping with Hercules historical credit performance and grading is that we will always downgrade and eventually depreciate on a fair value impairment if and when one of our venture stage companies express to close around an equity capital and for whatever reason that equity around the capital is delayed or does not close as expected we will then reevaluate the fair value of the loan to value and taking impairment on our loan on unrealized basis of what we believe would be the recovery of that asset in event of a distress or controlled sale of that company's asset to recover our loan. A big component of the $20 billion of unrealized depreciation in the second quarter is also attributed to merely impairment on pending close the new equity round of financing.
So I suppose credit related as well as speculation in our part as to whether or not that company successfully closes its pending round of equity capital, in event that would happen, that company would be reevaluated on the fair value basis and potentially either reverse any impairment that we've taken or maintain impairment as the reason for value for the loan to value at that point. We evaluate each and all credits our investments every quarter on that level specificity on determining the collectability and recoverability of our principal to loan value.
Jon Arfstrom – RBC Capital Markets
Okay, that’s all. Thank you.
Operator
Our next question will come from Douglas Harter with Credit Suisse.
Douglas Harter – Credit Suisse
Thank you. I was wondering if you could talk about the amount of your portfolio that’s coming up for equity, your next round of equity in the back half of the year.
David Lund
Yes, we are looking at about a third of the portfolio, somewhere in the neighborhood of anywhere from 19 companies to 23 companies that are in the process or will be looking to raise capital.
Douglas Harter – Credit Suisse
Just for comparison sake how do that compare sort of the first half of the year?
David Lund
Yes, it has been running probably we're looking at about 15 I think at the end of the first quarter no wonder we are going to see a higher amount coming into the back half of this year so it's pretty comfortable.
Manuel Henriquez
Yes, Doug, our credit sheet to kind of get you there quickly is this. Because the venture stage companies, all of which requires subsequent equity rounds of financing to sustain their business model, they should usually arrange capital every 9 months to 14 months intervals with the contraction of venture capital industry and the shrinking of the venture capitals you saw in Q1, we suddenly saw an elongation of that process taking longer to secure the next round of equity capital that has been historically expected mean that historically company to start capital raising three months to four months prior to the capital need, coming to the surface, now we are seeing the process taking easily six months, and in some cases up to eight months of a process so ironically just when they complete to raise round of equity capital they're already positioned themselves to start embarking on understanding what the milestones of what the venture capitalists are expecting from that company for its next round of financing.
Now, the good news is that in the second quarter we started seeing that timeframe starting to compress a little bit so rather taking five months or seven months to raise capital we're seeing some companies now successfully getting multiple different term sheets coming in, it's still taking maybe four months to five months, for example. So it’s all that a month maybe two months being shaved off of the process, but it’s still too early to say that we're still not facing six months to eight months process for companies to raise money.
Douglas Harter – Credit Suisse
Right, thank you.
Operator
Our next question comes from Vernon Plack with BB&T Capital Markets.
Vernon Plack – BB&T Capital Markets
Thanks very much. Hey, Dave, could you give me those non-accrual numbers again please?
David Lund
Yes, we had four companies non-accrual, was about $6 million in the value and it represented about 1.5% of the loan portfolio on a value basis and about 6.2% on a cost basis.
Vernon Plack – BB&T Capital Markets
And how did that compare to the previous quarter?
David Lund
It’s up a little bit. We had three companies at the end of the first quarter it was about $1.4 million and they were smaller credits.
Vernon Plack – BB&T Capital Markets
Alright and fees of course are higher this quarter could you give me an idea why those fees were higher?
David Lund
Yes, we had some restructured fees that came through in this quarter and for about three companies or four companies in particular that pushed up the amount of fees that we gathered in the quarter.
Manuel Henriquez
Vernon, the best we're looking at is I would say that the Q2 had probably $1.5 million to $1.7 million of non-recurring one-time fees meaning that I think that the second quarter probably had that much of fees that we expect to see happen again in Q3 and beyond.
Vernon Plack – BB&T Capital Markets
Okay, just to get a sense for at least the next quarter I am assuming that we should see your cash position build again, correct?
Manuel Henriquez
Yes.
Vernon Plack – BB&T Capital Markets
Okay, alright, thank you.
David Lund
You are welcome.
Operator
At this point, that is all the time we have for questions. Mr.
Henriquez, I would like to turn the conference back over to you for any closing remarks.
Manuel Henriquez
Thank you, operator, and thank you every one for continued interest and support of Hercules Technology Growth Capital. If you are interested in arranging a meeting or have just little questions please contact David Lund, our CFO, or myself at 650-289-3060.
Dave and I will be meeting with investors throughout the country over the course of next two weeks to four weeks, we will be doing a Midwest tour sometime next week and we expect to be on a east coast either late August or early September, and we will be more than happy to meet with investors. Thank you, once again.
Operator
This concludes today’s conference call. We thank you for your participation.