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Capital Southwest (NASDAQ:CSWC)
Q4 2018 Earnings Conference Call
Jun. 5, 2018 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Thank you for joining today's Capital Southwest fourth fiscal quarter 2018 earnings call. Participating on the call today are Bowen Diehl, CEO; Michael Sarner, CFO; and Christ Rehberger, VP, finance. I will now turn the call over to Chris Rehberger.

Chris Rehberger -- Vice President, Finance

Thank you. I would like to remind everyone that in the course of this call, we will be making certain forward-looking statements. These statements are based on current conditions, currently available information and management's expectations, assumptions, and beliefs. They are not guarantees of future results and are subject to numerous risks, uncertainties, and assumptions that could cause actual results to differ materially from such statements.

For information concerning these risks and uncertainties, see Capital Southwest's publicly available filings with the SEC. The company does not undertake any obligation to update or revise any forward-looking statements, whether as a result of new information, future events, changing circumstances or any other reason after the date of this press release, except as required by law. I will now hand the call off to our president and chief executive officer, Bowen Diehl.

Bowen S. Diehl -- President, Chief Executive Officer, and Director

Thanks, Chris, and thanks to everyone for joining us for our fourth-quarter 2018 earnings call. Throughout our prepared remarks, we will refer to various slides in our earnings presentation, which can be found on our website at www.capitalsouthwest.com. We are pleased to be here with you this morning to announce our quarterly annual results for the fiscal year 2018. This year, our focus remained on building a Lower Middle Market portfolio, consisting largely of first-lien senior debt with smaller equity co-investments across the loan portfolio where significant equity upside opportunity exists.

We continue to execute under our shareholder-friendly internally managed structure, which at its foundation closely aligns our interests with the interest of our fellow shareholders in generating sustainable long-term value through stable increasing dividends and NAV per share growth. Laid out on Slide 5 are some important summary points on our performance for the fiscal year ending March 31, 2018. During the year we paid $0.99 per share in quarterly dividends, a 25% increase in dividends over the $0.76 per share we paid out during our fiscal 2017. We were able to accomplish this, while growing NAV per share to $19.08 from $17.80 per share as of the end of the fiscal year '17.

As a result, our total return on equity for the fiscal-year '18 was 13.7%. During the year, we significantly grew the right side of our balance sheet, increasing our total debt capitalization through increasing commitments on our revolving line of credit from $100 million to $180 million and issuing $57.5 million in unsecured Baby Bonds, which today trade on the NASDAQ under the ticker CSWCL. Subsequent to year-end, we added an additional $30 million in commitments to our credit facility from both new and existing lenders, bringing our total credit facility commitments to its current level of $210 million. Our increased capital base has been utilized to grow our portfolio over 35% from $287 million at March 31, 2017 to $393 million at March 31, 2018.

During the year, we originated $169 million in total commitments in 17 portfolio companies, including $10 million invested in equity alongside eight of our loans, while exiting 11 companies for $61 million in proceeds, generating a weighted average IRR of 12.2%. We are pleased to note that three years into our credit strategy, we had a portfolio with no loans on non-accrual and only one investment on our internal watch list. In fact, Wastewater Specialities the company we had mentioned on previous calls is being on our internal watch list, has now been sold. The transaction closed last Friday, resulting in our first-lien loan being may be in full with contractual prepayment fees.

The exit generated an IRR of approximately 17%. Our current watch list credit recently added to the list is a distribution and logistics company, in which we have a first-lien loan and no equity. The company has underperformed and has breached our financial covenants. That said, the company has signed up a large number of new customers that are expected to ramp up in the coming months.

The financial sponsor and other equity investors are very bullish on the company's prospects and are preparing to invest significant equity dollars to fund the necessary growth CAPEX to prepare the company to take on this new business. We feel pretty good about the long-term prospects of this company and very good about the security of our shareholders capital in this deal. We're also pleased with the support this sponsors providing the company and think the management team has done an excellent job, signing up some interesting new customers. Specific to the fourth quarter, as seen on Slide 6, we experienced strong portfolio performance, growing NAV per share by $0.64 during the quarter to $19.08 per share, while earning $0.28 per share in pre-tax net investment income.

During the quarter, we achieved net portfolio growth of 7%, increasing the investment portfolio to $393 million from $367 million at the end of the prior quarter. Our I-45 senior loan fund continued its solid performance, providing a 13% annualized cash yield on our capital in the fund for the quarter. Finally, this quarter, we repurchased 36,000 shares under our share-repurchase program. As we have previously said, we're committed to building long-term shareholder value, while the number of shares we can purchase in any given day or week is significantly limited due to the low trading volume of our stock.

If the market price presents itself where it make sense to repurchase shares, then we will repurchase what we can. As we've illustrated in the past quarterly updates, Slide 7 shows our continued progress and track record of increasing shareholder dividends and driving increases in NAV per share through thoughtfully building a portfolio well-performing assets. For the quarter ending March 31, 2018, we paid out $0.28 per share in quarterly dividends, generating a 6.6% annualized dividend yield to our shareholders, while increasing NAV significantly. NAV appreciation this quarter was driven largely by appreciation in our equity investment in Titan Liner and in MRI.

As we have mentioned on our past -- our last several quarterly calls, Titan Liner's financial performance has been quite robust, as the company has continued to benefit from significant increases in oil and gas drilling activity and from a management team that has done a great job managing the business and generating what we believe are market-share gains. Titan Liner has been in an active sale process for the past several months and is under letter of intent today for a sale transaction that we expect to close very soon. Regarding MRI, the company continues to perform very well, with growth being driven by increased profit margins on its core products and increasing market penetration on several -- with several new products. We also recently announced our capitalization policy following the passage of the Small Business Credit Availability Act.

The act allows for business development companies to decrease the required minimum assets coverage ratio applicable to the company from 200% down to 150%. Stated differently, maximum allowable leverage at the BDC can be increased from the prior limit of 1:1 debt-to-equity up to a maximum of 2:1 debt-to-equity. BDCs can access additional financial flexibility either immediately through a vote of their shareholders or one year after a resolution of the BDCs board of directors that adopts the new leverage limitation. After careful consideration of the company's long-term strategy, the board announced two resolutions.

First, that it approved the adoption of the new regulatory limitation, and second, that it also adopted a self-imposed more restricted limitation on leverage to Capital Southwest of only 1.5:1, or 166% asset coverage. While the additional financial flexibility provided by the legislation is certainly a positive for the company and that it provides Capital Southwest with the flexibility to manage balance sheet leverage above our previously stated target of 0.8:1. Our philosophy on leverage of Capital Southwest has not changed. We remain steadfast in our view that leverage should be prudently applied to an underlying portfolio of assets based on the security and quality of the assets.

Specifically, we consider factors, such as the portion of the portfolio in first-lien assets, the weighted average leverage at the portfolio companies themselves and the underlying portfolio loan performance. While we do not view balance sheet leverage at Capital Southwest near 2:1 is being appropriate, we do believe that targeting balance sheet leverage at Capital Southwest greater than 0.8:1 may be appropriate. Frankly, 0.8:1 previously stated leverage target was a much cushion to the 1:1 leverage limitation from a regulatory perspective as it was evaluating the optimal leverage level appropriate for a well-performing portfolio of largely first-lien assets. We believe that the additional leverage will better enable us to increase the security and quality of our loan portfolio, while allowing for additional economics flowing from the any increase in leverage levels at Capital Southwest to flow to our shareholders.

The second resolution by our board implementing a more restrictive leverage limitation specific to Capital Southwest was meant to communicate our intent to be measured and prudent in managing any changes in Capital Southwest leverage levels. Since our growth plan does not currently contemplate needing the additional leverage over the next 12 months, our board of directors elected to pass the resolution at this time, and then utilize the one-year waiting period to obtain feedback from our shareholders and our lenders to take into consideration in our capitalization decisions over the longer-term, as all of these decisions we made in the context of creating attractive risk-adjusted returns and long-term sustainable value for our shareholders. Again, it is important to emphasize that our internally managed structure allows for virtually 100% of the economics earned from any incremental leverage to flow to our shareholders. This is in stark contrast to the externally managed structure where much of the incremental economics flow to the asset manager.

Our Investment Strategy as described on Slide 8, which focuses on a blend of both Lower Middle Market and Upper Middle Market assets provides us strategic flexibilities we have built the robust capability to seek attractive risk-adjusted returns in both markets. In our core market, the Lower Middle Market, we directly originate opportunities consisting of debt investments as well as equity investments made alongside our debt. Building on a high-performing and granular portfolio of equity co-investment it's important to driving growth and NAV per share, while mitigating future credit losses. On the other hand, our capability and presence in the Upper Middle Market provides us the ability to opportunistically invest in a more liquid market when attractive risk-adjusted returns exists.

This quarter, as seen on Slide 9, we committed $27 million to two new portfolio of investments and two add-on existing portfolio companies. Three of the investments were in the Lower Middle Market and two included equity co-investments. On a weighted-average basis, the debt investments made during the quarter had a yield maturity of 11.2%. During the quarter, as seen on Slide 10, we received $5 million in proceeds from the exit of one Upper Middle Market second-lien investment held since December 5, 2015, that generated an IRR over this time of 13%.

This continues our track record of generating strong risk-adjusted returns on our shareholders capital as we have now had 19 exits since the launch of our credit strategy three years ago, representing over $122 million in proceeds and a weighted average IRR on exits of 16.9%. On Slide 11, we break out our on-balance sheet credit portfolio, excluding I-45, between the Lower Middle Market and the Upper Middle Market. As of the end of the quarter, the portfolio is approximately 75%, 25% weighted on a cost basis between the Lower Middle Market and Upper Middle Market, respectively. We had 19 Lower Middle Market investments comprised of first-lien, sub-debt, and equity securities with an average hold size of $10.8 million, a weighted average EBITDA of $8.6 million, a weighted average yield of 11.9% and leverage measured as debt-to-EBITDA through our security of 3.3 times.

Within our Lower Middle Market portfolio as of the end of the quarter, we held equity ownership in approximately 74% of our portfolio companies. Our Upper Middle Market portfolio consisted of 10 loans, including first-lien and second-lien debt with an average hold size of $6.6 million, weighted average EBITDA of $86.2 million, a weighted average yield of 10.2% and leverage through our security of 4.3 times. On our balance sheet credit portfolio at Capital Southwest, as shown on Slide 12, again, excluding I-45, this grew 6% to $239 million, driven by strong Lower Middle Market first-lien activity. As the portfolio has grown, the percentage of the credit portfolio represented by the Lower Middle Market has increased by design to now 72%.

As we have stated on prior calls, we believe the Lower Middle Market to be the market that has demonstrated the most attractive risk-adjusted returns through the economic cycle as debt pricing, terms and leverage are more attractive and we often have the opportunity to invest in equity in companies with very interesting growth prospects. While we have increased the percentage of the portfolio represented by the Lower Middle Market, we have also continue to heavily emphasize first-lien senior loans in our investment strategy. As of the end of the quarter, 82% of our on-balance sheet credit portfolio was in first-lien senior securities. As illustrated on Slide 13, now, including capital invested in I-45, our overall all investment portfolio grew 7% quarter over quarter, increasing to $393 million from $367 million at the beginning of the quarter.

We continue to believe we have positioned our investment -- invested assets well for any economic environment we may face in the future. We have a well-diversified portfolio, heavily biased toward first-lien and secured debt investments preparing us for a recession, while at the same time, 95% of our credit exposure is invested in floating rate securities as can be seen on Slide 14, so that our shareholders also continue to benefit should interest rates continue to rise. Specific to our I-45 senior loan fund as seen on Slide 15, we saw slight net portfolio growth with fund assets growing to $221 million from $218 million at the beginning of the quarter. During the quarter, I-45 committed $24 million in four new and four add-on credit investments, while receiving $19 million in proceeds from the exits and sales of credits during the quarter, which generated a weighted average IRR of 8.9% at the fund level.

As of the end of the quarter, the I-45 portfolio was 94% first-lien, with diversity among industries and an average hold size of 2.3% of the portfolio. The portfolio had a weighted average EBITDA of $74 million and weighted average leverage through the I-45 security of 3.6 times. In our markets, the environment remains robust and highly competitive, while the business and economic environment is highly favorable for our portfolio companies, the quantum of liquidity in both the private equity and leveraged finance markets continues to give rise to valuation and leverage levels that make it more difficult to find and consistently generate attractive risk-adjusted returns. As most of you know, the Upper Middle Market or syndicated market continues to see tight spreads as the market has given back much of the increase in LIBOR and reduced spreads.

In addition, in the syndicated Upper Middle Market, leverage levels are high, and in many cases, the portion of underwritten EBITDA are represented by pro forma adjustments or at elevated levels. This clearly creates an environment that makes it difficult to generate attractive risk-adjusted returns. We believe being highly selective in our credits in which we invest, taking small position so that our portfolio is highly granular, diverse and relatively easy to sell out of, all the while investing through an efficiently levered vehicle like a senior loan fund is the best strategy for generating attractive risk-adjusted returns in this market right now. In the Lower Middle Market, it is also very competitive and it has been for a while, so we don't believe the environment has changed all that much over the past several quarters.

Over the past year, LIBOR spreads on senior loans have generally tightened by approximately 100 basis points, but increases in leverage levels have been much less pronounced than we have seen in the Upper Middle Market. Importantly, loan terms, such as covenants and LIBOR floors have remained firmly intact. We continue to focus on maximizing our investment pipeline, while maintaining the investment discipline we have consistently described to you since the launch of our credit strategy three years ago. We continue to model each and every investment we underwrite for stress test purposes, assuming the Great Recession repeats itself during our hold period and insisting that our financial model demonstrate that our loan remains well within enterprise value with our interest being paid through such a cycle.

This methodology will, by definition, buy us the portfolio toward first-lien senior debt, while appropriately matching capital structures at our portfolio companies to the potential volatility, specific to the portfolio of companies businesses and industries in which they operate. We continue to be pleased with the flow of quality, Lower Middle Market deals being generated by our investment team. Our close rate has remained less than 3% over the last 12 months. So a robust pipeline of opportunities is key to maintaining our conservative underwriting approach in a competitive market.

I will now hand the call over to Michael to review the specifics of our financial performance for the quarter.

Michael S. Sarner -- Chief Financial Officer

Thanks, Bowen. As seen on Slide 16, our investment portfolio produced $9.9 million in investment income this quarter with a weighted average yield on all investments of 10.5%. This represents an increase of $855,000 versus $9 million from the previous quarter, mostly attributable to net portfolio growth. We incurred $3.4 million in operating expenses this quarter, excluding interest expense, which was flat from $3.4 million in the previous quarter.

For the quarter, we earned pre-tax net investment income of $4.5 million, or $0.28 per share, compared to $0.27 per share during the prior quarter. As a result, we paid out $0.28 per share in the regular dividends for the quarter, an increase of $0.02 per share over the $0.26 per share paid out in the prior quarter. We continue to focus on growing our quarterly dividends in a sustainable manner, demonstrated by our last 12 months dividend coverage of 103%. As seen on Slide 17, during the quarter, our NAV increased by $9.8 million to $308.3 million, or $19.08 per share.

The increase in NAV is primarily due to an increase in net realized and unrealized gains during the current quarter, generated primarily from, as Bowen mentioned, appreciation in our equity investments in Titan Liner and MRI. We produced a total annualized return on equity of 20.1% during the quarter. During fiscal year 2018, we produced a 13.7% total return on equity and increased NAV of approximately $23.2 million. This compares to a total return on equity of 8.5% during fiscal-year 2017.

As illustrated on Slide 18, our on-balance sheet investment portfolio mix, excluding capital invested in I-45 with 73% debt and 27% equity at quarter-end and 92% of our total portfolio produced income in the form of either interest or dividends. The weighted average yield on our debt portfolio was 11.5% for the quarter, up from 11% the previous quarter. And as of the end of the quarter, there were no assets on non-accrual. During the March quarter, the equity markets experienced significant volatility, which presented an excellent opportunity to repurchase shares at an attractive discount toward net asset value.

As Bowen mentioned, despite being limited by trading volume and the quantity of shares we can accumulate on any trading day, we were able to repurchase 36,000 shares at a blended price of $16.37 per share, representing approximately $600,000. We believe these purchases provide both immediate and long-term accretion that will benefit all shareholders. The repurchases also further highlight the advantages of our internally managed structure, which incentivizes us to grow shareholder value, while maintaining sufficient capital flexibility, rather than solely focusing on growing our assets under management. After these purchases, we have approximately $9.4 million remaining on our $10 million board-approved share-repurchase program.

We will continue to assess opportunities in the market to purchase shares when we believe our stock is undervalued. At quarter-end, we had significant liquidity, consisting of $140 million of available capacity on our ING-led balance sheet credit facility, $22 million in additional capacity on the Deutsche Bank led I-45 credit facility, and $8 million in balance sheet cash. In April, we increased the ING credit facility commitments to $200 million with the addition of a new lender. In May, we further increased the ING credit facility commitments to $210 million with a commitment increase from a current lender.

As seen on Slide 19, we have significant unused debt capacity and no payment obligations until late 2021, which will enable us to significantly grow our portfolio. I will now hand the call back to Bowen for some final comments.

Bowen S. Diehl -- President, Chief Executive Officer, and Director

Thanks, Michael. And thank you, everyone, for joining us today. I'm extremely proud of what our team has accomplished so far. Capital Southwest has grown and the business and portfolio has developed consistent with the vision and strategy we communicated to our shareholders over three years ago.

We continue to work tirelessly to execute our investment strategy and to be good stewards of our shareholders capital. Everyone here at Capital Southwest is totally dedicated to our No. 1 goal, the creation of long-term sustainable shareholder value. This concludes our prepared remarks.

Operator, we are ready to open the lines up for questions.

Questions and Answers:

Operator

Thank you. [Operator instructions] And our first question comes from Mickey Schleien from Ladenburg. Your line is open.

Mickey M. Schleien -- Ladenburg Thalmann -- Analyst

Yeah. Good morning, everyone. Bowen, I wanted to ask you about dynamics in the Lower Middle Market. I think the market appreciates that, it's partially insulated from the volatility and the more liquid markets and that it's harder to do -- harder to originate deals there, so you get better terms.

But on the other hand, can you give us some insight into how the LMM companies that you target performed during the downturns in the economy, especially EBITDA declines and default rates?

Bowen S. Diehl -- President, Chief Executive Officer, and Director

Yeah. Sure. Thanks, Mickey. I would say to your question on how they perform, and if you think about across our portfolio, we have companies that EBITDA in the Great Recession went down as, maybe 30% and others that went, EBITDA were flat or even up during the Great Recession based on the nuances of their business models.

And so it's a fairly big range. What we try to do is we try to match the capital structure, which may or may not work for the borrower, right, which is why we lose the deal. But we try to match the capital structure with that potential volatility. So as you would imagine, the Lower Middle Market companies that have the higher potential volatility are going to have lower leverage in our portfolio.

Mickey M. Schleien -- Ladenburg Thalmann -- Analyst

That's helpful. Thank you. And on the two LMM deals, Prism and ITA, how did you source those two deals and are they small companies where you did all the financing or did you lead a club or some sort?

Bowen S. Diehl -- President, Chief Executive Officer, and Director

So on Prism, we lead a club with another lower middle market lender. We led -- it's a small deal initially, but it's going to grow as they do acquisitions, and so we brought on a co-lender to join us in that deal. And so when we source that -- just do networking with sponsors. And then on the ITA, we actually sourced that, but found our own business.

We sourced it through a small intermediary, actually that I had done business with or -- a couple of us had done business with at our former firm. We just have a relationship in the market with him, and we were the -- we led that, we're the only financing party there.

Mickey M. Schleien -- Ladenburg Thalmann -- Analyst

OK. And my last question. Do you -- haven't seen the proxy yet for the shareholder meeting, do you expect to potentially add a proposal there for higher leverage to accelerate the clock for that process?

Bowen S. Diehl -- President, Chief Executive Officer, and Director

We haven't gone that route. The board decided, as I said in my remarks, the board decided to approve the leverage change, also though message prudent in approving a self-imposed limitation and then take the next year. Because as we said we don't need the leverage above our target for the next year. And so we got a lot of time to talk to our shareholders, talk to our lenders and watch the portfolio, watch the market and kind of make that decision over that time period.

With -- in the context of the feedback we've gained over that year, and so rather than going in through the additional expense of terms of the proxy preliminary things like preliminary proxy issuances with the -- and the comments SEC which generate legal expenses, which as a smaller BDC like us, that matters, we decided to take this route.

Mickey M. Schleien -- Ladenburg Thalmann -- Analyst

I appreciate that. Those are all my questions this morning. Thank you.

Operator

Thank you. [Operator instructions] And our next question comes from Christopher Testa from National Securities Corp. Your line is open.

Christopher Testa -- National Securities -- Analyst

Hey. Good morning, guys. Thanks for taking my question. Appreciate all the thoughtfulness that you guys put into describing how you're going to handle the leverage increase.

I just have just a couple more questions about that. You guys have mentioned that you see the SLF as one of the better risk-adjusted returns in the market, given where spreads are, but at the same time, you guys have predominately on the balance sheet more Lower Middle Market loans. Going forward, as you guys were able to move toward 1:1, given that you now have much higher cushion at 1 1/2 times, should we expect maybe more -- higher composition of Upper Middle Market loans on the balance sheet or are you still seeing that as a better risk-adjusted return on balance sheet as well as the SLF?

Bowen S. Diehl -- President, Chief Executive Officer, and Director

Yes, let me correct part of what you said, Chris, and thanks for your question, by the way. You said that -- we said that one of the more attractive returns in the market is in the Upper Middle Market, that's actually not correct. What I meant to convey is that, every market is very competitive, like I said, spreads tight, leverage level high, lots of add-backs, and so the way to play in that market is to take small pieces of a lot of loans within the universe of loans that we find attracted and basically good fundamental businesses. Take small pieces, so that you have a very granular portfolio, so if anyone of them doesn't do well, it doesn't move the needle, right? So that's, granularity is the key.

Then efficiently levering it in a senior loan fund, which is, as you know, a very low leverage CLO kind of entity, right? It's not 10:1 leverage, it's 2:1 leverage or less. And so just take little bites of a bunch of loans. And so that kind of looks -- that looks like a senior loan fund, right? So that -- so we think the senior loan fund, we still -- we think that's a nice vehicle for us, but as you can see, the assets really aren't growing all that much because we're not driving growth in that fund because we're not really seeing the value to drive growth in the Upper Middle Market in our portfolio. So if the environment stays like it is today and the leverage were to increase, we would look at our portfolio and say, OK, we see more value in the Lower Middle Market now.

OK that's assumption -- that's fact one. Fact two then is we -- what is the optimal leverage on a portfolio that is in fact largely Lower Middle Market, and of course, largely first-lien. And so we think that leverage could be above the 0.8. We don't think that's 2:1 leverage.

Some BDCs are effectively getting 2:1 leverage through SBICs. We do think the Lower Middle Market first-lien asset class, certainly a performing asset class could handle more leverage than the 0.8:1. But I wouldn't assume that in our leverage calculation that we're going to turbocharge our positions in the Upper Middle Market. Because you think about the number of deals we see that we like and the size holds that we want to take in those deals in the Upper Middle Market that kind of fit nicely in the senior loan fund.

So we're putting new deals in the senior loan fund and at the same time, we're getting recapped out of deals in the senior loan funds, with senior loan funds kind of hanging out at the 220, 225 asset size, maybe it grows a little bit from there. But I wouldn't assume that because we're adjusting leverage that we're going to all of a sudden put a whole lot more money to work in the Upper Middle Market, at least, in the environment we're in right now.

Michael S. Sarner -- Chief Financial Officer

And also, Chris, the I-45 credit facility has a lower cost of capital surplus $240 million and slightly higher advance rates. So we're able to get decent returns even with lower yields in the Upper Middle Markets.

Bowen S. Diehl -- President, Chief Executive Officer, and Director

But again, smaller bites, very granular, it's kind of how I would see play in this market.

Christopher Testa -- National Securities -- Analyst

Got it. OK. That's great detail. Thank you for that.

And just you had mentioned Media Recovery continues to perform well and obviously that's been a really great investment for you guys. I'm just curious, I mean, as you look in your crystal ball, what do you think the time line on monetization of this is, is the thinking behind this somewhat that you actually want to take on more leverage on the revolver before you actually monetize this, so you don't have to deploy so much capital and risk creating a drag on earnings or is that just totally out of the question and you guys are simply looking to wait until you think you're going to get the best value for this?

Bowen S. Diehl -- President, Chief Executive Officer, and Director

First and foremost, we're looking at the investment, the company strategy, the company's growth and working with the management team that we put in place three years ago, doing an excellent job of managing that business. But trying to think, OK, when is the right time to sell against the backdrop of a couple of things, right? We are in a very white-hot M&A market. We need not lose context of that. We are -- ultimately if it continues to grow and it continues to appreciate, it's just going to become a larger and larger asset on our books.

And I don't -- the strategy that we laid out three years ago is not to become an MRI strategy, right? So we want at some point it gets large and it probably needs to be sold and we are in a nice market. So you put all those variables together, you don't really -- you can't really turn the dial up and down by days or weeks, of course. But if you think about general timing of all of those variables, I think, it's fair to say that this is an asset that will be sold in the next 12 months.

Christopher Testa -- National Securities -- Analyst

Got it. OK. That --

Michael S. Sarner -- Chief Financial Officer

And Chris, to your question, I think, also, we tell you that with the dry powder we have, we kind of anticipate putting that capital to work and levering up over the next 12 to 15 months. So if actually might, be around the same timing of when we lever up and when we see this exit occur.

Christopher Testa -- National Securities -- Analyst

Got it. OK, Yeah. That makes sense. Great.

And cov-lite obviously has been a problem in the Upper Middle Market with over three-quarters of the loans being cov-lite there. Just wondering how much of that dip down into kind of the sub-$40 million, $50 million EBITDA market. I mean, I would assume it's not in the $8 million to $10 million EBITDA market, where you have a lot of your Lower Middle Market loans at that level. But if you could just give us a sense of how much you're seeing covenants and deterioration in terms kind of get down from the Upper Middle Market, that would be appreciated?

Bowen S. Diehl -- President, Chief Executive Officer, and Director

Yes, we are -- I mean, given we're kind of in the Upper Middle Market, which is large and you just described it and we've been talking about the competitiveness and the term deterioration and stuff in the Upper Middle Market. In the Lower Middle Market, where we play actively, as you also said, it's certainly, as we said, we certainly get -- are getting robust terms in those deals. In the kind of middle zone, larger, not quite Upper Middle Market, larger, not quite Lower Middle Market world, we don't do a lot of deals in that area, but we do a handful a year or handful or half-a-handful of club deals were we're partnering with, maybe two other lenders or so, that they lead and that we're taking a $10-ish million kind of position in, and on those deals, we've had covenants. And I think the covenants are little bit certainly higher cushions than the Lower Middle Market in terms of little bit looser, but it hasn't been near as much -- it's not near as loose as in the Upper Middle Market.

So it's kind of somewhere in between, Chris, I guess is the better way to say.

Christopher Testa -- National Securities -- Analyst

OK. All right, that's fair. And last one for me, just what caused the increase in income from your affiliate investments this quarter?

Michael S. Sarner -- Chief Financial Officer

Sure. There is actually a few factors there. We reclassed two portfolio companies from nonaccrual to affiliate -- non-control to affiliate due to voting security percentage being greater than 5%, that was at $35 million. We had two originations during the quarter that were in the affiliate category, and that was about $15 million, and then we had one prepayment during the quarter, that was non-controlled category, about $5 million.

Christopher Testa -- National Securities -- Analyst

Got it. OK. So the current quarterly run rate, we should, for modeling purposes kind of use that going forward as a base?

Michael S. Sarner -- Chief Financial Officer

Yes. That's correct.

Christopher Testa -- National Securities -- Analyst

OK.

Bowen S. Diehl -- President, Chief Executive Officer, and Director

Yes, the affiliate hurdle, as you know, is a 5% ownership, so it's pretty low. So as you move forward, you'll see a lot of our investments we make are co-investment, it's very oftentimes we are in the 5% to 10% kind of ownership, which would be affiliate.

Christopher Testa -- National Securities -- Analyst

Right. OK. That makes sense. Thanks for taking my questions today, guys.

Bowen S. Diehl -- President, Chief Executive Officer, and Director

Sure.

Operator

Thank you. And our next question comes from Troy Ward from Ares. Your line is open.

Troy Ward -- Ares -- Analyst

Great. Thanks, guys. Thanks for taking my question. Actually, question on the current liability stack.

So on Slide 19, you showed the facility in the 2022 senior notes, the Baby Bonds. Can you just talk about if any of these liabilities have covenants tied to the 200% asset coverage? And I know you did some -- you had conversations with your lenders post quarter-end, some changes, some increases. Can you just talk about how the lenders are thinking about lower asset coverage or higher debt-to-equity going forward?

Michael S. Sarner -- Chief Financial Officer

Sure. So obviously, the revolver as other BDCs have -- has a 1:1 covenant, the notes do not. They just require you to stay compliant within the BDC. So but obviously the governor being the revolver, we have had conversations.

I think for our lender particularly, I think, they're still putting together white papers and considering how they're going to handle it. Generally, what they have discussed is they're looking at companies that had performed well over the last six, 12, 18 months to see what's kind of levels they're going to allow in terms of overall leverage. I think body language has been positive. But for us, we have 12 months before we're going to be up against the 1:1 leverage.

So we have some time to work with them on an amendment and we're going to obviously see how they interact with other BDCs and where they reset those levels. We're hopeful that it's going to be consistent with our policy that we've set, if not better.

Troy Ward -- Ares -- Analyst

OK. Great. That's great color. Thanks, guys.

Michael S. Sarner -- Chief Financial Officer

Thanks, Troy.

Operator

Thank you. And our next question comes from Chris McCampbell from Hilltop Securities. Your line is open.

Chris McCampbell -- Hilltop Securities -- Analyst

Good morning, guys. In regards to dividend policy, your rate of change and dividend growth is slowing. Should our expectations be that we've gotten to a point where increases are going to be less frequent?

Michael S. Sarner -- Chief Financial Officer

No, I don't think that's the case. I think what you saw this quarter was that we did raise a significant amount of capital. The Baby Bonds that were raised at the very end of December, and therefore, it was a bit of an overhang in this quarter. We also have unused fees on our revolver, so, therefore, when you use those proceeds to pay it down, we're going to incur additional costs there.

And also think we had some late-stage originations. So I think, there will be -- a bit of a J-Curve as we move forward and we still expect to see dividend growth over the next really six to 12 months.

Chris McCampbell -- Hilltop Securities -- Analyst

OK. Great. Thanks.

Operator

And I'm showing no further questions at this time. I would now like to turn the conference back over to Bowen Diehl for any closing remarks.

Bowen S. Diehl -- President, Chief Executive Officer, and Director

Thanks, operator, and thanks, everybody, for joining us today. We really appreciate it, and we look forward to keeping you apprised of our progress on future calls. Have a great week.

Operator

[Operator signoff]

Duration: 44 minutes

Call Participants:

Chris Rehberger -- Vice President, Finance

Bowen S. Diehl -- President, Chief Executive Officer, and Director

Michael S. Sarner -- Chief Financial Officer

Mickey M. Schleien -- Ladenburg Thalmann -- Analyst

Christopher Testa -- National Securities -- Analyst

Troy Ward -- Ares -- Analyst

Michael S. Sarner -- Chief Financial Officer

Chris McCampbell -- Hilltop Securities -- Analyst

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