Fidus Investment Corp (FDUS) 2020 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Fidus First Quarter 2020 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference call is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker for today, Jody Burfening. You may begin.

Thank you, Twanda, 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 conference 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 forward-looking statements, including statements regarding the goals, strategy, 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 position. 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 sale into 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 fair 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 the December 31, 2019.

In addition, we proactively placed 2 portfolio companies on nonaccrual and 1 on PIK nonaccrual, companies that until the pandemic hit us have been performing in a solid manner. Accent Food Services remains on nonaccrual. In total, we ended the first quarter with nonaccruals equal to 6.7% of our portfolio on a fair value basis.

Without knowing how long or how deep 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 29, the Board declared a second quarter dividend of $0.30 per share, which will be payable on June 26 to stockholders of record as of June 12. 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 a revolving loan in first lien debt in Combined Systems, Inc., a leading designer, manufacturer and marketer of nonlethal 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 protein 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 in 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 investments. 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 4 companies that have sold their underlying operations. On a fair value basis, the breakdown of the portfolio by investment type as of March 31 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 positions 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. In 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 3 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 accrual related to net unrealized depreciation in the fair value of the portfolio.

As of March 31, 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 1x, or 0.6x statutory leverage excluding exempt SBA debentures.

Net investment income, or NII, for the 3 months ended March 31 was $0.71 per share 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 3 months ended March 31, 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 31, 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 31. The weighted average yield is computed using the effective interest rates for debt investments at cost, including the accretion of original issue discount and loan origination fees but excluding investments on nonaccrual, if any.

Now I'd like to briefly discuss our available liquidity. As of March 31, 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. 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?

(Operator Instructions) Our first question comes from the line of Paul Johnson with KBW.

I recall that I believe you have a 1x 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?

Paul, let me -- this is Shelby. 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 0.6x regulatory leverage. And if you'll recall, we have a fair amount of SBIC debentures in our capital stack. And so as a result, to really hit 1x regulatory leverage, we would have to add an incremental $150 million of whether it 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 SBIC debentures.

I see. Okay. And then maybe a little bit more on that. I know you guys said that you are, at this point, focusing more on liquidity and being more defensive, using repayments to build cash and perhaps delever a little bit. But I'm wondering, with that 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?

Great question, Paul. I think where we sit today, we are -- we've kind of hit the pause button with regard to new investment opportunities. We -- 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 looking to deliberately increase our leverage in a material way is how I would say it. It doesn't mean we don't have the capacity to, and -- but that's how we're thinking about it at this point.

Okay. 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?

Sure. Great question, Paul. 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 a private equity group doing something as well, so sharing the pain, if you will. But that's how we have -- or other capital structure constituents, quite frankly. But that's how we've approached 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.

Sure. And on -- yes, and then on the PPP loans or any of the Fed Reserve programs have you heard of, or have you -- do you know of any of your portfolio companies have been able to access any of those lines?

Yes. Short answer is yes. Given our focus on the lower middle market, a number, if not a 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 deal that 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 possible, what the yield was on the deal? What sort of opportunity was presented in the business, and that sort of thing?

Yes. Interestingly, I mean, the facts of that situation are that we committed to that kind of prepandemic. 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, and, 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 Tjaden with Raymond James.

So first question, just to kind of hammer down on the language from the press release. So the new nonaccruals, when you say proactively, should we take that to mean they paid interest in 1Q and were placed on nonaccrual after? Just how should we interpret that?

Sure. It's interesting. That's a great question. And what I would say is the facts and circumstances were different in all 3 scenarios. One was -- 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 nonaccrual. And what's similar is that shelter-in-place directives meaningfully impacted both companies. One of those was EbLens, it's a retailer in the Northeast; and the second was Virginia Tile that had some operations in Michigan, and they obviously were meaningfully impacted as well due to SIP orders there. Our PIK nonaccrual, Mirage, also experienced shelter-in-place orders but actually was later designating an essential business. So that's how that unfolded. Hopefully, that's helpful. They were more -- they all did pay us what they were supposed to, but we did put them on nonaccrual due to risk points.

Okay. 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 in 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 in time. Well, I shouldn't say any credit, there's -- 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%. And so -- but what I would say with regard to Accent 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.

Okay. 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, right? And that was according to valuation policies and whatnot. In terms of credit deterioration from a backward-looking, which is how most -- how -- that's the information we have when we're doing valuation at March 30, I would say that was not the case. So the valuations were us taking into account the various situations and the outlooks that we could see, and so that's how we went about it.

Shelby, do you want to add to that?

Yes. And 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 in 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-month 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 forecast, but in our conversations with portfolio companies and management, any insights we had into forecasted financials, we would factor into whether it be a 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.

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?

That's more a dollar volume, quite frankly. So what we did, just to put a little color on it, and 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 consider low risk from a capital preservation. Doesn't mean there may not be a covenant that's going to happen, but just in terms of how can the company manage through this? And are we pretty comfortable with, a, getting paid; b, capital preservation? And so thankfully, a large -- a 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. They may require more work over the next 9 months to a year, but -- or covenants and things like that, but things we're comfortable with. And then you got more hands-on ones, ones that are shut down right now, for instance. And that would be in the highest-risk category. And so that falls in the -- it's less than 20% on a dollar basis, but it -- and not all of them are shut down by any stretch, but just higher-risk category.

From a shutdown perspective, we have 3 that are not really fully -- not operational today in a meaningful way, and then -- from a portfolio company perspective. And then, obviously, we've got a couple of others that are impacted by shelter-in-place orders, meaning one of their plants may be shut down or several of their plants may be shut down, that kind of thing. And then we got others that are just being impacted by the end market and the malaise and the economy. But -- so hopefully, that's helpful. But that's how we're managing the business, and that's how we kind of came up with that statement.

Okay. That's helpful. 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.

Sure. I mean I think the -- I mean I think we're working together very well. There's -- there were some near-term needs that took place, and I partially mentioned those earlier. Gave you an example a company got ahead of this. They knew they were going to need to be shut down, and they want -- 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. The -- so that was near term and those happened. What I expect to happen as we move forward is that conversations will increase over the next 2 quarters. We do expect some financial covenants to be broken in Q2, and then I'm sure there'll be a couple more in Q3. How things are dealt with will be on a case-by-case basis, as you know, meaning sponsors, tranche lenders, and that could be us, or second lien or sub debt, which could be us as well, will be -- all participate in multiparty negotiations in a go-forward solution. So clearly, there's risk that incremental nonaccruals over the next 3, 6, 9 months could transpire. And from our perspective, we have a very resilient and high-quality group of portfolio companies, which from -- 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. And I think we're going to be at the table having those negotiations. But it's -- 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 our perspective.

Okay. That's helpful. And 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.

Sure. Well, let me give you a little bit on the dividend. I figured you to 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 is experiencing and the current volatile economic environment, 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 is -- 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 investing 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 to focus on the long run and to be hands on in doing so, which is exactly what we're doing. So when you think about it from a -- we have not, and I'd say, really factored in our dividend decision or we didn't factor in 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 8 out of 10 scenarios, meaning we didn't cut so far that we will cover our dividend in all of the worst downside scenarios that anyone can construct. We don't think those scenarios will materialize where we wouldn't be able to cover at $0.30. 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. Yes, 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 it. Hopefully, that's helpful just from a thought process perspective.

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

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 nonaccrual 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 nonaccrual. I'm thinking Palmetto Moon, Hilco, FDS, Bandon Fitness, I mean, they're all kind of not at deep, deep discounts but at significant discounts. And what was the decision process between keeping some of those on accrual versus not? And then, I guess, quite honestly, before, when you mentioned that 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 that last question. So I think you're generally correct. The ones that have been impacted, obviously, you would think that'd be reflected, by the stay-in-place orders in particular, those would be the ones that -- 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, wanted to get ahead of it, put money in the lending community because there were 5 people involved in this situation, participated and helped as well. And it gave the company running room for 6 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 on how we're thinking about it. Where we had more clarity, where someone's late for -- by 15 or 20 days, and quite frankly, they just didn't know what they have, and I will 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. And so I -- 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've been -- you haven't really drawn on the -- your SBA debentures for roughly 2 years now. And I'm wondering, just with all the stress, is -- 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 2 years?

Great question. Well, I think a couple of things. We got our license -- our third license up and running really at, call it, the beginning of the second quarter last year. So we haven't ramped it, that's for sure. We have started using it. Our first license was in wind down until last year, right? And our -- and we repaid that. And our second one was fully utilized, quite frankly, for the past couple of years. And when we had repayments, we've recycled that capital. But so that's a little bit of the dynamic. We've had the SBA really for less than a year right now operational, a 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, and we don't put them in that fund. And so that -- I'd say those are the 2 factors. There's certain -- if you do a private equity financing or private equity-driven financing, there's some that have fund types, and I'm not going to get into specifics, that don't qualify for the SBA. There's some that have fund types that do. And so those are -- we follow those regs. So that's the dynamic.

Go ahead, Shelby.

And Chris, I would just add, 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 SBA debentures. So that's part of the equation.

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

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, somebody selling disposable medical supplies to hospitals or things like that. But to the -- 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?

Sure. It's a great question. What I would say, Mickey, is our focus is on the portfolio right now for -- 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 deploying capital given where we are from a leverage perspective. We want to maintain very strong liquidity. And -- but if we are going to underwrite, and we are looking at a few things, 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 comfort with that revenue line and profitability line. And so there's a fair number of businesses out there. I told you, our low-risk category is a large majority of what we have, and -- or a 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 have been forced to be shut down. So that's the situation. But with regard to new business, we are going to be very prudent. We are still in the middle of a 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 and more focused on our portfolio because we think that's the right thing to do right now.

I understand, and fair enough. Ed, most of the portfolio, obviously, in terms of the debt investments are at 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 shut down, but anything you could say about that would be helpful.

When you say prepayment risk, I want to make sure I'm following you.

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

Sure. We do have some that fall in that category. And interestingly, I had an update from one of our partners yesterday on a deal that's small, less than $10 million in size, that has 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 it, 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 a tighter range would be very helpful if you could give it to us.

I think the average, and I don't have it 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 a couple, several ARR loans that are less focused on EBITDA, more focused on the contractual revenue from a -- 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, it's not a big part of it. So there is a wide range. And -- but the average is in the low double digits is from a weighted average perspective.

Okay. That's helpful. 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?

Sure. I think our leverage was 4.7x, but that does not reflect -- that's more February numbers, right?

Right.

And that does incorporate the ARR loans, it incorporates everything. But the -- so undoubtedly, I would expect the leverage to go up on an average basis. The interest coverage is 3.4x as of February. But our -- obviously, our priority here was focusing more on the going forward as opposed to the backwards. So...

I understand. 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's voluntary.

Yes. So that's a go-forward, right? It's for the second quarter. So you'll see it in the second quarter numbers. And the -- from our perspective, Mickey, what we're all experiencing, fear of infection, shelter-in-place orders, jobs being 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've thought about it.

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

That's correct.

Okay. And lastly maybe, for -- I'm sorry?

No, no, no. I mean, look, 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 -- but we wanted to do something here in the second quarter that felt good, and we thought it was the right thing to do.

Okay. 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?

Sure. It's a fairly simple answer because you're absolutely correct, Mickey, in 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 1 new deal closed here, quite frankly that Ed mentioned that had been in the pipeline and we had made a commitment a while back. And so as events in kind of starting mid- to end of March started unfolding, just the timing of that transaction slipped. I had kind of cash reserved 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 have 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 has rallied and spreads have tightened?

I really don't, just because, as you're aware, all of our investments are really level 3 unobservable 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.

Sure. Yes, makes sense. Okay, I'll just ask one more quick question. It sounds like kind of the worst is yet to come in 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 there were 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 periods, deferred principal payments or eliminated covenants or anything else? And just curious how you think about that going forward.

Sure. Great question. Again, in general, we haven't had to do a lot of what you're suggesting at this point. As I mentioned in the -- around Q1, early on, there were a couple -- and we've -- another situation, just to give you an example, someone we already were in covenant default and had been for a while, we are 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. Very -- 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 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 -- 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 where the underlying assets are, 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 interest and our capital. So -- but there's a lot more of those conversations to take place with regard to all BDCs. So -- and we're not...

At this time, I would like to turn the call back over to 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.