Fidus Investment Corporation (FDUS) Q1 2020 Earnings Report, Transcript and Summary

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 [Operator Instructions]. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, 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 Web site 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 Web site 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 covering 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 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 the December 31, 2019. In addition, we proactively placed two portfolio companies on non-accrual and one on PIK non-accrual. Company stat until the pandemic hit us have been performing in a solid manner. 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 they give us additional liquidity on our balance sheet, we were 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 weigh 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 $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 firstly, 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 Hunter Defense Technologies 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 and 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 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%. 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'd 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 Twanda for Q&A. Twanda?

Thank you [Operator Instructions]. Our first question comes from the line of 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. And so as a result, to really hit one times regulatory leverage, we would have to add an incremental 150 million of 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. And so we aren’t working to deliberately increase our leverage in a material way is how I would say it, that doesn't mean we don't have the capacity to, 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 fed 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, I think to help round out situations we've funded $1.5 million to just help with liquidity situations, typically that's in connection with private equity groups doing something as well, so sharing the pain, if you will. But that's how we have or other capital structures, constituents, quite frankly, but that's how we approach things. And to-date that dollar amount has been relatively low. As I just mentioned. I think I'm right, don't hold me to it, but at $1.5 million at this point. But we're 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 fed reserve programs. Have you heard of or do you know of, any of your portfolio companies have been able to access any of those lines?

The short answer is, yes. Given our focus on the lower middle market, a number is not good number of our portfolio companies did access the PPP program. And 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 in 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%, 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 those 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 obviously were meaningfully impacted as well due to SIP orders there. Our PIK non-accrual Mirage also experienced shelter in place orders, but actually was later designated an essential business. So that's how that unfolded. Hopefully, that's helpful. But they more proactive -- they all did pay us what they were supposed to, but we did put them on non-accrual due to risk points.

I guess moving on to Access Foods. So kind of just from a long term outlook perspective. Given their focus on, as I understand it, breakroom solutions and things like that. Even with people returning to work, it seems like the breakroom 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?

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. But what I would say with regard to accident is that management is doing a great job of kind of managing the situation that they're facing, which is this company was impacted as you might imagine or I'm sure understand by the shelter in place orders. And so they have done a very good job of managing thus far through the situation. How the company comes out of it, 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 in a second is, spread widening definitely was part of it and that was according to evaluation policies and whatnot. In terms of credit deterioration from a backward looking, which is how most -- that the information we have when we're doing evaluation at March 30th, I would say that was not the case. So the valuations were taken into account the various situations and the outlooks that we could see and so that's how we went about it. Shelby you want to add to that?

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, obviously, we did take into account higher cost of capital assumptions. I would say some of the movements, particularly on the equity side, really just had to do with calibration of multiples in line with kind of public comps granted given where we invest. It's hard to find a true public comp. But from a fair value methodology perspective, it's an appropriate thing to do to calibrate multiples downward. And to your point, yes, we did as opposed to solely relying 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 it's probably early for updated forecasts. But in our conversations with portfolio companies and management, any insights we had into forecasts and financials we would factor into whatever it’d be forecasted driver or kind of a blend but recognizing the trailing 12 months is probably not the best indicator of future performance in this point in time.

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

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. So what we did just to put a little color on it. 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 have look, 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 considered low risk from a capital preservation. 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 that we are we pretty comfortable with; A, getting paid; B, capital preservation. And so, thankfully a large -- good majority, large 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 were comfortable with. And then you got more hands on ones that are shutdown right now for instance. And that would be in the highest risk category. And so that that falls in the -- it’s 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 then from a portfolio company perspective. And then obviously, we've got a couple others that are impacted by shelter in place orders, meaning one of their plants may be shutdown or several of their plants maybe shutdown that kind of thing. And then we got others that are just being impacted by the end market and the malaise in the economy. So hopefully that's helpful. So that's how we're managing the business and that's how we kind of came up with that statement.

And I'm curious, I mean, the portfolio has a decent amount of second lien type exposure 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 example a company 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. And 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. So 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 risk that incremental non-accruals over the next three, six, nine months could transpire. And 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 forwards solutions to consider. And I think we're going to be at the table having those negotiations. But there's uncertainty with regard to 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 the place to start from, from our perspective.

If I could ask one question about the dividend and certainly understand the move lower as a cautionary move, if nothing else. 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?

Well, let me give you a little bit on the dividend. I figured you'd ask that question or some version of it. I think to start and it's the approach is given the high level of uncertainty that everyone's experiencing and the current volatile economic environment that it's difficult to handicap. We feel like it's in the best long-term interest of our shareholders to operate with an abundance of caution, including with regard to our dividend distribution policy. And operating with a conservative mindset is how we have always operated this company. We're highly focused on maintaining a strong balance sheet and a resilient one, and we're equally as focused on maintaining a strong liquidity position, in particular to be able to support our portfolio as warranted and as necessary. So capital preservation has been always and is just a critical and top of mind subject for us. And then it gets back to the quality of the portfolio for us and we believe it's very resilient over the long run. It was constructed with an eye towards invest in companies that we believe possess long-term cash generating abilities that are more defensive in nature, good market positions and possess positive long-term outlooks. In this interim and very uncertain environment, we believe it’s best focus on the long run and hands on in doing so, which is exactly what we're doing. So when you think about it from -- we did not, and I'd say really factored in our dividend decision, or we didn't say factor and spillover when we determined our dividend decision. Having said that, we know it's there and we think that’s a very, very good thing, but it was not how we came up with it. What I would say is our thought process was the following on the dividend From a scenario perspective, we wanted to be in a position to cover our dividend in out of 10 scenarios. Meaning we didn't cut so far that we will cover our dividend in all of the worst of the worst downside scenario that anyone can construct. We don't think those scenarios will materialize, where we wouldn't be able to cover at 30 but we clearly need to be in a position to weather that if it does happen. And so we feel like we're in a position to weather anything that's thrown at us and that's our plan. So, we're all living in unprecedented times. And we're prepared to do what we need to do to be as well positioned as possible as we get to the other side is how I would say. Hopefully that's helpful just from a thought process perspective.

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 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, I think it comes with uncertainty. I went through a few minutes ago where a sponsor came 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. And so, hopefully that gives you a sense and 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. And 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 a couple things. We got our license or third license up and running really call it the beginning of the second quarter last year. So no we haven't ramped it that's for sure. We have started using it. Our first license was in wind down until last year and we repaid that. Our second one was fully utilized, quite frankly for the past couple of years. And when we had repayments, we recycled that capital. So that's a little bit of the dynamic. We've had the SBA really for less than a year right now operational new fund. The second thing I'd say is, obviously, there are very strict regulations on what qualifies and what doesn't qualify, and we follow those regs, including the unwritten ones. And so some don't qualify and we don't put them in there, we don't put them in that fund. And so I'd say those are the two factors. There's certain -- if you do a private equities financing or private equity driven financing, there's some that have fun types, and I'm not going get into specifics, they don't qualify for SBA. There's some that have fun types that do. And so those are -- we follow those regs, so that's the dynamic.

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 to 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, somebody's 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 is on the portfolio right now to a large, large extent, and that’s representing 90% of our time. And 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. So what we've done is, we've hit what I would call and to be honest, most lenders have the pause button. Just to wait and 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 that we know we're not going to make huge investments, I would say 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 a comfort with that revenue line and profitability line. So there's 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 been forced to be shutdown. 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 effectively shutdown, but anything you could say about that would be helpful?

When you say prepayment risk so I'll make sure I'm falling you, sounds like you…

Well, in other words, do you have borrowers are 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 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 opportunity to redeploy that capital. So it doesn't concern me and 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. And there's all these philosophical discussions 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.

The average I don’t have in front of me, but I think it's in the $11 million to $12 million range right now, don’t hold me to it, but I feel pretty comfortable with that statement. The average EBITDA, I will tell you the range is, we've got couple several ARR loans that are less focused on EBITDA and more focused on the contractual revenue, think of a software company. And we have first lien investments in those situations and feel great about the -- and they obviously can cut expenses and get the EBITDA way up. So those would be smaller EBITDA businesses but we feel great about the assets and we're first lien. And then we've got a couple that are $125 million in EBITDA, not a lot that's not a big part of it. So there is a wide range. But the average is in the low-double digits 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 potential to violate probably this covenant. Any guidance you can give us on that?

I think our average was 4.7 times, but that does not reflect -- that's more February numbers. And that does incorporate ARR loans and incorporates everything. So undoubtedly, I would expect the leverage to go up on an average basis. The interest coverage is 3.4 times as of February, but obviously our priority here was focusing more on the going forward as opposed to the backwards.

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…

So I mean that's a go forward it's for the second quarter, so you'll see it in the second quarter numbers. And from our perspective, Mickey, what we're all experiencing fear of infection, shelter in place orders, jobs been eliminated all around us, it’s incredibly unfortunate and it's also sad in many cases and very sad in many cases. So needing to reduce our dividend because of COVID-19 and the stay in place orders or shelter in place orders falls in the exact same category of sad and really unfortunate. So we've always put our shareholders first and this decision is a reflection of that, and it's also a reflection of who we are as a firm. So 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 is 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. And 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 so much cash on the balance sheet Shelby? It's now $27 million, which is -- I mean, you've been there before, but I would have expected a lower number. Is there --- can you walk us through that?

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, and then Ed mentioned that had been in the pipeline and we've made a commitment a while back. 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.

Our next question comes from the line of Tim Hayes with B. Riley.

Most of them have been answered, but just a quick one, and it might be tough to gauge at this point. But Shelby, do you an estimate of approximately how much of the spread driven and multiple driven marks have been reversed so far in the second quarter as the broader market is rallied and spreads have tightened?

I really don't. Just because as you're aware, all of our investments are really level three on observable inputs. And so our valuations process is somewhat dependent on getting to the end of the quarter so end of Q2 with updated financials, which we don't yet have and then taking a look at public company comps at that point in time. It's not something that we can easily value on kind of a weekly basis.

I'll just ask one more quick question. It sounds like it's kind of the worst is yet to come and that the first quarter results didn't truly reflect the headwinds that you'll face from the economic impacts of the outbreak. But I'm just curious if any measures you took in the first quarter to provide relief or forbearance to borrowers, or if that's something that you'll probably have to work through in the near future going forward? Have you at this point granted extended interest only period, deferred principal payments, or eliminated covenants or anything else? And just curious how you think about that going forward?

In general, we haven't had to do a lot of what you're suggesting at this point. As I mentioned in around Q1 early on, there were a couple -- another situation just to give you an example. Someone we already were in covenant default and have been for a while, we're working through a situation sponsor put in $2.5 million. And with that, we've put a set of projections that we think can withstand the next 12 months. And at the same time, we feel very comfortable with those levels. Not overly levered, very liquid situation. So, we will obviously work through situations with the borrowers. We obviously expect everyone to participate. It's not a one sided conversation. And so there will be more of that as we move forward. I would say that the ones that needed attention have gotten it. And I think in general, what we're seeing is people are trying to get ahead of any potential covenant breaches or any liquidity issues and obviously with the idea of positioning those portfolio companies to get to the other side. And so those conversation, there's more of those conversations to have, no question. And there's risk with some of those conversations. But there's also again, this is where I go back to, we've got a pretty good portfolio that we feel great about, quite frankly. It's not going to be without fault, but it's one of the underlying assets in our opinion good ones and ones that should be, make it to the other side. And so we've got to do the best that we can to help those companies do that, as well as at the same time protect our interests and our capital. But there's a lot more of those conversations to take place with regard to all BDCs, and we're not…

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

Thank you, Twanda. 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.