Hercules Capital, Inc. annual report, FY2022

Hercules Capital, Inc. — FY2022 Form 10-K

Reporting period: Fiscal year ended December 31, 2022; filed February 16, 2023. Hercules is an internally managed business development company (BDC) and regulated investment company (RIC) specializing in debt financing for venture-backed and institutional-backed technology, life sciences, healthcare, and sustainable technology companies. This summary covers the full year, not Q4 alone.

Key financial and portfolio metrics

MetricFY2022 / Dec. 31, 2022Comparable period
Total investment income$321.7 million$281.0 million in 2021
Net investment income (NII)$188.1 million; $1.48 per basic share$150.0 million; $1.29 per basic share in 2021
Net realized gain (loss)$(0.9) million$20.9 million in 2021
Net unrealized appreciation (depreciation)$(85.1) million$3.3 million in 2021
Net increase in assets from operations$102.1 million; $0.80 per basic share$174.2 million; $1.50 per basic share in 2021
Portfolio yieldTotal 11.9%; effective debt yield 12.7%; core debt yield 12.3%Total 11.9%; effective 12.9%; core 11.4% in 2021
Portfolio fair value$2.964 billion, including $2.795 billion of debt investments$2.435 billion total in 2021
Net assets / NAV per share$1.401 billion / $10.53$1.309 billion / $11.22 in 2021
Debt outstanding$1.594 billion principal; $1.574 billion carrying value$1.250 billion principal in 2021
Liquidity$606.8 million reported available, including $15.8 million cash and cash equivalents—
Cash flowsOperating activities used $424.8 million; financing activities provided $314.5 millionOperating activities provided $128.6 million; financing activities used $229.9 million in 2021
Distributions$1.97 per share declared; $249.1 million total$1.55 per share; $179.6 million in 2021

Changes versus 2021

  • Investment income rose 14.5%, primarily from a larger average debt portfolio and higher benchmark rates. Contractual interest income increased, while fee income fell to $14.4 million from $27.6 million, largely because fewer early repayments generated accelerated fees.
  • NII increased to $188.1 million, but net assets from operations declined to $102.1 million as $85.1 million of unrealized depreciation replaced modest unrealized appreciation in 2021. Total shareholder return was approximately negative 10.1%, versus positive 25.6% in 2021.
  • NAV per share fell 6.2% to $10.53. Net assets increased overall, supported in part by issuing 14.6 million shares through ATM offerings for $229.7 million net proceeds.
  • The portfolio expanded, and senior secured debt grew to 92.5% of portfolio fair value from 88.6%. Drug discovery and development, software, and consumer and business services together represented 80.5% of portfolio fair value.
  • Credit indicators weakened: weighted average debt investment grade moved to 2.23 from 2.10, and grade 3 investments rose to 36.3% of debt fair value from 26.3%. Grade 4 and 5 investments together were 2.2% of debt fair value. Non-accrual investments were 0.6% of portfolio amortized cost, compared with 1.0% in 2021.

Liquidity, leverage, outlook, and risks

  • Available liquidity included borrowing capacity of $153 million under the SMBC facility and $438 million under the MUFG facility, in addition to cash. Restricted cash was $10.1 million. Management stated that liquidity was ample for near-term capital requirements.
  • Regulatory asset coverage was 198.5% excluding SBA debentures and 187.7% including them, against a 150% minimum. Debt principal maturities were reported as none within one year, $382 million in one to three years, and $1.212 billion beyond three years.
  • After year-end, Hercules amended the MUFG facility, extending its maturity to January 2026 plus a 12-month amortization period, and established a $100 million SMBC letter-of-credit facility. It also reported $34.9 million net proceeds from ATM share sales in January 2023.
  • The company’s variable distribution policy targets quarterly distributions approximating 90%–100% of taxable quarterly or potential annual income; future distributions are not assured. In February 2023, the Board declared a $0.39-per-share fourth-quarter distribution and a further $0.32-per-share supplemental distribution payable in four quarterly installments during 2023.
  • Management highlighted macroeconomic uncertainty, inflation, market volatility, geopolitical events, and ongoing pressure on some portfolio companies’ liquidity. Fewer IPO and M&A exits could prolong holding periods, constrain portfolio-company financing, and increase valuation pressure or losses. Rising rates may lift income on floating-rate loans but also increase borrowing costs and portfolio-company debt burdens.
  • Material risks include industry concentration, borrower defaults, illiquid investments, leverage and covenant compliance, valuation uncertainty, unfunded commitments, and RIC distribution requirements. Available unfunded commitments were $628.9 million, versus $286.8 million in 2021; some commitments require milestones or may not be drawn.
  • Most investments are Level 3 and valued using significant unobservable inputs. The auditor identified Level 3 investment valuation as a critical audit matter. PwC issued an unqualified opinion on the financial statements and concluded internal control over financial reporting was effective.

Important facts for investors to verify

  • Review subsequent portfolio performance, especially the grade 3–5 exposures, non-accrual borrowers, and largest positions; confirm the status and recovery prospects of investments written down or written off in 2022.
  • Assess whether portfolio fair values and NAV remain supportable given the reliance on Level 3 estimates and the reported unrealized depreciation.
  • Reconcile the $628.9 million of available unfunded commitments with liquidity, credit-facility availability, and the timing and conditions for borrower draws.
  • Check current debt balances, asset coverage, covenant headroom, refinancing terms, and the cost and maturity profile of floating-rate borrowings.
  • Compare NII and taxable income with distributions, and confirm the 2023 distribution amount and tax character; 2022 distributions included ordinary income and long-term capital gains.
  • Monitor ATM share issuance and NAV-per-share trends: the company issued 14.6 million shares in 2022 and reported lower year-end NAV per share.