FIDUS INVESTMENT Corp Q1 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by. And welcome to the Fidus Investment Corporation First Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Jody Burfening. You may begin.

Thank you, Tuanda, and good morning, everyone. Thank you for joining us for Fidus Investment Corporation's first quarter 2020 earnings conference call. With me this morning are Ed Ross, Fidus Investment Corporation's Chairman and Chief Executive Officer, and Shelby Sherard, Chief Financial Officer. Fidus Investment Corporation issued a press release yesterday afternoon with the details of the company's quarterly financial results. A copy of the press release is available on the Investor Relations page of the company's website at fdus.com. I'd like to remind everyone that this call is being recorded. A replay of today's call is available by using the telephone numbers and conference ID provided in the earnings press release. In addition, an archived webcast replay will be available on the Investor Relations page of the company's website following the conclusion of this call. I'd also like to call your attention to the customary Safe Harbor disclosure regarding forward-looking information included on today's call. The conference call today will contain statements, including statements regarding the goals, strategies, beliefs, future potential, operating results, and cash flows of Fidus Investment Corporation. Although management believes these statements are reasonable based on estimates, assumptions, and projections as of today, May 1, 2020, these statements are not guarantees of future performance. Time-sensitive information may no longer be accurate at the time of any telephonic or webcast replay. Actual results may differ materially as a result of risks, uncertainties, and other factors, including but not limited to the factors set forth in the company's filings with the Securities and Exchange Commission. Fidus undertakes no obligation to update or revise any of these forward-looking statements. With that, I would now like to turn the call over to Ed. Good morning, Ed.

Good morning, Jody, and good morning, everyone. Welcome to our first quarter 2020 earnings conference call. I hope all of you and your loved ones are doing well. Given where we are today in light of the COVID-19 pandemic and associated government actions and uncertainties around the duration and depth of an economic downturn, I'm going to devote most of my remarks today to discussing the impacts on our portfolio companies at this time and on our management priorities going forward. Shelby will cover the first quarter financial results and our liquidity positions. Once we have completed our prepared remarks, we'll be happy to take your questions. Through mid-March, our portfolio is performing well. Deal flow and M&A in the lower middle market was reasonably healthy. And we were deploying the proceeds from repayments in February's equity sales in the income-producing investments. As the business and economic implications of the pandemic have become increasingly apparent, we have been acutely focused on our portfolio companies, working closely with the senior management teams and sponsors of these businesses. We have found that across the board, our portfolio companies have taken the necessary actions to manage business disruptions and have prepared plans to withstand a slowdown in economic activity. As of today, the vast majority of our 62 portfolio companies are operational. Nevertheless, while a little more than 80% of our portfolio companies remain in the low to medium risk range, the adverse consequences of government-mandated shutdowns on the future financial performance of some of them and mark-to-market or value accounting at quarter-end led us to write down the fair value of our portfolio by approximately $44 million. As a result, NAV declined 8.8% to $375.5 million or $15.37 per share as of March 31, 2020, compared to $412.3 million or $16.85 per share as of December 31, 2019. In addition, we proactively placed two portfolio companies on non-accrual and one on PIK non-accrual. Prior to the pandemic, these companies had been performing solidly. Accent Food Services remains on non-accrual. In total, we ended the first quarter with non-accruals equal to 6.7% of our portfolio on a fair value basis. Without knowing how long or how a COVID-19 induced recession will be, our focus for the foreseeable future will be on maintaining a strong liquidity position while funding and supporting our portfolio companies as warranted. In light of the unprecedented uncertainties that we're facing, and to give us additional liquidity on our balance sheet, we recommended a reduction in the quarterly dividend to the Board of Directors. The Directors agreed. And on April 29th, the Board declared a second quarter dividend of $0.30 per share, which will be payable on June 26th to stockholders of record as of June 12th. At the same time, we have elected to waive 20% of the income incentive fee for the second quarter. Moving to a review of the first quarter, adjusted net investment income, which we define as net investment income, excluding any capital gain incentive fee attributable to realized and unrealized gains and losses, was $8.5 million or $0.35 per share compared to $10 million or $0.41 per share for the same period last year. In terms of originations, we invested a total of $68.2 million in debt and equity securities during the quarter, primarily in first lien debt in connection with debt recapitalizations. Investments in new portfolio companies totaled $36.9 million and consisted of $11.9 million in revolving loan and first lien debt in Combined Systems Inc, a leading designer, manufacturer, and marketer of non-lethal security products for the global defense and law enforcement markets; $15 million in first lien debt in Routeware, Inc, a leading provider of highly integrated fleet automation, software, and systems for waste haulers and municipalities; and $10 million in first lien debt in Western's Smokehouse, LLC, a preferred manufacturing solution for the top brands and retailers in premium crafted perfumed snacks. Subsequent to quarter-end, we invested $12.5 million in subordinated debt and common equity of ECM Industries LLC, a global manufacturer and supplier of electrical products through a wide range of premium brands. In terms of repayments and realizations, we received proceeds totaling $73.8 million, including $35.9 million in net proceeds and a net realized gain of $20.4 million from the partial sale of a group of equity investments that we announced on our last earnings call in February. In addition, we received payments totaling $9.2 million related to repayment in full of our first lien debt investment and payments totaling $10.4 million related to the sale of Fiber Materials Inc., recognizing a net realized gain of $9.8 million on our equity investment. In Q1, we monetized approximately $46.5 million in equity investments, recognizing net realized gains amounting to $30.3 million in connection with our strategy to redeploy equity proceeds into yielding assets. Turning to our portfolio construction and metrics, the fair market value of our investment portfolio as of March 31, 2020, was $718.9 million equal to 98.3% of cost. We ended the quarter with 62 active portfolio companies and four companies that have sold their underlying operations. On a fair value basis, the breakdown of the portfolio by investment type as of March 31st was as follows: first lien debt 19.1%, second lien debt 52%, and subordinated debt 19.5%. Having monetized a sizable portion of our equity portfolio, equity investments now account for only 9.4% of the portfolio on a fair value basis compared to 17.6% as of December 31, 2019. Overall, while we continue to keep close tabs on our portfolio companies' operations at this time, we believe our portfolio is in reasonably good shape to weather the crisis. From an industry perspective, our portfolio of high-quality lower middle market companies is well diversified. On a fair value basis, it is comprised of a mix of manufacturers and service providers, with oil and gas-related businesses accounting for 4.3% and a little more than 3% in retail on a cost basis. Our focus on investing in companies with defensive characteristics, business models that can withstand economic stresses, strong free cash flows and resilient and positive long-term outlooks position us to make it through this difficult time. I mentioned earlier that our priority is on maintaining liquidity until we have more clarity on the pace of the economic recovery. We believe this is a prudent response to uncertainties that none of us have faced before. And facing unknowns, we are operating with an abundance of caution, protecting our conservative capital structure while continuing to focus on capital preservation in the long-term interest of our shareholders. Now, I'll turn the call over to Shelby to provide some details on our financials and operating results. Shelby.

Thank you, Ed, and good morning, everyone. I’ll review our first quarter results in more detail and close with comments on our liquidity position. Please note I will be providing comparative commentary versus the prior quarter Q4 2019. Total investment income was $20 million for the three months ended March 31, 2020, a $0.5 million increase from Q4, primarily due to an increase in fee income from investment activity. Total expenses, including income tax provision, were $2.6 million for the first quarter, approximately $11.6 million lower than the prior quarter, primarily due to a decrease in the capital gains incentive fee accruals related to net unrealized depreciation in the fair value of the portfolio. As of March 31st, the weighted average interest rate on our outstanding debt was 4.6%. We had $373.8 million of debt outstanding comprised of $156.5 million of SBA debentures, $182.3 million of public notes, and $35 million outstanding on the line. Our debt-to-equity ratio was 1 times or 0.6 times statutory leverage excluding exempt SBA debentures. Net investment income or NII for the three months ended March 31st was $0.71 versus $0.22 per share in Q4. Adjusted NII, which excludes any capital gains incentive fee accruals or reversals attributable to realized and unrealized gains and losses on investments, was $0.35 per share in Q1 versus $0.34 per share in Q4. For the three months ended March 31st, Fidus had approximately $30.3 million of net realized gains, as Ed mentioned, from the sale of 50% of our equity investments in 20 portfolio companies and the exit of our equity investment in Fiber Materials. Turning now to portfolio statistics, as of March 31st, our total investment portfolio had a fair value of $718.9 million. Our average portfolio company investment on a cost basis was $11.8 million at the end of the first quarter. We have equity investments in approximately 90.9% of our portfolio companies with a weighted average fully diluted equity ownership of 4.8%. The weighted average effective yield on debt investments was 12% as of March 31st. The weighted average yield is computed using the effective interest rates for debt investments at cost, including the accretion of original issued discount and loan origination fees, but excluding investments on non-accrual if any. Now, I would like to briefly discuss our available liquidity. As of March 31st, our liquidity and capital resources included cash of $27.2 million, $65 million of availability on our line of credit, resulting in total liquidity of approximately $92.2 million. We also have access to $161.5 million of additional SBA debentures under our third SBIC license, subject to regulatory requirements and approval. Now, I will turn the call back to Ed for concluding comments. Ed?

Thanks, Shelby. And as always, I'd like to thank our team and the Board of Directors at Fidus for their dedication and hard work, and our shareholders for their continued support. I will now turn the call over to Tuanda for Q&A. Tuanda?

Thank you. Our first question comes from Paul Johnson with KBW. Your line is open.

I recall that I believe you have a one times debt to equity leverage covenant in your credit facility, and correct me if I'm wrong there. But now that 2:1 leverage is effective for you guys as of April. Are you planning on going back to amend or ask for an amendment of that covenant? And is that even possible in today's environment?

Let me just kind of point out one thing. You are correct, and that's the covenant in our line of credit, however, that's based on regulatory leverage. So right now we have 0.6 times regulatory leverage. And if you recall, we have a fair amount of SBIC debentures in our capital stack. As a result, to really hit one times regulatory leverage, we would have to add an incremental $150 million, whether it’d be on the line of credit or unsecured debt. So we have ample room even with the existing coverage, because again it does take into account the exemption for us SBIC debentures.

And then maybe a little bit more, and I know you guys said that you're, at this point, focusing more on liquidity and being more defensive, using repayments to build cash and perhaps de-lever a little bit, but I'm wondering, with an SBIC, those available debentures. I mean, are you comfortable accessing additional leverage under the SBIC license at this time, or are you more focused on just conserving liquidity?

I think, where we sit today, we’ve kind of hit the pause button with regard to new investment opportunities, and we think that’s what’s prudent. There's a lack of clarity on how the economy is going to restart. And we think operating again with an abundance of caution makes a ton of sense. So we aren’t actively working to deliberately increase our leverage in a material way, but that doesn't mean we don't have the capacity to do so, but that's how we're thinking about it at this point.

And then on your portfolio companies, I'm curious. I mean, I think you have a very manageable unfunded commitment liability. But have you seen a high demand from any of your portfolio companies for additional financing? And also in addition to that, have any of your companies been able to access and benefit from any of the federal reserve PPP loan programs or any of the available lines of support?

I think I'll take the first one in terms of high demand from our portfolio companies at this point. And to this point, the answer to that is, no, it's been relatively low. I think as of today, we've funded $1.5 million to just help with liquidity situations, typically in connection with private equity groups doing something as well, so sharing the pain, if you will. But that dollar amount has been relatively low. We are prepared for more if that is necessary, as warranted, and as makes sense, and that’s the position that we want to be in.

And then on the PPP loans, or any of the federal reserve programs. Have you heard of or do you know of any of your portfolio companies that have been able to access any of those lines?

The short answer is yes. Given our focus on the lower middle market, a number, not a good number, of our portfolio companies did access the PPP program. Obviously, that's improved the liquidity for those companies that did access the program, which in our mind is a positive in times like this. Thankfully, we have a short list of companies in tight liquidity situations at the moment. But as with all things these days, that also can change, but that's the situation at the moment.

And my last question, I'm just curious on the deals you did post quarter, the ECM Industries, I believe that was a new portfolio company. Can you just tell us a little bit about that deal? Maybe perhaps if it’s possible, what the yield was on the deal, what sort of opportunity was presented in the business and that sort of thing?

Interestingly, I mean, the fact of that situation we committed to that kind of free pandemic. And so the yield was I think 11.5%, though I don't have it in front of me, but I think I'm right. It's a larger business, very high quality, very high free cash flow in our opinion will be resilient over the long haul. So we're not scared that we made that investment, but we fully committed to that prior to the pandemic and so that's the situation there.

Our next question comes from the line of Matt Jaden with Raymond James.

So first question just to kind of hammer down on the language from the press release. So the new non-accruals, when you say proactively. Should we take that to mean they paid interest in 1Q and replaced on non-accrual after just how should we interpret that?

What I would say is the facts and circumstances were different in all three scenarios. One company was late paying us, and the other was not fully operational due to shelter-in-place orders. They both did pay us our quarterly interest so those are the full non-accruals. And what's similar is that shelter-in-place directives meaningfully impacted both companies. One of those is EbLens, it's a retailer in the northeast, and the second was Virginia Tile that has some operations in Michigan and they were obviously impacted due to SIP orders there. Our PIK non-accrual Mirage also experienced shelter-in-place orders, but was later designated an essential business. So that's how that unfolded. Hopefully, that's helpful. But they did pay us what they were supposed to, but we put them on non-accrual due to risk points.

I guess moving on to Accent Foods. So kind of just from a long-term outlook perspective, given their focus on, as I understand it, break room solutions and things like that. Even with people returning to work, it seems like the break room operations and things like that are definitely going to be a while off and returning to normal. So any color you can give on long-term outlook for that asset?

The long-term outlook is a very difficult thing to answer, with regard to any credit from my perspective at this point. So I didn’t see any creditors. We actually have over 80% of our portfolio that we think is in very sound shape, doesn't mean perfect but sound and well over 80. Management is doing a great job of managing the situation that they're facing, which is that this company was impacted as you might imagine or I'm sure understand by the shelter-in-place orders. They have done a very good job of managing thus far through the situation. How the company comes out of it and how we navigate the situation, there's a lot of uncertainty with that and it's very difficult to handicap. So I'm not going to try to for that reason.

And then last question would just be on NAV, so some of the markdowns we saw. Can you give any color on how much of that incorporated forward outlook versus actual credit deterioration quarter-to-date and/or spread widening?

What I would say, and Shelby can jump in a second, is that spread widening definitely contributed to the situation, and that was in line with our evaluation policies. From a backward-looking perspective regarding credit deterioration, which is how we assess information when we evaluate on March 30th, I would say that was not an issue. The valuations reflected the different situations and the outlooks we could see, and that guided our approach. Shelby, do you want to add anything?

I would just add that, obviously, for all BDCs, fair valuations this quarter is a bit of a challenge just in light of volatility and uncertainty and GAAP mark-to-market requirements. So as Ed mentioned, we did take into account higher cost of capital assumptions. I would say some of the movements, particularly on the equity side, had to do with calibration of multiples in line with kind of public comps. However, it’s hard to find a true public comp. But from a fair value methodology perspective, it's appropriate to calibrate multiples downward. And yes, we did not solely rely on trailing 12 months financial metrics for valuation drivers, particularly for portfolio companies that we expected to be more materially impacted by economic shutdowns. We did either factor in uncertainty discounts or updated forecasts to any insights we had into forecasts and financials we would factor into whatever it would be forecasted driver or kind of a blend, recognizing the trailing 12 months is probably not the best indicator of future performance at this point in time.

Our next question comes from the line of Bryce Rowe with National Securities.

A couple of questions here. Ed, you mentioned the 80% being in that lower to medium risk type bucket. Do you think about that in terms of dollar volume or just actual number of companies within the portfolio?

It's more dollar volume quite frankly. What we've been doing, it was twice a week, now we're doing it once a week. To get our hands around the different situations, we kind of split our portfolio into higher risk and higher risk would look like, we're going to have most likely a covenant default and got to work through a situation companies that are being impacted or projected covenant default and companies that are being impacted in a meaningful manner by the stay in place orders in particular. And then we have medium risk and then what we consider low risk from a capital preservation perspective. It doesn't mean there may not be a covenant that's going to happen, but just in terms of manage, how can the company manage through this and we are pretty comfortable with; A, getting paid; B, capital preservation. Thankfully, a large majority, a good majority is in the low-risk category, and then the next step is the medium. And again, we feel good about those assets and they may require more work over the next nine months to a year, or covenants and things like that, but things we are comfortable with. And then you've got a more hands-on situation that is shutdown right now, for instance. And that would fall in the highest risk category. And so that falls in the less than 20% on a dollar basis, and not all of them are shutdown, by any stretch, but just higher risk category. From a shutdown perspective, we have three that are not operational today in a meaningful way, and we also have a couple others that are impacted by shelter-in-place orders, meaning one of their plants may be shutdown or several of their plants may be shut down, that kind of thing.

And I'm curious, I mean, the portfolio has a decent amount of second lien type exposure and subordinated exposure. Obviously, you've grown the first lien portion. But curious how you're interacting with sponsors and maybe the more senior lender in the deal throughout this process and how well you're kind of working together with the different parties involved?

I mean, I think we're working together very well. There’s some near-term needs that took place. And I partially mentioned those earlier, giving an example of a company that got ahead of this. They knew they were going to need to be shut down and they put in $2.5 million of liquidity to help get to the other side. Quite frankly, the banks and us or the first lien lenders also collectively put in $2.5 million to give the company liquidity, and that was $500,000 from us. And so that was an example of everyone working together to get to the other side, and having a supportive sponsor. That was near-term, and those happen. What I expect to happen as we move forward is that conversations will increase over the next two quarters. We do expect some financial covenants to be broken in Q2. And then I'm sure there will be a couple more in Q3. How things are dealt with will be on a case-by-case basis, as you know. Meaning sponsors, lenders and that could be us or second lien or sub-debt, which could be us as well, will all participate in multi-party negotiations and the go-forward solution. So clearly, there's a risk that incremental non-accruals over the next three, six, nine months could transpire. From our perspective, we have a very resilient and high-quality group of portfolio companies, which is the most important factor in the long run. For those portfolio companies impacted more meaningfully from the shelter-in-place orders, there's a limitless number of go-forward solutions to consider. I think we're going to be at the table having those negotiations. But there's uncertainty regarding all of them, quite frankly. But I think we feel good about the underlying assets that we have in our portfolio and I think that's where we should start from, from our perspective.

If I could ask one question about the dividend and certainly understand the move lower as a cautionary move, just curious how you weighed the dividend reduction against the level of spillover income that you had at the end of the year. And then the spillover income having kind of grown here in the first quarter with the realized gains you’ve booked?

Let me provide some insight on the dividend. I anticipated you would ask about it. Given the current economic uncertainty and volatility, we find it challenging to make predictions. We believe it's in the best long-term interest of our shareholders to adopt a cautious approach, particularly concerning our dividend policy. Our company has always operated with a conservative mindset, focusing on maintaining a strong and resilient balance sheet, along with a solid liquidity position to support our portfolio as needed. Capital preservation is a critical priority for us. Regarding our portfolio's quality, we believe it is very resilient over time, designed to invest in companies with strong long-term cash generation potential, defensiveness, good market positions, and positive long-term outlooks. In this uncertain environment, we prefer to concentrate on the long-term, which is exactly what we're doing. When it comes to our dividend decision, we did not take spillover income into account; we simply wanted to ensure that we could cover our dividend in various scenarios, avoiding a cut that would jeopardize our ability to pay in the worst-case scenarios. While we don’t foresee circumstances that would hinder our ability to maintain a $0.30 dividend, we need to be ready to withstand any challenges. We feel prepared to handle whatever comes our way, and that's our strategy. These are unprecedented times, and we are committed to positioning ourselves effectively as we move forward. I hope this insight into our thought process is helpful.

Our next question comes from the line of Chris Kotowski with Oppenheimer. Your line is open.

Most of mine have been asked. But I guess just if you look at, I'm curious about the decision to put some companies on non-accrual proactively. But then there are other companies where you see the fair value marks and they're kind of in the same area as the ones that you did put on non-accrual. I’m thinking Palmetto Moon, Hilco, FDS, Bandon Fitness, I mean they’re all kind of not deep, deep discounts but at significant discounts. And what was the decision process between keeping some of those non-accrual versus not? And then I guess quite honestly before when you mentioned the 80% you think is in good shape, presumably the other 20% is that universe of companies that have been marked?

That's probably generally correct. I mean, I'm not looking at the list right now, Chris on the last question, so I think generally correct. The ones that have been impacted, obviously, we would think that would be reflected by the stay-in-place orders in particular. Those would be the ones where you would see material depreciation relative to the quarter before. So that's definitely the case. I think with regard to how we made the decisions, it comes down to uncertainty. I went through a few minutes ago regarding a situation where we had a sponsor come to the table wanting to get ahead of it for money in the lending community, because there were five people involved in this situation, participated and helped as well, and gave the company running room for six months on a shutdown basis, quite frankly. That's different, and that's a first lien situation. That's different than a situation where I don't have that clarity of the future. So, hopefully that gives you sense of how we’re thinking about it, where we have more clarity, where someone's late for about 15 or 20 days and quite frankly, they just didn't know what they have. I would tell you in that situation, things are better than they ever thought they would be right now, which is great. But they were worried and then they finally paid. So hopefully that tells you, it really comes down to clarity and uncertainty from my perspective on how we made those decisions.

And then I guess my second question would be, I mean, you haven't really drawn on your SBA debentures for roughly two years now. And I'm wondering just with all this stress, are there more cases where some of your portfolio companies might be eligible for SBA funding these days than they have been over the last two years?

Well, I think there are a couple of things to note. We initiated our third license at the beginning of the second quarter last year, but we haven't ramped it up yet. We have started using it, though. Our first license was being phased out until last year when we made the final repayment. The second license has been fully utilized for the past couple of years, and we recycled that capital whenever we had repayments. So that's part of the situation. We have only had the SBA operationally for less than a year. Additionally, there are very strict regulations regarding what qualifies for SBA funding, and we adhere to those regulations, including the unspoken guidelines. Some projects do not qualify, and we exclude them from that fund. To summarize, certain types of private equity financing may or may not qualify for SBA funding, and we ensure compliance with those regulations.

And Chris, I would just add and Ed mentioned it, but a big part of the equation is just cash management. And so to the extent, we had the third license up and operational, let’s call it for the past year. However, if we received a repayment in our second SBIC fund and I was sitting on idle cash, we would put that to work first before borrowing additional SBI debentures, so that's part of the equation.

Our next question comes from the line of Mickey Schleien with Ladenburg.

Good morning, Ed and Shelby, a lot of good questions this morning. Just a couple more, if I can. Ed, I'm trying to understand whether there's any deal flow out there that even looks modestly interesting to you. There's obviously some candidates, that would be great, people selling disposable medical supplies to hospitals or things like that. But are you seeing anything at all like that? And to the extent that you are, how are you approaching underwriting given how tough, certainly the second quarter will be and all the uncertainty about the second half of the year?

What I would say, Mickey, is our focus is on the portfolio right now to a large extent, and that’s representing 90% of our time. There’s a lot of reasons for that, including we're not going to deliberately try to grow the portfolio in a meaningful way right now, just given uncertainty and given the ability to underwrite. We've hit what I would call and to be honest, most lenders have the pause button. We're just waiting to see where we are here as we continue to come out of, or as the restart kind of unfolds and make sure we have some clarity with regard to it. So there's a lot at play, we're not going to be aggressive for deploying capital, given where we are from a leverage perspective. We want to maintain very strong liquidity. But if we are going to underwrite, and we are looking at a few things, we know we're not going to make huge investments, but we are looking at them. But I will tell you that what we are looking at would be very much recurring revenue businesses, which has been a big focus of ours for a long time and ones where you have comfort with that revenue line and profitability line. There are a fair number of businesses out there, I told you our low-risk categories, a large majority of what we have are large majority of our portfolio companies and dollars that we have invested in. There's a lot of businesses that are actually doing just fine. And then there are others that are being forced to be shut down. So that's the situation. With regard to new business, we are going to be very prudent. We are still in the middle of the pause button situation. But as we come out of it, we're going to obviously be highly, highly selective and focused on the best of the best credits but more focused on our portfolio, because we think that's the right thing to do right now.

Ed, most of the portfolio, obviously, in terms of the debt investments are fixed rates but clearly, there's an overall downward trajectory for interest rates. Could you give us some context of prepayment risk in the portfolio? I suppose it's a difficult question given that the borrowers themselves don't know what to expect and the markets are effectively shutdown, but anything you could say about that would be helpful?

When you say prepayment risk, I want to make sure I'm following you. It sounds like you…

Well, in other words, do you have borrowers that are in a strong enough position to go to their lenders and say, look, interest rates are dropping. I want a better price?

We do have some that fall in that category and interestingly I have an update from one of our partners yesterday on a deal with a small, less than $10 million size that that is the intent of. They were going to sell the company. Now they're going to hold on to it and they're focused on cash flow and reducing our interest rate. So we probably will get repaid on that one. But I think we definitely have some of those scenarios. I could see that happening over the next year. But I also will tell you there will be opportunities to redeploy that capital. So it doesn't concern me and I'm more than welcome and quite frankly, so that's how I think about that.

And in terms of understanding the portfolio's risk, Ed, could you give us a sense of the portfolio borrowers' average EBITDA? I know you published a range, but it's a fairly broad range. There’s all these philosophical discussions of whether lower middle market is actually riskier than upper middle or not. But that number or at least the tighter range would be very helpful if you could give it to us.

I don’t have the exact average in front of me, but I believe it's currently in the $11 million to $12 million range, though I wouldn't want to be held to that. The average EBITDA range includes a couple of ARR loans that prioritize contractual revenue more than EBITDA, similar to a software company model. We have first lien investments in those cases, and we are confident about those since they can control expenses and improve EBITDA significantly. These tend to be smaller EBITDA businesses, but we have strong confidence in the assets and our first lien position. Additionally, we have a few businesses generating around $125 million in EBITDA, which isn't a large segment overall. Therefore, there's a broad range, but the average is in the low double digits when considered from a weighted average perspective.

And likewise, what is the portfolio's debt-to-EBITDA ratio? And I guess that would be as of March, and given the trajectory of EBITDA, any sense of where you think that's headed? And I think you alluded to the potential to violate probably this covenant. Any guidance you can give us on that?

I believe our average was 4.7 times, but that's more reflective of February numbers. It includes ARR loans and everything else. Therefore, I would expect the leverage to increase on average. The interest coverage is 3.4 times as of February, but our main focus is on moving forward rather than looking back.

And just a couple of sort of housekeeping questions. I think you mentioned in your prepared remarks that you're voluntarily waiving 20% of the income incentive fee. Is that correct?

That is correct.

Okay, but I didn't see that elsewhere in the Q or the press release. So that voluntary…

That's a go-forward, it's for the second quarter, so you'll see it in the second quarter numbers. From our perspective, what we're all experiencing—fear of infection, shelter-in-place orders, jobs being eliminated all around us—is incredibly unfortunate and sad in many cases. Needing to reduce our dividend because of COVID-19 and the stay-in-place orders falls in the exact same category of sad and really unfortunate. We've always put our shareholders first, and this decision reflects that and also who we are as a firm. Hopefully, that's helpful. That's how we thought about it.

No, I appreciate it, and I'm sure shareholders do as well. And just to confirm, is voluntary for the second quarter? It's not a permanent change in the management contract?

That's correct.

And last quarter…

The facts and circumstances are changing all the time in this environment as we're all aware. And so we're going to continue to keep our shareholders top of mind. We want to do something here in the second quarter that felt good and we thought it’s the right thing to do.

And maybe for Shelby. Why do we have so much cash on the balance sheet, Shelby? It's now $27 million, which is higher than I would have expected. Can you explain that to us?

It's a fairly simple answer, because you're absolutely correct, Mickey, and that I kind of like to run a tight ship and minimize interest expense. But the practical reality was, as we had our subsequent events, we did have one new deal close here. Quite frankly, as Ed mentioned, that had been in the pipeline, and so as events and kind of certain mid to end of March started unfolding, just the timing of that transaction flipped. I had kind of cash reserves ready to fund that deal. And so that's part of the explanation as to why my cash balance was higher at the end of March.

At this time, I'd like to turn the call back over to the Ed Ross for closing remarks.

Thank you, Tuanda. And thank you, everyone for joining us this morning. We look forward to speaking with you on our second quarter call in early August. Everyone, please be safe.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may now disconnect. Everyone have a wonderful day.