Attached files
file | filename |
---|---|
EX-31.3 - EXHIBIT 31.3 - MCG CAPITAL CORP | dex313.htm |
EX-32.1 - EXHIBIT 32.1 - MCG CAPITAL CORP | dex321.htm |
EX-32.2 - EXHIBIT 32.2 - MCG CAPITAL CORP | dex322.htm |
EX-32.3 - EXHIBIT 32.3 - MCG CAPITAL CORP | dex323.htm |
EX-31.1 - EXHIBIT 31.1 - MCG CAPITAL CORP | dex311.htm |
EX-15.1 - EXHIBIT 15.1 - MCG CAPITAL CORP | dex151.htm |
EX-31.2 - EXHIBIT 31.2 - MCG CAPITAL CORP | dex312.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2009
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number 0-33377
MCG CAPITAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware | 54-1889518 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) | |
1100 Wilson Boulevard, Suite 3000 Arlington, VA |
22209 | |
(Address of principal executive offices) | (Zip Code) |
(703) 247-7500
(Registrants telephone number, including area code)
None
(Former name, former address, and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ¨ | Accelerated filer | x | |||
Non-accelerated filer | ¨ (Do not check if a smaller reporting company) | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act). Yes ¨ No x
As of October 30, 2009, there were 76,398,325 shares of the registrants $0.01 par value Common Stock outstanding.
Table of Contents
FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2009
TABLE OF CONTENTS
Table of Contents
ITEM 1. | FINANCIAL STATEMENTS |
Consolidated Balance Sheets
(in thousands, except per share amounts) |
September 30, 2009 |
December 31, 2008 |
||||||
(unaudited) | ||||||||
Assets |
||||||||
Cash and cash equivalents |
$ | 47,166 | $ | 46,149 | ||||
Cash, securitization accounts |
68,405 | 37,493 | ||||||
Cash, restricted |
20,817 | 979 | ||||||
Investments at fair value |
||||||||
Non-affiliate investments (cost of $618,841 and $605,906, respectively) |
582,147 | 584,336 | ||||||
Affiliate investments (cost of $39,913 and $45,141, respectively) |
50,350 | 56,126 | ||||||
Control investments (cost of $701,020 and $819,076, respectively) |
404,747 | 562,686 | ||||||
Total investments (cost of $1,359,774 and $1,470,123, respectively) |
1,037,244 | 1,203,148 | ||||||
Interest receivable |
6,141 | 8,472 | ||||||
Other assets |
14,614 | 16,193 | ||||||
Total assets |
$ | 1,194,387 | $ | 1,312,434 | ||||
Liabilities |
||||||||
Borrowings (maturing within one year of $2,036 and $44,500, respectively) |
$ | 568,507 | $ | 636,649 | ||||
Interest payable |
3,854 | 5,367 | ||||||
Other liabilities |
10,059 | 11,507 | ||||||
Total liabilities |
582,420 | 653,523 | ||||||
Stockholders equity |
||||||||
Preferred stock, par value $0.01, authorized 1 share, none issued and outstanding |
| | ||||||
Common stock, par value $0.01, authorized 200,000 shares on September 30, 2009 and December 31, 2008, 75,970 issued and outstanding on September 30, 2009 and 76,075 issued and outstanding on December 31, 2008 |
760 | 761 | ||||||
Paid-in capital |
1,002,938 | 997,318 | ||||||
Undistributed (distributions in excess of) earnings |
||||||||
Paid-in capital |
(162,783 | ) | (162,783 | ) | ||||
Other |
95,839 | 91,624 | ||||||
Net unrealized depreciation on investments |
(324,787 | ) | (267,948 | ) | ||||
Stockholder loans |
| (61 | ) | |||||
Total stockholders equity |
611,967 | 658,911 | ||||||
Total liabilities and stockholders equity |
$ | 1,194,387 | $ | 1,312,434 | ||||
Net asset value per common share at end of period |
$ | 8.06 | $ | 8.66 |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
1
Table of Contents
Consolidated Statements of Operations
(unaudited)
Three months ended September 30, |
Nine months ended September 30, |
|||||||||||||||
(in thousands, except per share amounts) |
2009 | 2008 | 2009 | 2008 | ||||||||||||
Revenue |
||||||||||||||||
Interest and dividend income |
||||||||||||||||
Non-affiliate investments (less than 5% owned) |
$ | 15,861 | $ | 18,198 | $ | 47,958 | $ | 55,652 | ||||||||
Affiliate investments (5% to 25% owned) |
1,115 | 1,656 | 3,383 | 5,205 | ||||||||||||
Control investments (more than 25% owned) |
6,082 | 10,529 | 22,742 | 42,065 | ||||||||||||
Total interest and dividend income |
23,058 | 30,383 | 74,083 | 102,922 | ||||||||||||
Advisory fees and other income |
||||||||||||||||
Non-affiliate investments (less than 5% owned) |
335 | 466 | 1,081 | 1,399 | ||||||||||||
Control investments (more than 25% owned) |
218 | 447 | 991 | 1,071 | ||||||||||||
Total advisory fees and other income |
553 | 913 | 2,072 | 2,470 | ||||||||||||
Total revenue |
23,611 | 31,296 | 76,155 | 105,392 | ||||||||||||
Operating expenses |
||||||||||||||||
Interest expense |
5,518 | 7,991 | 18,391 | 26,706 | ||||||||||||
Employee compensation |
||||||||||||||||
Salaries and benefits |
4,115 | 4,081 | 10,824 | 13,673 | ||||||||||||
Amortization of employee restricted stock awards |
2,279 | 1,802 | 5,603 | 5,406 | ||||||||||||
Total employee compensation |
6,394 | 5,883 | 16,427 | 19,079 | ||||||||||||
General and administrative expense |
3,041 | 4,408 | 12,568 | 12,377 | ||||||||||||
Total operating expenses |
14,953 | 18,282 | 47,386 | 58,162 | ||||||||||||
Net operating income before net investment loss, (loss) gain on extinguishment of debt and income tax (benefit) provision |
8,658 | 13,014 | 28,769 | 47,230 | ||||||||||||
Net realized loss on investments |
||||||||||||||||
Non-affiliate investments (less than 5% owned) |
(2,820 | ) | 5,359 | (5,991 | ) | 5,484 | ||||||||||
Affiliate investments (5% to 25% owned) |
| 1 | (1,947 | ) | (61 | ) | ||||||||||
Control investments (more than 25% owned) |
(1,502 | ) | (14,823 | ) | (21,934 | ) | (14,551 | ) | ||||||||
Total net realized loss on investments |
(4,322 | ) | (9,463 | ) | (29,872 | ) | (9,128 | ) | ||||||||
Net unrealized appreciation (depreciation) on investments |
||||||||||||||||
Non-affiliate investments (less than 5% owned) |
4,064 | (12,644 | ) | (15,124 | ) | (24,725 | ) | |||||||||
Affiliate investments (5% to 25% owned) |
(1,400 | ) | 4,214 | (548 | ) | 4,836 | ||||||||||
Control investments (more than 25% owned) |
(1,652 | ) | (61,685 | ) | (39,883 | ) | (151,866 | ) | ||||||||
Derivative and other fair value adjustments |
(1,086 | ) | (146 | ) | (1,284 | ) | 273 | |||||||||
Total net unrealized appreciation (depreciation) on investments |
(74 | ) | (70,261 | ) | (56,839 | ) | (171,482 | ) | ||||||||
Net investment loss before income tax (benefit) provision |
(4,396 | ) | (79,724 | ) | (86,711 | ) | (180,610 | ) | ||||||||
(Loss) gain on extinguishment of debt before income tax (benefit) provision |
(118 | ) | | 5,025 | | |||||||||||
Income tax (benefit) provision |
(39 | ) | 236 | (293 | ) | 568 | ||||||||||
Net income (loss) |
$ | 4,183 | $ | (66,946 | ) | $ | (52,624 | ) | $ | (133,948 | ) | |||||
Earnings (loss) per basic and diluted common share |
$ | 0.06 | $ | (0.90 | ) | $ | (0.71 | ) | $ | (1.87 | ) | |||||
Cash distributions declared per common share |
$ | | $ | | $ | | $ | 0.71 | ||||||||
Weighted-average common shares outstandingbasic and diluted |
75,876 | 74,296 | 74,588 | 71,526 |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
2
Table of Contents
Consolidated Statements of Changes in Net Assets
(unaudited)
Nine months ended September 30, |
||||||||
(in thousands, except per share amounts) |
2009 | 2008 | ||||||
(Decrease) increase in net assets from operations |
||||||||
Net operating income before net investment loss, gain on extinguishment of debt and income tax benefit (provision) |
$ | 28,769 | $ | 47,230 | ||||
Net realized loss on investments |
(29,872 | ) | (9,128 | ) | ||||
Net unrealized depreciation on investments |
(56,839 | ) | (171,482 | ) | ||||
Gain on extinguishment of debt |
5,025 | | ||||||
Income tax benefit (provision) |
293 | (568 | ) | |||||
Net loss |
(52,624 | ) | (133,948 | ) | ||||
Distributions to stockholders |
||||||||
Distributions declared |
| (49,185 | ) | |||||
Net decrease in net assets resulting from stockholder distributions |
| (49,185 | ) | |||||
Capital share transactions |
||||||||
Issuance of common stock |
| 57,107 | ||||||
Amortization of restricted stock awards |
||||||||
Employee |
5,603 | 5,406 | ||||||
Restructuring expense |
| 88 | ||||||
Non-employee director |
108 | 194 | ||||||
Cancellation of common stock held as collateral for stockholder loans |
(92 | ) | (105 | ) | ||||
Stockholder loans |
||||||||
Unrealized (appreciation) depreciation on stockholder loans |
(31 | ) | 328 | |||||
Repayment of stockholder loans |
92 | 105 | ||||||
Net increase in net assets resulting from capital share transactions |
5,680 | 63,123 | ||||||
Total decrease in net assets |
(46,944 | ) | (120,010 | ) | ||||
Net assets |
||||||||
Beginning of period |
658,911 | 834,689 | ||||||
End of period |
$ | 611,967 | $ | 714,679 | ||||
Net asset value per common share at end of period |
$ | 8.06 | $ | 9.39 | ||||
Common shares outstanding at end of period |
75,970 | 76,117 |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
3
Table of Contents
Consolidated Statements of Cash Flows
(unaudited)
Nine months ended September 30, |
||||||||
(in thousands) |
2009 | 2008 | ||||||
Cash flows from operating activities | ||||||||
Net loss |
$ | (52,624 | ) | $ | (133,948 | ) | ||
Adjustments to reconcile net loss to net cash provided by operating activities |
||||||||
Investments in portfolio companies |
(55,078 | ) | (70,817 | ) | ||||
Principal collections related to investment repayments or sales |
145,414 | 164,574 | ||||||
Increase in interest receivable, accrued payment-in-kind interest and dividends |
(8,753 | ) | (20,756 | ) | ||||
Amortization of restricted stock awards |
||||||||
Employee |
5,603 | 5,494 | ||||||
Non-employee director |
108 | 194 | ||||||
Decrease in cashsecuritization accounts from interest collections |
1,644 | 64 | ||||||
Depreciation and amortization |
4,195 | 2,755 | ||||||
Unrealized (appreciation) depreciation on stockholder loans |
(123 | ) | 328 | |||||
Decrease (increase) in other assets |
1,754 | (1,635 | ) | |||||
Decrease in other liabilities |
(3,263 | ) | (4,232 | ) | ||||
Realized loss on investments |
29,872 | 9,128 | ||||||
Change in unrealized depreciation on investments |
56,839 | 171,482 | ||||||
Gain on extinguishment of debt |
(5,025 | ) | | |||||
Net cash provided by operating activities |
120,563 | 122,631 | ||||||
Cash flows from financing activities | ||||||||
Payments on borrowings |
(63,117 | ) | (98,067 | ) | ||||
Increase in cash in restricted and securitization accounts |
||||||||
Securitization accounts for repayment of principal on debt |
(32,556 | ) | (4,144 | ) | ||||
Restricted cash |
(19,838 | ) | | |||||
Payment of financing costs |
(4,127 | ) | (3,413 | ) | ||||
Issuance of common stock, net of costs |
| 57,107 | ||||||
Distributions paid |
| (78,130 | ) | |||||
Cancellation of common stock held as collateral for stockholder loans |
| (105 | ) | |||||
Repayment of stockholder loans |
92 | 105 | ||||||
Net cash used in financing activities |
(119,546 | ) | (126,647 | ) | ||||
Increase (decrease) in cash and cash equivalents |
1,017 | (4,016 | ) | |||||
Cash and cash equivalents | ||||||||
Beginning balance |
46,149 | 23,297 | ||||||
Ending balance |
$ | 47,166 | $ | 19,281 | ||||
Supplemental disclosure of cash flow information | ||||||||
Interest paid |
$ | 16,741 | $ | 25,687 | ||||
Income taxes paid |
51 | 1,105 | ||||||
Payment-in-kind interest collected |
1,564 | 4,881 | ||||||
Dividend income collected |
8,344 | 3,519 |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
4
Table of Contents
Consolidated Schedule of Investments
September 30, 2009 (unaudited)
(dollars in thousands)
Portfolio Company |
Industry |
Investment(9) |
Principal | Cost | Fair Value | ||||||||
Control Investments(4): |
|||||||||||||
Avenue Broadband LLC(2) |
Cable |
Subordinated Debt (14.0%, Due 3/14-12/14)(1) | $ | 14,254 | $ | 14,161 | $ | 14,161 | |||||
Preferred Units (10.0%, 17,100 units)(1) | 20,366 | 22,842 | |||||||||||
Warrants to purchase Class B Common Stock | | | |||||||||||
Broadview Networks Holdings, Inc.(6) | Communications-CLEC | Series A Preferred Stock (12.0%, 87,254 shares) | 81,984 | 70,139 | |||||||||
Series A-1 Preferred Stock (12.0%, 100,702 shares) | 77,495 | 68,695 | |||||||||||
Class A Common Stock (4,698,987 shares) | | | |||||||||||
Cleartel Communications, Inc.(2)(6)(17) | Communications-CLEC | Subordinated Debt (11.1%, Due 10/09-3/11)(7) | 46,379 | 37,398 | | ||||||||
Series B Preferred Stock (8.0%, 57,862 shares) | 50,613 | | |||||||||||
Common Stock (744,777 shares) | 62,125 | | |||||||||||
Guaranty ($2,000) | |||||||||||||
GMC Television Broadcasting, LLC(2)(6)(20) | Broadcasting |
Senior Debt (4.3%, Due 12/16)(1)(7) | 23,720 | 21,328 | 20,711 | ||||||||
Subordinated Debt (14.0%, Due 12/16)(1)(7) | 8,773 | 6,976 | | ||||||||||
Subordinated Unsecured Debt (16.0%, Due 12/16)(7) | 1,026 | 1,000 | | ||||||||||
Class B Voting Units (8.0%, 86,700 units) | 9,071 | | |||||||||||
Intran Media, LLC |
Other Media |
Senior Debt (9.5%, Due 12/11)(1) | 9,000 | 8,917 | 8,917 | ||||||||
Series A Preferred Units (10.0%, 86,000 units) | 9,095 | 1,367 | |||||||||||
Series B Preferred Units (10.0%, 30,000 units) | 3,000 | 140 | |||||||||||
Jet Plastica Investors, LLC(2) | Plastic Products |
Senior Debt (9.3%, Due 12/12)(1) | 12,461 | 12,361 | 12,361 | ||||||||
Subordinated Debt A (15.6%, Due 3/13)(1) | 18,072 | 17,864 | 17,864 | ||||||||||
Subordinated Debt B (17.0%, Due 3/13)(1)(8) | 18,887 | 17,582 | 13,909 | ||||||||||
Preferred LLC Interest (8.0%, 301,595 units) | 34,014 | | |||||||||||
JetBroadband Holdings, LLC(2) | Cable |
Subordinated Unsecured Debt (14.9%, Due 8/15-2/16) | 28,486 | 28,315 | 28,315 | ||||||||
Series A Preferred Units (10.0%, 133,204 units) | 18,471 | 12,712 | |||||||||||
Series B Preferred Units (24,441 units) | 5,000 | 10,000 | |||||||||||
MTP Holding, LLC(6) |
Communications-Other | Common LLC Interest (79,171 units) | 3 | 28 | |||||||||
NPS Holdings Group, LLC(2)(5)(18) | Business Services | Senior Debt A1 and A2 (6.0%, Due 6/13)(1) | 6,636 | 5,222 | 5,222 | ||||||||
Senior Debt A3 (6.0%, Due 6/13)(1)(7) | 7,703 | 6,177 | 408 | ||||||||||
Series A Preferred Units (347 units) | | | |||||||||||
Series B Preferred Units (5.0%, 10,731 units) | 10,731 | | |||||||||||
Common Stock (36,500 units) | | | |||||||||||
Orbitel Holdings, LLC(2) |
Cable |
Senior Debt (9.0%, Due 3/12)(1) | 16,300 | 16,217 | 16,217 | ||||||||
Preferred LLC Interest (10.0%, 120,000 units) | 13,996 | 14,335 | |||||||||||
PremierGarage Holdings, LLC(2)(6) | Home Furnishings | Senior Debt (8.0%, Due 12/10-9/11)(1)(7) | 9,834 | 9,233 | 9,233 | ||||||||
Preferred LLC Units (8.0%, 400 units) | 400 | 236 | |||||||||||
Common LLC Units (79,935 units) | 4,971 | | |||||||||||
RadioPharmacy Investors, LLC(2) | Healthcare |
Senior Debt (7.0%, Due 12/10)(1) | 8,500 | 8,480 | 8,480 | ||||||||
Subordinated Debt (15.0%, Due 12/11)(1) | 10,062 | 10,029 | 10,029 | ||||||||||
Preferred LLC Interest (8.0%, 70,000 units) | 8,123 | 630 | |||||||||||
Superior Industries Investors, LLC(2) | Sporting Goods |
Subordinated Debt (16.0%, Due 3/13)(1) | 19,758 | 19,665 | 19,665 | ||||||||
Preferred Units (8.0%, 125,400 units) | 14,978 | 14,296 | |||||||||||
Total Sleep Holdings, Inc.(2)(6) | Healthcare |
Subordinated Debt (15.0%, Due 9/11-3/12)(7) | 35,821 | 30,534 | 3,835 | ||||||||
Unsecured Note (0.0%, Due 6/11)(7) | 375 | 332 | | ||||||||||
Series A Preferred Stock (10.0%, 3,700 shares) | 3,793 | | |||||||||||
Common Stock (4,046,875 shares) | 1,000 | | |||||||||||
Total Control Investments (represents 39.0% of total investments at fair value) |
701,020 | 404,747 | |||||||||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
5
Table of Contents
MCG Capital Corporation
Consolidated Schedule of Investments
September 30, 2009 (unaudited)
(dollars in thousands)
Portfolio Company |
Industry |
Investment(9) |
Principal | Cost | Fair Value | ||||||||
Affiliate Investments(3): |
|||||||||||||
Advanced Sleep Concepts, Inc.(2) | Home Furnishings | Senior Debt (13.3%, Due 10/11)(1) | $ | 6,195 | $ | 6,082 | $ | 5,637 | |||||
Subordinated Debt (16.0%, Due 4/12)(1) | 5,073 | 4,971 | 4,731 | ||||||||||
Series A Preferred Stock (20.0%, 49 shares) | 297 | | |||||||||||
Common Stock (423 shares) | 525 | | |||||||||||
Warrants to purchase Common Stock (expire 10/16) | 348 | | |||||||||||
Cherry Hill Holdings, Inc.(6) | Entertainment | Series A Preferred Stock (10.0%, 750 shares) | 907 | 738 | |||||||||
Stratford SchoolHoldings, Inc.(2) | Education | Senior Debt (6.9%, Due 7/11-9/11)(1) | 3,440 | 3,397 | 3,357 | ||||||||
Subordinated Debt (14.0%, Due 12/11)(1) | 6,717 | 6,692 | 6,692 | ||||||||||
Series A Convertible Preferred Stock (12.0%, 10,000 shares) | 210 | 11,217 | |||||||||||
Warrants to purchase Common Stock (expire 5/15)(1) | 67 | 3,120 | |||||||||||
Sunshine Media Delaware, LLC(2)(6) | Publishing | Common Stock (145 shares) | 581 | | |||||||||
Class A LLC Interest (8.0%, 563,808 units) | 564 | | |||||||||||
Options to acquire Warrants to purchase | | | |||||||||||
Class B LLC Interest (expire 5/14) | |||||||||||||
Velocity Technology Enterprises, Inc.(2) | Business Services | Senior Debt (8.0%, Due 12/12)(1) | 13,849 | 13,772 | 13,358 | ||||||||
Series A Preferred Stock (1,506,602 shares) | 1,500 | 1,500 | |||||||||||
Total Affiliate Investments (represents 4.9% of total investments at fair value) |
39,913 | 50,350 | |||||||||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
6
Table of Contents
MCG Capital Corporation
Consolidated Schedule of Investments
September 30, 2009 (unaudited)
(dollars in thousands)
Portfolio Company |
Industry |
Investment(9) |
Principal | Cost | Fair Value | ||||||||
Non-Affiliate Investments (less than 5% owned): |
|||||||||||||
Active Brands International, Inc.(2) | Consumer Products | Senior Debt (10.2%, Due 6/12)(1) | $ | 23,746 | $ | 23,646 | $ | 21,212 | |||||
Subordinated Debt (17.0%, Due 9/12)(1)(7) | 14,986 | 12,437 | 5,011 | ||||||||||
Class A-1 Common Stock (3,056 shares) | 3,056 | | |||||||||||
Warrants to purchase Class A-1 Common Stock (expire 6/17) | 331 | | |||||||||||
Allens T.V. Cable Service, Inc. | Cable | Senior Debt (7.8%, Due 12/12)(1) | 6,580 | 6,555 | 6,555 | ||||||||
Subordinated Debt (10.3%, Due 12/12)(1) | 2,463 | 2,413 | 2,337 | ||||||||||
Warrants to purchase Common Stock (expire 11/15) | | 42 | |||||||||||
Amerifit Nutrition, Inc.(2) | Healthcare | Senior Debt (11.8%, Due 3/10)(1) | 2,740 | 2,727 | 2,727 | ||||||||
B & H Education, Inc. | Education | Series A-1 Convertible Preferred Stock (12.0%, 5,384 shares) | 1,622 | 2,678 | |||||||||
BLI Holdings, Inc.(2) | Drugs | Senior Debt (11.3%, Due 12/09)(1) | 10,333 | 10,208 | 10,208 | ||||||||
Coastal Sunbelt Holding, Inc.(2)(19) | Food Services | Senior Debt (9.1%, Due 8/14-2/15)(1) | 22,186 | 21,949 | 21,568 | ||||||||
Subordinated Debt (16.0%, Due 8/15)(1) | 8,423 | 8,342 | 8,342 | ||||||||||
Coastal Sunbelt Real Estate, Inc. | Real Estate Investments | Subordinated Unsecured Debt (15.0%, Due 7/12) | 2,173 | 2,163 | 2,161 | ||||||||
Series A-2 Preferred Stock (12.0%, 20,000 shares) | 2,656 | 447 | |||||||||||
Warrants to purchase Class B Common Stock | | | |||||||||||
Construction Trailer Specialists, Inc.(2) | Auto Parts | Senior Debt (14.1%, Due 7/12-10/12)(1)(8) | 9,584 | 9,485 | 8,004 | ||||||||
Cruz Bay Publishing, Inc. | Publishing | Subordinated Debt (12.8%, Due 12/13)(1) | 20,000 | 19,793 | 17,590 | ||||||||
CWP/RMK Acquisition Corp.(2)(6) | Home Furnishings | Senior Debt (8.5%, Due 6/11)(1)(7) | 6,448 | 6,223 | 4,715 | ||||||||
Subordinated Debt (13.0%, Due 12/12)(1)(7) | 12,416 | 9,501 | | ||||||||||
Common Stock (500 shares) | 500 | | |||||||||||
Cyrus Networks, LLC | Business Services | Senior Debt (4.3%, Due 7/13)(1) | 5,167 | 5,139 | 5,126 | ||||||||
Subordinated Debt (7.5%, Due 1/14)(1) | 6,066 | 6,058 | 6,037 | ||||||||||
Dayton Parts Holdings, LLC | Auto Parts | Preferred LLC Interest (10.0%, 16,470 units) | 631 | 631 | |||||||||
Class A Common LLC Interest (8.0%, 10,980 units) | 400 | | |||||||||||
Empower IT Holdings, Inc.(2) | Information Services | Senior Debt (11.0%, Due 5/12)(1) | 6,806 | 6,744 | 6,744 | ||||||||
Equibrand Holding Corporation(2) | Leisure Activities | Senior Debt (9.5%, Due 9/10)(1) | 4,640 | 4,626 | 4,626 | ||||||||
Subordinated Debt (16.0%, Due 3/11)(1) | 9,531 | 9,507 | 9,507 | ||||||||||
G&L Investment Holdings, LLC(2) | Insurance | Subordinated Debt (7.9%, Due 5/14)(1) | 17,500 | 16,993 | 15,695 | ||||||||
Series A Preferred Shares (14.0%, 5,000,000 shares) | 6,440 | 6,440 | |||||||||||
Class C Shares (621,907 shares) | 529 | 362 | |||||||||||
Golden Knight II CLO, Ltd.(6) | Diversified Financial Services | Income Notes (8.0%, Due 4/19) | 3,575 | 1,287 | |||||||||
GSDM Holdings, LLC(2) | Healthcare | Senior Debt (7.5%, Due 2/13)(1) | 8,011 | 7,942 | 7,758 | ||||||||
Subordinated Debt (14.0%, Due 8/13)(1) | 7,928 | 7,893 | 7,893 | ||||||||||
Series B Preferred Units (12.5%, 4,213,333 units) | 4,397 | 2,074 | |||||||||||
Home Interiors & Gifts, Inc.(6)(10) | Home Furnishings | Senior Debt (8.0%, Due 3/11)(7) | 4,141 | 3,763 | 36 | ||||||||
Jenzabar, Inc. | Technology | Senior Preferred Stock (11.0%, 3,750 shares) | 5,916 | 5,916 | |||||||||
Subordinated Preferred Stock (109,800 shares) | 1,098 | 1,098 | |||||||||||
Warrants to purchase Common Stock (expire 4/16) | 422 | 21,149 | |||||||||||
Lambeau Telecom Company, LLC(15) | Communications-CLEC | Senior Debt (12.0%, Due 2/13)(8) | 1,428 | 1,415 | 1,062 | ||||||||
Legacy Cabinets, Inc.(6) | Home Furnishings | Subordinated Debt (10.5%, Due 8/13)(1)(7) | 2,328 | 2,184 | | ||||||||
LMS INTELLIBOUND, INC.(2) | Logistics | Senior Debt (8.6%, Due 3/146/14)(1) | 27,795 | 27,416 | 27,025 | ||||||||
Subordinated Debt (16.0%, Due 9/14)(1) | 7,000 | 6,838 | 6,838 | ||||||||||
Marietta Intermediate Holding Corporation(6) | Cosmetics | Subordinated Debt (12.0%, Due 12/11)(1)(7) | 2,474 | 2,028 | | ||||||||
Maverick Healthcare | Healthcare | Subordinated Debt (16.0%, Due 4/14)(1) | 12,779 | 12,630 | 12,630 | ||||||||
Equity, LLC | Preferred Units (10.0%, 1,250,000 units) | 1,403 | 1,282 | ||||||||||
Class A Common Units (1,250,000 units) | | |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
7
Table of Contents
MCG Capital Corporation
Consolidated Schedule of Investments
September 30, 2009 (unaudited)
(dollars in thousands)
Portfolio Company |
Industry | Investment(9) |
Principal | Cost | Fair Value | ||||||||
MCI Holdings LLC(2) | Healthcare | Subordinated Debt (12.7%, Due 4/13)(1) | $ | 32,088 | $ | 31,956 | $ | 31,956 | |||||
Class A LLC Interest (4,712,042 units) | 3,000 | 9,269 | |||||||||||
Metropolitan Telecommunications Holding Company(2) | Communications- CLEC |
Senior Debt (10.8%, Due 9/10-12/11)(1) | 21,474 | 21,355 | 21,355 | ||||||||
Warrants to purchase Common Stock (expire 9/13) | 1,843 | 10,080 | |||||||||||
Miles Media Group, LLC(2) | Publishing | Senior Debt (12.5%, Due 6/13)(1) | 17,595 | 17,300 | 17,300 | ||||||||
NDSSI Holdings, LLC(2) | Electronics | Senior Debt (9.9%, Due 9/13-3/14)(1) | 19,421 | 19,242 | 18,468 | ||||||||
Subordinated Debt (15.0%, Due 9/14)(1) | 22,102 | 22,038 | 22,038 | ||||||||||
Series A Preferred Units (516,691 units) | 718 | 718 | |||||||||||
Class A Common Units (1,000,000 units) | 333 | 476 | |||||||||||
New Century Companies, Inc.(6) | Industrial Equipment |
Warrants to purchase Common Stock (expire 6/10) | | | |||||||||
Philadelphia Newspapers, LLC(6)(13) | Newspaper | Subordinated Unsecured Debt (16.5%, Due 6/14)(7) | 5,082 | 5,071 | | ||||||||
Powercom Corporation(6)(15) | Communications- CLEC |
Warrants to purchase Class A Common Stock (expire 6/14) | 286 | | |||||||||
Quantum Medical Holdings, LLC (2) | Laboratory | Senior Debt (6.3%, Due 5/11)(1) | 15,500 | 15,471 | 15,471 | ||||||||
Instruments | Subordinated Debt (15.0%, Due 12/11)(1) | 18,032 | 17,942 | 17,942 | |||||||||
Preferred LLC Interest (1,000,000 units) | 617 | 1,186 | |||||||||||
Restaurant Technologies, Inc. | Food Services | Senior Debt (17.6%, Due 2/12)(1) | 39,120 | 38,831 | 38,831 | ||||||||
Common Stock (47,512 shares) | 352 | 35 | |||||||||||
Warrants to purchase Common Stock (Expire 6/14) | | | |||||||||||
Sagamore Hill Broadcasting, LLC(2) | Broadcasting | Senior Debt (15.5%, Due 8/11)(1)(8) | 26,356 | 25,971 | 25,121 | ||||||||
Summit Business Media Intermediate Holding Company, LLC(6) | Information Services |
Subordinated Debt (15.0%, Due 7/14)(1)(7) | 6,402 | 5,996 | 1,196 | ||||||||
Tegra Medical Holdings, LLC(12) | Industrial Products |
Senior Debt (9.5%, Due 10/13)(1) | 25,492 | 25,310 | 25,310 | ||||||||
Common Units (1,000,000 units) | 1,000 | 1,043 | |||||||||||
Teleguam Holdings, LLC(2) | Communications- Other |
Subordinated Debt (7.3%, Due 10/12)(1) | 20,000 | 19,864 | 17,833 | ||||||||
The e-Media Club I, LLC(6) | Investment Fund | LLC Interest (74 units) | 88 | 7 | |||||||||
The Matrixx Group, Incorporated | Plastic Products | Subordinated Debt (18.0%, Due 11/14)(1) | 14,525 | 14,525 | 14,525 | ||||||||
ValuePage, Inc.(6) | Communications- Other |
Senior Debt (12.8%, Due 6/08)(7) | 1,263 | 993 | | ||||||||
VOX Communications Group Holdings, LLC(2)(6) | Broadcasting | Senior Debt (13.5%, Due 3/09)(1)(7) | 11,424 | 10,463 | 6,505 | ||||||||
Convertible Preferred Subordinated Notes (12.5%, Due 6/15-6/17)(7) | 2,103 | 1,414 | | ||||||||||
VS&A-PBI Holding LLC(6) | Publishing | LLC Interest | 500 | | |||||||||
WebMediaBrands Inc.(6)(14) | Information Services |
Common Stock (148,373 shares) | 2,114 | 107 | |||||||||
Wireco Worldgroup Inc. | Industrial Equipment |
Senior Debt (2.5%, Due 2/14)(1) | 3,900 | 3,918 | 3,373 | ||||||||
Xpressdocs Holdings, Inc.(2) | Business Services |
Senior Debt (9.0%, Due 7/11-12/11)(1) | 13,855 | 13,809 | 13,301 | ||||||||
Subordinated Debt (16.0%, Due 7/12)(1)(8) | 6,512 | 6,427 | 3,888 | ||||||||||
Series A Preferred Stock (161,870 shares) | 500 | | |||||||||||
Total Non-Affiliate Investments (represents 56.1% of total investments at fair value) | 618,841 | 582,147 | |||||||||||
Total Investments | $ | 1,359,774 | $ | 1,037,244 | |||||||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
8
Table of Contents
MCG Capital Corporation
Consolidated Schedule of Investments
September 30, 2009 (unaudited)
(dollars in thousands)
Counterparty |
Instrument |
Interest Rate |
Expiring | Notional | Cost | Fair Value |
|||||||||||
Interest Rate Swaps |
|||||||||||||||||
SunTrust Bank |
Interest Rate SwapPay Fixed/Receive Floating | 10.0 | % | 11/10 | $ | 16,000 | $ | | $ | (545 | ) | ||||||
Interest Rate SwapPay Fixed/Receive Floating | 14.0 | % | 11/10 | 8,000 | | (272 | ) | ||||||||||
Interest Rate SwapPay Fixed/Receive Floating | 13.0 | % | 08/11 | 12,500 | | (270 | ) | ||||||||||
Interest Rate SwapPay Fixed/Receive Floating | 9.0 | % | 08/11 | 8,681 | | (188 | ) | ||||||||||
Total Interest Rate Swaps | $ | 45,181 | $ | | $ | (1,275 | ) | ||||||||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
9
Table of Contents
MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2008
(dollars in thousands)
Portfolio Company |
Industry |
Investment(9) |
Principal | Cost | Fair Value | ||||||||
Control Investments(4): | |||||||||||||
Avenue Broadband LLC(2) | Cable | Subordinated Debt (14.0%, Due 3/14-12/14)(1) | $ | 13,727 | $ | 13,619 | $ | 13,619 | |||||
Preferred Units (10.0%, 17,100 units)(1) | 18,960 | 25,992 | |||||||||||
Warrants to purchase Class B Common Stock | | | |||||||||||
Broadview Networks Holdings, Inc.(6) | Communications-CLEC | Series A Preferred Stock (12.0%, 87,254 shares) | 81,984 | 70,666 | |||||||||
Series A-1 Preferred Stock (12.0%, 100,702 shares) | 77,495 | 68,659 | |||||||||||
Class A Common Stock (4,698,987 shares) | | | |||||||||||
Cleartel Communications, Inc.(2)(6)(17) | Communications-CLEC | Subordinated Debt (11.2%, Due 5/09-3/11)(7) | 41,172 | 36,047 | | ||||||||
Series B Preferred Stock (8.0%, 57,862 shares) | 50,612 | | |||||||||||
Common Stock (744,777 shares) | 62,125 | | |||||||||||
Guaranty ($5,000) | |||||||||||||
Coastal Sunbelt, LLC(2)(19) | Food Services | Senior Debt (8.4%, Due 1/12-7/12)(1) | 22,246 | 22,127 | 22,127 | ||||||||
Subordinated Debt (14.8%, Due 1/13)(1) | 8,223 | 8,115 | 8,115 | ||||||||||
Preferred LLC Interest (12.0%, 123,250 units) | 14,597 | 14,648 | |||||||||||
Warrants to purchase Class B Common Stock | | | |||||||||||
Crystal Media Network, LLC(6)(5) | Broadcasting | LLC Interest | 2,447 | 2,556 | |||||||||
GMC Television Broadcasting, LLC(2)(6)(20) | Broadcasting | Senior Debt (9.2%, Due 4/12-6/12)(1)(7) | 23,712 | 22,520 | 22,520 | ||||||||
Subordinated Debt (14.0%, Due 6/13)(1)(7) | 8,000 | 7,076 | 5,465 | ||||||||||
Class B Voting Units (8.0%, 86,700 units) | 9,071 | | |||||||||||
Intran Media, LLC | Other Media | Senior Debt (10.7%, Due 12/11)(1) | 9,000 | 8,888 | 8,888 | ||||||||
Series A Preferred Units (10.0%, 86,000 units) | 9,095 | 1,956 | |||||||||||
Series B Preferred Units (10.0%, 30,000 units) | 3,000 | 1,096 | |||||||||||
Jet Plastica Investors, LLC(2) | Plastic Products | Subordinated Debt A (14.8%, Due 3/13)(1) | 16,377 | 16,124 | 16,124 | ||||||||
Subordinated Debt B (15.0%, Due 3/13)(1) | 17,050 | 17,050 | 13,823 | ||||||||||
Preferred LLC Interest (8.0%, 301,595 units) | 34,014 | | |||||||||||
JetBroadband Holdings, LLC(2) | Cable | Subordinated Unsecured Debt (14.8%, Due 8/15-2/16) | 26,911 | 25,577 | 25,577 | ||||||||
Preferred Units (10.0%, 133,204 units) | 18,470 | 16,562 | |||||||||||
LMS Intellibound Investors, LLC(2) | Logistics | Senior Debt (7.5%, Due 8/12)(1) | 11,328 | 11,223 | 11,223 | ||||||||
Subordinated Debt (15.0%, Due 11/12)(1) | 17,000 | 16,882 | 16,882 | ||||||||||
Preferred Units (12.0%, 19,650 units) | 23,780 | 38,845 | |||||||||||
Warrants to purchase Class B Common Stock | | | |||||||||||
MTP Holding, LLC(6) | Communications-Other | Common LLC Interest (79,171 units) | 3 | 28 | |||||||||
National Product Services, Inc.(2)(5)(18) | Business Services | Senior Debt A1 and A2 (10.1%, Due 6/09) | 6,456 | 5,504 | 5,504 | ||||||||
Senior Debt A3 (7.5%, Due 6/09) | 7,430 | 4,717 | 3,988 | ||||||||||
Subordinated Debt (16.0%, Due 6/09)(7) | 16,010 | 12,305 | | ||||||||||
Common Stock (995,428 shares) | | | |||||||||||
Orbitel Holdings, LLC(2) | Cable | Senior Debt (9.0%, Due 3/12)(1) | 16,300 | 16,192 | 16,192 | ||||||||
Preferred LLC Interest (10.0%, 120,000 units) | 13,324 | 11,597 | |||||||||||
Letter of Credit ($97) | |||||||||||||
PremierGarage Holdings, LLC(2)(5) | Home Furnishings | Senior Debt (9.7%, Due 6/10-12/10)(1) | 8,782 | 8,702 | 7,832 | ||||||||
Preferred LLC Units (8.0%, 445 units) | 4,971 | | |||||||||||
Common LLC Units (356 units) | | | |||||||||||
RadioPharmacy Investors, LLC(2) | Healthcare | Senior Debt (8.1%, Due 12/10)(1) | 8,500 | 8,469 | 8,469 | ||||||||
Subordinated Debt (15.0%, Due 12/11)(1) | 9,837 | 9,793 | 9,793 | ||||||||||
Preferred LLC Interest (8.0%, 70,000 units) | 8,123 | 3,479 | |||||||||||
Superior Industries Investors, LLC(2) | Sporting Goods | Subordinated Debt (14.0%, Due 3/13)(1) | 18,033 | 17,920 | 17,920 | ||||||||
Preferred Units (8.0%, 125,400 units) | 14,978 | 18,611 |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
10
Table of Contents
MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2008
(dollars in thousands)
Portfolio Company |
Industry |
Investment(9) |
Principal | Cost | Fair Value | ||||||||
TNR Holdings Corp.(2)(6)(16) |
Entertainment | Senior Debt (12.0%, Due 7/13)(7) | $ | 2,104 | $ | 1,708 | $ | 1,708 | |||||
Series A Preferred Stock (8.0%, 43,264 shares) | 28,770 | 25,682 | |||||||||||
Legacy Series A Preferred Stock (12.5%, 585,939 shares) | 15,000 | | |||||||||||
Legacy Common Stock (1,806 shares) | 3,000 | | |||||||||||
Warrants to purchase Common Stock (expire 7/18) | | | |||||||||||
Warrants to purchase Legacy Common Stock (expire 9/17) | | | |||||||||||
Total Sleep Holdings, Inc.(2) | Healthcare | Subordinated Debt (15.0%, Due 9/11-3/12) | 32,429 | 29,579 | 26,540 | ||||||||
Unsecured Note (0.0%, Due 6/11) | 375 | 327 | | ||||||||||
Series A Preferred Stock (10.0%, 3,700 shares) | 3,793 | | |||||||||||
Common Stock (4,046,875 shares) | 1,000 | | |||||||||||
WMAC II, Inc.(6)(11) | Publishing | Guaranty ($833) | |||||||||||
Total Control Investments (represents 46.7% of total investments at fair value) |
819,076 | 562,686 | |||||||||||
Affiliate Investments(3): |
|||||||||||||
Advanced Sleep Concepts, Inc.(2) | Home Furnishings | Senior Debt (13.9%, Due 10/11)(1) | 6,195 | 6,023 | 5,629 | ||||||||
Subordinated Debt (16.0%, Due 4/12)(1) | 4,922 | 4,791 | 4,426 | ||||||||||
Series A Preferred Stock (20.0%, 49 shares) | 298 | | |||||||||||
Common Stock (423 shares) | 525 | | |||||||||||
Warrants to purchase Common Stock (expire 10/16) | 348 | | |||||||||||
Cherry Hill Holdings, Inc.(2)(6) | Entertainment | Series A Preferred Stock (10.0%, 750 shares) | 907 | 878 | |||||||||
Stratford School Holdings, Inc.(2) | Education | Senior Debt (6.8%, Due 7/11-9/11)(1) | 3,700 | 3,634 | 3,634 | ||||||||
Subordinated Debt (14.0%, Due 12/11)(1) | 6,717 | 6,683 | 6,683 | ||||||||||
Series A Convertible Preferred Stock (12.0%, 10,000 shares) | 120 | 12,842 | |||||||||||
Warrants to purchase Common Stock (expire 5/15)(1) | 67 | 3,903 | |||||||||||
Sunshine Media Delaware, LLC(2)(6) | Publishing | Common Stock (145 shares) | 581 | | |||||||||
Class A LLC Interest (8.0%, 563,808 units) | 564 | | |||||||||||
Options to acquire Warrants to purchase Class B LLC Interest (expire 5/14) | | | |||||||||||
Velocity Technology Enterprises, Inc.(2) | Business Services | Senior Debt (8.0%, Due 12/12)(1) | 16,817 | 16,705 | 16,204 | ||||||||
Series A Preferred Stock (1,506,602 shares) | 1,500 | 1,500 | |||||||||||
XFone, Inc.(6) | Communications-Other | Common Stock (837,556 shares) | 2,395 | 419 | |||||||||
Warrants to purchase Common Stock (expire 3/11) | | 8 | |||||||||||
Total Affiliate Investments (represents 4.7% of total investments at fair value) |
45,141 | 56,126 | |||||||||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
11
Table of Contents
MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2008
(dollars in thousands)
Portfolio Company |
Industry |
Investment(9) |
Principal | Cost | Fair Value | ||||||||
Non-Affiliate Investments (less than 5% owned): | |||||||||||||
Active Brands International, lnc.(2) | Consumer Products | Senior Debt (8.2%, Due 6/12)(1) | $ | 20,000 | $ | 19,882 | $ | 18,942 | |||||
Subordinated Debt (15.0%, Due 9/12)(1)(7) | 13,822 | 13,071 | 3,913 | ||||||||||
Class A-1 Common Stock (3,056 shares) | 3,056 | | |||||||||||
Warrants to purchase Class A-1 Common Stock (expire 6/17) | 332 | | |||||||||||
Allens T.V. Cable Service, Inc. | Cable | Senior Debt (8.2%, Due 12/12)(1) | 7,430 | 7,394 | 7,351 | ||||||||
Subordinated Debt (10.5%, Due 12/12)(1) | 2,349 | 2,288 | 2,214 | ||||||||||
Warrants to purchase Common Stock (expire 11/15) | | 30 | |||||||||||
Amerifit Nutrition, Inc.(2) | Healthcare | Senior Debt (11.4%, Due 3/10)(1) | 3,634 | 3,600 | 3,600 | ||||||||
B & H Education, Inc. | Education | Series A-1 Convertible Preferred Stock (12.0%, 5,384 shares) | 1,490 | 2,000 | |||||||||
BLI Holdings, Inc.(2) | Drugs | Senior Debt (11.3%, Due 1/09)(1) | 11,333 | 11,234 | 11,234 | ||||||||
CEI Holdings Inc. | Cosmetics | Senior Debt (6.3%, Due 3/14)(1) | 3,918 | 3,927 | 1,674 | ||||||||
Cervalis LLC | Business Services | Senior Debt (7.3%, Due 3/12)(1) | 19,625 | 19,525 | 19,034 | ||||||||
Coastal Sunbelt Real Estate, Inc. | Real Estate Investments | Subordinated Unsecured Debt (15.0%, Due 7/12) | 2,124 | 2,111 | 2,111 | ||||||||
Series A-2 Preferred Stock (12.0%, 20,000 shares) | 2,507 | 3,080 | |||||||||||
Warrants to purchase Class B Common Stock | | | |||||||||||
Construction Trailer Specialists, Inc.(2) | Auto Parts | Senior Debt (9.7%, Due 7/12-10/12)(1) | 8,776 | 8,704 | 8,704 | ||||||||
Cruz Bay Publishing, Inc. | Publishing | Subordinated Debt (10.5%, Due 12/13)(1) | 20,000 | 19,858 | 17,348 | ||||||||
CWP/RMK Acquisition Corp.(2) | Home Furnishings | Senior Debt (9.6%, Due 6/11)(1) | 6,005 | 5,971 | 5,104 | ||||||||
Subordinated Debt (14.1%, Due 12/12)(1)(7) | 11,929 | 10,198 | 3,489 | ||||||||||
Common Stock (500 shares) | 500 | | |||||||||||
Cyrus Networks, LLC | Business Services | Senior Debt (5.8%, Due 7/13)(1) | 5,441 | 5,408 | 4,915 | ||||||||
Subordinated Debt (9.1%, Due 1/14)(1) | 6,066 | 6,057 | 5,110 | ||||||||||
Dayton Parts Holdings, LLC(2) | Auto Parts | Subordinated Debt (6.5%, Due 6/11)(1) | 21,500 | 21,380 | 21,380 | ||||||||
Preferred LLC Interest (10.0%, 16,470 units) | 589 | 589 | |||||||||||
Class A Common LLC Interest (8.0%, 10,980 units) | 400 | 338 | |||||||||||
Empower IT Holdings, Inc.(2) | Information Services | Senior Debt (11.0%, Due 5/12)(1) | 8,534 | 8,455 | 8,455 | ||||||||
Equibrand Holding Corporation(2) | Leisure Activities | Senior Debt (11.1%, Due 9/10)(1) | 4,640 | 4,604 | 4,604 | ||||||||
Subordinated Debt (16.0%, Due 3/11)(1) | 9,248 | 9,212 | 9,212 | ||||||||||
Flexsol Packaging Corp.(6) | Plastic Products | Subordinated Debt (14.3%, Due 12/12)(1)(7) | 3,081 | 3,058 | 1,133 | ||||||||
G&L Investment Holdings, LLC(2) | Insurance | Subordinated Debt (9.7%, Due 5/14)(1) | 17,500 | 16,912 | 15,164 | ||||||||
Series A Preferred Shares (14.0%, 5,000,000 shares) | 5,810 | 5,810 | |||||||||||
Class C Shares (621,907 shares) | 529 | 284 | |||||||||||
Golden Knight II CLO, Ltd. | Diversified Financial Services | Income Notes (8.0%, Due 4/19) | 3,575 | 435 | |||||||||
GSDM Holdings, LLC(2) | Healthcare | Senior Debt (7.5%, Due 2/13)(1) | 8,775 | 8,682 | 8,355 | ||||||||
Subordinated Debt (14.0%, Due 8/13)(1) | 7,809 | 7,767 | 7,767 | ||||||||||
Series B Preferred Units (12.5%, 4,213,333 units) | 4,397 | 1,965 | |||||||||||
Home Interiors & Gifts, Inc.(6)(10) | Home Furnishings | Senior Debt (8.0%, Due 3/11)(7) | 4,141 | 3,991 | 667 | ||||||||
Jenzabar, Inc. | Technology | Senior Preferred Stock (11.0%, 5,000 shares) | 7,475 | 7,475 | |||||||||
Subordinated Preferred Stock (109,800 shares) | 1,098 | 1,098 | |||||||||||
Warrants to purchase Common Stock (expire 4/16) | 422 | 27,407 | |||||||||||
Jupitermedia Corporation(6)(14) | Information Services | Common Stock (148,373 shares) | 2,114 | 56 | |||||||||
Legacy Cabinets, Inc. | Home Furnishings | Subordinated Debt (9.8%, Due 8/13)(1) | 2,328 | 2,313 | 752 | ||||||||
Marietta Intermediate Holding Corporation(6) | Cosmetics | Subordinated Debt (12.0%, Due 12/11)(1)(7) | 2,262 | 2,028 | | ||||||||
Maverick Healthcare Equity, LLC | Healthcare | Subordinated Debt (13.5%, Due 4/14)(1) | 12,596 | 12,493 | 12,494 | ||||||||
Preferred Units (10.0%, 1,250,000 units) | 1,403 | 1,403 | |||||||||||
Class A Common Units (1,250,000 units) | | 138 | |||||||||||
MCI Holdings LLC(2) | Healthcare | Subordinated Debt (12.7%, Due 4/13)(1) | 31,446 | 31,280 | 31,280 | ||||||||
Class A LLC Interest (4,712,042 units) | 3,000 | 8,305 |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
12
Table of Contents
MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2008
(dollars in thousands)
Portfolio Company |
Industry |
Investment(9) |
Principal | Cost | Fair Value | ||||||||
Metropolitan Telecommunications Holding Company(2) | Communications-CLEC | Senior Debt (10.8%, Due 6/10-9/10)(1) | $ | 23,769 | $ | 23,530 | $ | 23,530 | |||||
Warrants to purchase Common Stock (expire 9/13) | 1,843 | 9,655 | |||||||||||
Miles Media Group, LLC(2) | Publishing | Senior Debt (12.5%, Due 6/13)(1) | 18,274 | 17,913 | 17,395 | ||||||||
NDSSI Holdings, LLC(2) | Electronics | Senior Debt (9.9%, Due 9/13-3/14)(1) | 19,921 | 19,697 | 19,189 | ||||||||
Subordinated Debt (15.0%, Due 9/14)(1) | 21,284 | 21,211 | 21,211 | ||||||||||
Series A Preferred Units (516,691 units) | 718 | 718 | |||||||||||
Class A Common Units (1,000,000 units) | 333 | 900 | |||||||||||
New Century Companies, Inc.(6) | Industrial Equipment | Warrants to purchase Common Stock (expire 6/10) | | | |||||||||
New England Precision Grinding Holdings, LLC(12) |
Industrial Products | Senior Debt (11.1%, Due 10/13)(1) | 25,685 | 25,464 | 25,033 | ||||||||
Common Units (1,000,000 units) | 1,000 | 1,213 | |||||||||||
PartMiner, Inc.(2) | Information Services | Senior Debt (8.7%, Due 6/09)(1) | 854 | 846 | 846 | ||||||||
Philadelphia Newspapers, LLC(6)(13) | Newspaper | Subordinated Unsecured Debt (16.5%, Due 6/14)(7) |
5,082 | 5,070 | | ||||||||
Powercom Corporation(15) | Communications-CLEC | Senior Debt (11.5%, Due 6/11) | 1,357 | 1,357 | 1,279 | ||||||||
Warrants to purchase Class A Common Stock (expire 6/14) | 286 | | |||||||||||
Quantum Medical Holdings, LLC(2) | Laboratory Instruments | Senior Debt (7.5%, Due 5/11)(1) | 15,500 | 15,438 | 15,438 | ||||||||
Subordinated Debt (15.0%, Due 12/11)(1) | 18,032 | 17,911 | 17,911 | ||||||||||
Preferred LLC Interest (1,000,000 units) | 557 | 1,704 | |||||||||||
Restaurant Technologies, Inc. | Food Services | Senior Debt (16.6%, Due 2/12)(1) | 37,197 | 36,929 | 36,929 | ||||||||
Series B Preferred Stock (499 shares) | 15 | 19 | |||||||||||
Series A-4 Convertible Preferred Stock (7,813 shares) | 336 | 97 | |||||||||||
Sagamore Hill Broadcasting, LLC(2) | Broadcasting | Senior Debt (11.5%, Due 8/12)(1) | 25,800 | 25,664 | 24,793 | ||||||||
Summit Business Media Intermediate Holding Company, LLC | Information Services | Subordinated Debt (7.5%, Due 7/14)(1) | 6,000 | 5,995 | 4,261 | ||||||||
Teleguam Holdings, LLC(2) | Communications-Other | Subordinated Debt (9.2%, Due 10/12)(1) | 20,000 | 19,831 | 16,920 | ||||||||
The e-Media Club I, LLC(6) | Investment Fund | LLC Interest (74 units) | 88 | 9 | |||||||||
The Matrixx Group, Incorporated | Plastic Products | Subordinated Debt (15.5%, Due 11/14)(1) | 14,238 | 14,238 | 14,238 | ||||||||
ValuePage, Inc.(6) | Communications-Other | Senior Debt (12.8%, Due 6/08)(7) | 1,230 | 998 | 28 | ||||||||
VOX Communications Group Holdings, LLC(2) |
Broadcasting | Senior Debt (13.5%, Due 3/09)(1) | 11,312 | 10,725 | 10,674 | ||||||||
Convertible Preferred Subordinated Notes (12.5%, Due 6/15-6/17)(7) | 1,856 | 1,415 | 393 | ||||||||||
VS&A-PBI Holding LLC(6) | Publishing | LLC Interest | 500 | | |||||||||
Wireco Worldgroup Inc. | Industrial Equipment | Senior Debt (3.7%, Due 2/14)(1) | 3,930 | 3,951 | 2,576 | ||||||||
Xpressdocs Holdings, Inc.(2) | Business Services | Senior Debt (8.9%, Due 7/11-12/11)(1) | 15,168 | 15,091 | 14,550 | ||||||||
Subordinated Debt (16.0%, Due 7/12)(1) | 6,390 | 6,355 | 6,238 | ||||||||||
Series A Preferred Stock (161,870 shares) | 501 | 170 | |||||||||||
Total Non-Affiliate Investments (represents 48.6% of total investments at fair value) |
605,906 | 584,336 | |||||||||||
Total Investments |
$ | 1,470,123 | $ | 1,203,148 | |||||||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
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MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2008
(dollars in thousands)
Counterparty |
Instrument |
Interest Rate |
Expiring | Notional | Cost | Fair Value |
|||||||||||
Interest Rate Swaps |
|||||||||||||||||
SunTrust Bank |
Interest Rate SwapPay Fixed/Receive Floating | 10.0 | % | 11/10 | $ | 16,000 | $ | | $ | (649 | ) | ||||||
Interest Rate SwapPay Fixed/Receive Floating | 14.0 | % | 11/10 | 8,000 | | (324 | ) | ||||||||||
Total Interest Rate Swaps |
$ | 24,000 | $ | | $ | (973 | ) | ||||||||||
(1) | Some or all of this security is funded through our SBIC subsidiary or one of our other financing subsidiaries and may have been pledged as collateral in connection therewith. See Note 5Borrowings to the Consolidated Financial Statements. |
(2) | Includes securities issued by one or more of the portfolio companys affiliates. |
(3) | Affiliate investments represent companies in which we own at least 5%, but not more than 25% of the portfolio companys voting securities. |
(4) | Control investments represent companies in which we own more than 25% of the portfolio companys voting securities. |
(5) | Represents a non-majority-owned control portfolio company of which we own at least 25%, but not more than 50% of the portfolio companys voting securities. |
(6) | Portfolio company is non-income producing at period end. |
(7) | Loan or debt security is on non-accrual status. |
(8) | During the quarter ended September 30, 2009, we did not recognize paid-in-kind interest or accretion income because the fair value of our investment was below its cost basis. However, we continue to accrue interest that is receivable in cash from the portfolio company. |
(9) | Interest rates represent the weighted-average annual stated interest rate on loans and debt securities, presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates. Rates on preferred stock and preferred LLC interests, where applicable, represent the contractual rate. |
(10) | On April 29, 2008, Home Interiors & Gifts, Inc. filed for Chapter 11 bankruptcy protection. |
(11) | On October 2, 2008, Working Mother Media, Inc. changed its name to WMAC II, Inc. |
(12) | On January 14, 2009, New England Precision Grinding Holdings, LLC changed its name to Tegra Medical Holdings, LLC. |
(13) | On February 22, 2009, Philadelphia Newspapers, LLC filed for Chapter 11 bankruptcy protection. |
(14) | On February 24, 2009, Jupitermedia Corporation changed its name to WebMediaBrands Inc. |
(15) | On February 28, 2009, this obligation and all of the assets of Powercom Corporation (other than its accounts receivable), were transferred to Lambeau Telecom Company, LLC, an affiliate of BCN Telecom, Inc., or BCN, in satisfaction of certain subordinated liabilities of Powercom Corporation owed to BCN. |
(16) | On July 28, 2008, we converted our debt securities in TNR Entertainment Corp. into preferred stock of TNR Holdings Corp. and invested $2.0 million in debt in TNR Holdings Corp. The amounts reported herein for December 31, 2008 as Legacy Series A Preferred Stock, Legacy Common Stock and Warrants to purchase Legacy Common Stock, relate to our equity investment in TNR Entertainment Corp. On April 20, 2009, TNR Holdings Corp. repaid in full its debt together with all accrued interest and we concurrently sold our equity in TNR Holdings Corp. for an aggregate between the two transactions of $11.6 million in cash. On August 17, 2009, we dissolved TNR Entertainment Corp. |
(17) | On August 25, 2009, Birch Communications, Inc. acquired substantially all of the operating assets of Cleartel Communications, Inc., or Cleartel, an MCG control investment. The cash portion of the purchase price was used primarily to pay off third-party senior debt under Cleartels senior credit facility with Textron Financial Corporation and its equipment leasing facility with Relational, LLC. On the closing date of the sale, Cleartel entered into a Transition Services Agreement, or TSA with Birch to provide certain services necessary to effect an orderly transition of the business from Cleartel to Birch. Once the TSA is terminated and Cleartel is dissolved, we expect to recognize a realized loss with an offsetting reduction in our unrealized losses, which is expected to occur in the fourth quarter of 2009. |
(18) | On July 22, 2009, we recapitalized our investment in National Product Services, Inc. through a series of related debt and equity transactions. MCGs new investment is in NPS Holdings Group, LLC. |
(19) | On August 13, 2009, we sold our equity investment in Coastal Sunbelt Holdings, Inc., or Coastal, a subsidiary of Coastal Sunbelt, LLC for $15.2 million to Coastals management team and MSouth Equity Partners, LP, which resulted in the reclassification of our investment in Coastal from a control investment to a non-affiliate investment beginning in the quarter ended September 30, 2009. |
(20) | On October 26, 2009, we completed an asset exchange transaction between HITV Operating Co., Inc., a subsidiary of GMC Television Broadcasting, LLC, and KHNL/KFVE, LLC, a wholly owned subsidiary of Raycom Media Inc. See Note 12Subsequent Events for additional information about the exchange agreement. |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
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Notes to the Condensed Consolidated Financial Statements (Unaudited)
NOTE 1DESCRIPTION OF BUSINESS
These Condensed Consolidated Financial Statements present the results of operations, financial position and cash flows of MCG Capital Corporation and its consolidated subsidiaries. The terms we, our, us and MCG refer to MCG Capital Corporation and its consolidated subsidiaries.
We are a solutions-focused commercial finance company that provides capital and advisory services to middle-market companies throughout the United States. We are an internally managed, non-diversified, closed-end investment company that elected to be regulated as a business development company, or BDC, under the Investment Company Act of 1940, as amended, or the 1940 Act. Our organization includes the following categories of subsidiaries:
Wholly Owned Special-Purpose Financing SubsidiariesThese subsidiaries are bankruptcy remote, special-purpose entities to which we transfer certain loans. Each financing subsidiary, in turn, transfers the loans to a Delaware statutory trust. For accounting purposes, the transfers of the loans to the Delaware statutory trusts are structured as on-balance sheet securitizations.
Small Business Investment SubsidiariesWe own Solutions Capital I, LP, a wholly owned subsidiary licensed by the United States Small Business Administration, or SBA, which operates as a small business investment company, or SBIC, under the Small Business Investment Act of 1958, as amended, or SBIC Act. In connection with the formation of Solutions Capital I, LP, MCG also established another wholly owned subsidiary, Solutions Capital GP, LLC, to act as the general partner of Solutions Capital I, LP, while MCG is the sole limited partner.
Taxable SubsidiariesWe currently qualify as a regulated investment company, or RIC, for federal income tax purposes, which allows us to avoid paying corporate income taxes on any income or gains that we distribute to our stockholders. We have certain wholly owned taxable subsidiaries, or Taxable Subsidiaries, which each hold one or more portfolio investments listed on our Consolidated Schedule of Investments. The purpose of these Taxable Subsidiaries is to permit us to hold portfolio companies organized as limited liability companies, or LLCs, (or other forms of pass-through entities) and still satisfy the RIC tax requirement that at least 90% of our gross revenue for income tax purposes must consist of investment income. Absent the Taxable Subsidiaries, a portion of the gross income of any LLC (or other pass-through entity) portfolio investment would flow through directly to us for the 90% test. To the extent that such income did not consist of investment income, it could jeopardize our ability to qualify as a RIC and, therefore, cause us to incur significant federal income taxes. The income of the LLCs (or other pass-through entities) owned by Taxable Subsidiaries is taxed to the Taxable Subsidiaries and does not flow through to us, thereby helping us preserve our RIC status and resultant tax advantages. We do not consolidate the Taxable Subsidiaries for income tax purposes and they may generate income tax expense because of the Taxable Subsidiaries ownership of the portfolio companies. We reflect any such income tax expense on our Consolidated Statement of Operations.
The accompanying financial statements reflect the consolidated accounts of MCG and the following subsidiaries: Solutions Capital I, LP; Solutions Capital GP, LLC; and MCGs special-purpose financing subsidiaries: MCG Finance V, LLC; MCG Finance VII, LLC and MCG Finance VIII, LLC.
BASIS OF PRESENTATION AND USE OF ESTIMATES
These unaudited financial statements and the accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America and conform to Regulation S-X under the Securities Exchange Act of 1934, as amended. We believe we have made all necessary adjustments so that the financial statements are presented fairly and that all such adjustments are of a normal recurring nature. We eliminated all significant intercompany balances. In accordance with Article 6 of Regulation S-X of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, we do not consolidate portfolio company investments, including those in which we have a controlling interest. Certain prior period information has been reclassified to conform to current year presentation. Further, in connection with the preparation of these Condensed Consolidated Financial Statements, we have evaluated subsequent events that occurred after the balance sheet date of September 30, 2009 through the date these financial statements were issued on November 4, 2009.
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Preparing financial statements requires us to make estimates and assumptions that affect the amounts reported on our Condensed Consolidated Financial Statements and accompanying notes. Although we believe the estimates and assumptions used in preparing these Condensed Consolidated Financial Statements and related notes are reasonable, actual results could differ materially.
Interim results are not necessarily indicative of results for a full year. You should read these Condensed Consolidated Financial Statements in conjunction with the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2008.
CERTAIN RISKS AND UNCERTAINTIES
Economic conditions during 2008 and 2009, which include market dislocations, resulted in a significant decline in the availability of debt and equity capital. Generally, the limited amount of available debt financing in the overall capital markets has shorter maturities, higher interest rates and fees and more restrictive terms than debt facilities available in the past. In addition, during 2008 and the nine months ended September 30, 2009, the price of our common stock was well below our net asset value, thereby making it undesirable to issue additional shares of our common stock. Because of these challenges, our strategies shifted during 2008 from originating debt and equity investments, to deleveraging our balance sheet, preserving liquidity necessary to meet our operational needs and servicing our borrowing obligations. Key initiatives that we undertook beginning in 2008 to provide necessary liquidity include: monetizations; the suspension of dividends; the repurchase of debt at significant discounts; the renegotiation of our debt agreements, which was completed in February 2009, and the implementation of a corporate restructuring. During a subsequent strategic review conducted during the third quarter of 2009, we concluded that the implementation of these initiatives had resulted in sufficient improvement in our financial and liquidity metrics to allow us to once again begin to consider future investment opportunities. Although there can be no assurance, we believe we have sufficient liquidity to meet our remaining 2009 operating requirements, as well as liquidity for new origination opportunities.
RECENT ACCOUNTING PRONOUNCEMENTS
CODIFICATION OF ACCOUNTING STANDARDS
In June 2009, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards No. 168The FASB Accounting Standards Codification and Hierarchy of Generally Accepted Accounting Principles, or SFAS 168. SFAS 168 introduced a new Accounting Standard Codification, or ASC, which organized current and future accounting standards into a single codified system. SFAS 168, which is now referred to as ASC Topic 105Generally Accepted Accounting Principles, or ASC 105, under the new codification, superseded, but did not significantly change, all previously existing accounting standards. ASC 105 was effective for interim periods ending after September 15, 2009. We adopted ASC 105 beginning with our Quarterly Report on Form 10-Q for the quarter ended September 30, 2009.
As part of our adoption of this standard, our discussions about specific accounting standards must now reference the standards as set forth in the new codification. To assist readers of our financial statements, we have included the new ASC reference, as well as the reference to the standard as it was originally issued.
STANDARD ON SUBSEQUENT EVENTS
In May 2009, FASB issued SFAS 165Subsequent Events, which was subsequently included in ASC Topic 855Subsequent Events, or ASC 855. ASC 855 provides guidance on managements assessment of subsequent events and requires additional disclosure about the timing of managements assessment of subsequent events. ASC 855 did not significantly change the accounting requirements for the reporting of subsequent events. ASC 855 was effective for interim or annual financial periods ending after June 15, 2009 and we adopted this standard as of June 30, 2009. Our adoption of this standard did not affect our financial position or results of operations.
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FAIR VALUE MEASUREMENTS
FASB set forth most of the accounting guidance associated with the measurement and disclosure of fair value in ASC Topic 820Fair Value Measurements and Disclosures. Prior to its adoption of the new codification, FASB issued a number of standards that either affected the measurement and disclosure of fair value or provided additional guidance or clarification. All such amendments have been incorporated into ASC 820, including the following:
| In February 2008, FASB issued FASB Staff Position No. FAS 157-2Effective Date of FASB No. 157, which deferred the date for which ASC 820 was required to be adopted for nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008, with early adoption permitted in certain cases. Our adoption of this standard as of January 1, 2009 did not have a material effect on our financial position or results of operations. |
| In October 2008, FASB issued FASB Staff Position No. FAS 157-3Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active, which provided an illustrative example of how to determine the fair value of a financial asset in an inactive market. This standard did not change the fair value measurement principles previously set forth by FASB. We adopted this modification in January 2009. Our practice for determining the fair value of our investment portfolio has been, and continues to be, consistent with the guidance provided in the example included in the October 2008 guidance. Therefore, our adoption of this standard did not affect our practices for determining the fair value of our investment portfolio and did not have a material effect on our financial position or results of operations. |
| In April 2009, FASB issued FASB Staff Position No. FAS 157-4Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Indentifying Transactions That Are Not Orderly, which established standards for determining whether normal market activity exists for Level 2 assets and liabilities. In addition, the standard expands disclosure requirements for fair value reporting and requires a categorization of investments consistent with that required for ASC 320InvestmentsDebt and Equity Securities. We adopted this standard for the period ended June 30, 2009. Since our Level 2 investments comprise less than 0.5% of our investment portfolio, our adoption of this standard, did not have a material effect on our financial position or results of operations. |
In April 2009, FASB issued FASB Staff Position No. FAS 107-1 and APB 28-1Interim Disclosures about Fair Value of Financial Instruments, which was subsequently incorporated into ASC Topic 825Financial Instruments. The April 2009 guidance requires disclosures about financial instruments, including fair value, carrying amount, and method and significant assumptions used to estimate the fair value. We adopted this standard as of June 30, 2009. Our adoption of this standard did not affect our financial position or results of operations.
In August 2009, FASB issued Accounting Standard Update No. 2009-05Measuring Liabilities at Fair Value, or ASU 2009-05. The August 2009 update provides clarification to ASC 820 for the valuation techniques required to measure the fair value of liabilities. ASU 2009-05 also provides clarification around required inputs to the fair value measurement of a liability and definition of a Level 1 liability. ASU 2009-05 is effective for interim and annual periods beginning after August 28, 2009. We will adopt this standard beginning with our financial statements ending December 31, 2009. We do not anticipate that our adoption of this standard will have a material effect on our financial position and results of operations.
TWO-CLASS METHOD OF PRESENTING EARNINGS PER SHARE
In June 2008, FASB issued FASB Staff Position EITF 03-06-1Determining Whether Instruments Granted in Share-based Payment Transactions are Participating Securities, which was subsequently incorporated into ASC Topic 260Earnings Per Share. The June 2008 guidance requires companies to include unvested share-based payment awards that contain non-forfeitable rights to dividends in the computation of earnings per share pursuant to the two-class method. In effect, this standard requires companies to report basic and diluted earnings per share in two broad categories. First, companies must report basic and diluted earnings per share associated with the unvested share-based payments with non-forfeitable dividend rights. Second, companies must report separately basic and diluted earnings per share for their remaining common stock. This standard was effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. We adopted this standard beginning with our financial statements ended March 31, 2009. As
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required, we applied this standard retroactively to all reported periods. Our adoption of this standard did not have a material impact on our financial position or results of operations. See Note 9Earnings (Loss) Per Share for additional information about our adoption of this standard.
DISCLOSURES ABOUT DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In March 2008, FASB issued SFAS No. 161Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133, which was subsequently incorporated into ASC Topic 815Derivatives and Hedging, or ASC 815. The March 2008 guidance requires qualitative disclosures about: objectives and strategies for using derivatives; quantitative disclosures about fair value amounts of, and gains and losses on, derivative instruments; and disclosures about credit-risk-related contingent features in derivative agreements. This standard was effective for fiscal years beginning after November 15, 2008 and interim periods within those fiscal years. We adopted this standard as of January 1, 2009. We have reflected the disclosure requirements for ASC 815 in Note 2Investment Portfolio.
ACCOUNTING FOR TRANSFERS OF FINANCIAL ASSETS
In June 2009, FASB issued SFAS 166Accounting for Transfers of Financial Assets. This statement amends SFAS 140Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, which was subsequently incorporated into ASC Topic 860Transfers and Servicing, or ASC 860. The June 2009 guidance removed the concept of a qualifying special-purpose entity from ASC 860. The June 2009 guidance also established specific conditions for reporting the transfer of a portion of a financial asset as a sale. This June 2009 guidance must be applied as of the beginning of each reporting entitys first annual reporting period that begins after November 15, 2009 and early application is prohibited. We will adopt this standard as of January 1, 2010. We do not anticipate that our adoption of this standard will have a material effect on our financial position and results of operations.
INCOME TAXES
In September 2009, FASB issued ASU 2009-06Implementation Guidance on Accounting for Uncertainty in Income Taxes and Disclosure Amendments for Nonpublic Entities, or ASU 2009-06. The September 2009 update did not change existing GAAP but provides implementation guidance to ASC 740Income Taxes, or ASC 740. In addition, ASU 2009-06 eliminates certain disclosures required by ASC 740 for nonpublic companies, but does not alter the disclosure requirements for public companies. ASU 2009-06 is effective for interim and annual periods ending after September 15, 2009. We adopted this standard as of September 30, 2009. Our adoption of this standard did not affect our financial position or results of operations.
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NOTE 2INVESTMENT PORTFOLIO
The following table summarizes the composition of our investment portfolio at cost:
September 30, 2009 | December 31, 2008 | |||||||||||||
(dollars in thousands) |
Investments at Cost |
Percent of Total Portfolio |
Investments at Cost |
Percent of Total Portfolio |
||||||||||
Debt investments |
||||||||||||||
Senior secured debt |
$ | 441,687 | 32.5 | % | $ | 445,392 | 30.3 | % | ||||||
Subordinated debt |
||||||||||||||
Secured |
401,237 | 29.5 | 439,440 | 29.9 | ||||||||||
Unsecured |
38,295 | 2.8 | 34,500 | 2.3 | ||||||||||
Total debt investments |
881,219 | 64.8 | 919,332 | 62.5 | ||||||||||
Equity investments |
||||||||||||||
Preferred equity |
393,617 | 28.9 | 463,333 | 31.5 | ||||||||||
Common/common equivalents equity |
84,938 | 6.3 | 87,458 | 6.0 | ||||||||||
Total equity investments |
478,555 | 35.2 | 550,791 | 37.5 | ||||||||||
Total investments |
$ | 1,359,774 | 100.0 | % | $ | 1,470,123 | 100.0 | % | ||||||
The following table summarizes the composition of our investment portfolio at fair value: | ||||||||||||||
September 30, 2009 | December 31, 2008 | |||||||||||||
(dollars in thousands) |
Investments at Fair Value |
Percent of Total Portfolio |
Investments at Fair Value |
Percent of Total Portfolio |
||||||||||
Debt investments |
||||||||||||||
Senior secured debt |
$ | 416,302 | 40.1 | % | $ | 428,817 | 35.7 | % | ||||||
Subordinated debt |
||||||||||||||
Secured |
292,144 | 28.2 | 351,425 | 29.2 | ||||||||||
Unsecured |
30,476 | 2.9 | 28,081 | 2.3 | ||||||||||
Total debt investments |
738,922 | 71.2 | 808,323 | 67.2 | ||||||||||
Equity investments |
||||||||||||||
Preferred equity |
252,604 | 24.4 | 339,576 | 28.2 | ||||||||||
Common/common equivalents equity |
45,718 | 4.4 | 55,249 | 4.6 | ||||||||||
Total equity investments |
298,322 | 28.8 | 394,825 | 32.8 | ||||||||||
Total investments |
$ | 1,037,244 | 100.0 | % | $ | 1,203,148 | 100.0 | % | ||||||
Our debt instruments bear contractual interest rates ranging from 2.5% to 18.0%, a portion of which may be deferred. As of September 30, 2009, approximately 58.8% of the fair value of our loan portfolio was at variable rates, based on a LIBOR benchmark or prime rate, and 41.2% of the fair value of our loan portfolio was at fixed rates. As of September 30, 2009, approximately 41.1% of our loan portfolio, at fair value, had LIBOR floors between 1.5% and 4.0% on the LIBOR base index and prime floors between 3.0% and 6.0%. At origination, our loans generally have four- to eight-year stated maturities. Borrowers typically pay an origination fee based on a percent of the total commitment and a fee on undrawn commitments.
When one of our loans becomes more than 90 days past due, or if we otherwise do not expect the customer to be able to service its debt and other obligations, we will, as a general matter, place the loan on non-accrual status and generally will cease recognizing interest income on that loan until all principal and interest has been brought current through payment or due to a restructuring such that the interest income is deemed to be collectible. However, we may make exceptions to this policy if the loan has sufficient collateral value and is in the process of collection. If the fair value of a loan is below cost, we may cease recognizing paid-in-kind interest and/or the accretion of a discount on the debt investment until such time that the fair value equals or exceeds cost.
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The following table summarizes the cost of loans more than 90 days past due and loans on non-accrual status:
September 30, 2009 | December 31, 2008 | |||||||||||||
(dollars in thousands) |
Investments at Cost |
% of Loan Portfolio |
Investments at Cost |
% of Loan Portfolio |
||||||||||
Loans greater than 90 days past due |
||||||||||||||
On non-accrual status |
$ | 41,201 | 4.68 | % | $ | 10,060 | 1.10 | % | ||||||
Not on non-accrual status |
| | | | ||||||||||
Total loans greater than 90 days past due |
$ | 41,201 | 4.68 | % | $ | 10,060 | 1.10 | % | ||||||
Loans on non-accrual status |
||||||||||||||
0 to 90 days past due |
$ | 131,850 | 14.96 | % | $ | 109,424 | 11.90 | % | ||||||
Greater than 90 days past due |
41,201 | 4.68 | 10,060 | 1.10 | ||||||||||
Total loans on non-accrual status |
$ | 173,051 | 19.64 | % | $ | 119,484 | 13.00 | % | ||||||
The following table summarizes the fair value of loans more than 90 days past due and loans on non-accrual status:
|
||||||||||||||
September 30, 2009 | December 31, 2008 | |||||||||||||
(dollars in thousands) |
Investments at Fair Value |
% of Loan Portfolio |
Investments at Fair Value |
% of Loan Portfolio |
||||||||||
Loans greater than 90 days past due |
||||||||||||||
On non-accrual status |
$ | 10,377 | 1.40 | % | $ | 695 | 0.09 | % | ||||||
Not on non-accrual status |
| | | | ||||||||||
Total loans greater than 90 days past due |
$ | 10,377 | 1.40 | % | $ | 695 | 0.09 | % | ||||||
Loans on non-accrual status |
||||||||||||||
0 to 90 days past due |
$ | 41,273 | 5.59 | % | $ | 38,619 | 4.77 | % | ||||||
Greater than 90 days past due |
10,377 | 1.40 | 695 | 0.09 | ||||||||||
Total loans on non-accrual status |
$ | 51,650 | 6.99 | % | $ | 39,314 | 4.86 | % | ||||||
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The following table summarizes our investment portfolio by industry at cost:
September 30, 2009 | December 31, 2008 | |||||||||||||
(dollars in thousands) |
Investments at Cost |
Percent of Total Portfolio |
Investments at Cost |
Percent of Total Portfolio |
||||||||||
TelecommunicationsCLEC (competitive local exchange carriers) |
$ | 334,514 | 24.6 | % | $ | 335,279 | 22.8 | % | ||||||
Communicationsother |
20,860 | 1.5 | 23,227 | 1.6 | ||||||||||
Cable |
125,494 | 9.2 | 115,824 | 7.9 | ||||||||||
Healthcare |
134,239 | 9.9 | 133,706 | 9.1 | ||||||||||
Food services |
69,474 | 5.1 | 82,119 | 5.6 | ||||||||||
Plastic products |
96,346 | 7.1 | 84,484 | 5.7 | ||||||||||
Broadcasting |
76,223 | 5.6 | 78,918 | 5.4 | ||||||||||
Business services |
69,335 | 5.1 | 93,668 | 6.4 | ||||||||||
Electronics |
42,331 | 3.1 | 41,959 | 2.9 | ||||||||||
Publishing |
38,738 | 2.9 | 39,416 | 2.7 | ||||||||||
Laboratory instruments |
34,030 | 2.5 | 33,906 | 2.3 | ||||||||||
Logistics |
34,254 | 2.5 | 51,885 | 3.5 | ||||||||||
Sporting goods |
34,643 | 2.5 | 32,898 | 2.2 | ||||||||||
Technology |
7,436 | 0.5 | 8,995 | 0.6 | ||||||||||
Education |
11,988 | 0.9 | 11,994 | 0.8 | ||||||||||
Consumer products |
39,470 | 2.9 | 36,341 | 2.5 | ||||||||||
Industrial products |
26,310 | 1.9 | 26,464 | 1.8 | ||||||||||
Home furnishings |
48,998 | 3.6 | 48,631 | 3.3 | ||||||||||
Insurance |
23,962 | 1.8 | 23,251 | 1.6 | ||||||||||
Leisure activities |
14,133 | 1.0 | 13,816 | 0.9 | ||||||||||
Other media |
21,012 | 1.5 | 20,983 | 1.4 | ||||||||||
Drugs |
10,208 | 0.8 | 11,234 | 0.8 | ||||||||||
Auto parts |
10,516 | 0.8 | 31,073 | 2.1 | ||||||||||
Information services |
14,854 | 1.1 | 17,410 | 1.2 | ||||||||||
Entertainment |
907 | 0.1 | 49,385 | 3.4 | ||||||||||
Other(a) |
19,499 | 1.5 | 23,257 | 1.5 | ||||||||||
Total |
$ | 1,359,774 | 100.0 | % | $ | 1,470,123 | 100.0 | % | ||||||
(a) | No individual industry within this category exceeds 1%. |
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The following table summarizes our investment portfolio by industry at fair value:
September 30, 2009 | December 31, 2008 | |||||||||||||||
(dollars in thousands) |
Investments at Fair Value |
Percent of Total Portfolio |
Investments at Fair Value |
Percent of Total Portfolio |
||||||||||||
TelecommunicationsCLEC |
$ | 171,331 | 16.5 | % | $ | 173,789 | 14.4 | % | ||||||||
Communicationsother |
17,861 | 1.7 | 17,403 | 1.5 | ||||||||||||
Cable |
127,516 | 12.3 | 119,134 | 9.9 | ||||||||||||
Healthcare |
98,563 | 9.5 | 123,589 | 10.3 | ||||||||||||
Food services |
68,776 | 6.6 | 81,935 | 6.8 | ||||||||||||
Plastic products |
58,659 | 5.7 | 45,317 | 3.8 | ||||||||||||
Broadcasting |
52,337 | 5.0 | 66,401 | 5.5 | ||||||||||||
Business services |
48,840 | 4.7 | 77,213 | 6.4 | ||||||||||||
Electronics |
41,700 | 4.0 | 42,018 | 3.5 | ||||||||||||
Publishing |
34,890 | 3.4 | 34,743 | 2.9 | ||||||||||||
Laboratory instruments |
34,599 | 3.3 | 35,054 | 2.9 | ||||||||||||
Logistics |
33,863 | 3.3 | 66,950 | 5.6 | ||||||||||||
Sporting goods |
33,961 | 3.3 | 36,531 | 3.0 | ||||||||||||
Technology |
28,163 | 2.7 | 35,980 | 3.0 | ||||||||||||
Education |
27,064 | 2.6 | 29,062 | 2.4 | ||||||||||||
Consumer products |
26,223 | 2.5 | 22,855 | 1.9 | ||||||||||||
Industrial products |
26,353 | 2.5 | 26,246 | 2.2 | ||||||||||||
Home furnishings |
24,588 | 2.4 | 27,899 | 2.3 | ||||||||||||
Insurance |
22,497 | 2.2 | 21,258 | 1.8 | ||||||||||||
Leisure activities |
14,133 | 1.4 | 13,816 | 1.2 | ||||||||||||
Other media |
10,424 | 1.0 | 11,940 | 1.0 | ||||||||||||
Drugs |
10,208 | 1.0 | 11,234 | 0.9 | ||||||||||||
Auto parts |
8,635 | 0.8 | 31,011 | 2.6 | ||||||||||||
Information services |
8,047 | 0.8 | 13,618 | 1.1 | ||||||||||||
Entertainment |
738 | 0.1 | 28,268 | 2.4 | ||||||||||||
Other(a) |
7,275 | 0.7 | 9,884 | 0.7 | ||||||||||||
Total |
$ | 1,037,244 | 100.0 | % | $ | 1,203,148 | 100.0 | % | ||||||||
(a) | No individual industry within this category exceeds 1%. |
We manage our interest rate exposure and financing facility requirements on an ongoing basis by comparing our interest rate sensitive assets to our interest rate sensitive liabilities, and from time to time, may enter into interest rate swaps. As of September 30, 2009, we included the $1.3 million fair value of these interest rate swaps in other liabilities on our Consolidated Balance Sheets. During the nine months ended September 30, 2009, we reported changes in the fair value of these interest rate swaps in net unrealized appreciation (depreciation) on investments on our Consolidated Statement of Operations. We did not designate any of our interest rate swaps as hedges for accounting purposes. Each quarter, we settle these interest rates swaps for cash.
As of September 30, 2008, the notional amount of our interest rate swaps was $24.0 million and the fair value of these interest rate swaps included in our liabilities was $0.1 million. The following table summarizes our existing interest rate swaps with SunTrust Bank, as the counterparty, for which we pay fixed interest rates and receive floating interest rates as of September 30, 2009:
(dollars in thousands) | As of September 30, 2009 | Unrealized Appreciation (Depreciation) | |||||||||||||||||||||||
Date | Interest | Fair | Three months ended | Nine months ended | |||||||||||||||||||||
Entered |
Expiring |
Rate | Notional | Cost | Value | September 30, 2009 | September 30, 2009 | ||||||||||||||||||
07/08 | 11/10 | 10.0 | % | $ | 16,000 | $ | | $ | (545 | ) | $ | 26 | $ | 104 | |||||||||||
07/08 | 11/10 | 14.0 | % | 8,000 | | (272 | ) | 13 | 52 | ||||||||||||||||
03/09 | 08/11 | 13.0 | % | 12,500 | | (270 | ) | (84 | ) | (270 | ) | ||||||||||||||
03/09 | 08/11 | 9.0 | % | 8,681 | | (188 | ) | (59 | ) | (188 | ) | ||||||||||||||
Total | $ | 45,181 | $ | | $ | (1,275 | ) | $ | (104 | ) | $ | (302 | ) | ||||||||||||
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NOTE 3FAIR VALUE MEASUREMENT
As of January 1, 2008, we adopted SFAS 157Fair Value Measurements, which was subsequently included in ASC Topic 820Fair Value Measurements and Disclosures, or ASC 820. ASC 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about assets and liabilities measured at fair value. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This fair value definition focuses on exit price in the principal, or most advantageous, market and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs.
FAIR VALUE HIERARCHY
ASC 820 establishes the following three-level hierarchy, based upon the transparency of inputs to the fair value measurement of an asset or liability as of the measurement date:
ASC 820 |
Inputs to Fair Value Methodology | |
Level 1 |
Quoted prices in active markets for identical assets or liabilities | |
Level 2 |
Quoted prices for similar assets or liabilities; quoted markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the financial instrument; inputs, other than quoted prices, that are observable for the asset or liability; or inputs that are derived principally from, or corroborated by, observable market information | |
Level 3 |
Pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption is unobservable or when the estimation of fair value requires significant management judgment |
We categorize a financial instrument in the fair value hierarchy based on the lowest level of input that is significant to its fair value measurement.
ASSETS AND LIABILITIES MEASURED AT FAIR VALUE ON A RECURRING BASIS
The following table presents the assets and liabilities that we report at fair value on our Consolidated Balance Sheet by ASC 820 hierarchy:
As of September 30, 2009 | ||||||||||||
(in thousands) |
Quoted Market Prices in Active Markets (Level 1) |
Internal Models with Significant Observable Market Parameters (Level 2) |
Internal Models with Significant Unobservable Market Parameters (Level 3) |
Total Fair Value Reported in Consolidated Balance Sheet | ||||||||
ASSETS | ||||||||||||
Non-affiliate investments |
||||||||||||
Senior secured debt |
$ | | $ | 3,373 | $ | 309,028 | $ | 312,401 | ||||
Subordinated secured debt |
| | 201,258 | 201,258 | ||||||||
Unsecured subordinated debt |
| | 2,161 | 2,161 | ||||||||
Preferred equity |
| 1,287 | 22,470 | 23,757 | ||||||||
Common/common equivalents |
107 | | 42,463 | 42,570 | ||||||||
Total non-affiliate investments |
107 | 4,660 | 577,380 | 582,147 | ||||||||
Affiliate investments |
||||||||||||
Senior secured debt |
| | 22,352 | 22,352 | ||||||||
Subordinated secured debt |
| | 11,423 | 11,423 | ||||||||
Preferred equity |
| | 13,455 | 13,455 | ||||||||
Common/common equivalents |
| | 3,120 | 3,120 | ||||||||
Total affiliate investments |
| | 50,350 | 50,350 | ||||||||
Control investments |
||||||||||||
Senior secured debt |
| | 81,549 | 81,549 | ||||||||
Subordinated secured debt |
| | 79,463 | 79,463 | ||||||||
Unsecured subordinated debt |
| | 28,315 | 28,315 | ||||||||
Preferred equity |
| | 215,392 | 215,392 | ||||||||
Common/common equivalents |
| | 28 | 28 | ||||||||
Total control investments |
| | 404,747 | 404,747 | ||||||||
Total assets at fair value |
$ | 107 | $ | 4,660 | $ | 1,032,477 | $ | 1,037,244 | ||||
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As of September 30, 2009 | ||||||||||||||
(in thousands) |
Quoted Market Prices in Active Markets (Level 1) |
Internal Models with Significant Observable Market Parameters (Level 2) |
Internal Models with Significant Unobservable Market Parameters (Level 3) |
Total Fair Value Reported in Consolidated Balance Sheet |
||||||||||
LIABILITIES | ||||||||||||||
Interest rate swaps(a) |
| (1,275 | ) | | (1,275 | ) | ||||||||
Total liabilities at fair value |
$ | | $ | (1,275 | ) | $ | | $ | (1,275 | ) | ||||
(a) | Represents interest rate swaps on loans used as collateral on a securitized borrowing facility. The fair values of the interest rate swaps are included in other liabilities on our Consolidated Balance Sheets. See Note 2Investment Portfolio for additional information about these interest rate swaps. |
VALUATION METHODOLOGIES
As required by the 1940 Act, we classify our investments by level of control. Control investments include both majority-owned control investments and non-majority owned control investments. A majority-owned control investment represents a security in which we own more than 50% of the voting interest of the portfolio company and generally control its board of directors. A non-majority owned control investment represents a security in which we own 25% to 50% of the portfolio companys equity. Non-control investments represent both affiliate and non-affiliate securities for which we do not have a controlling interest. Affiliate investments represent securities in which we own 5% to 25% of the portfolio companys equity. Non-affiliate investments represent securities in which we own less than 5% of the portfolio companys equity.
| Majority-Owned Control InvestmentsMajority-owned control investments comprise 38.5% of our investment portfolio. Market quotations are not readily available for these investments; therefore, we use a combination of market and income approaches to determine their fair value. Typically, private companies are bought and sold based on multiples of EBITDA, cash flows, net income, revenues or, in limited cases, book value. Generally, we apply multiples that we observe for other comparable companies to relevant financial data for the portfolio company. Also, in a limited number of cases, we use income approaches to determine the fair value of these securities, based on our projections of the discounted future free cash flows that the portfolio company will likely generate, as well as industry derived capital costs. Our valuation approaches for majority-owned investments estimate the value were we to sell or exit the investment. These valuation approaches assume the highest and best use of the investment by market participants and consider the value of our ability to control the portfolio companys capital structure and the timing of a potential exit. |
| Non-Majority-Owned Control InvestmentsNon-majority owned investments comprise 0.5% of our investment portfolio. For our non-majority owned equity investments, we use the same market and income valuation approaches used to value our majority-owned control investments. For non-majority-owned control debt investments, we estimate fair value using the market yield approach based on the expected future cash flows discounted at the loans effective interest rates, based on our estimate of current market rates. We may adjust discounted cash flow calculations to reflect other market conditions or the perceived credit risk of the borrower. |
| Non-Control InvestmentsNon-control investments comprise 61.0% of our investment portfolio. Quoted prices are not available for 99.2% of our non-control investments, which represent 60.5% of our investment portfolio. For our non-control equity investments, we use the same market and income approaches used to value our control investments. For non-control debt investments, we estimate fair value using a market yield approach based on the expected future cash flows discounted at the loans effective interest rates, based on our estimate of current market rates. We may adjust discounted cash flow calculations to reflect other market conditions or the perceived credit risk of the borrower. |
| Thinly Traded and Over-the-Counter SecuritiesGenerally, we value securities that are traded in the over-the-counter market or on a stock exchange at the average of the prevailing bid and ask prices on the date of the relevant period end. However, we may apply a discount to the market value of restricted or thinly traded public securities to reflect the impact that these restrictions have on the value of these securities. We review factors including the trading volume, total securities outstanding and our percentage ownership of securities to determine whether the trading levels are active (Level 1) or inactive (Level 2). As of September 30, 2009, these securities represented 0.5% of our investment portfolio. |
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Our valuation analyses incorporate the impact that key events could have on the securities values, including private mergers and acquisitions, purchase transactions, public offerings, letters of intent and subsequent debt or equity sales. Our valuation analyses consider key external data, such as market changes and industry valuation benchmarks. We also use independent valuation firms to provide additional data points for our quarterly valuation analyses. Our general practice is to obtain an independent valuation or review of valuation once per year for each portfolio investment that had a fair value in excess of $5.0 million, unless the fair value has otherwise been validated through a sale of some or all of our investment in the portfolio company. Valuation firms performed independent valuations or reviewed valuations of 45 portfolio companies over the last four quarters, representing $979.4 million, or 94.4%, of the fair value of our total portfolio investments and $295.5 million, or 99.1%, of the fair value of our equity portfolio investments. In addition, the fair value of $50.6 million of our debt investments, representing 6.9% of the fair value of our debt portfolio and 4.9% of the fair value of our total portfolio, was validated with sales transactions involving the portfolio company. In total, either we obtained an independent valuation or review or we considered recent sales transactions for 99.3% of the fair value of our investment portfolio.
As of September 30, 2009 | ||||||||||||||||||||
Investments at Fair Value | Percent of | |||||||||||||||||||
(dollars in thousands) |
Debt | Equity | Total | Debt Portfolio |
Equity Portfolio |
Total Portfolio |
||||||||||||||
Quarter independent valuation/review prepared(a) |
||||||||||||||||||||
Third quarter 2009 |
$ | 129,385 | $ | 149,915 | $ | 279,300 | 17.5 | % | 50.3 | % | 26.9 | % | ||||||||
Second quarter 2009 |
145,662 | 12,529 | 158,191 | 19.7 | 4.2 | 15.3 | ||||||||||||||
First quarter 2009 |
269,275 | 103,855 | 373,130 | 36.4 | 34.8 | 35.9 | ||||||||||||||
Fourth quarter 2008 |
139,508 | 29,225 | 168,733 | 18.9 | 9.8 | 16.3 | ||||||||||||||
Total independent valuation/review |
683,830 | 295,524 | 979,354 | 92.5 | 99.1 | 94.4 | ||||||||||||||
Quarter fair value validated with sales transaction |
||||||||||||||||||||
Third quarter 2009 |
50,621 | | 50,621 | 6.9 | | 4.9 | ||||||||||||||
Total validated with sales transaction |
50,621 | | 50,621 | 6.9 | | 4.9 | ||||||||||||||
Not evaluated during the 12 months ended September 30, 2009 |
4,471 | 2,798 | 7,269 | 0.6 | 0.9 | 0.7 | ||||||||||||||
Total investment portfolio |
$ | 738,922 | $ | 298,322 | $ | 1,037,244 | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
(a) | Independent valuations/reviews prepared more than one time during the twelve months ended September 30, 2009 have that investments fair value reflected in the most recent quarter for which an independent valuation/review was prepared. |
The majority of the valuations performed by the independent valuation firms utilize proprietary models and inputs. We have used, and intend to continue to use, independent valuation firms to provide additional support for our internal analyses. Our board of directors considers our valuations, as well as the independent valuations and reviews, in its determination of the fair value of our investments. The fair value of our interest rate swaps is based on a binding broker quote, which is based on the estimated net present value of the future cash flows using a forward interest rate yield-curve in effect as of the measurement period.
Due to the uncertainty inherent in the valuation process, such estimates of fair value may differ significantly from the values that would have been used had a ready market for the securities existed, and such differences could be material. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to differ from the valuations currently assigned.
CHANGES IN LEVEL 3 FAIR VALUE MEASUREMENTS
We classify securities in the Level 3 valuation hierarchy based on the significance of the unobservable factors to the overall fair value measurement. Our fair value approach for Level 3 securities primarily uses unobservable inputs, but may also include observable, actively quoted components derived from external sources. Accordingly, the gains and losses in the table below include fair value changes due, in part, to observable factors. Additionally, we transfer investments in and out of Level 3 securities as of the ending balance sheet date, based on changes in the use of observable and unobservable inputs utilized to perform the valuation for the period. During the third quarter, there was no transfer activity in or out of Level 3 securities.
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The following table provides a reconciliation of fair value changes during the three-month period from June 30, 2009 through September 30, 2009 for all investments for which we determine fair value using unobservable (Level 3) factors.
Fair value measurements using unobservable inputs (Level 3) | ||||||||||||||||
(in thousands) |
Non-affiliate Investments |
Affiliate Investments |
Control Investments |
Total | ||||||||||||
Fair value June 30, 2009 |
||||||||||||||||
Senior secured debt |
$ | 294,718 | $ | 23,519 | $ | 107,152 | $ | 425,389 | ||||||||
Subordinated secured debt |
188,989 | 11,363 | 83,119 | 283,471 | ||||||||||||
Unsecured subordinated debt |
2,145 | | 25,816 | 27,961 | ||||||||||||
Preferred equity |
23,769 | 14,468 | 232,519 | 270,756 | ||||||||||||
Common/common equivalents equity |
44,415 | 3,519 | 2,584 | 50,518 | ||||||||||||
Total fair value June 30, 2009 |
554,036 | 52,869 | 451,190 | 1,058,095 | ||||||||||||
Realized/unrealized (loss) gain |
||||||||||||||||
Senior secured debt |
(240 | ) | 46 | (2,664 | ) | (2,858 | ) | |||||||||
Subordinated secured debt |
3,844 | (4 | ) | 3,010 | 6,850 | |||||||||||
Unsecured subordinated debt |
(2 | ) | | (1,000 | ) | (1,002 | ) | |||||||||
Preferred equity |
(1,703 | ) | (1,044 | ) | (2,740 | ) | (5,487 | ) | ||||||||
Common/common equivalents equity |
(1,950 | ) | (399 | ) | (1 | ) | (2,350 | ) | ||||||||
Total realized/unrealized loss |
(51 | ) | (1,401 | ) | (3,395 | ) | (4,847 | ) | ||||||||
Purchases, issuances and (settlements), net |
||||||||||||||||
Senior secured debt |
(6,878 | ) | (1,213 | ) | (1,511 | ) | (9,602 | ) | ||||||||
Subordinated secured debt |
172 | 64 | 1,587 | 1,823 | ||||||||||||
Unsecured subordinated debt |
18 | | 3,499 | 3,517 | ||||||||||||
Preferred equity |
404 | 31 | (14,387 | ) | (13,952 | ) | ||||||||||
Common/common equivalents equity |
(2 | ) | | (2,555 | ) | (2,557 | ) | |||||||||
Total purchases, issuances and (settlements), net |
(6,286 | ) | (1,118 | ) | (13,367 | ) | (20,771 | ) | ||||||||
Transfers into Level 3 |
||||||||||||||||
Senior secured debt |
21,428 | | (21,428 | ) | | |||||||||||
Subordinated secured debt |
8,253 | | (8,253 | ) | | |||||||||||
Total transfers into Level 3 |
29,681 | | (29,681 | ) | | |||||||||||
Fair value as of September 30, 2009 |
||||||||||||||||
Senior secured debt |
309,028 | 22,352 | 81,549 | 412,929 | ||||||||||||
Subordinated secured debt |
201,258 | 11,423 | 79,463 | 292,144 | ||||||||||||
Unsecured subordinated debt |
2,161 | | 28,315 | 30,476 | ||||||||||||
Preferred equity |
22,470 | 13,455 | 215,392 | 251,317 | ||||||||||||
Common/common equivalents equity |
42,463 | 3,120 | 28 | 45,611 | ||||||||||||
Total fair value as of September 30, 2009 |
$ | 577,380 | $ | 50,350 | $ | 404,747 | $ | 1,032,477 | ||||||||
The following table summarizes the unrealized (depreciation) appreciation on our Level 3 investments for the three months ended September 30, 2009.
Fair value measurements using unobservable inputs (Level 3) | ||||||||||||||||
(in thousands) |
Non-affiliate Investments |
Affiliate Investments |
Control Investments |
Total | ||||||||||||
Change in unrealized (depreciation) appreciation |
||||||||||||||||
Senior secured debt |
$ | (240 | ) | $ | 46 | $ | (2,664 | ) | $ | (2,858 | ) | |||||
Subordinated secured debt |
6,593 | (4 | ) | 4,584 | 11,173 | |||||||||||
Unsecured subordinated debt |
(2 | ) | | (1,000 | ) | (1,002 | ) | |||||||||
Preferred equity |
(1,703 | ) | (1,044 | ) | (2,461 | ) | (5,208 | ) | ||||||||
Common/common equivalents equity |
(1,950 | ) | (399 | ) | (110 | ) | (2,459 | ) | ||||||||
Total change in unrealized (depreciation) appreciation on Level 3 investments |
$ | 2,698 | $ | (1,401 | ) | $ | (1,651 | ) | $ | (354 | ) | |||||
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The following table provides a reconciliation of fair value changes during the nine-month period from December 31, 2008 to September 30, 2009 for all investments for which we determine fair value using unobservable (Level 3) factors.
Fair value measurements using unobservable inputs (Level 3) | ||||||||||||||||
(in thousands) |
Non-affiliate Investments |
Affiliate Investments |
Control Investments |
Total | ||||||||||||
Fair value December 31, 2008 |
||||||||||||||||
Senior secured debt |
$ | 289,982 | $ | 25,467 | $ | 108,451 | $ | 423,900 | ||||||||
Subordinated secured debt |
210,902 | 11,109 | 128,281 | 350,292 | ||||||||||||
Unsecured subordinated debt |
2,504 | | 25,577 | 28,081 | ||||||||||||
Preferred equity |
26,128 | 15,220 | 297,793 | 339,141 | ||||||||||||
Common/common equivalents equity |
48,279 | 3,903 | 2,584 | 54,766 | ||||||||||||
Total fair value December 31, 2008 |
577,795 | 55,699 | 562,686 | 1,196,180 | ||||||||||||
Realized/unrealized (loss) gain |
||||||||||||||||
Senior secured debt |
(6,096 | ) | (32 | ) | (4,504 | ) | (10,632 | ) | ||||||||
Subordinated secured debt |
(5,151 | ) | 153 | (30,813 | ) | (35,811 | ) | |||||||||
Unsecured subordinated debt |
(394 | ) | | (1,005 | ) | (1,399 | ) | |||||||||
Preferred equity |
(2,898 | ) | (1,855 | ) | (20,913 | ) | (25,666 | ) | ||||||||
Common/common equivalents equity |
(6,030 | ) | (783 | ) | (4,972 | ) | (11,785 | ) | ||||||||
Total realized/unrealized loss |
(20,569 | ) | (2,517 | ) | (62,207 | ) | (85,293 | ) | ||||||||
Purchases, issuances and (settlements), net |
||||||||||||||||
Senior secured debt |
(7,513 | ) | (3,083 | ) | 10,253 | (343 | ) | |||||||||
Subordinated secured debt |
(29,913 | ) | 161 | 7,130 | (22,622 | ) | ||||||||||
Unsecured subordinated debt |
51 | | 3,743 | 3,794 | ||||||||||||
Preferred equity |
(760 | ) | 90 | (61,488 | ) | (62,158 | ) | |||||||||
Common/common equivalents equity |
214 | | 2,416 | 2,630 | ||||||||||||
Total purchases, issuances and (settlements), net |
(37,921 | ) | (2,832 | ) | (37,946 | ) | (78,699 | ) | ||||||||
Transfers into (out of) Level 3 |
||||||||||||||||
Senior secured debt |
32,655 | | (32,651 | ) | 4 | |||||||||||
Subordinated secured debt |
25,420 | | (25,135 | ) | 285 | |||||||||||
Total transfers into (out of) Level 3 |
58,075 | | (57,786 | ) | 289 | |||||||||||
Fair value as of September 30, 2009 |
||||||||||||||||
Senior secured debt |
309,028 | 22,352 | 81,549 | 412,929 | ||||||||||||
Subordinated secured debt |
201,258 | 11,423 | 79,463 | 292,144 | ||||||||||||
Unsecured subordinated debt |
2,161 | | 28,315 | 30,476 | ||||||||||||
Preferred equity |
22,470 | 13,455 | 215,392 | 251,317 | ||||||||||||
Common/common equivalents equity |
42,463 | 3,120 | 28 | 45,611 | ||||||||||||
Total fair value as of September 30, 2009 |
$ | 577,380 | $ | 50,350 | $ | 404,747 | $ | 1,032,477 | ||||||||
The following table summarizes the unrealized (depreciation) appreciation on our Level 3 investments for the nine months ended September 30, 2009.
Fair value measurements using unobservable inputs (Level 3) | ||||||||||||||||
(in thousands) |
Non-affiliate Investments |
Affiliate Investments |
Control Investments |
Total | ||||||||||||
Change in unrealized (depreciation) appreciation |
||||||||||||||||
Senior secured debt |
$ | (6,096 | ) | $ | (32 | ) | $ | (4,787 | ) | $ | (10,915 | ) | ||||
Subordinated secured debt |
(2,402 | ) | 153 | (29,248 | ) | (31,497 | ) | |||||||||
Unsecured subordinated debt |
(394 | ) | | (1,005 | ) | (1,399 | ) | |||||||||
Preferred equity |
(2,898 | ) | (1,855 | ) | (2,763 | ) | (7,516 | ) | ||||||||
Common/common equivalents equity |
(6,030 | ) | (783 | ) | (2,081 | ) | (8,894 | ) | ||||||||
Total change in unrealized depreciation on Level 3 investments |
$ | (17,820 | ) | $ | (2,517 | ) | $ | (39,884 | ) | $ | (60,221 | ) | ||||
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NOTE 4CONCENTRATIONS OF INVESTMENT RISK
As of September 30, 2009, approximately 18.2% of the fair value of our investment portfolio was composed of investments in the communications industry. The 18.2% included 16.5% invested in CLECs and 1.7% invested in other communications companies, including an international telecommunications service provider, a paging service and a telecommunications tower company. As of December 31, 2008, approximately 15.9% of the fair value of our investment portfolio was composed of investments in the communications industry, including 14.4% invested in CLECs and 1.5% invested in other communications companies. For the nine months ended September 30, 2009 and 2008, our portfolio companies in the communications industry contributed $3.4 million, or 4.4%, and $13.9 million, or 13.2%, respectively, of our total revenues.
Our investment in Broadview Networks Holdings, Inc., or Broadview, a CLEC that we control, represents our single largest investment. As of September 30, 2009 and December 31, 2008, the fair value of our investment in Broadview represented $138.8 million and $139.3 million, or 13.4% and 11.6%, respectively, of the fair value of our investment portfolio. We did not accrete any dividends with respect to our investment in Broadview during the nine months ended September 30, 2009, because we determined that the total value that we had recorded for this investment equaled the total enterprise value for this investment and any additional accretion of dividends would not be supportable or appropriate under our valuation polices. However, during the nine months ended September 30, 2008, our investment in Broadview contributed $8.0 million, or 7.6%, of our total revenues. Currently, we do not expect to accrete any further dividends on our Broadview investment.
In addition to the communications industry, we have concentrations in the cable, healthcare and food service industries. The following table summarizes, by industry, our fair value and revenue concentrations in our investments:
Investments at Fair Value | Revenue for the nine months ended | |||||||||||||||||||||||||||||
September 30, 2009 | December 31, 2008 | September 30, 2009 | September 30, 2008 | |||||||||||||||||||||||||||
(dollars in thousands) |
Amount | % of Total Portfolio |
Amount | % of Total Portfolio |
Amount | % of Total Revenue |
Amount | % of Total Revenue |
||||||||||||||||||||||
Industry |
||||||||||||||||||||||||||||||
Communications |
$ | 189,192 | 18.2 | % | $ | 191,192 | 15.9 | % | $ | 3,378 | 4.4 | % | $ | 13,936 | 13.2 | % | ||||||||||||||
Cable |
127,516 | 12.3 | 119,134 | 9.9 | 8,296 | 10.9 | 7,912 | 7.5 | ||||||||||||||||||||||
Healthcare |
98,563 | 9.5 | 123,589 | 10.3 | 8,909 | 11.7 | 11,354 | 10.8 | ||||||||||||||||||||||
Food services |
68,776 | 6.6 | 81,935 | 6.8 | 8,884 | 11.7 | 8,079 | 7.7 |
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NOTE 5BORROWINGS
The following table summarizes our borrowing facilities and the potential borrowing capacity of those facilities and contingent borrowing eligibility of Solutions Capital I, LP, a wholly owned subsidiary, as an SBIC, under the SBIC Act:
September 30, 2009 | December 31, 2008 | |||||||||||||||
(dollars in thousands) |
Maturity Date | Potential Maximum Borrowing |
Amount Outstanding |
Potential Maximum Borrowing |
Amount Outstanding | |||||||||||
Unsecured Notes |
||||||||||||||||
Series 2005-A |
October 2010(a) | $ | 37,641 | $ | 37,641 | $ | 50,000 | $ | 50,000 | |||||||
Series 2007-A |
October 2012 | 18,820 | 18,820 | 25,000 | 25,000 | |||||||||||
Commercial Loan Funding Trust Facility |
||||||||||||||||
Class A Variable Funding Certificate |
August 2011(b) | 175,648 | 164,566 | 218,750 | 162,219 | |||||||||||
Class B Variable Funding Certificate |
August 2011(b) | | | 31,250 | 24,950 | |||||||||||
Term Securitizations |
||||||||||||||||
Series 2006-1 Class A-1 Notes |
April 2018 | 106,250 | 106,250 | 106,250 | 106,250 | |||||||||||
Series 2006-1 Class A-2 Notes |
April 2018 | 50,000 | | 50,000 | | |||||||||||
Series 2006-1 Class A-3 Notes |
April 2018 | 85,000 | 85,000 | 85,000 | 85,000 | |||||||||||
Series 2006-1 Class B Notes |
April 2018 | 58,750 | 58,750 | 58,750 | 58,750 | |||||||||||
Series 2006-1 Class C Notes(c) |
April 2018 | 45,000 | 40,000 | 45,000 | 40,000 | |||||||||||
Series 2006-1 Class D Notes(d) |
April 2018 | 47,500 | 29,880 | 47,500 | 37,380 | |||||||||||
Unsecured Revolving Line of Credit(e) |
May 2009 | | | 70,000 | 44,500 | |||||||||||
SBIC (Maximum borrowing potential)(f) |
(g) | 130,000 | 27,600 | 130,000 | 2,600 | |||||||||||
Total borrowings |
$ | 754,609 | $ | 568,507 | $ | 917,500 | $ | 636,649 | ||||||||
(a) | On October 28, 2009, the Series 2005-A and Series 2007-A Unsecured Notes were amended, which, in part, extended the maturity date of the Series 2005-A Unsecured Notes to October 2011. See Note 12Subsequent Events for additional information about these amendments. |
(b) | Renewable each February at the lenders discretion. The lender provided this renewal in February 2009. At that time, the final legal maturity became August 2011. In conjunction with additional collateral transferred to this facility in February 2009, the Class B advances were retired. |
(c) | Amount outstanding excludes $5.0 million of notes that we repurchased in December 2008 for $1.6 million. The notes that MCG, the parent company, purchased are eliminated from this schedule as part of the consolidation process. |
(d) | Amount outstanding excludes $10.1 million of notes that we repurchased in December 2008 for $2.4 million and $7.5 million of notes that we repurchased in January 2009 for $2.1 million. The notes that MCG, the parent company, purchased are eliminated from this schedule as part of the consolidation process. |
(e) | On May 4, 2009, we repaid the balance of this facility. |
(f) | As of September 30, 2009, we had the potential to borrow up to $130.0 million of SBA-guaranteed debentures under the SBIC program. The SBA has approved and committed up to $130.0 million in borrowings to the SBIC. To realize the full $130.0 million borrowing potential approved and committed by the SBIC under this program, we must fund a total of $65.0 million to the SBIC, of which we have funded $18.6 million as of September 30, 2009. Based on our funded capital, Solutions Capital I, LP may, subject to the SBAs approval, borrow up to an additional $28.3 million to originate investments. To access the entire $130.0 million that has been approved and committed by the SBA, we would have to fund an additional $46.4 million. In February 2009, the American Recovery and Reinvestment Act of 2009 was passed into law which, among other things, included a provision that increased the maximum amount of outstanding leverage available to SBIC companies up to $150.0 million. |
(g) | Currently, we may originate new borrowings through September 2012 at which time we can apply for a new commitment. We must repay borrowings under the SBIC program within ten years after the borrowing date, which will occur between September 2018 and September 2022. |
Each of our credit facilities has certain collateral requirements and/or financial covenants. As of December 31, 2008, the net worth covenant of our warehouse facility requires that we maintain a minimum stockholders equity of not less than $525.0 million, plus 50% of any equity raised after February 26, 2009. The terms of this facility include a step-down provision that allows us to reduce the minimum stockholders equity requirement to $500.0 million, plus 50% of the proceeds from any equity issuances after February 26, 2009, if we reduce the effective advance rate for the advances outstanding to less than 60% of eligible collateral and we provide formal notice to the lender. Under these covenants, we must also maintain an asset coverage ratio of at least 180%.
As a BDC, we are not permitted to incur indebtedness or issue senior securities, including preferred stock, unless immediately after such borrowing we have an asset coverage for total borrowings (excluding borrowings by our SBIC facility) of at least 200%. In addition, we may not be permitted to declare any cash dividend or other distribution on our outstanding common shares, or purchase any such shares, unless, at the time of such declaration or purchase, we have an asset coverage of at least 200% after deducting the amount of such dividend, distribution or purchase price. If we are unable to meet this asset coverage requirement, we may not be able to incur additional senior debt. As of September 30, 2009, our ratio of total assets to total borrowings and other senior securities was
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212%. Because borrowings by our SBIC facility are exempt from the minimum BDC asset coverage requirement, we have $28.3 million of unused, previously funded borrowing capacity remaining in our SBIC subject to the SBAs approval.
We fund all of our current debt facilities, except our unsecured notes through our bankruptcy remote, special-purpose, wholly owned subsidiaries. Therefore, these subsidiaries assets may not be available to our creditors. In some cases, advances under our debt facilities are subject to certain collateral levels, collateral quality, leverage and other restrictive covenants. We continue to service the portfolio investments that are used as collateral in our secured borrowing facilities. Additional information about these facilities is provided below.
Unsecured Notes. In October 2005, we issued $50.0 million of Series 2005-A unsecured notes, at a fixed interest rate of 6.73% per annum. In October 2007, we issued an additional $25.0 million of Series 2007-A unsecured notes at a fixed interest rate of 6.71% per annum. Both of these tranches are five-year notes that require semi-annual interest payments. We issued these notes through private placements with Bayerische Hypo-Und Vereinsbank, AG, New York Branch, or HVB, acting as the placement agent. In February 2009, these notes were amended. In connection with these amendments, MCG and the noteholders agreed to a number of modifications to the terms of the notes, including certain financial covenants. The minimum asset coverage ratio that we are required to maintain has been lowered from 200% to 180% effective as of December 31, 2008. The minimum consolidated stockholders equity requirement was reduced from $642.9 million prior to December 31, 2008 to $500.0 million effective as of and after December 31, 2008. The cross-default provisions were modified so that defaults of indebtedness by certain direct and indirect subsidiaries, including Solutions Capital I, L.P. and the special purpose subsidiaries relating to the 2006-1 term securitization and our secured warehouse credit facility, would not constitute defaults under the unsecured notes, as long as we (the parent company) or any other subsidiary that is not a non-recourse financing subsidiary are not liable for the repayment of such indebtedness. The interest rate for the Series 2005-A unsecured notes, increased from 6.73% to 8.98%. The interest rate for the Series 2007-A unsecured notes, increased from 6.71% to 8.96%. The amendments also require us to offer to repurchase the unsecured notes with a portion of certain monetization proceeds at a purchase price of 102% of the principal amount to be purchased.
On May 4, 2009, we repaid our revolving line of credit. Prior to that repayment, we were required to use 60% of the cash net proceeds of any sale of unencumbered assets to reduce amounts outstanding under the unsecured notes and the revolving line of credit on a pro rata basis, based on then-outstanding amounts. After such repayment, we agreed to direct 40% of such net monetization proceeds from unencumbered asset sales as, and when, such sales occur to the repurchase of the notes, unless an event of default under one of the financing subsidiary debt facilities has occurred and is continuing, in which case the percentage of net proceeds increases to 60%.
The following table summarizes the reductions in the borrowing capacity from monetization proceeds during the nine months ended September 30, 2009:
(in thousands) |
Quarter Ended | Monetization Payment |
Maximum Borrowing Capacity After Monetization Payment | |||||
Unsecured Note Series |
||||||||
2005-A |
March 31, 2009 | $ | 5,314 | $ | 44,686 | |||
June 30, 2009 | 3,128 | 41,558 | ||||||
September 30, 2009 | 3,917 | 37,641 | ||||||
2007-A |
March 31, 2009 | 2,658 | 22,342 | |||||
June 30, 2009 | 1,564 | 20,778 | ||||||
September 30, 2009 | 1,958 | 18,820 |
As of September 30, 2009, the outstanding balances under the Series 2005-A and Series 2007-A unsecured notes were $37.6 million and $18.8 million, respectively. In connection with the February 2009 amendment to the unsecured notes, we also agreed to limit the amount of debt from the 2006-1 term securitization and our common stock that we may repurchase. For every $5.0 million of unsecured notes we offer to purchase, we may repurchase $2.5 million of debt from the 2006-1 term securitization. Once we have offered to purchase $35.0 million in unsecured notes, then we may also repurchase $1.0 million in shares of our common stock for every $5.0 million increment of unsecured notes offered to be repurchased, provided that the amount of permitted 2006-1 debt repurchases shall be reduced by the amount of any MCG common stock repurchases made. We paid to the holders of the unsecured notes an
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amendment fee of $375,000, or 0.50%. On October 28, 2009, the Series 2005-A and Series 2007-A Unsecured Notes were amended, which, in part, extended the maturity date of the Series 2005-A Unsecured Notes to October 2011 and increased the interest rate thereunder to 9.98%. See Note 12Subsequent Events for additional information about this amendment.
MCG Commercial Loan Funding Trust. We established, through MCG Commercial Loan Funding Trust, a $250.0 million warehouse financing facility funded through Three Pillars Funding LLC, an asset-backed commercial paper conduit administered by SunTrust Robinson Humphrey, Inc., or SunTrust. The warehouse financing facility, which operates like a revolving credit facility, is secured primarily by MCG Commercial Loan Funding Trusts assets, including commercial loans that we sold to the trust. The pool of commercial loans in the trust must meet certain requirements, such as term, average life, investment rating, agency rating and industry diversity requirements. We must also meet certain requirements related to portfolio performance, including required minimum portfolio yield and limitations on delinquencies and charge-offs. We funded this facility through two separate Variable Funding Certificates, or VFCs, including a $218.75 million Class A VFC and a $31.25 million Class B VFC.
In February 2009, SunTrust renewed its annual liquidity commitment for this facility. We paid a $2.4 million, or 1.25%, facility fee for this renewal. In connection with this renewal, a number of modifications were made to the warehouse facility terms, including a reduction in the facility borrowing commitment from $250.0 million to $190.0 million. In conjunction with this reduction, the Class B VFC was retired. The legal final maturity date is now August 2011, subject to contractual terms and conditions. The amendment also eliminated the requirement for a six-month standstill upon non-liquidity renewal. If a new agreement or extension is not executed by February 2010, the warehouse facility enters an 18-month amortization period during which principal under the facility is paid down through orderly monetizations of portfolio company assets that are financed through the facility. The facility is funded by third parties through the commercial paper market with SunTrust providing a liquidity backstop, subject to SunTrusts annual liquidity commitment.
Advances under the Class A VFC may be up to 64% of eligible collateral. The warehouse facility is non-recourse to us; therefore, in the event of a termination event or upon the legal final maturity date, the lenders under the warehouse facility may only look to the collateral to satisfy the outstanding obligations under this facility. The following table summarizes the collateral under the MCG Commercial Loan Funding Trust as of September 30, 2009 and December 31, 2008.
September 30, 2009 | December 31, 2008 | |||||||||||||
(dollars in thousands) |
Amount | % | Amount | % | ||||||||||
Securitized assets |
||||||||||||||
Senior secured debt |
$ | 162,070 | 60.1 | % | $ | 164,188 | 64.3 | % | ||||||
Subordinated secured debt |
107,428 | 39.9 | 91,347 | 35.7 | ||||||||||
Total securitized assets |
$ | 269,498 | 100.0 | % | $ | 255,535 | 100.0 | % | ||||||
The interest rate for Class A advances has been increased to the commercial paper rate plus 2.50%. Class A advances previously bore interest at the commercial paper rate plus 1.50%. The minimum asset coverage ratio that we are required to maintain was reduced from 200% to 180% effective as of December 31, 2008, and the minimum consolidated stockholders equity requirement was reduced from $654.0 million prior to December 31, 2008 to $525.0 million as of and after December 31, 2008, plus 50% of any equity raised after February 26, 2009. The terms of this facility include a step-down provision that allows us to reduce the minimum stockholders equity requirement to $500.0 million plus 50% of the proceeds from any equity issuances after February 26, 2009, if we reduce the effective advance rate for the advances outstanding to less than 60% of eligible collateral and we formally notify the lender.
Prior to the commencement of any amortization period, we will contribute 80% of net proceeds from monetizations of collateral financed in the warehouse facility to reduce the facility borrowing limit, until such limit is reduced to $150.0 million. In addition, 7.5% of the sale of the first $100.0 million of unencumbered investment assets by us will be used to repay the warehouse facility.
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The following table summarizes the reductions in the facility borrowing limit from monetization proceeds:
(in thousands) |
Monetization Payment |
Maximum Borrowing Capacity After Monetization Payment | ||||
Quarter ended: |
||||||
March 31, 2009 |
$ | 1,491 | $ | 188,509 | ||
June 30, 2009 |
2,894 | 185,615 | ||||
September 30, 2009 |
9,967 | 175,648 |
MCG Commercial Loan Trust 2006-1. In April 2006, we completed a $500.0 million debt securitization through MCG Commercial Loan Trust 2006-1, a wholly owned subsidiary. The 2006-1 Trust issued $106.25 million of Class A-1 Notes, $50.0 million of Class A-2 Notes, $85.0 million of Class A-3 Notes, $58.75 million of Class B Notes, $45.0 million of Class C Notes and $47.5 million of Class D Notes. The respective classes of notes bear interest at LIBOR plus 0.33%, 0.35%, 0.33%, 0.58%, 1.05% and 2.25%.
All the notes are secured by the assets of MCG Commercial Loan Trust 2006-1. The following table summarizes the assets securitized under this facility as of September 30, 2009 and December 31, 2008.
September 30, 2009 | December 31, 2008 | |||||||||||||
(dollars in thousands) |
Amount | % | Amount | % | ||||||||||
Securitized assets |
||||||||||||||
Senior secured debt |
$ | 210,196 | 58.6 | % | $ | 224,661 | 56.7 | % | ||||||
Subordinated secured debt |
148,335 | 41.4 | 171,914 | 43.3 | ||||||||||
Total securitized assets |
$ | 358,531 | 100.0 | % | $ | 396,575 | 100.0 | % | ||||||
We retain all of the equity in the securitization. The securitization includes a five-year reinvestment period ending in April 2011, unless we terminate this facility earlier, during which the trust may use principal collections received on the underlying collateral to purchase new collateral from us. Up to 55% of the collateral may be non-senior secured, and, in certain instances, unsecured commercial loans. The remaining 45% must be senior secured commercial loans.
The Class A-1, Class B, Class C and Class D Notes are term notes. The Class A-2 Notes are a revolving class of secured notes and have a five-year revolving period. The Class A-3 Notes are a delayed draw class of secured notes, which were drawn in full during April 2007. From time to time, the trust purchases additional commercial loans from us, primarily using the proceeds from the Class A-2 revolving notes. The pool of commercial loans in the trust must meet certain requirements, such as asset mix and concentration, collateral coverage, term, agency rating, minimum coupon, minimum spread and sector diversity requirements.
In December 2008, we repurchased $15.1 million of collateralized loan obligations for $4.0 million that previously had been issued by Commercial Loan Trust 2006-1. In January 2009, we purchased an additional $7.5 million of these notes for $2.1 million, which resulted in a $5.4 million gain on extinguishment of debt during the quarter ending March 31, 2009.
Unsecured Revolving Line of Credit. In June 2008, we entered into an agreement, effective May 30, 2008, for a one-year unsecured revolving line of credit facility with a $70.0 million commitment. SunTrust Bank acted as the agent for this facility and SunTrust acted as arranger for this facility. Originally, SunTrust Bank committed $25.0 million to this facility, while Chevy Chase Bank, F.S.B.; Sovereign Bank; and BMO Capital Markets, Inc., each committed $15.0 million. Advances under this facility bore interest at LIBOR plus 2.75%, prime plus 1.25% or the Federal Funds rate plus 4.00% (reduced to the Federal Funds rate plus 3.00%, if the Federal Funds rate was less than 0.25% below LIBOR), with a commitment fee of 0.25% per annum on undrawn amounts. We used this facility for: the origination of loans to, and investments in, primarily middle-market companies; repayment of indebtedness; working capital and other general corporate purposes. In February 2009, the unsecured revolving line of credit agreement was amended to reduce the maximum borrowing limit from $70.0 million to $35.0 million and increase the interest rate on borrowings under this facility to LIBOR plus 400 basis points from LIBOR plus 275 basis points. The amendment also reduced the minimum stockholders equity requirements from $650.0 million prior to December 31, 2008 to $500.0 million plus 50% of the proceeds from post-amendment date equity issuances for the periods ending as of and after December 31, 2008. In addition, we agreed to maintain minimum cash and cash equivalents of $12.5 million at all times and a quarterly cash coverage ratio of not less than 1.25 to 1.00. We were required to direct a portion of any monetization proceeds to pay down debt.
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Up to 60% of the net proceeds of any sale by us or unencumbered investment assets was used to reduce amounts outstanding under the revolving line of credit and our unsecured notes on a pro rata basis, based on then-outstanding amounts. All asset monetizations were at our sole discretion based upon the economic merits of any proposed transaction. Dividends payable in cash with a declared payment date prior to July 1, 2009 were limited to the minimum amount required for us to maintain our status as a RIC. On May 4, 2009, we repaid this facility in full in advance of its May 29, 2009 maturity.
SBIC Debentures. In December 2004, we formed a wholly owned subsidiary, Solutions Capital I, LP. Solutions Capital I, LP has a license from the SBA to operate as an SBIC under the SBIC Act. As of September 30, 2009, the license gave Solutions Capital I, LP the potential to borrow up to $130.0 million. The SBA has approved and committed $130.0 million in borrowings to the SBIC, subject to certain capital requirements and customary procedures. These funds can be used to provide debt and equity capital to qualifying small businesses. We may use the borrowings from the SBA to fund new originations; however, we may not use these borrowings to originate debt to companies that are currently in our portfolio without SBA approval. In addition, we may not use these funds for MCGs, the parent companys, working capital.
To realize the full $130.0 million potential borrowing for which we have been approved under this program, we must fund a total of $65.0 million to the SBIC, of which we have funded $18.6 million as of September 30, 2009. Based on our current funded capital, Solutions Capital I, LP may, subject to the SBAs approval, borrow up to an additional $28.3 million to originate new investments. To access the entire $130.0 million that the SBA has approved and committed, we would have to fund an additional $46.4 million.
The American Recovery and Reinvestment Act of 2009, which was passed into law in February 2009, included a provision that increased the maximum amount of outstanding leverage available to SBIC companies up to $150.0 million, which represents a $12.9 million increase over the $137.1 million limit as of December 31, 2008. Solutions Capital I, LP would require the SBAs approval and commitment in order to access this incremental borrowing capacity. To access the entire $150.0 million, we would have to fund a total of $56.4 million, in addition to the $18.6 million that we had funded through September 30, 2009. As of September 30, 2009 and December 31, 2008, we had $30.6 million and $27.8 million, respectively, of investments and we had $20.8 million and $0.8 million, respectively, of restricted cash to be used for investments in our SBIC.
Once drawn, the SBIC debt bears an interim interest rate of LIBOR plus 30 basis points. The rate becomes fixed at the time of SBA pooling, which is within nine months of funding, and is set to the then-current 10-year treasury rate plus a spread and an annual SBA charge. As of September 30, 2009, the SBIC had $27.6 million outstanding summarized in the following table:
Amount Outstanding | ||||||||||||||||
(dollars in thousands) |
September 30, 2009 |
December 31, 2008 |
Rate | Treasury Rate at Pooling Date |
Spread in basis points | |||||||||||
Tranche |
||||||||||||||||
2008-10B |
$ | 2,600 | $ | 2,600 | 6.44 | % | Fixed | 3.80 | % | 264 | ||||||
2009-10A |
12,000 | | 5.34 | % | Fixed | 2.81 | % | 253 | ||||||||
2009-10B |
13,000 | | 4.95 | % | Fixed | 3.44 | % | 151 | ||||||||
Total |
$ | 27,600 | $ | 2,600 | 5.19 | % | 3.16 | % | 203 | |||||||
In October 2008, we received exemptive relief from the SEC, which effectively allows us to exclude debt issued by Solutions Capital I, LP from the calculation of our consolidated BDC asset coverage ratio.
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The following table summarizes repayments based on the contractual principal collections of the outstanding loans that comprise the collateral, where applicable. Actual repayments could differ significantly due to prepayments by our borrowers and modifications of our borrowers existing loan agreements.
September 30, 2009 | ||||||||||
(in thousands) |
Debt with Recourse |
Debt without Recourse |
Total | |||||||
2009(a) |
$ | | $ | 2,036 | $ | 2,036 | ||||
2010 |
37,641 | 162,530 | (b) | 200,171 | ||||||
2011 |
| | | |||||||
2012 |
18,820 | | 18,820 | |||||||
2013 |
| | | |||||||
Thereafter(c) |
27,600 | 319,880 | 347,480 | |||||||
Total |
$ | 84,061 | $ | 484,446 | $ | 568,507 | ||||
(a) | Each of our borrowing facilities contain provisions that require that we apply a portion of the proceeds we receive from monetizations to paydown a portion of the outstanding balances. The amounts payable in 2009 reflect the paydowns we were required to make in connection with monetizations that occurred through September 30, 2009. |
(b) | On October 28, 2009, our Series 2005-A and Series 2007-A Unsecured Notes were amended, which, in part, extended the maturity date for $37.6 million of our debt from October 2010 to October 2011. See Note 12Subsequent Events for additional information about this amendment. |
(c) | Recourse on Solutions Capital I, LPs outstanding debt is limited to MCGs commitment of $65.0 million. As of September 30, 2009, we had $27.6 million of debt outstanding. |
The following table summarizes our aggregate outstanding borrowings as of September 30, 2009 and December 31, 2008, by interest rate benchmark:
(in thousands) |
September 30, 2009 |
December 31, 2008 | ||||||
Interest rate benchmark |
||||||||
LIBOR |
$ | 319,880 | $ | 371,880 | ||||
Commercial paper rate |
164,566 | 187,169 | ||||||
Fixed rate |
84,061 | 77,600 | ||||||
Total borrowings |
$ | 568,507 | $ | 636,649 | ||||
As of September 30, 2009, we reported $568.5 million of borrowings on our Consolidated Balance Sheet at cost. We estimate that the fair value of these borrowings as of September 30, 2009 was approximately $452.0 million, based on market data and current interest rates.
NOTE 6CAPITAL STOCK
We have one class of common stock and one class of preferred stock authorized. Our board of directors is authorized to: provide for the issuance of shares of preferred stock in one or more series; establish the number of shares to be included in each such series; and establish the designations, voting powers, preferences and rights of the shares of each such series, and any qualifications, limitations or restrictions thereof, subject to the 1940 Act.
On June 17, 2009, our stockholders approved a proposal to authorize us to issue securities to subscribe to, convert to, or purchase shares of our common stock in one or more offerings up to an aggregate of 10 million shares. This proposal permits us to issue securities that may be converted into or exercised for shares of our common stock at a conversion or exercise price per share not less than our current market price at the date such securities are issued. This conversion or exercise price may; however, be less than our net asset value per share at the date such securities are issued or the date such securities are converted into or exercised for shares of our common stock. The approval expires on the earlier of June 17, 2010 or the date of our 2010 Annual Meeting of Stockholders.
In 2008, we raised $57.7 million of net proceeds by issuing 9.5 million shares of newly issued common stock in a rights offering. See Note 9Earnings (Loss) Per Share for additional details regarding this rights offering.
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NOTE 7SHARE-BASED COMPENSATION
EMPLOYEE SHARE-BASED COMPENSATION
From time to time, we award shares of restricted common stock to employees under our Amended and Restated 2006 Employee Restricted Stock Plan, or the 2006 Plan, which our stockholders initially approved in June 2006. Under the terms of the 2006 Plan, we may award up to 3,500,000 shares of common stock to employees. Shares of restricted common stock awarded under the 2006 Plan may be subject to the employees meeting service or performance conditions specified at the time of award. The award date is the date on which the shares are awarded by the Compensation Committee of our board of directors, while the fair value of the respective stock award is based on the closing price of our common stock on the NASDAQ Global Select Market on the award date. We amortize restricted stock awards on a straight-line basis over the requisite service period and report this expense as amortization of employee restricted stock awards on our Consolidated Statements of Operations.
During the nine months ended September 30, 2009, we did not issue any shares of restricted stock under the 2006 Plan. During the nine-months ended September 30, 2008, we issued 1,211,000 shares of restricted stock under the 2006 Plan, with a weighted-average fair value per share of common stock on the award date of $5.46. These 2008 awards included 648,000 shares of restricted stock awarded under the 2006 Plan as part of the MCG Capital 2008 Retention Program, or the Retention Program, with a weighted-average fair value per share of common stock of $3.58. The forfeiture provisions for the shares of restricted common stock issued under the Retention Program will lapse on a cliff basis in March 2011. The forfeiture provisions for the other shares of restricted common stock awarded in 2008 generally lapse ratably, in quarterly installments, over the three- or four-year period set forth in the respective award agreements.
During the nine months ended September 30, 2009 and 2008, we recognized $5.6 million and $5.5 million, respectively, of compensation expense related to share-based compensation awards. As of September 30, 2009, all the restricted share awards for which forfeiture provisions have not lapsed carried non-forfeitable dividend rights to the holder of the restricted shares. We record dividends paid on shares of restricted common stock for which forfeiture provisions are expected to lapse to retained earnings, while we record dividends paid on shares of restricted common stock for which forfeiture provisions are not expected to lapse to compensation expense. No dividends were paid during the nine months ended September 30, 2009. During the nine months ended September 30, 2008, all dividends paid on restricted common stock were charged to retained earnings, except for dividends paid on shares securing non-recourse employee loans, because we expected the forfeiture provisions to lapse for all such shares. As of September 30, 2009, we had $6.2 million of unrecognized compensation cost related to restricted common stock awarded to employees. We will recognize these costs over the remaining weighted-average requisite service period of 1.5 years.
Long-Term Incentive Plan
On July 23, 2009, our board of directors approved the Long-Term Incentive Plan, or the LTIP, which is effective for the three-year period ending July 22, 2012. LTIP participants, including our executive officers and key, non-executive employees, will be eligible, in the sole discretion of the Compensation Committee of our board of directors, to receive their respective portions of up to an aggregate of 865,000 shares of our restricted common stock to be issued under the 2006 Plan and up to $5.2 million of cash bonuses if the closing price of our common stock achieves specific price thresholds for 20 consecutive trading days. We are under no obligation to issue restricted stock or to pay a cash award under the LTIP, until such time as the Compensation Committee of our board of directors makes such determination in its sole discretion, regardless of whether the share price thresholds have been achieved. The following table summarizes the price thresholds, the cumulative percentage and number of shares eligible to be awarded at each threshold, and the cash bonus eligible to be paid after achievement of each stock price threshold:
Potential Stock Awards | Aggregate Dollar Amount for Each Share Price threshold Achieved | |||||||
Share Price |
% of Award |
Number of Shares |
||||||
$3.00 |
25 | % | 216,250 | $ | | |||
$4.00 |
25 | % | 216,250 | | ||||
$5.00 |
25 | % | 216,250 | 1,000,000 | ||||
$6.00 |
15 | % | 129,750 | 996,000 | ||||
$7.00 |
10 | % | 86,500 | 1,006,000 | ||||
$8.00 |
| % | | 2,209,000 | ||||
100 | % | 865,000 | $ | 5,211,000 | ||||
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Shares of common stock subject to restricted stock awards under the LTIP may not be issued until such time as our share price achieves the price thresholds set forth in the preceding table and the issuance of such shares is authorized by the Compensation Committee of our board of directors. As such, the participants in the LTIP are not eligible to receive dividends on the shares of common stock subject to their awards of restricted stock until a share price threshold is attained and the common stock is issued. Upon issuance, forfeiture provisions for two-thirds of the applicable stock awards will lapse immediately, while the forfeiture provision for the remaining one-third will lapse twelve months later. We are accounting for the restricted stock awards as equity awards under ASC 718CompensationStock Compensation, or ASC 718. We have estimated the fair value of these awards to be approximately $1.9 million and are amortizing this amount on a straight-line basis over the derived service period. During the nine months ended September 30, 2009, we recognized $0.8 million of compensation expense for these equity awards.
Cash awards under the LTIP may not be issued until such time that our share price achieves the thresholds set forth in the preceding table and the payment of such awards is authorized by the Compensation Committee of our board of directors. Upon achievement of a price threshold, two-thirds of the associated cash is expected to be paid out immediately and the remaining one-third will be paid out twelve months later. We are accounting for the cash portion of the LTIP as liability awards under ASC 718. As liability awards, we are required to account for the awards based on the fair value of the award at the end of each reporting period and to recognize the expense over the then-current estimated requisite service period. As of September 30, 2009, the fair value of these awards was $1.8 million. However, because ASC 718 requires us to adjust the fair value of the cash awards each quarter, the expense that we ultimately recognize could vary between zero and $5.2 million. During the nine months ended September 30, 2009, we recognized $0.3 million of compensation expense for these equity awards.
NON-EMPLOYEE DIRECTOR SHARE BASED COMPENSATION
During June 2006, our stockholders initially approved the Amended and Restated 2006 Non-Employee Director Restricted Stock Plan, or the 2006 Non-Employee Plan, under which we may issue up to 100,000 shares of common stock to our non-employee directors. During the nine months ended September 30, 2009 and 2008, we awarded 22,500 and 15,000 shares of restricted common stock, respectively, to eligible non-employee directors. During the nine months ended September 30, 2009 and 2008, we recognized $0.1 million and $0.2 million, respectively, of compensation costs related to share-based awards to non-employee directors. We include this compensation cost in general and administrative expense on our Consolidated Statements of Operations. As of September 30, 2009, we had $0.1 million of unrecognized compensation cost related to restricted common stock awarded to non-employee directors, which we expect to recognize over the remaining weighted-average requisite service period of 1.7 years.
SUMMARY OF EMPLOYEE AND NON-EMPLOYEE DIRECTOR SHARE-BASED COMPENSATION
The following table summarizes our restricted stock award activity during the nine months ended September 30, 2009:
Shares | Weighted-Average Grant Date Fair Value per Share | |||||
Subject to forfeiture provisions as of December 31, 2008(a) |
1,451,000 | $ | 8.49 | |||
Awarded |
22,500 | 2.46 | ||||
Forfeiture period lapsed |
(324,000 | ) | 14.29 | |||
Forfeited(b) |
(27,000 | ) | 7.01 | |||
Subject to forfeiture provisions as of September 30, 2009(c) |
1,122,500 | $ | 6.73 | |||
(a) | Includes 11,600 performance shares held in trust with a weighted-average award date fair value of $19.37 per share. |
(b) | Includes 2,400 performance shares that were held in trust with a weighted-average award date fair value of $19.37 per share. |
(c) | Includes 9,200 performance shares held in trust with a weighted-average award date fair value of $19.37 per share. |
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NOTE 8INCOME TAXES
As a RIC, we are taxed under Subchapter M of the Internal Revenue Code. As such, our income generally is not taxable to the extent we distribute it to stockholders and we meet certain qualification tests as outlined in the Internal Revenue Code. However, income from certain investments owned by our wholly owned subsidiaries is subject to federal, state and local income taxes. We met our distribution requirements as a RIC for 2008 and will monitor distribution requirements for 2009 in order to ensure compliance under Subchapter M of the Internal Revenue Code.
We use the asset and liability method to account for our taxable subsidiaries income taxes. Using this method, we recognize deferred tax assets and liabilities for the estimated future tax effects attributable to temporary differences between financial reporting and the tax bases of assets and liabilities. In addition, we recognize deferred tax benefits associated with net operating carryforwards that we may use to offset future tax obligations. We measure deferred tax assets and liabilities using the enacted tax rates expected to apply to taxable income in the years in which we expect to recover or settle those temporary differences. During the nine months ended September 30, 2009 and 2008, we recorded an income tax benefit of $0.3 million and an income tax provision of $0.6 million, respectively, which were attributable primarily to unrealized depreciation or appreciation on investments held by our subsidiaries.
From December 2001 through September 30, 2009, we declared distributions per share of $11.78. Each year, we mail statements on Form 1099-DIV to our stockholders that identify whether we made distributions from ordinary income, net capital gains on the sale of securities, which are each taxable distributions, and/or a return of paid-in-capital surplus, which is a nontaxable distribution. A portion of our distributions may represent a return of capital to our stockholders, to the extent that the total distributions paid in a given year exceed current and accumulated taxable earnings and profits. A portion of the distributions that we paid to stockholders during fiscal years 2008, 2006, 2005, 2004 and 2003 represented a return of capital.
Historically, we have declared dividends that were paid the following quarter. The following table summarizes the distributions that we declared and paid since January 1, 2008.
Date Declared | Record Date | Payment Date | Amount | ||||
May 6, 2008 | June 30, 2008 | July 30, 2008 | $ | 0.27 | |||
February 22, 2008 | March 12, 2008 | April 29, 2008 | 0.44 |
We determine the tax attributes of our distributions as of the end of our fiscal year based upon our taxable income for the full year and distributions paid during the full year. During the nine months ended September 30, 2009, we did not make any distributions to stockholders. However, we will monitor 2009 taxable income in order to ensure compliance with the distribution requirements as a RIC.
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Taxable income differs from net income recognized in accordance with accounting principles generally accepted in the United States, or GAAP, because of temporary and permanent differences in income and expense recognition. Taxable income generally excludes unrealized gains and losses from appreciation or depreciation of our investments, which are included in GAAP net income. Further, amounts recognized for financial reporting purposes may differ from amounts included in taxable income due to the accrued dividends on preferred stock, which increase the book basis but not the tax basis of our investments, and non-accrual interest on loans, which increase the tax basis but not the book basis. The following table summarizes the cost of our investments, as well as the unrealized appreciation and depreciation for federal income tax purposes, as of September 30, 2009 and December 31, 2008:
(in thousands) |
September 30, 2009 | December 31, 2008 | ||||||||
Cost for federal income tax purposes |
$ | 1,317,867 | $ | 1,413,241 | ||||||
Gross unrealized appreciation |
||||||||||
Unrealized appreciation of fair value of portfolio investments (GAAP) |
59,014 | 85,754 | ||||||||
Book to tax differences |
87,634 | 91,770 | ||||||||
Gross unrealized appreciationtax basis |
146,648 | 177,524 | ||||||||
Gross unrealized depreciation |
||||||||||
Unrealized depreciation of fair value of portfolio investments (GAAP) |
(383,801 | ) | (353,702 | ) | ||||||
Book to tax differences |
(45,727 | ) | (34,888 | ) | ||||||
Gross unrealized depreciationtax basis |
(429,528 | ) | (388,590 | ) | ||||||
Net unrealized depreciationtax basis |
(282,880 | ) | (211,066 | ) | ||||||
Less: Unrealized depreciation of fair value of other assets (GAAP) |
2,257 | 973 | ||||||||
Total investments at fair value (GAAP) |
$ | 1,037,244 | $ | 1,203,148 | ||||||
The following table reconciles GAAP net loss to taxable net income (loss) for the nine months ended September 30, 2009 and the year ended December 31, 2008: | ||||||||||
(in thousands) |
Nine months ended September 30, 2009 |
Year ended December 31, 2008 |
||||||||
Net loss |
$ | (52,624 | ) | $ | (191,245 | ) | ||||
Difference between book and tax losses on investments(a) |
(14,784 | ) | (73,272 | ) | ||||||
Net change in unrealized depreciation on investments not taxable until realized |
56,839 | 248,218 | ||||||||
Capital losses in excess of capital gains |
34,985 | | ||||||||
Timing difference related to deductibility of long-term incentive compensation |
4,399 | 6,642 | ||||||||
Taxable interest income on non-accrual loans(b) |
18,307 | 2,051 | ||||||||
Dividend income accrued for GAAP purposes that is not yet taxable |
(4,815 | ) | (19,972 | ) | ||||||
Distributions from taxable subsidiaries |
74 | 483 | ||||||||
Federal tax (benefit) provision |
(293 | ) | 789 | |||||||
Other, net |
292 | 4,181 | ||||||||
Taxable income (loss) before deductions for distributions |
$ | 42,380 | $ | (22,125 | ) | |||||
(a) | Results for the year ended December 31, 2008, primarily reflect the write-off, for tax purposes, of the common stock of Cleartel. |
(b) | Results for the year ended December 31, 2008, reflect the reversal of interest that we previously recognized on non-accrual loans of a portfolio investment that we liquidated. We applied the proceeds from the liquidation to the portfolio companys outstanding principal balance on the debt obligation to us. |
In December 2007, we received an examination report from the IRS. See Note 10Contingencies and CommitmentsLegal Proceedings and Tax Reviews for information regarding that report.
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NOTE 9EARNINGS (LOSS) PER SHARE
The following table summarizes our calculation of basic and diluted earnings (loss) per share for the three and nine months ended September 30, 2009 and 2008:
Three months ended September 30, |
Nine months ended September 30, |
|||||||||||||||||
(dollars in thousands, except per share amounts) |
2009 | 2008 | 2009 | 2008 | ||||||||||||||
Numerator |
||||||||||||||||||
Net income (loss) |
$ | 4,183 | $ | (66,946 | ) | $ | (52,624 | ) | $ | (133,948 | ) | |||||||
Less: Dividends declaredcommon and restricted shares |
| | | (49,272 | ) | |||||||||||||
Undistributed earnings |
4,183 | (66,946 | ) | (52,624 | ) | (183,220 | ) | |||||||||||
Percentage allocated to common shares(a) |
98.4 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||||
Undistributed earningscommon shares |
4,116 | (66,946 | ) | (52,624 | ) | (183,220 | ) | |||||||||||
Add: Dividends declaredcommon shares |
| | | 48,559 | ||||||||||||||
Numerator for basic and diluted earnings (loss) per share |
||||||||||||||||||
Common shares |
4,116 | (66,946 | ) | (52,624 | ) | (134,661 | ) | |||||||||||
Participating unvested shares |
67 | | | 713 | ||||||||||||||
Numerator for basic and diluted earnings per sharetotal |
$ | 4,183 | $ | (66,946 | ) | $ | (52,624 | ) | $ | (133,948 | ) | |||||||
Denominator for basic and diluted weighted-average shares outstanding |
||||||||||||||||||
Common shares outstanding |
74,672 | 74,296 | 74,588 | 71,526 | ||||||||||||||
Participating unvested shares |
1,204 | | | | ||||||||||||||
Basic and diluted weighted-average common shares outstandingtotal |
75,876 | 74,296 | 74,588 | 71,526 | ||||||||||||||
Earnings (loss) per sharebasic and diluted |
$ | 0.06 | $ | (0.90 | ) | $ | (0.71 | ) | $ | (1.87 | ) | |||||||
(a)Weighted-average shares |
||||||||||||||||||
Weighted-average common shares |
||||||||||||||||||
Weighted-average common shares outstanding |
74,672 | 74,296 | 74,588 | 70,066 | ||||||||||||||
Adjustment for bonus element of rights offering |
| | | 1,460 | ||||||||||||||
Basic weighted-average common shares |
74,672 | 74,296 | 74,588 | 71,526 | ||||||||||||||
Weighted-average restricted shares |
||||||||||||||||||
Weighted-average restricted shares |
1,204 | | | | ||||||||||||||
Bonus element of rights offering |
| | | | ||||||||||||||
Total weighted-average restricted shares |
1,204 | | | | ||||||||||||||
Total |
75,876 | 74,296 | 74,588 | 71,526 | ||||||||||||||
Percentage allocated to common shares |
98.4 | % | 100.0 | % | 100.0 | % | 100.0 | % |
ADOPTION OF FSP EITF 03-6-1
In June 2008, FASB issued FASB Staff Position EITF 03-06-1Determining Whether Instruments Granted in Share-based Payment Transactions are Participating Securities, which was subsequently incorporated into ASC Topic 260Earnings Per Share, or ASC 260. This standard requires companies to include unvested share-based payment awards that contain non-forfeitable rights to dividends in the computation of earnings per share pursuant to the two-class method. In effect, The June 2008 guidance requires that we must report basic and diluted earnings per share in two broad categories. First, we must report basic and diluted earnings per share associated with the unvested share-based payments with non-forfeitable rights to dividends. Second, we must report separately basic and diluted earnings per share for our remaining common stock.
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We adopted this standard on January 1, 2009. Holders of unvested shares of our issued and outstanding restricted common stock are eligible to receive non-forfeitable dividends, and, thus, these shares are participating securities requiring the two-class method of computing earnings per share under the provisions of ASC 260. The calculation of earnings per share for common shares excludes dividends attributable to our restricted common stock from the numerator and excludes the dilutive impact of those shares from the denominator. The provisions of the June 2008 guidance also require us to retroactively adjust all prior period earnings per share computations.
The retroactive application of this standard did not change our previously reported loss per share for any reporting period included in this Quarterly Report on Form 10-Q because the holders of the participating unvested shares are not required to fund any portion of the loss.
STOCKHOLDERS RIGHTS OFFERING
We issued transferable rights to stockholders of record on March 28, 2008. The rights entitled rights holders to subscribe for an aggregate of 9.5 million shares of our common stock. Record date stockholders received one right for every seven outstanding shares of common stock owned on the record date. The rights entitled the holders to purchase one new share of common stock for every right held. The per share subscription price in the offering equaled 88% of the volume-weighted average sales price volume of our common stock on the NASDAQ Global Select Market during the five trading days ended April 18, 2008. We issued all 9.5 million shares of common stock on April 29, 2008 at a subscription price of $6.36 per share. The market price of our common stock was $9.92 per share on March 25, 2008, which was the last day that our common stock and the rights were traded together. Since the $6.36 per share subscription price of common stock issued under the rights offering was lower than the $9.92 per share market price on March 25, 2008, the rights offering contained a bonus element. Accordingly, as required by ASC 260, we retroactively increased the weighted-average number of shares of common stock outstanding used to compute basic and diluted earnings per share by a factor of 1.052 for all historical periods prior to April 29, 2008 (the date that the common stock was issued in conjunction with the stockholders rights offering). This factor represents the impact of the bonus element of the rights offering on our common stock.
NOTE 10CONTINGENCIES AND COMMITMENTS
LEGAL PROCEEDINGS AND TAX REVIEWS
We are a party to certain legal proceedings incidental to the normal course of our business, including the enforcement of our rights under contracts with our portfolio companies. While the outcome of these legal proceedings cannot at this time be predicted with certainty, we do not expect that these proceedings will have a material effect on our financial condition or results of operations.
In December 2007, we received an examination report from the IRS related to its audit of our tax returns for the 2004 and 2005 tax years. The IRS proposed changes to certain deductions made by us for those years, primarily associated with the timing of certain realized losses in our portfolio. We are appealing the proposed changes and believe it is more likely than not that our appeal will be successful. If our appeal is not successful, we could be subject to up to $20.5 million of additional taxes, interest and penalties and we could be required to make up to $25.1 million of additional cash and/or stock distributions to our stockholders, although alternative options may be available to us in lieu of such distributions. At the present time, we believe that our total obligation associated with this examination should not exceed $1.0 million, including additional taxes, interest and penalties accrued through the settlement. We accrued the income tax expense for the majority of this estimated obligation in previous quarters. If, in the future, we believe our total obligation associated with this examination will increase, we would accrue the additional estimated amounts due.
FINANCIAL INSTRUMENTS
During the normal course of business, we are party to certain financial instruments, including loans, participations in loans, guarantees, letters of credit and other financial commitments. We conduct extensive due diligence and, when appropriate, obtain collateral to limit our credit risk. Generally, these commitments have fixed expiration dates or other termination clauses, which may require payment of a fee by the counterparty. We expect many of these commitments will not be fully used before they expire; therefore, the total commitment amounts do not necessarily represent future cash requirements.
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In accordance with GAAP, the unused portions of these commitments are not recorded on our Consolidated Balance Sheets. The following table summarizes the nominal dollar balance and the fair value of unused commercial loan commitments, guarantees and standby letters of credit as of September 30, 2009 and December 31, 2008:
(in thousands) |
September 30, 2009 | December 31, 2008 | ||||
Unused loan commitments(a) |
$ | 38,668 | $ | 43,393 | ||
Guarantees |
2,000 | 5,833 | ||||
Standby letters of credit |
| 97 | ||||
|
(a) | Estimated fair value of unused loan commitments as of both September 30, 2009 and December 31, 2008 was $0.2 million, based on the fees that we currently charge to enter into similar arrangements, taking into account the creditworthiness of the counterparties. |
We currently have one guarantee totaling $2.0 million, which relates to Cleartel Communications, Inc., or Cleartel, (supporting a telecommunications service provider), for which we consider the credit risk to be remote. We report off-balance sheet guarantees on our Consolidated Schedules of Investments, as required by the 1940 Act.
TRANSITION SERVICES AGREEMENTCLEARTEL COMMUNICATIONS, INC.
On August 25, 2009, Birch Communications, Inc. acquired substantially all of the operating assets of Cleartel, an MCG control investment. The cash portion of the purchase price was used primarily to pay off third-party senior debt under Cleartels senior credit facility with Textron Financial Corporation and its equipment leasing facility with Relational, LLC. On the closing date of the sale, Cleartel entered into a Transition Services Agreement, or TSA, with Birch to provide certain services necessary to effect an orderly transition of the business from Cleartel to Birch. Once the TSA is terminated and Cleartel is dissolved, which is expected to occur in the fourth quarter of 2009, we expect to recognize $150.3 million in both realized losses and in reversals of unrealized depreciation, resulting in no impact on our earnings per share for 2009. Since we reduced the fair value of our investment in Cleartel to zero during 2008, we do not expect that this transaction will have a material effect on our 2009 results of operations.
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NOTE 11FINANCIAL HIGHLIGHTS
The following schedule summarizes our financial highlights for the nine months ended September 30, 2009 and 2008:
(in thousands, except per share amounts) |
Nine months ended September 30, |
|||||||
2009 | 2008 | |||||||
PER SHARE DATA |
||||||||
Net asset value at beginning of period(a) |
$ | 8.66 | $ | 12.73 | ||||
Net loss |
||||||||
Net operating income before investment loss and gain on extinguishment of debt(b) |
0.39 | 0.66 | ||||||
Net change in unrealized depreciation on investments(b) |
(0.77 | ) | (2.40 | ) | ||||
Net realized losses on investments(b) |
(0.40 | ) | (0.12 | ) | ||||
Gain on extinguishment of debt(b) |
0.07 | | ||||||
Income tax provision(b) |
| (0.01 | ) | |||||
Net loss(b) |
(0.71 | ) | (1.87 | ) | ||||
Net decrease in net assets resulting from distributions(b) |
| (0.71 | ) | |||||
Net increase (decrease) in stockholders equity relating to stock-based transactions |
||||||||
Issuance of shares of common stock |
| (0.61 | ) | |||||
Issuance of shares of restricted common stock |
| (0.29 | ) | |||||
Net increase in stockholders equity from restricted stock amortization |
0.08 | 0.08 | ||||||
Dilutive effect of forfeiture provisions of previously issued restricted stock |
0.01 | | ||||||
Net increase in stockholders equity from other stock transactions |
0.02 | 0.06 | ||||||
Net increase (decrease) in stockholders equity relating to stock-based transactions |
0.11 | (0.76 | ) | |||||
Net asset value at end of period(a) |
$ | 8.06 | $ | 9.39 | ||||
MARKET PRICE PER SHARE AT END OF PERIOD |
$ | 4.19 | $ | 2.62 | ||||
TOTAL RETURN(c) |
490.14 | % | (67.47 | )% | ||||
SHARES OF COMMON STOCK OUTSTANDING(c) |
||||||||
Weighted-averagebasic and diluted |
74,588 | 71,526 | ||||||
End of period |
75,970 | 76,117 | ||||||
NET ASSETS |
||||||||
Average (annualized) |
$ | 623,629 | $ | 812,392 | ||||
End of period |
611,967 | 714,679 | ||||||
RATIOS (ANNUALIZED) |
||||||||
Operating expenses to average net assets |
10.16 | % | 9.56 | % | ||||
Net operating income to average net assets |
6.17 | % | 7.77 | % |
(a) | Based on total number of shares outstanding. |
(b) | Based on weighted-average number of shares outstanding. |
(c) | Total return = [(ending market price per share beginning market price per share + dividends paid per share) / beginning market price per share]. |
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NOTE 12SUBSEQUENT EVENTS
AMENDED NOTE PURCHASE AGREEMENT
On October 28, 2009, the terms of our Series 2005-A and Series 2007-A unsecured privately-placed notes were amended. In connection with this amendment, we and the noteholders agreed to a number of modifications, including:
| a one-year maturity extension of the Series 2005-A Notes to October 11, 2011; |
| a 100 basis point increase in the interest rate for the Series 2005-A Notes from 8.98% per annum to 9.98% per annum; |
| a $5.0 million prepayment by us to reduce the principal outstanding on Unsecured Notes applied on a pro-rata basis based on the principal amount outstanding under each series; and |
| an increase in the percentage of net cash proceeds of any monetization of unencumbered investment assets by us required to reduce amounts outstanding under the Unsecured Notes by 5% to 45% at such time as SunTrust has received an aggregate amount of $7.5 million from the required 7.5% sweep of net cash proceeds of the sale of the first $100.0 million of unencumbered assets under our Three Pillars Warehouse facility. |
The 8.96% interest rate and October 2012 maturity on the Series 2007-A Notes remains unchanged. The principal balance on the Series 2005-A Notes and Series 2007-A Notes is $34.3 million and $17.2 million, respectively, after giving effect to the $5.0 million payment described above.
ASSET EXCHANGE AGREEMENTGMC TELEVISION BROADCASTING, LLC
On October 26, 2009, we completed an asset exchange transaction between HITV Operating Co., Inc., or HITV, a subsidiary of GMC Television Broadcasting, LLC, and KHNL/KFVE, LLC, a wholly owned subsidiary of Raycom Media Inc. Pursuant to an asset exchange agreement, dated October 16, 2009, HITV exchanged with KHNL/KFVE, LLC certain assets that were used in the operation of HITVs Television Station KGMB in Honolulu, Hawaii in return for a $22.0 million note, with current pay interest, and certain of the programming assets that were used in the operation of KHNL/KFVE, LLCs Television Station KFVE-TV in Honolulu. Also on October 26, 2009, HITV entered into a shared services agreement with KHNL/KFVE, LLC, pursuant to which KHNL/KFVE, LLC is now providing certain services to HITVs Television Station KFVE-TV.
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
MCG Capital Corporation
We have reviewed the accompanying consolidated balance sheet of MCG Capital Corporation, including the consolidated schedule of investments, as of September 30, 2009, and the related consolidated statements of operations, for the three - and nine - month periods ended September 30, 2009 and 2008, and the consolidated statements of changes in net assets, cash flows and financial highlights for the nine-month periods ended September 30, 2009 and 2008. These financial statements are the responsibility of MCG Capital Corporations management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of MCG Capital Corporation as of December 31, 2008, including the consolidated schedule of investments, and the related consolidated statements of operations, changes in net assets, cash flows, and financial highlights for the year then ended (not presented herein), and in our report dated March 5, 2009 we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2008, including the consolidated schedule of investments, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
/s/ ERNST & YOUNG LLP
McLean, Virginia
November 4, 2009
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The following table summarizes key financial data for MCG Capital Corporation for the three and nine months ended September 30, 2009 and 2008. You should refer to this data when reading our Managements Discussion and Analysis of Financial Condition and Results of Operations and our unaudited Condensed Consolidated Financial Statements and notes thereto.
Three months ended September 30, |
Nine months ended September 30, |
||||||||||||||||
(in thousands, except per share amounts) |
2009 | 2008 | 2009 | 2008 | |||||||||||||
INCOME STATEMENT DATA | |||||||||||||||||
Revenue |
$ | 23,611 | $ | 31,296 | $ | 76,155 | $ | 105,392 | |||||||||
Net operating income before net investment loss, (loss) gain on extinguishment of debt and income tax (benefit) provision |
8,658 | 13,014 | 28,769 | 47,230 | |||||||||||||
DNOI(a) |
10,937 | 14,904 | 34,372 | 52,724 | |||||||||||||
Net income (loss) |
4,183 | (66,946 | ) | (52,624 | ) | (133,948 | ) | ||||||||||
PER COMMON SHARE DATA | |||||||||||||||||
Net operating income before net investment loss, (loss) gain on extinguishment of debt and income tax (benefit) provision per common sharebasic and diluted |
$ | 0.11 | $ | 0.18 | $ | 0.39 | $ | 0.66 | |||||||||
DNOI per common sharebasic and diluted(a) |
$ | 0.14 | $ | 0.20 | $ | 0.46 | $ | 0.74 | |||||||||
Earnings (loss) per common sharebasic and diluted |
$ | 0.06 | $ | (0.90 | ) | $ | (0.71 | ) | $ | (1.87 | ) | ||||||
Cash dividends declared per common share |
$ | | $ | | $ | | $ | 0.71 | |||||||||
SELECTED PERIOD-END BALANCES | |||||||||||||||||
Fair value of investment portfolio |
$ | 1,037,244 | $ | 1,296,469 | |||||||||||||
Total assets |
1,194,387 | 1,386,054 | |||||||||||||||
Borrowings |
568,507 | 652,968 | |||||||||||||||
Total stockholders equity |
611,967 | 714,679 | |||||||||||||||
Net asset value per common share outstanding(b) |
$ | 8.06 | $ | 9.39 | |||||||||||||
OTHER PERIOD-END DATA | |||||||||||||||||
Average size of investments |
|||||||||||||||||
Fair value |
$ | 15,958 | $ | 17,760 | |||||||||||||
Cost |
20,920 | 20,377 | |||||||||||||||
Number of portfolio companies |
65 | 73 | |||||||||||||||
Number of employees |
66 | 74 | |||||||||||||||
RECONCILIATION OF DNOI TO NET OPERATING INCOME BEFORE NET INVESTMENT LOSS, (LOSS) GAIN ON EXTINGUISHMENT OF DEBT AND TAX (BENEFIT) PROVISION |
|||||||||||||||||
Net operating income before net investment loss, (loss) gain on extinguishment of debt and income tax (benefit) provision |
$ | 8,658 | $ | 13,014 | $ | 28,769 | $ | 47,230 | |||||||||
Amortization of employee restricted stock awards(c) |
2,279 | 1,890 | 5,603 | 5,494 | |||||||||||||
DNOI(a) |
$ | 10,937 | $ | 14,904 | $ | 34,372 | $ | 52,724 | |||||||||
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDINGBASIC AND DILUTED |
75,876 | 74,296 | 74,588 | 71,526 | |||||||||||||
NUMBER OF COMMON SHARES OUTSTANDING AT PERIOD-END |
75,970 | 76,117 | 75,970 | 76,117 |
(a) | DNOI is net operating income before net investment loss, (loss) gain on extinguishment of debt and income tax (benefit) provision, as determined in accordance with accounting principles generally accepted in the United States, or GAAP, adjusted for amortization of employee restricted stock awards. We view DNOI and the related per share measures as useful and appropriate supplements to net operating income, net income, earnings per share and cash flows from operating activities. These measures serve as an additional measure of MCGs operating performance exclusive of employee restricted stock amortization, which represents an expense of the company but does not require settlement in cash. DNOI does include paid-in-kind, or PIK, interest and dividend income which are generally not payable in cash on a regular basis but rather at investment maturity or when declared. DNOI should not be considered as an alternative to net operating income, net income, earnings per share and cash flows from operating activities (each computed in accordance with GAAP). Instead, DNOI should be reviewed in connection with net operating income, net income, earnings per share and cash flows from operating activities in MCGs consolidated financial statements, to help analyze how MCGs business is performing. |
(b) | Based on common shares outstanding at period-end. |
(c) | Results for the three and nine months ended September 30, 2008 include $88 of amortization of employee restricted stock awards associated with our corporate restructuring. These expenses are reported as general and administrative expenses on our Consolidated Statements of Operations. |
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The following table summarizes key financial data for MCG Capital Corporation for the three months ended September 30, 2009 and 2008. You should refer to this data when reading our Managements Discussion and Analysis of Financial Condition and Results of Operations and our unaudited Condensed Consolidated Financial Statements and notes thereto.
Three months ended September 30, |
||||||||
(in thousands, except per share amounts) |
2009 | 2008 | ||||||
PORTFOLIO COMPANY DATA (FAIR VALUE) | ||||||||
Portfolio by type |
||||||||
Debt investments |
||||||||
Senior secured debt |
$ | 416,302 | $ | 383,493 | ||||
Subordinated debt |
||||||||
Secured |
292,144 | 453,336 | ||||||
Unsecured |
30,476 | 29,967 | ||||||
Total debt investments |
738,922 | 866,796 | ||||||
Equity investments |
||||||||
Preferred equity |
252,604 | 369,513 | ||||||
Common equity/equivalents |
45,718 | 60,160 | ||||||
Total equity investments |
298,322 | 429,673 | ||||||
Total portfolio |
$ | 1,037,244 | $ | 1,296,469 | ||||
% of total portfolio |
||||||||
Debt investments |
||||||||
Senior secured debt |
40.1 | % | 29.6 | % | ||||
Subordinated debt |
||||||||
Secured |
28.2 | 35.0 | ||||||
Unsecured |
2.9 | 2.3 | ||||||
Total debt investments |
71.2 | 66.9 | ||||||
Equity investments |
||||||||
Preferred equity |
24.4 | 28.5 | ||||||
Common equity/equivalents |
4.4 | 4.6 | ||||||
Total equity investments |
28.8 | 33.1 | ||||||
Total portfolio |
100.0 | % | 100.0 | % | ||||
YIELD ON AVERAGE LOAN PORTFOLIO (FAIR VALUE) |
||||||||
Average 90-Day LIBOR |
0.4 | % | 2.9 | % | ||||
Spread to avg. LIBOR on average loan portfolio excluding items below |
11.9 | 9.8 | ||||||
Impact of fee accelerations of unearned fees on paid/restructured loans |
0.1 | | ||||||
Impact of previously unaccrued loans |
| | ||||||
Impact of non-accrual loans |
(0.7 | ) | (0.8 | ) | ||||
Total yield on average loan portfolio |
11.7 | % | 11.9 | % | ||||
COMPOSITION OF LOAN PORTFOLIO BY INTEREST TYPE (FAIR VALUE) | ||||||||
% of loans with fixed interest rates |
41.2 | % | 41.1 | % | ||||
% of loans with floating interest rates |
58.8 | % | 58.9 | % | ||||
PERCENTAGE OF TOTAL DEBT INVESTMENTS (FAIR VALUE) | ||||||||
Loans on non-accrual status |
7.0 | % | 4.2 | % | ||||
Loans greater than 90 days past due |
1.4 | % | 0.2 | % | ||||
PERCENTAGE OF TOTAL DEBT INVESTMENTS (COST) | ||||||||
Loans on non-accrual status |
19.6 | % | 10.9 | % | ||||
Loans greater than 90 days past due |
4.7 | % | 1.1 | % | ||||
WEIGHTED AVERAGE PORTFOLIO COMPANY OPERATING METRICS(a) | ||||||||
Annual revenue(b)(c) |
$ | 126,860 | $ | 115,069 | ||||
Annual EBITDA(b)(c) |
19,284 | 16,081 | ||||||
Loan to value of non-broadly syndicated portfolio companies |
63.0 | % | 54.3 | % | ||||
Trailing twelve month equity EBITDA multiple(b)(d)(e) |
8.2x | 9.4x | ||||||
Forward twelve month equity EBITDA multiple(b)(c)(d)(e) |
7.5x | 8.7x | ||||||
Interest to EBITDA ratio(b) |
2.4x | 2.6x | ||||||
Debt to EBITDA ratio on the debt portfolio(e) |
6.3x | 5.3x |
(a) | Weighted based on the portfolio companys fair value as of the respective period end. |
(b) | Excludes portfolio companies with limited or no operations. |
(c) | Excludes public equity portfolio companies. |
(d) | Excludes portfolio companies valued on a liquidation basis. |
(e) | For portfolio companies with a nominal EBITDA amount, the EBITDA multiple is limited to 15x. In addition, the maximum debt to EBITDA ratio is limited to 15x. |
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ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The information contained in this section should be read in conjunction with the Selected Financial Data and our Condensed Consolidated Financial Statements and notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q.
This Quarterly Report on Form 10-Q, including Managements Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements that involve substantial risks and uncertainties. These forward-looking statements are not historical facts, but rather are based on current expectations, estimates, forecasts, projections, intentions, goals, strategies, plans, prospects and the beliefs and assumptions of our management, including, without limitation: our expectations regarding our results of operations, including revenues, net operating income, distributable net operating income, net investment losses and general and administrative expenses and the factors that may affect such results; the cause of unrealized losses; the performance of our current and former portfolio companies; our recent strategic initiatives, including monetizing assets (focusing on lower yielding equity investments), building liquidity, preserving capital and reducing debt obligations; our efforts to preserve net asset value and close the gap between net asset value and stock price; the amount, timing and price (relative to fair value) of asset monetizations; our efforts to rebuild stockholder value and our ability to enhance stockholder value by exploring new investment opportunities; our intention to pay only the minimum statutory dividend during 2009 and decision to make dividend distributions during 2010 based on quarterly assessments of liquidity, cash earnings and other key metrics; the timing of, and our ability to, repurchase equity, additional debt securities and make stockholder distributions; our future strategic plans, including plans to redeploy our investments in lower-yielding equity investments and cash in securitization and restricted accounts into new investment opportunities; our ability to generate operating income from new investments and to support the reinstitution and future growth of distributions to stockholders; the reduction in investments in equity securities to no more than 20% of the fair value of our total portfolio over the next few years; the limitation on future investing activities to debt investments; our level of investments in control companies beyond those that are currently in our portfolio; our underwriting process relative to macro economic conditions; our use of independent valuation firms to provide support for our internal valuation processes; our expectations regarding the pursuit of additional cost-saving measures during 2010; the management of our expense base relative to our asset size; the outcome of our tax appeal with the Internal Revenue Service; the sufficiency of liquidity, future cash flows from operations and monetizations to meet operating expenses during the upcoming year; our ability to access our SBIC facility and to exclude debt from our BDC asset coverage ratio; general market conditions; economic and other factors. Forward-looking statements can be identified by terminology such as anticipate, believe, could, could increase the likelihood, hope, target, project, goals, potential, predict, might, estimate, expect, intend, is planned, may, should, will, will enable, would be expected, look forward, may provide, would or similar terms, variations of such terms or the negative of those terms. These statements are not guarantees of future performance and are subject to risks, uncertainties, and other factors, some of which are beyond our control and difficult to predict. Important factors could cause our actual results to differ materially from those indicated or implied by forward-looking statements. Such factors that could cause or contribute to such differences include those risk factors discussed in Item IA of Part II of this Quarterly Report on Form 10-Q.
Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also could be incorrect. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this Quarterly Report on Form 10-Q should not be regarded as a representation by us that our plans and objectives will be achieved. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to update or revise any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.
DESCRIPTION OF BUSINESS
We are a solutions-focused commercial finance company providing capital and advisory services to middle-market companies throughout the United States. We make debt and equity investments primarily in companies with annual revenue of $20 million to $200 million and earnings before interest, taxes, depreciation and amortization, or EBITDA, of $3 million to $25 million, which we refer to as middle-market companies. Generally, our portfolio companies use our capital investment to finance acquisitions, recapitalizations, buyouts, organic
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growth and working capital. We identify and source new portfolio companies through multiple channels, including private equity sponsors, investment bankers, brokers, fund-less sponsors, institutional syndication partners, other club lenders and owner operators.
We are an internally managed, non-diversified, closed-end investment company that has elected to be regulated as a business development company, or BDC, under the Investment Company Act of 1940, or the 1940 Act. As a BDC we are required to meet various regulatory tests, which include investing at least 70% of our total assets in private or thinly traded public U.S.-based companies and meeting a 200% asset coverage ratio of total net assets to total senior securities, which include most of our borrowings (including accrued interest payable) and any preferred stock we may issue in the future. In addition, we have elected to be treated for federal income tax purposes as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code. In order to continue to qualify as a RIC for federal income tax purposes and obtain favorable RIC tax treatment, we must meet certain requirements, including certain minimum distribution requirements. If we satisfy these requirements, we generally will not have to pay corporate-level taxes on any income we distribute to our stockholders as dividends, allowing us to substantially reduce or eliminate our corporate-level tax liability. From time to time, our wholly owned subsidiaries may execute transactions that trigger corporate-level tax liabilities. In such cases, we recognize a tax provision in the period when it becomes more likely than not that the taxable event will occur.
RECENT DEVELOPMENTS
In late 2007, the United States entered into a period of recession, which has had a severe adverse impact on many companies, especially those in the financial services sector. Since the nation entered this recession, the stock market has plummeted precipitously, a number of financial institutions have failed, the availability of debt and equity capital became severely constrained, unemployment rose and consumer confidence eroded significantly, all of which led to a decline in consumer spending. As these events unfolded, banks and others in the financial services industries have had to recognize significant losses resulting primarily from a general decline in the fair value of their respective asset portfolios. In recent months, however, certain economic indicators have shown modest improvements. Nonetheless, we believe it is premature to conclude that these improvements are necessarily indicative of a sustained economic recovery and it is possible that the economy could again regress.
Consistent with other companies in the financial services industry, we have been affected adversely by many of these macro-economic events. For example, the deterioration in consumer confidence and general reduction in spending by both consumers and businesses led to an overall reduction in the performance of certain companies in our portfolio, as well as a reduction in certain comparable multiples that we use to estimate the fair value of certain companies in our investment portfolio. As a result, during the second half of 2008 and the first three quarters of 2009, we have had to reduce the fair value of a number of our debt and equity investments.
In 2008, we established a multi-pronged strategy aimed at preserving liquidity and strengthening our capital base, including: the suspension of dividends; the monetization of portfolio investments with an emphasis on monetizing junior debt and equity securities; the renegotiation of key borrowing agreements; and the reduction of general and administrative costs. We believe that the execution of this plan has helped to begin to rebuild value for our stockholders. For example:
| In February 2009, we successfully renegotiated three of our credit facilities, which provided us with continuing debt financing with repayment terms that are tied to future monetizations, as well as relaxed key covenant requirements. In October 2009, we also successfully renegotiated the maturity of our unsecured privately-placed notes issued in 2005 from October 2010 to October 2011; |
| The cash balance in our securitization and restricted accounts, which may be deployed for suitable new investment opportunities, has increased from $38.5 million as of December 31, 2008 to $89.2 million as of September 30, 2009. In addition, we maintained a $47.2 million balance of unrestricted cash and cash equivalents as of September 30, 2009; |
| Since our deleveraging initiatives began in July 2008, we have completed a total of $216.1 million of investment monetizations, including $124.0 million during the nine months ended September 30, 2009; |
| The fair value losses on our investment portfolio have declined. During the three months ended September 30, 2009, we recorded a $4.4 million loss on the fair value of our portfolio and other assets compared to a $79.7 million loss during the three months ended September 30, 2008; and |
| During the three months ended September 30, 2009, we reported earnings per share of $0.06, compared with a $0.90 loss per share during the same quarter of 2008. |
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While the execution of our 2008 strategic plan, combined with modest improvements in the economy, have enabled us to achieve these results, we continue to be cautious about the stability of the economy and the potential for further near-term economic growth. As such, in the third quarter of 2009 we undertook a comprehensive review of our historical performance and developed a multi-year strategic plan. The following sections describe our Strategic Plan and summarize the results from the implementation of our 2008 strategic plan.
STRATEGIC PLAN
During the third quarter of 2009, we developed a comprehensive strategic plan intended to enhance stockholder value, close the gap between our stock price and our net asset value, or NAV, and enable the future resumption of dividends. Since it is possible that the economy may not recover fully for several years, or may even regress, our strategic plan focuses on specific actions we can take regardless of the availability of incremental capital.
While management continues to be cautious about the state of the economy, we believe that we can increase stockholder value by converting lower-yielding equity investments and deploying cash in securitization and restricted accounts into yield-oriented new investment opportunities. As we execute this plan over the next several years, we plan to continue to monetize our equity portfolio, which has an average annual earnings yield of 1.9%, and redeploy that capital and cash held in securitization and restricted accounts into debt securities with interest yields that are expected to increase our operating income and support the reinstitution and future growth of distributions to our stockholders. As we execute on this monetization strategy, we will continue to focus on preserving our NAV and enhancing the overall return profile on our investment capital. We estimate this component of our strategy will reduce our investment in equity securities to no more than 20% of the fair value of our total portfolio over the next few years. We generally expect to limit our future investing activities to debt investments until such time that we have closed the valuation gap between our stock price and our NAV and can validate the performance returns of our existing equity portfolio. We do not intend to make significant investments in control companies beyond those that are currently in our portfolio for the foreseeable future. When making new investments we expect to underwrite credit in a manner consistent with our expectation that macro economic conditions will be under pressure for an extended period of time. Over time, if we can meet our goals with respect to leverage levels and unrestricted cash balances, we will seek to potentially repurchase equity and additional debt securities, subject to the limitations set forth in our private placement borrowing agreements. To help provide sustainable stockholder value, we expect to make future distributions to stockholders based upon a quarterly assessment of cash earnings, liquidity, statutory distribution requirements, asset coverage ratio and our borrowing agreements.
MONETIZATIONS
Since the second half of 2008, we have focused on the monetization of certain debt and equity investments in our portfolio to deleverage our balance sheet and build cash reserves. Beginning in 2008 and continuing into 2009, the availability of capital became increasingly constrained. Thus, it has become more challenging to consummate monetizations on a timely basis.
However, during the nine months ended September 30, 2009, we successfully monetized $124.0 million of our portfolio investments (at close to our carrying value). These monetizations include the sale of our equity investment in LMS Intellibound Investors, LLC, or LMS, in February 2009 for $40.5 million, or $16.3 million and $4.1 million above the most recently reported cost and fair value, respectively; as well as the $10.2 million prepayment of our subordinated debt investment in LMS at par in June 2009. Other monetizations completed during the first three quarters of 2009, include the February 2009 repayment of our $21.5 million second-lien debt investment in Dayton Parts Holding, LLC at par and $0.9 million above its most previously reported fair value; and the June 2009 repayment of our $18.7 million senior debt investment in Cervalis, LLC at par and $0.4 million above the most recently reported fair value. In April 2009, we monetized our senior debt and equity investment in TNR Holdings Corp., or TNR, for $11.6 million. Our monetization of TNR represents a distressed sale, which was completed at 23.8% and 42.3% of our most recently reported cost and fair value, respectively, which we exited after three major customers notified TNR that they did not intend to renew their contracts. In addition, in August 2009, we sold our equity investment in Coastal Sunbelt Holdings, Inc., for $15.2 million, or 98% of its most recently reported cost and fair value. A comprehensive list of 2009 monetization activity is included in the Portfolio Composition and Investment Activity section of this Managements Discussion and Analysis of Financial Conditions and Results of Operations.
In 2008, we successfully monetized $155.6 million of our portfolio assets, including $92.1 million of monetizations (at close to our carrying value) during the second half of the year. Since initiating our deleveraging initiatives in
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July 2008, we have completed a total of $216.1 million of investment monetizations, including 22 monetizations that were completed at 105.8% and 99.5% of their most recently reported cost and fair value, respectively, as well as the TNR distressed sale at 23.8% and 42.3% of its most recently reported cost and fair value, respectively.
We will strive to continue monetizing assets over the course of the next several quarters with a focus on monetizing lower yielding equity investments. However, the timing of such monetizations depends largely upon future market conditions. We are under no contractual or other obligation to monetize assets at specified times, levels or prices.
BORROWING AGREEMENTS
In October 2009, we successfully amended our Series 2005-A and Series 2007-A unsecured privately-placed notes. These amendments extended the scheduled maturity of the Series 2005-A Notes by one year to October 11, 2011. In addition, the amendments increased the interest rate on the Series 2005-A notes by 100 basis points to 9.98%. The amendments also required us to make a $5.0 million prepayment, spread ratably to holders of the Series 2005-A and Series 2007-A privately held notes. The percentage of net cash proceeds of any monetization of unencumbered investment assets to be swept to reduce amounts outstanding under the Unsecured Notes increased by 5% to 45% after the secured warehouse facility receives $7.5 million of net proceeds pursuant to its required 7.5% sweep. The interest rate and maturity of the Series 2007-A notes remains unchanged.
On May 4, 2009, we elected to repay our unsecured revolving line of credit prior to the maturity date of May 29, 2009. In February 2009, we successfully renegotiated three of our debt facilities. These amendments relaxed key covenant requirements under the borrowing facilities. Most significantly, the minimum net worth requirement was reduced from $654.0 million to $525.0 million, plus 50% of the proceeds from post amendment date equity issuances in our secured warehouse facility and to $500.0 million for our unsecured privately-placed notes. In addition, cross-default provisions related to our unsecured privately-placed notes were modified so that the defaults under other non-recourse facilities would not be an event of default for the unsecured notes. We also obtained a liquidity renewal and covenant relief from SunTrust Robinson Humphrey, Inc., or SunTrust, for our secured warehouse facility, which includes a final maturity for this facility of August 2011.
As described more fully in the Liquidity and Capital ResourcesBorrowings section of this Managements Discussion and Analysis of Financial Conditions and Results of Operations, we agreed to increase the interest rates paid under the facilities. These amendments provide us with continuing debt financing with repayment terms that are tied to future monetizations.
In addition to the borrowing facilities described above, our wholly owned subsidiary, Solutions Capital I, LP has a license, which allows us to borrow up to $130.0 million under the Small Business Investment Act of 1958, as amended, based upon our current commitment and existing approval by the United States Small Business Administration, or SBA. As of September 30, 2009, we had $27.6 million of debt under the facility. We must repay these borrowings within ten years after the borrowing date, which will occur between 2018 and 2022. In October 2008, we received exemptive relief from the Securities and Exchange Commission, or SEC, that, among other things, allows us effectively to exclude debt issued by Solutions Capital I, LP from the calculation of our consolidated BDC asset coverage ratio. The American Recovery and Reinvestment Act of 2009, which was passed into law in February 2009, included a provision that increased the maximum amount of outstanding leverage to available SBIC companies up to $150.0 million, representing a $12.9 million increase over the SBAs $137.1 million maximum limit as of December 31, 2008. The SBAs approval and commitment would be required in order to access this incremental borrowing capacity. To access the entire $150.0 million, we would have to fund a total of $56.4 million, in addition to the $18.6 million that we had funded through September 30, 2009. There is no assurance that we could draw up to the maximum limit available under the SBIC program.
DIVIDEND SUSPENSION
We did not declare dividends during the nine months ended September 30, 2009. Currently, we expect to apply certain losses for tax purposes in 2009 that we recognized for book purposes during 2008, which could result in a significant reduction to our statutorily required dividend payment in 2009. In order to preserve capital, we intend to pay the statutory minimum dividend for 2009. Due to anticipated loss transactions in the fourth quarter of 2009, we do not expect there will be any required distributions. We will make our decisions with respect to the actual level of 2010 dividends on a quarter-by-quarter basis during 2010, after taking into account the minimum statutorily required level of distributions, gains and losses recognized for tax purposes, portfolio transactional events, our liquidity, cash earnings and our asset coverage ratio at the time of such decision. Variables that could affect dividend levels in 2010 to meet our RIC requirements include the actual timing of gains and losses for tax purposes, equity investment monetizations and net operating income.
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REPURCHASE OF COLLATERALIZED LOAN OBLIGATIONS
In January 2009, we repurchased $7.5 million of collateralized loan obligations for $2.1 million that our wholly owned subsidiary, Commercial Loan Trust 2006-1, had previously issued. As a result of this purchase, we recognized a $5.4 million gain on extinguishment of debt for the quarter ended March 31, 2009. In total, since December 2008, we have repurchased a total of $22.6 million of collateralized loan obligations.
In addition to being able to extinguish this debt for less than 27% of the principal amount of the associated notes, our interest expense will be reduced by approximately $0.6 million of annual interest expense, based on LIBOR in effect as of September 30, 2009, over the remaining life of the Commercial Loan Trust 2006-1 facility.
CORPORATE RESTRUCTURING
In August 2008, we announced the implementation of a corporate restructuring that resulted in lower incentive compensation for our executives, a 27% reduction in our workforce and the closure of certain facilities. Subsequent to the August 2008 reduction in force, additional employees have separated from MCG, whom we do not expect to replace in the near-term and as of September 30, 2009 our workforce comprised 66 employees. Including our reduction in force and voluntary terminations, we have reduced our workforce from 101 to 66, or 35%, since we began our cost reduction initiatives. To further control our employee compensation expense, we implemented a base salary freeze for essentially all personnel during 2009. We expect to pursue additional cost-saving measures into 2010 and plan to manage our expense base relative to our asset size.
PERFORMANCE BASED INCENTIVE COMPENSATION
On July 23, 2009, our board of directors approved two compensation plans that are designed to incentivize management and key non-executive employees to increase stockholder value and our companys overall success. The 2009 Annual Incentive Cash Bonus Plan, provides executive officers and key non-executive employees the opportunity to earn up to an aggregate of $4.0 million of cash bonuses upon the achievement of certain individual and strategic goals during 2009 in each of five categories: 1) equity portfolio monetizations; 2) BDC asset coverage ratio; 3) earnings from the portfolio; 4) earnings per share; and 5) successful renegotiation of our credit facilities. The 2009 Long-Term Incentive Program, or LTIP, provides an opportunity for executive officers and key non-executive employees to receive a total of up to an aggregate of 865,000 shares of our restricted common stock to be issued under our Amended and Restated 2006 Employee Restricted Stock Plan and cash bonuses of up to an aggregate of $5.2 million if, among other things, the market price of MCGs common stock reaches specific price thresholds within the LTIPs 36-month performance period.
OVERVIEW OF RESULTS OF OPERATIONS
For the three months ended September 30, 2009, we reported net income of $4.2 million, or $0.06 per diluted share, compared to a net loss of $66.9 million, or $0.90 per diluted share, for the three months ended September 30, 2008. Our net operating income during the third quarter of 2009 was $8.7 million, or $0.11 per diluted share, compared to $13.0 million, or $0.18 per diluted share, during the third quarter of 2008.
The $4.2 million of net income reported for the three months ended September 30, 2009 primarily reflects the recognition of $4.4 million of net investment losses during the third quarter of 2009. These investment losses included $4.3 million of realized losses on our investments and $4.3 million of unrealized depreciation, which represents valuation write-downs of several portfolio investments, including $2.9 million and $2.6 million of unrealized depreciation on our investments in NPS Holdings Group, LLC and Coastal Sunbelt Real Estate, Inc., respectively. These losses were partially offset by a $4.2 million reversal of unrealized depreciation on our investments. The unrealized depreciation recognized on our portfolio investments was due predominantly to the performance of some of our portfolio companies and a reduction in certain comparable multiples used to estimate the fair value of our investments.
The $4.4 million, or 33.5%, decrease in net operating income during the third quarter of 2009 from the same quarter in 2008 was attributable primarily to a decrease in interest income resulting from lower average LIBOR, combined with an increase in the average balance of loans that are on non-accrual status and a decline in average loan balances.
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PORTFOLIO COMPOSITION AND INVESTMENT ACTIVITY
As of September 30, 2009, the fair value of our investment portfolio was $1,037.2 million, which represents a $165.9 million, or 13.8%, decrease from the $1,203.1 million fair value as of December 31, 2008. The following sections describe the composition of our investment portfolio as of September 30, 2009 and describe key changes in our portfolio during the nine months ended September 30, 2009.
PORTFOLIO COMPOSITION
The following table summarizes the composition of our investment portfolio at fair value:
September 30, 2009 | December 31, 2008 | |||||||||||||||
(dollars in thousands) |
Investments at Fair Value |
Percent of Total Portfolio |
Investments at Fair Value |
Percent of Total Portfolio |
||||||||||||
Debt investments |
||||||||||||||||
Senior secured debt |
$ | 416,302 | 40.1 | % | $ | 428,817 | 35.7 | % | ||||||||
Subordinated debt |
||||||||||||||||
Secured |
292,144 | 28.2 | 351,425 | 29.2 | ||||||||||||
Unsecured |
30,476 | 2.9 | 28,081 | 2.3 | ||||||||||||
Total debt investments |
738,922 | 71.2 | 808,323 | 67.2 | ||||||||||||
Equity investments |
||||||||||||||||
Preferred equity |
252,604 | 24.4 | 339,576 | 28.2 | ||||||||||||
Common/common equivalents equity |
45,718 | 4.4 | 55,249 | 4.6 | ||||||||||||
Total equity investments |
298,322 | 28.8 | 394,825 | 32.8 | ||||||||||||
Total investments |
$ | 1,037,244 | 100.0 | % | $ | 1,203,148 | 100.0 | % | ||||||||
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The following table summarizes our investment portfolio by industry at fair value:
September 30, 2009 | December 31, 2008 | |||||||||||||||
(dollars in thousands) |
Investments at Fair Value |
Percent of Total Portfolio |
Investments at Fair Value |
Percent of Total Portfolio |
||||||||||||
TelecommunicationsCLEC |
$ | 171,331 | 16.5 | % | $ | 173,789 | 14.4 | % | ||||||||
Communicationsother |
17,861 | 1.7 | 17,403 | 1.5 | ||||||||||||
Cable |
127,516 | 12.3 | 119,134 | 9.9 | ||||||||||||
Healthcare |
98,563 | 9.5 | 123,589 | 10.3 | ||||||||||||
Food services |
68,776 | 6.6 | 81,935 | 6.8 | ||||||||||||
Plastic products |
58,659 | 5.7 | 45,317 | 3.8 | ||||||||||||
Broadcasting |
52,337 | 5.0 | 66,401 | 5.5 | ||||||||||||
Business services |
48,840 | 4.7 | 77,213 | 6.4 | ||||||||||||
Electronics |
41,700 | 4.0 | 42,018 | 3.5 | ||||||||||||
Publishing |
34,890 | 3.4 | 34,743 | 2.9 | ||||||||||||
Laboratory instruments |
34,599 | 3.3 | 35,054 | 2.9 | ||||||||||||
Logistics |
33,863 | 3.3 | 66,950 | 5.6 | ||||||||||||
Sporting goods |
33,961 | 3.3 | 36,531 | 3.0 | ||||||||||||
Technology |
28,163 | 2.7 | 35,980 | 3.0 | ||||||||||||
Education |
27,064 | 2.6 | 29,062 | 2.4 | ||||||||||||
Consumer products |
26,223 | 2.5 | 22,855 | 1.9 | ||||||||||||
Industrial products |
26,353 | 2.5 | 26,246 | 2.2 | ||||||||||||
Home furnishings |
24,588 | 2.4 | 27,899 | 2.3 | ||||||||||||
Insurance |
22,497 | 2.2 | 21,258 | 1.8 | ||||||||||||
Leisure activities |
14,133 | 1.4 | 13,816 | 1.2 | ||||||||||||
Other media |
10,424 | 1.0 | 11,940 | 1.0 | ||||||||||||
Drugs |
10,208 | 1.0 | 11,234 | 0.9 | ||||||||||||
Auto parts |
8,635 | 0.8 | 31,011 | 2.6 | ||||||||||||
Information services |
8,047 | 0.8 | 13,618 | 1.1 | ||||||||||||
Entertainment |
738 | 0.1 | 28,268 | 2.4 | ||||||||||||
Other(a) |
7,275 | 0.7 | 9,884 | 0.7 | ||||||||||||
Total |
$ | 1,037,244 | 100.0 | % | $ | 1,203,148 | 100.0 | % | ||||||||
(a) | No individual industry within this category exceeds 1%. |
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As of September 30, 2009, our ten largest portfolio companies comprised 47.7% of the fair value of our investment portfolio. These ten customers accounted for 41.9% of our total revenue during the nine months ended September 30, 2009. As of September 30, 2009, approximately 18.2% of the fair value of our portfolio was invested in companies in the communications industry, of which 16.5% were competitive local exchange carriers, or CLECs. Our largest portfolio company, Broadview Networks Holdings, Inc., or Broadview, which is a CLEC, represents 13.4% of the fair value of our portfolio. Our remaining investments in the communications industry include an international telecommunications service provider, a paging service and a telecommunications tower company. See Results of Operations for additional information regarding our investment in Broadview.
In addition to the communications industry, we have concentrations in the cable, healthcare and food service industries. The following table summarizes, by industry, our fair value and revenue concentrations in our investments:
Investments at Fair Value | Revenue for the nine months ended | |||||||||||||||||||||||
September 30, 2009 | December 31, 2008 | September 30, 2009 | September 30, 2008 | |||||||||||||||||||||
(dollars in thousands) |
Amount | % of Total Portfolio |
Amount | % of Total Portfolio |
Amount | % of Total Revenue |
Amount | % of Total Revenue |
||||||||||||||||
Industry |
||||||||||||||||||||||||
Communications |
$ | 189,192 | 18.2 | % | $ | 191,192 | 15.9 | % | $ | 3,378 | 4.4 | % | $ | 13,936 | 13.2 | % | ||||||||
Cable |
127,516 | 12.3 | 119,134 | 9.9 | 8,296 | 10.9 | 7,912 | 7.5 | ||||||||||||||||
Healthcare |
98,563 | 9.5 | 123,589 | 10.3 | 8,909 | 11.7 | 11,354 | 10.8 | ||||||||||||||||
Food services |
68,776 | 6.6 | 81,935 | 6.8 | 8,884 | 11.7 | 8,079 | 7.7 |
OVERVIEW OF CHANGES IN INVESTMENT PORTFOLIO
During the nine months ended September 30, 2009, we made $74.6 million of originations and advances, including originations to five existing portfolio companies, compared to $103.1 million of originations and advances during the nine months ended September 30, 2008. The following table summarizes our total portfolio investment activity during the nine months ended September 30, 2009 and 2008:
Nine months ended September 30, |
||||||||
(in thousands) |
2009 | 2008 | ||||||
Beginning investment portfolio |
$ | 1,203,148 | $ | 1,545,090 | ||||
Originations and advances |
74,603 | 103,097 | ||||||
Gross payments, reductions and sales of securities |
(155,322 | ) | (172,675 | ) | ||||
Net unrealized loss |
(86,970 | ) | (175,032 | ) | ||||
Net realized loss |
(30,230 | ) | (9,173 | ) | ||||
Amortization of unearned income |
600 | 1,885 | ||||||
Reversals of unrealized depreciation |
31,415 | 3,277 | ||||||
Ending investment portfolio |
$ | 1,037,244 | $ | 1,296,469 | ||||
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The following table shows our originations and advances during the nine months ended September 30, 2009 and 2008 by security type:
Nine months ended September 30, | ||||||||||||
2009 | 2008 | |||||||||||
(dollars in thousands) |
Amount | % of Total | Amount | % of Total | ||||||||
Debt investments |
||||||||||||
Senior secured debt |
$ | 49,568 | 66.4 | % | $ | 36,741 | 35.6 | % | ||||
Subordinated debt |
||||||||||||
Secured |
11,055 | 14.8 | 39,671 | 38.5 | ||||||||
Unsecured |
3,766 | 5.1 | 2,218 | 2.2 | ||||||||
Total debt investments |
64,389 | 86.3 | 78,630 | 76.3 | ||||||||
Equity investments |
||||||||||||
Preferred equity |
10,214 | 13.7 | 24,430 | 23.7 | ||||||||
Common/common equivalents equity |
| | 37 | | ||||||||
Total equity investments |
10,214 | 13.7 | 24,467 | 23.7 | ||||||||
Total originations and advances |
$ | 74,603 | 100.0 | % | $ | 103,097 | 100.0 | % | ||||
The following table shows our gross payments, reductions and sales of securities during the nine months ended September 30, 2009 and 2008 by security type:
Nine months ended September 30, | ||||||||||||
2009 | 2008 | |||||||||||
(dollars in thousands) |
Amount | % of Total | Amount | % of Total | ||||||||
Debt investments |
||||||||||||
Senior secured debt |
$ | 50,589 | 32.6 | % | $ | 100,993 | 58.5 | % | ||||
Subordinated secured debt |
34,562 | 22.2 | 42,183 | 24.4 | ||||||||
Total debt investments |
85,151 | 54.8 | 143,176 | 82.9 | ||||||||
Equity investments |
||||||||||||
Preferred equity |
67,189 | 43.3 | 17,712 | 10.3 | ||||||||
Common/common equivalents equity |
2,982 | 1.9 | 11,787 | 6.8 | ||||||||
Total equity investments |
70,171 | 45.2 | 29,499 | 17.1 | ||||||||
Total originations and advances |
$ | 155,322 | 100.0 | % | $ | 172,675 | 100.0 | % | ||||
During the nine months ended September 30, 2009 and 2008, our gross payments, reductions and sales of securities by transaction type included:
Nine months ended September 30, | |||||||
(in thousands) |
2009 | 2008 | |||||
Sale of equity investments |
$ | 61,827 | $ | 22,726 | |||
Principal repayments |
53,411 | 83,384 | |||||
Scheduled principal amortization |
30,176 | 39,430 | |||||
Collection of accrued paid-in-kind interest and dividends |
9,908 | 8,402 | |||||
Loan sales |
| 18,733 | |||||
Total gross payments, reductions and sales of securities |
$ | 155,322 | $ | 172,675 | |||
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SIGNIFICANT CHANGES IN PORTFOLIO
As shown in the following table, during the nine months ended September 30, 2009, we monetized eleven portfolio investments with proceeds totaling $124.0 million:
Nine months ended September 30, 2009 | ||||||||||||
(in thousands) |
Principal Repayments |
Sale of Equity Investments |
PIK Interest and Dividend Prepayments |
Total | ||||||||
Monetizations |
||||||||||||
LMS Intellibound Investors, LLC |
$ | 10,000 | $ | 35,907 | $ | 4,729 | $ | 50,636 | ||||
Dayton Parts Holdings, LLC |
21,500 | | | 21,500 | ||||||||
Cervalis LLC |
18,688 | | | 18,688 | ||||||||
Coastal Sunbelt, LLC |
| 12,066 | 3,138 | 15,204 | ||||||||
TNR Holdings Corp. |
2,000 | 9,622 | | 11,622 | ||||||||
Crystal Media Network, LLC |
| 2,556 | | 2,556 | ||||||||
Jenzabar, Inc. |
| 1,250 | 575 | 1,825 | ||||||||
CEI Holdings Inc. |
665 | | | 665 | ||||||||
Partminer, Inc. |
250 | | 354 | 604 | ||||||||
XFone, Inc. |
| 426 | | 426 | ||||||||
Flexsol Packaging Corp. |
308 | | | 308 | ||||||||
Total monetizations |
53,411 | 61,827 | 8,796 | 124,034 | ||||||||
Other scheduled payments |
30,176 | | 1,112 | 31,288 | ||||||||
Total gross payments, reductions and sales of securities |
$ | 83,587 | $ | 61,827 | $ | 9,908 | $ | 155,322 | ||||
The proceeds from eight of these monetizations correlated closely with the most recently reported fair value of the associated investments. TNR, CEI Holdings Inc. and XFone, Inc. were completed at 42%, 41% and 17%, respectively, of their most recently reported fair values.
ASSET QUALITY
Asset quality is generally a function of portfolio company performance and economic conditions, as well as our underwriting and ongoing management of our investment portfolio. In addition to various risk management and monitoring tools, we use the following investment rating system to characterize and monitor our expected level of returns on each investment in our portfolio:
Investment |
Summary Description | |
1 | Capital gain expected or realized | |
2 | Full return of principal and interest or dividend expected with customer performing in accordance with plan | |
3 | Full return of principal and interest or dividend expected, but customer requires closer monitoring | |
4 | Some loss of interest or dividend expected, but still expect an overall positive internal rate of return on the investment | |
5 | Loss of interest or dividend and some loss of principal investment expected, which would result in an overall negative internal rate of return on the investment |
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The following table shows the distribution of our investments on our 1 to 5 investment rating scale at fair value as of September 30, 2009 and December 31, 2008:
(dollars in thousands) |
September 30, 2009 | December 31, 2008 | ||||||||||||||||
Investment Rating |
Investments at Fair Value |
% of Total Portfolio |
Investments at Fair Value |
% of Total Portfolio |
||||||||||||||
1 |
$ | 599,261 | (a) | 57.8 | % | $ | 719,765 | (a) | 59.8 | % | ||||||||
2 |
135,988 | 13.1 | 206,829 | 17.2 | ||||||||||||||
3 |
281,638 | 27.1 | 233,172 | 19.4 | ||||||||||||||
4 |
11,125 | 1.1 | 32,648 | 2.7 | ||||||||||||||
5 |
9,232 | 0.9 | 10,734 | 0.9 | ||||||||||||||
Total |
$ | 1,037,244 | 100.0 | % | $ | 1,203,148 | 100.0 | % | ||||||||||
(a) As of September 30, 2009 and December 31, 2008, Investment Rating 1 includes $244.3 million and $362.9 million, respectively, of loans to companies in which we also hold equity securities. |
|
When one of our loans becomes more than 90 days past due, or if we otherwise do not expect the customer to be able to service its debt and other obligations, we will, as a general matter, place the loan on non-accrual status and generally will cease recognizing interest income on that loan until all principal and interest has been brought current through payment or due to a restructuring such that the interest income is deemed to be collectible. However, we may make exceptions to this policy if the loan has sufficient collateral value and is in the process of collection. If the fair value of a loan is below cost, we may cease recognizing paid-in-kind interest and/or the accretion of a discount on the debt investment until such time that the fair value equals or exceeds cost.
The following table summarizes loans on non-accrual status and loans greater than 90 days past due, at cost, as of September 30, 2009 and December 31, 2008:
September 30, 2009 | December 31, 2008 | |||||||||||
(dollars in thousands) |
Investments at Cost |
% of Loan Portfolio |
Investments at Cost |
% of Loan Portfolio |
||||||||
Loans greater than 90 days past due |
||||||||||||
On non-accrual status |
$ | 41,201 | 4.68 | % | $ | 10,060 | 1.10 | % | ||||
Not on non-accrual status |
| | | | ||||||||
Total loans greater than 90 days past due |
$ | 41,201 | 4.68 | % | $ | 10,060 | 1.10 | % | ||||
Loans on non-accrual status |
||||||||||||
0 to 90 days past due |
$ | 131,850 | 14.96 | % | $ | 109,424 | 11.90 | % | ||||
Greater than 90 days past due |
41,201 | 4.68 | 10,060 | 1.10 | ||||||||
Total loans on non-accrual status |
$ | 173,051 | 19.64 | % | $ | 119,484 | 13.00 | % | ||||
The following table summarizes loans on non-accrual status and loans greater than 90 days past due, at fair value, as of September 30, 2009 and December 31, 2008:
September 30, 2009 | December 31, 2008 | |||||||||||
(dollars in thousands) |
Investments at Fair Value |
% of Loan Portfolio |
Investments at Fair Value |
% of Loan Portfolio |
||||||||
Loans greater than 90 days past due |
||||||||||||
On non-accrual status |
$ | 10,377 | 1.40 | % | $ | 695 | 0.09 | % | ||||
Not on non-accrual status |
| | | | ||||||||
Total loans greater than 90 days past due |
$ | 10,377 | 1.40 | % | $ | 695 | 0.09 | % | ||||
Loans on non-accrual status |
||||||||||||
0 to 90 days past due |
$ | 41,273 | 5.59 | % | $ | 38,619 | 4.77 | % | ||||
Greater than 90 days past due |
10,377 | 1.40 | 695 | 0.09 | ||||||||
Total loans on non-accrual status |
$ | 51,650 | 6.99 | % | $ | 39,314 | 4.86 | % | ||||
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The following table summarizes the changes in the cost and fair value of the loans in non-accrual status from December 31, 2008 through September 30, 2009:
Nine months ended September 30, 2009 |
||||||||
(In thousands) |
Cost | Fair Value | ||||||
Beginning non-accrual loan balance |
$ | 119,484 | $ | 39,314 | ||||
Additional loans on non-accrual statusby industry |
||||||||
Broadcasting |
11,462 | 6,716 | ||||||
Business services |
6,177 | 408 | ||||||
Healthcare |
30,867 | 3,835 | ||||||
Home furnishings |
17,640 | 13,948 | ||||||
Information services |
5,996 | 1,195 | ||||||
Total additional loans on non-accrual status |
72,142 | 26,102 | ||||||
Advances to companies on non-accrual status |
1,350 | 1,350 | ||||||
Loans converted to equity |
(10,731 | ) | | |||||
Payments received from loans on non-accrual status |
(7,620 | ) | (7,620 | ) | ||||
Change in unrealized loss on non-accrual loans |
| (5,922 | ) | |||||
Realized loss on non-accrual loans |
(1,574 | ) | (1,574 | ) | ||||
Total change in non-accrual loans |
53,567 | 12,336 | ||||||
Ending non-accrual loan balance |
$ | 173,051 | $ | 51,650 | ||||
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RESULTS OF OPERATIONS
The following section compares our results of operations for the three months ended September 30, 2009 to the three months ended September 30, 2008.
COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008
The following table summarizes the components of our net income (loss) for the three months ended September 30, 2009 and 2008:
Three months ended September 30, |
Variance | ||||||||||||||
(dollars in thousands) |
2009 | 2008 | $ | Percentage | |||||||||||
Revenue |
|||||||||||||||
Interest and dividend income |
|||||||||||||||
Interest income |
$ | 21,050 | $ | 26,825 | $ | (5,775 | ) | (21.5 | )% | ||||||
Dividend income |
1,289 | 2,751 | (1,462 | ) | (53.1 | ) | |||||||||
Loan fees |
719 | 807 | (88 | ) | (10.9 | ) | |||||||||
Total interest and dividend income |
23,058 | 30,383 | (7,325 | ) | (24.1 | ) | |||||||||
Advisory fees and other income |
553 | 913 | (360 | ) | (39.4 | ) | |||||||||
Total revenue |
23,611 | 31,296 | (7,685 | ) | (24.6 | ) | |||||||||
Operating expenses |
|||||||||||||||
Interest expense |
5,518 | 7,991 | (2,473 | ) | (30.9 | ) | |||||||||
Employee compensation |
|||||||||||||||
Salaries and benefits |
4,115 | 4,081 | 34 | 0.8 | |||||||||||
Amortization of employee restricted stock |
2,279 | 1,802 | 477 | 26.5 | |||||||||||
Total employee compensation |
6,394 | 5,883 | 511 | 8.7 | |||||||||||
General and administrative expense |
3,041 | 4,408 | (1,367 | ) | (31.0 | ) | |||||||||
Total operating expenses |
14,953 | 18,282 | (3,329 | ) | (18.2 | ) | |||||||||
Net operating income before net investment loss, loss on extinguishment of debt and income tax (benefit) provision |
8,658 | 13,014 | (4,356 | ) | (33.5 | ) | |||||||||
Net investment loss before income tax (benefit) provision |
(4,396 | ) | (79,724 | ) | 75,328 | 94.5 | |||||||||
Loss on extinguishment of debt before income tax (benefit) provision |
(118 | ) | | (118 | ) | NM | |||||||||
Income tax (benefit) provision |
(39 | ) | 236 | (275 | ) | NM | |||||||||
Net income (loss) |
$ | 4,183 | $ | (66,946 | ) | $ | 71,129 | NM | |||||||
NM=Not Meaningful
TOTAL REVENUE
Total revenue includes interest and dividend income and advisory fees and other income. During the three months ended September 30, 2009, our total revenue was $23.6 million, which represents a $7.7 million, or 24.6%, decrease from the three months ended September 30, 2008. This decline was composed of: a $5.8 million, or 21.5%, decrease in interest income; a $1.5 million, or 53.1%, decrease in dividend income; a $0.3 million, or 39.4%, decrease in advisory fees and other income; and a $0.1 million, or 10.9%, decrease in loan fees. We expect that our revenues will be below historical levels until such time that interest rates rise and/or we originate new investments. The following sections describe the reasons for these variances.
INTEREST INCOME
The level of interest income that we earn depends upon the level of interest-bearing investments outstanding during the period, as well as the weighted-average yield on these investments. The weighted-average yield varies each period because of changes in the composition of our portfolio of debt investments, changes in stated interest rates and the balance of loans on non-accrual status for which we are not accruing interest. During the three months ended September 30, 2009, the total yield on our average debt portfolio at fair value was 11.7% compared to 11.9% during the three months ended September 30, 2008. The weighted-average LIBOR was 0.4% during the three months ended September 30, 2009, compared to 2.9% during the three months ended September 30, 2008. The spread to average LIBOR on our average loan portfolio at fair value during the three months ended September 30, 2009 was 11.3% compared to 8.9% during the three months ended September 30, 2008, due to the decrease in LIBOR increasing the spreads on our fixed rate loans and loans with LIBOR floors, a decrease in the fair value of loans on non-accrual, and an increase in some of our rates on loans that we have amended since September 30, 2008.
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During the three months ended September 30, 2009, interest income was $21.0 million, compared to $26.8 million during the three months ended September 30, 2008, which represented a $5.8 million, or 21.5%, decrease. This decrease reflected a $5.8 million decrease resulting from a 250 basis point reduction in average LIBOR, a $5.3 million reduction from average loan balances and a $3.2 million decrease in interest income resulting from an increase in the average daily balance of loans that are on non-accrual status. These decreases were partially offset by a $6.1 million increase in interest income resulting from a 233 basis point increase in our spread to LIBOR and a $2.4 million increase in interest income resulting from the impact of interest rate floors.
PIK Income
Interest income includes certain amounts that we have not received in cash, such as contractual paid-in-kind, or PIK, interest. PIK interest represents contractually deferred interest that is added to the loan balance and which may be prepaid by either contract or the portfolio companys choice, but is generally paid at the end of the loan term. The following table shows the PIK-related activity for the three months ended September 30, 2009 and 2008, at cost:
Three months ended September 30, |
||||||||||||
(in thousands) |
2009 | 2008 | ||||||||||
Beginning PIK loan balance |
$ | 34,383 | $ | 19,965 | ||||||||
PIK interest earned during the period |
3,675 | 3,659 | ||||||||||
Interest receivable converted to PIK |
2,420 | 1,449 | ||||||||||
Principal payments of cash on PIK loans |
(378 | ) | (511 | ) | ||||||||
PIK converted to other securities |
(2,129 | ) | (889 | ) | ||||||||
Realized loss |
(81 | ) | | |||||||||
Ending PIK loan balance |
$ | 37,890 | $ | 23,673 | ||||||||
As of September 30, 2009 and 2008, we were not accruing interest on $11.1 million and $2.6 million, respectively, of the PIK loans shown in the preceding table.
DIVIDEND INCOME
We accrete dividends on equity investments with stated dividend rates as they are earned, to the extent that we believe the dividends will be paid ultimately and the associated portfolio company has sufficient value to support the accretion. We recognize dividends on our other equity investments when we receive the dividend payment. Our dividend income varies from period to period because of changes in the size and composition of our equity investments, the yield from the investments in our equity portfolio and the ability of the portfolio companies to declare and pay dividends. The following table summarizes our dividend activity for the three months ended September 30, 2009 and 2008:
Three months ended September 30, |
||||||||||||
(in thousands) |
2009 | 2008 | ||||||||||
Beginning accrued dividend balance |
$ | 89,520 | $ | 89,625 | ||||||||
Dividend income earned during the period |
1,289 | 2,751 | ||||||||||
Payment of dividends |
(3,175 | ) | (2,852 | ) | ||||||||
Ending accrued dividend balance |
$ | 87,634 | $ | 89,524 | ||||||||
During the three months ended September 30, 2009, our dividend income was $1.3 million, which represented a $1.5 million, or 53.1%, decrease from the three months ended September 30, 2008. This decrease in dividend income was partially due to the sale of three investments, Coastal Sunbelt, LLC, JUPR Holdings Inc. and LMS, which caused dividend income to decrease by $1.1 million. In addition, we ceased to accrete dividends on six investments, which resulted in an additional $0.7 million reduction in dividend income because the fair value of the investment did not support further accretion. We started accreting dividends on one investment, which partially offset these decreases by $0.3 million.
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In August 2009, the sale of our equity investment in Coastal Sunbelt, LLC resulted in the payment of $3.1 million of dividends that we had accreted up to that date.
LOAN FEES
Loan fees include origination fees on loans that we defer and amortize into interest income over the life of the loan. When repayments or restructurings with major modifications occur, we accelerate the recognition of previously unamortized loan origination fees into loan income. These accelerations have the effect of increasing current period income and may reduce future amortizable income. Because the repayments and restructurings may vary from period to period, the level of loan origination fees included in interest income may also vary. During the three months ended September 30, 2009, our loan fees decreased $0.1 million, or 10.9%, compared to the same period in 2008 primarily because of decreased loan origination activity. We anticipate that loan origination activity during the remainder of 2009 will continue to be lower than historical levels.
ADVISORY FEES AND OTHER INCOME
Advisory fees and other income primarily include fees related to advisory and management services, equity structuring fees, syndication fees, prepayment fees, bank interest and other income. Generally, advisory fees and other income relate to specific transactions or services and, therefore, may vary from period to period depending on the level and types of services provided. During the three months ended September 30, 2009, we earned $0.6 million of advisory fees and other income, which represents a $0.3 million, or 39.4%, decrease from the three months ended September 30, 2008. This decrease was due primarily to lower loan origination activity.
TOTAL OPERATING EXPENSES
Total operating expenses include interest, employee compensation and general and administrative expenses. During the three months ended September 30, 2009, we incurred $15.0 million of operating expenses, representing a $3.3 million, or 18.2%, decrease from the same quarter in the prior year. This decrease was composed of a $2.5 million decrease in interest expense and a $1.3 million decrease in general and administrative expense. These decreases were partially offset by a $0.5 million increase in employee compensation expense. The reasons for these variances are discussed in more detail below.
INTEREST EXPENSE
During the three months ended September 30, 2009, we incurred $5.5 million of interest expense, which represented a $2.5 million, or 30.9%, decrease from the same period in 2008. The previously described reduction in average LIBOR from 2.9% in the third quarter of 2008 to 0.4% in the third quarter of 2009 resulted in a $4.3 million decrease in interest expense. In addition, a decrease in average borrowing balances resulted in a $0.8 million decrease in interest expense. These decreases were partially offset by $2.4 million of additional interest, resulting from a widening of the interest rate spread from 1.4% during the three months ended September 30, 2008 to 2.8% during the three months ended September 30, 2009 and a $0.2 million increase in our amortization of debt costs. Interest expense for the three months ended September 30, 2009 and 2008 includes $0.2 million and $0.1 million, respectively, of interest expense associated with our average balances in our securitized and restricted cash accounts.
EMPLOYEE COMPENSATION
Employee compensation expense includes base salaries and benefits, variable annual incentive compensation and amortization of employee stock awards.
During the three months ended September 30, 2009, our employee compensation expense was $6.4 million, which represented a $0.5 million, or 8.7%, increase from the same period in 2008. Our salaries and benefits increased by $0.1 million, or 0.8%, primarily due to a $0.7 million increase in incentive compensation, partially offset by a $0.6 million decrease in salaries and benefits, reflecting a 27% reduction in force in August 2008, ten subsequent voluntary terminations and base compensation freezes for essentially all personnel in 2009.
During the three months ended September 30, 2009, we recognized $2.3 million of compensation expense related to restricted stock awards, compared to $1.8 million for the three months ended September 30, 2008, which represented a $0.5 million, or 26.5%, increase, primarily attributable to the amortization of restricted stock awarded to employees in September 2008 as part of the MCG Capital 2008 Retention Program and the amortization of stock which could be awarded to executives and key employees as part of our LTIP. Awards under the LTIP are contingent upon the closing price of MCGs stock meeting certain price thresholds and the approval of the Compensation Committee of our board of directors.
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GENERAL AND ADMINISTRATIVE
During the three months ended September 30, 2009, general and administrative expense was $3.0 million, which represented a $1.4 million, or 31.0%, decrease over the same period in 2008. This decrease was primarily attributable to $1.0 million of corporate restructuring charges recognized in the third quarter of 2008 and $0.2 million of fees paid in the third quarter of 2008 for borrowing facility transactions that were not consummated, as well as decreases in professional, depreciation, directors fees and employee recruitment expenses.
NET OPERATING INCOME BEFORE NET INVESTMENT LOSS, LOSS ON EXTINGUISHMENT OF DEBT AND INCOME TAX (BENEFIT) PROVISION
Net operating income before net investment loss, loss on extinguishment of debt and income tax (benefit) provision for the three months ended September 30, 2009 totaled $8.7 million, compared with $13.0 million for the three months ended September 30, 2008. This decrease was due to the items discussed above.
DISTRIBUTABLE NET OPERATING INCOME
Distributable net operating income, or DNOI, is net operating income before net investment loss, loss on extinguishment of debt and income tax (benefit) provision, as determined in accordance with accounting principles generally accepted in the United States, or GAAP, adjusted for amortization of employee restricted stock awards. We view DNOI and the related per share measures as useful and appropriate supplements to net operating income, net income, earnings per share and cash flows from operating activities. These measures serve as an additional measure of MCGs operating performance exclusive of employee restricted stock amortization, which represents an expense of the company, but does not require settlement in cash. DNOI does include PIK interest and dividend income which are generally not payable in cash on a regular basis but rather at investment maturity or when declared. DNOI should not be considered as an alternative to net operating income, net income, earnings per share or cash flows from operating activities (each computed in accordance with GAAP). Instead, DNOI should be reviewed in connection with net operating income, net income, earnings per share and cash flows from operating activities in MCGs consolidated financial statements, to help analyze how MCGs business is performing.
During the three months ended September 30, 2009, DNOI was $10.9 million, or $0.14 per share on a diluted basis, compared to $14.9 million, or $0.20 per share, for the three months ended September 30, 2008. The following table shows a reconciliation of our reported net operating income before net investment loss, loss on extinguishment of debt and income tax (benefit) provision to DNOI for the quarters ended September 30, 2009 and 2008:
Three months ended September 30, |
||||||||||
(in thousands, except per share data) |
2009 | 2008 | ||||||||
Net operating income before net investment loss, loss on extinguishment of debt and income tax (benefit) provision |
$ | 8,658 | $ | 13,014 | ||||||
Amortization of employee restricted stock awards |
2,279 | 1,890 | (b) | |||||||
DNOI |
$ | 10,937 | $ | 14,904 | ||||||
Weighted-average common shares outstandingbasic and diluted |
75,876 | 74,296 | ||||||||
Income (loss) per common sharebasic and diluted |
$ | 0.06 | $ | (0.90 | ) | |||||
Net operating income before net investment loss, loss on extinguishment of debt and income tax (benefit) provision per common sharebasic and diluted |
$ | 0.11 | $ | 0.18 | ||||||
DNOI per common sharebasic and diluted(a) |
$ | 0.14 | $ | 0.20 |
(a) | DNOI is net operating income before net investment loss, loss on extinguishment of debt and income tax (benefit) provision, as determined in accordance with GAAP, adjusted for amortization of employee restricted stock awards. Amortization of employee restricted stock awards represents a non-cash company expense. DNOI includes PIK, interest and dividend income that generally are not payable on a regular basis, but rather at maturity or when declared. DNOI is not an alternative to measures computed in accordance with GAAP, such as net operating income, net income, earnings per share or cash flows. Instead, DNOI is a non-GAAP metric that provides supplemental information about our business performance to consider together with GAAP measures. |
(b) | Includes $88 of amortization of employee restricted stock awards associated with our corporate restructuring. These expenses are reported as general and administrative expenses on our Consolidated Statements of Operations. |
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NET INVESTMENT LOSS BEFORE INCOME TAX (BENEFIT) PROVISION
During the three months ended September 30, 2009, we incurred $4.4 million of net investment losses before income tax (benefit) provision, compared to $79.7 million during the same period in 2008. These amounts represent the total of net realized gains and losses, net unrealized (depreciation) appreciation, and reversals of unrealized (appreciation) depreciation. We reverse unrealized (appreciation) depreciation at the time that we realize the gain or loss.
The following table summarizes our realized and unrealized (loss) and gain on investments and changes in our unrealized appreciation and depreciation on investments for the three months ended September 30, 2009:
(in thousands) | Three months ended September 30, 2009 | |||||||||||||||||||
Portfolio Company |
Industry | Type | Realized (Loss)/Gain |
Unrealized (Depreciation)/ Appreciation |
Reversal of Unrealized (Appreciation)/ Depreciation |
Net (Loss)/ Gain |
||||||||||||||
NPS Holdings Group, LLC |
Business Services | Control | $ | (1,580 | ) | $ | (2,921 | ) | $ | 1,574 | $ | (2,927 | ) | |||||||
Coastal Sunbelt Real Estate, Inc. |
Real Estate Investments | Non-affiliate | | (2,580 | ) | | (2,580 | ) | ||||||||||||
RadioPharmacy Investors, LLC |
Healthcare | Control | | (2,103 | ) | | (2,103 | ) | ||||||||||||
Jenzabar, Inc. |
Technology | Non-affiliate | | (2,000 | ) | | (2,000 | ) | ||||||||||||
Stratford School Holdings, Inc. |
Education | Affiliate | | (1,491 | ) | | (1,491 | ) | ||||||||||||
Jet Plastica Investors, LLC |
Plastic Products | Control | | 3,129 | | 3,129 | ||||||||||||||
Active Brands International, Inc. |
Consumer Products | Non-affiliate | | 2,763 | | 2,763 | ||||||||||||||
Intran Media, LLC |
Other Media | Control | | 1,349 | | 1,349 | ||||||||||||||
Golden Knight II CLO, Ltd |
Diversified Financial Services | Non-affiliate | | 1,144 | | 1,144 | ||||||||||||||
Flexsol Packaging Corp. |
Plastic Products | Non-affiliate | (2,821 | ) | | 2,772 | (49 | ) | ||||||||||||
Other |
79 | (1,540 | ) | (170 | ) | (1,631 | ) | |||||||||||||
Total |
$ | (4,322 | ) | $ | (4,250 | ) | $ | 4,176 | $ | (4,396 | ) | |||||||||
During the quarter ended September 30, 2009, we recapitalized National Product Services, Inc. into NPS Holdings Group, LLC. As a result of this recapitalization, we reversed $1.6 million of unrealized depreciation and realized a $1.6 million loss. Subsequent to the recapitalization, we recorded $2.9 million of unrealized depreciation on our investment in NPS Holdings Group, LLC. During July 2009, our investment in subordinated debt of Flexsol Packaging was settled at approximately our reported fair value for this investment. As a result of this settlement, we reversed $2.8 million of previously unrealized depreciation and realized a $2.8 million loss. The remaining unrealized depreciation shown in the above table resulted predominantly from a change in the performance of certain of our portfolio companies, and to a lesser extent, the comparable multiples that we used to estimate the fair value of the investments.
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The following table summarizes our realized gain and (loss) on our investments and changes in unrealized appreciation and depreciation on our investments during the three months ended September 30, 2008:
(in thousands) | Three Months Ended September 30, 2008 | |||||||||||||||||||
Portfolio Company |
Industry | Type | Realized (Loss)/ Gain |
Unrealized Appreciation/ (Depreciation) |
Reversal of Unrealized (Appreciation)/ Depreciation |
Net Gain/ (Loss) |
||||||||||||||
Broadview Networks Holdings, Inc. |
Communications | Control | $ | | $ | (48,189 | ) | $ | | $ | (48,189 | ) | ||||||||
Intran Media, LLC. |
Other Media | Control | | (6,115 | ) | | (6,115 | ) | ||||||||||||
Total Sleep Holdings, Inc. |
Healthcare | Control | | (5,694 | ) | | (5,694 | ) | ||||||||||||
Working Mother Media, Inc. |
Publishing | Control | (20,750 | ) | | 15,404 | (5,346 | ) | ||||||||||||
GMC Television Broadcasting, LLC |
Broadcasting | Control | | (5,273 | ) | | (5,273 | ) | ||||||||||||
National Product Services, Inc. |
Business Services | Control | | (4,097 | ) | | (4,097 | ) | ||||||||||||
Jet Plastica Investors, LLC |
Plastic Products | Control | | (3,249 | ) | | (3,249 | ) | ||||||||||||
Active Brands International, Inc. |
Consumer Products | Non-affiliate | | (2,762 | ) | | (2,762 | ) | ||||||||||||
Philadelphia Newspapers, LLC |
Newspaper | Non-affiliate | | (1,596 | ) | | (1,596 | ) | ||||||||||||
G&L Investment Holdings, LLC |
Insurance | Non-affiliate | | (1,205 | ) | | (1,205 | ) | ||||||||||||
Cruz Bay Publishing, Inc. |
Publishing | Non-affiliate | | (1,083 | ) | | (1,083 | ) | ||||||||||||
CWP/RMK Acquisition Corp. |
Home Furnishings | Non-affiliate | | (1,037 | ) | | (1,037 | ) | ||||||||||||
Coastal Sunbelt, LLC |
Food Services | Control | | (1,034 | ) | | (1,034 | ) | ||||||||||||
Wiesner Publishing Company, LLC |
Publishing | Non-affiliate | 5,344 | | (5,503 | ) | (159 | ) | ||||||||||||
Stratford School Holdings, Inc. |
Education | Affiliate | | 4,624 | | 4,624 | ||||||||||||||
MCI Holdings LLC |
Healthcare | Non-affiliate | | 2,458 | | 2,458 | ||||||||||||||
Avenue Broadband LLC |
Cable | Control | | 2,329 | | 2,329 | ||||||||||||||
Jenzabar, Inc. |
Technology | Non-affiliate | | 1,423 | | 1,423 | ||||||||||||||
JUPR Holdings, Inc. |
Information Services | Control | 5,994 | | (5,958 | ) | 36 | |||||||||||||
Other |
(51 | ) | (3,621 | ) | (83 | ) | (3,755 | ) | ||||||||||||
Total |
$ | (9,463 | ) | $ | (74,121 | ) | $ | 3,860 | $ | (79,724 | ) | |||||||||
During the three months ended September 30, 2008, we recorded $48.2 million of unrealized depreciation on Broadview, primarily resulting from a reduction of the comparable multiples that we used to estimate Broadviews fair value. In September 2008, we also sold substantially all of the assets of Working Mother Media, Inc., for net proceeds of $4.3 million, which resulted in a $5.3 million loss in addition to $15.4 million of unrealized depreciation on this investment reported as of June 30, 2008. We also sold our investments in Wiesner Publishing Company, LLC and JUPR Holdings, Inc. for approximately fair value of these investments reported as of June 30, 2008. These changes and the remaining unrealized depreciation shown in the above table predominantly resulted from a change in the comparable multiples that we used to estimate the fair value of the investments and, to a lesser extent, the performance of some portfolio companies.
LOSS ON EXTINGUISHMENT OF DEBT
We incurred a $0.1 million premium, when we repurchased $5.9 million of our private placement notes during the third quarter of 2009. This premium represents 102% of the principal amount to be purchased with monetization proceeds as required by our agreement with the holders of these unsecured notes.
INCOME TAX (BENEFIT) PROVISION
During the three months ended September 30, 2009, we recorded $0.1 million income tax benefit compared to a $0.2 million income tax provision during the three months ended September 30, 2008. Our income taxes primarily relate to unrealized gains and losses on our investments and the performance of certain of our investments that are held in taxable subsidiaries.
In December 2007, we received an examination report from the IRS related to its audit of our tax returns for the 2004 and 2005 tax years. The IRS proposed changes to certain deductions made by us for those years, primarily associated with the timing of certain realized losses in our portfolio. We are appealing the proposed changes and believe it is more likely than not that our appeal will be successful. If our appeal is not successful, we could be subject to up to $20.5 million of additional taxes, interest and penalties and we could be required to make up to
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$25.1 million of additional cash and/or stock distributions to our stockholders, although alternative options may be available to us in lieu of such distributions. At the present time, we believe that our total obligation associated with this examination should not exceed $1.0 million, including additional taxes, interest and penalties accrued through the settlement. We accrued the income tax expense for the majority of this estimated obligation in previous quarters. If, in the future, we believe our total obligation associated with this examination will increase, we would accrue the additional estimated amounts due.
NET INCOME (LOSS)
During the three months ended September 30, 2009, we recorded net income of $4.2 million, compared to a net loss of $66.9 million during the three months ended September 30, 2008. This improvement is attributable to the items discussed above.
COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008
The following table summarizes the components of our net loss for the nine months ended September 30, 2009 and 2008:
Nine months ended September 30, |
Variance | ||||||||||||||
(dollars in thousands) |
2009 | 2008 | $ | Percentage | |||||||||||
Revenue |
|||||||||||||||
Interest and dividend income |
|||||||||||||||
Interest income |
$ | 67,196 | $ | 82,873 | $ | (15,677 | ) | (18.9 | )% | ||||||
Dividend income |
4,815 | 17,429 | (12,614 | ) | (72.4 | ) | |||||||||
Loan fees |
2,072 | 2,620 | (548 | ) | (20.9 | ) | |||||||||
Total interest and dividend income |
74,083 | 102,922 | (28,839 | ) | (28.0 | ) | |||||||||
Advisory fees and other income |
2,072 | 2,470 | (398 | ) | (16.1 | ) | |||||||||
Total revenue |
76,155 | 105,392 | (29,237 | ) | (27.7 | ) | |||||||||
Operating expenses |
|||||||||||||||
Interest expense |
18,391 | 26,706 | (8,315 | ) | (31.1 | ) | |||||||||
Employee compensation |
|||||||||||||||
Salaries and benefits |
10,824 | 13,673 | (2,849 | ) | (20.8 | ) | |||||||||
Amortization of employee restricted stock |
5,603 | 5,406 | 197 | 3.6 | |||||||||||
Total employee compensation |
16,427 | 19,079 | (2,652 | ) | (13.9 | ) | |||||||||
General and administrative expense |
12,568 | 12,377 | 191 | 1.5 | |||||||||||
Total operating expenses |
47,386 | 58,162 | (10,776 | ) | (18.5 | ) | |||||||||
Net operating income before net investment loss, gain on extinguishment of debt and income tax (benefit) provision |
28,769 | 47,230 | (18,461 | ) | (39.1 | ) | |||||||||
Net investment loss before income tax (benefit) provision |
(86,711 | ) | (180,610 | ) | 93,899 | 52.0 | |||||||||
Gain on extinguishment of debt |
5,025 | | 5,025 | NM | |||||||||||
Income tax (benefit) provision |
(293 | ) | 568 | (861 | ) | NM | |||||||||
Net loss |
$ | (52,624 | ) | $ | (133,948 | ) | $ | 81,324 | 60.7 | ||||||
NM=Not Meaningful
TOTAL REVENUE
During the nine months ended September 30, 2009, our total revenue was $76.2 million, which represents a $29.2 million, or 27.7%, decrease from the nine months ended September 30, 2008. This decline was composed of a $15.7 million, or 18.9%, decrease in interest income; a $12.6 million, or 72.4%, decrease in dividend income; a $0.5 million, or 20.9%, decrease in loan fees and a $0.4 million, or 16.1%, decrease in advisory fees and other income. We expect that our revenues will be below historical levels until such time that interest rates rise and/or we originate new investments. The following sections describe the reasons for these variances.
INTEREST INCOME
During the nine months ended September 30, 2009, the total yield on our average debt portfolio at fair value was 11.9% compared to 11.7% during the nine months ended September 30, 2008. The spread to average LIBOR on
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our average loan portfolio at fair value during the nine months ended September 30, 2009 was 11.0% compared to 8.7% during the nine months ended September 30, 2008. The weighted-average LIBOR was 0.8% during the nine months ended September 30, 2009, compared to 3.0% during the nine months ended September 30, 2008. The decrease in LIBOR resulted in an increase on the spreads on both our fixed-rate loans and on variable-rate loans with LIBOR floors.
During the nine months ended September 30, 2009, interest income was $67.2 million, compared to $82.9 million during the nine months ended September 30, 2008, which represented a $15.7 million, or 18.9%, decrease. This decrease primarily reflected a $17.3 million decrease in interest income resulting from a 20.4% decrease in the average balance of loans in our portfolio. In addition, the previously discussed decrease in LIBOR resulted in a $15.7 million decrease in interest income and an increase in the average daily balance of loans that were on non-accrual status resulted in a $9.5 million decrease in interest income. These decreases were partially offset by a $20.1 million increase in interest income, resulting from a 236 basis point increase in our spread to LIBOR and a $6.7 million increase in interest income resulting from the impact of interest rate floors.
PIK Income
The following table shows the PIK related activity for the nine months ended September 30, 2009 and 2008, at cost:
Nine months ended September 30, |
||||||||||||
(in thousands) |
2009 | 2008 | ||||||||||
Beginning PIK loan balance |
$ | 26,354 | $ | 17,685 | ||||||||
PIK interest earned during the period |
12,098 | 10,855 | ||||||||||
Interest receivable converted to PIK |
3,212 | 4,170 | ||||||||||
Principal payments of cash on PIK loans |
(1,564 | ) | (4,881 | ) | ||||||||
PIK converted to other securities |
(2,129 | ) | (4,156 | ) | ||||||||
Realized loss |
(81 | ) | | |||||||||
Ending PIK loan balance |
$ | 37,890 | $ | 23,673 | ||||||||
As of September 30, 2009 and 2008, we were not accruing interest on $11.1 million and $2.6 million, respectively, of the PIK loans shown in the preceding table.
DIVIDEND INCOME
The following table summarizes our dividend activity for the nine months ended September 30, 2009 and 2008:
Nine months ended September 30, |
||||||||||||
(in thousands) |
2009 | 2008 | ||||||||||
Beginning accrued dividend balance |
$ | 91,770 | $ | 75,614 | ||||||||
Dividend income earned during the period |
4,815 | 17,429 | ||||||||||
Payment of dividends |
(8,344 | ) | (3,519 | ) | ||||||||
Accrued dividends converted to other securities |
(607 | ) | | |||||||||
Ending accrued dividend balance |
$ | 87,634 | $ | 89,524 | ||||||||
During the nine months ended September 30, 2009, our dividend income was $4.8 million, which represented a $12.6 million, or 72.4%, decrease from the nine months ended September 30, 2008. During the second quarter of 2008, we stopped accreting dividends on our Broadview investment, because our fair value reflects the full value of this investment. As a result, during the nine months ended September 30, 2009, we did not accrete any dividends from our Broadview investment, as compared to the $8.0 million of dividends we accreted for this investment during the nine months ended September 30, 2008. In addition, the sales of our investments in Coastal Sunbelt, LLC, JUPR Holdings Inc. and LMS resulted in a $2.4 million reduction in dividend income. We also ceased to accrete dividends on six investments, which resulted in an additional $2.5 million reduction in dividend income because the fair value of the investment did not support further accretion.
In February 2009, the sale of our equity investment in LMS resulted in the payment of $4.6 million of dividends that we had accreted up to that date. In August 2009, the sale of our equity investment in Coastal Sunbelt, LLC resulted in the payment of $3.1 million of dividends that we had accreted up to that date.
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LOAN FEES
During the nine months ended September 30, 2009, our loan fees decreased $0.5 million, or 20.9%, compared to the same period in 2008 primarily because of decreased loan origination activity. We anticipate that loan origination activity during the remainder of 2009 will continue to be lower than historical levels.
TOTAL OPERATING EXPENSES
During the nine months ended September 30, 2009, we incurred $47.4 million of operating expenses, representing a $10.8 million, or 18.5%, decrease from the same period in 2008. This decrease was composed of an $8.3 million decrease in interest expense and a $2.7 million decrease in employee compensation expenses. These decreases were partially offset by a $0.2 million increase in general and administrative expense. The reasons for these variances are discussed in more detail below.
INTEREST EXPENSE
During the nine months ended September 30, 2009, we incurred $18.4 million of interest expense, which represented an $8.3 million, or 31.1%, decrease from the same period in 2008. The previously described reduction in average LIBOR from 3.0% in the first nine months of 2008 to 0.8% in the first nine months of 2009 resulted in an $11.5 million decrease in interest expense. In addition, a decrease in average borrowing balances resulted in a $2.6 million decrease in interest expense. These decreases were partially offset by $4.4 million of additional interest resulting from a widening of the interest rate spread from 1.7% during the nine months ended September 30, 2008 to 2.5% during the nine months ended September 30, 2009; and a $1.4 million increase in our amortization of debt costs. As discussed in Liquidity and Capital ResourcesBorrowings, we renegotiated amendments to three of our debt facilities in February 2009. Interest expense for the nine months ended September 30, 2009 and 2008 includes $0.6 million and $0.1 million, respectively, of interest expense associated with our average balances in our securitized and restricted cash accounts.
EMPLOYEE COMPENSATION
During the nine months ended September 30, 2009, our employee compensation expense was $16.4 million, which represented a $2.7 million, or 13.9%, decrease from the same period in 2008. Salaries and benefits decreased by $2.8 million, or 20.8%, primarily as a result of the previously described reduction in our workforce in August 2008 and voluntary terminations.
During the nine months ended September 30, 2009, we recognized $5.6 million of compensation expense related to restricted stock awards, compared to $5.4 million for the nine months ended September 30, 2008, which represented a $0.2 million, or 3.6%, increase, primarily attributable to the amortization of restricted stock awarded to employees in September 2008 as part of the MCG Capital 2008 Retention Program and the amortization of stock which could be awarded to executives and key employees as part of our LTIP. Awards under the LTIP are contingent upon the closing price of MCGs stock meeting certain price thresholds and the approval of the Compensation Committee of our board of directors. The increases from these additional awards were largely offset by the absence of amortization expense associated with restricted stock awards that were forfeited by separated employees.
GENERAL AND ADMINISTRATIVE
During the nine months ended September 30, 2009, general and administrative expense was $12.6 million, which represented a $0.2 million, or 1.5%, increase over the same period in 2008. This increase was attributable primarily to $1.7 million of expense associated with our settlement of matters pertaining to the contested election of directors to our board of directors at our 2009 Annual Meeting, a $1.1 million increase in insurance expense and $0.9 million of severance costs related to an executives departure. These increases were partially offset by $1.0 million of corporate restructuring charges recognized in the third quarter of 2008, $0.7 million of fees paid in 2008 for borrowing facility transactions that were not consummated, as well as decreases in occupancy, travel and employee recruitment expenses.
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NET OPERATING INCOME BEFORE NET INVESTMENT LOSS, GAIN ON EXTINGUISHMENT OF DEBT AND INCOME TAX (BENEFIT) PROVISION
Net operating income before net investment losses, gains on extinguishment of debt and income tax (benefit) provision for the nine months ended September 30, 2009 totaled $28.8 million, compared with $47.2 million for the nine months ended September 30, 2008. This decrease is due to the items discussed above.
DISTRIBUTABLE NET OPERATING INCOME
During the nine months ended September 30, 2009, DNOI was $34.4 million, or $0.46 per share, compared to $52.7 million, or $0.74 per share, for the nine months ended September 30, 2008. The following table shows a reconciliation of our reported net operating income before net investment loss, gain on extinguishment of debt and income tax (benefit) provision to DNOI for the nine months ended September 30, 2009 and 2008:
Nine months ended September 30, |
||||||||
(in thousands, except per share data) |
2009 | 2008 | ||||||
Net operating income before net investment loss, gain on extinguishment of debt and income tax (benefit) provision |
$ | 28,769 | $ | 47,230 | ||||
Amortization of employee restricted stock awards |
5,603 | 5,494 | (b) | |||||
DNOI |
$ | 34,372 | $ | 52,724 | ||||
Weighted-average common shares outstandingbasic and diluted
|
|
74,588
|
|
|
71,526
|
| ||
Loss per common sharebasic and diluted |
$ | (0.71 | ) | $ | (1.87 | ) | ||
Net operating income before net investment loss, gain on extinguishment of debt and income tax (benefit) provision per common sharebasic and diluted |
$ | 0.39 | $ | 0.66 | ||||
DNOI per common sharebasic and diluted(a) |
$ | 0.46 | $ | 0.74 |
(a) | DNOI is net operating income before net investment loss, gain on extinguishment of debt and income tax (benefit) provision, as determined in accordance with GAAP, adjusted for amortization of employee restricted stock awards. Amortization of employee restricted stock awards represents a non-cash company expense. DNOI includes PIK, interest and dividend income that generally are not payable on a regular basis, but rather at maturity or when declared. DNOI is not an alternative to measures computed in accordance with GAAP, such as net operating income, net income, earnings per share and cash flows. Instead, DNOI is a non-GAAP metric that provides supplemental information about our business performance to consider together with GAAP measures. |
(b) | Includes $88 of amortization of employee restricted stock awards associated with our corporate restructuring. These expenses are reported as general and administrative expenses on our Consolidated Statements of Operations. |
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NET INVESTMENT LOSS BEFORE GAIN ON EXTINGUISHMENT OF DEBT AND INCOME TAX (BENEFIT) PROVISION
The following table summarizes our realized (loss) and gain on investments and changes in our unrealized appreciation and depreciation on investments for the nine months ended September 30, 2009:
(in thousands) | Nine months ended September 30, 2009 | |||||||||||||||||||
Portfolio Company |
Industry | Type | Realized (Loss)/Gain |
Unrealized Appreciation (Depreciation) |
Reversal of Unrealized (Appreciation)/ Depreciation |
Net (Loss)/ Gain |
||||||||||||||
Total Sleep Holdings, Inc. |
Healthcare | Control | $ | | $ | (23,665 | ) | $ | | $ | (23,665 | ) | ||||||||
TNR Holdings Corp. |
Entertainment | Control | (36,697 | ) | (15,801 | ) | 36,889 | (15,609 | ) | |||||||||||
GMC Television Broadcasting, LLC |
Broadcasting | Control | | (6,982 | ) | | (6,982 | ) | ||||||||||||
Jenzabar, Inc. |
Technology | Non-affiliate | | (6,258 | ) | | (6,258 | ) | ||||||||||||
NPS Holdings Group, LLC |
Business Services | Control | (1,580 | ) | (5,040 | ) | 1,574 | (5,046 | ) | |||||||||||
Avenue Broadband LLC |
Cable | Control | | (4,556 | ) | | (4,556 | ) | ||||||||||||
Superior Industries Investors, LLC |
Sporting Goods | Control | | (4,315 | ) | | (4,315 | ) | ||||||||||||
VOX Communications Group Holdings, LLC |
Broadcasting | Non-affiliate | | (4,299 | ) | | (4,299 | ) | ||||||||||||
CWP/RMK Acquisition Corp. |
Home Furnishings | Non-affiliate | | (3,433 | ) | | (3,433 | ) | ||||||||||||
Summit Business Media Intermediate Holding Company, LLC |
Information Services | Non-affiliate | | (3,066 | ) | | (3,066 | ) | ||||||||||||
RadioPharmacy Investors, LLC |
Healthcare | Control | | (2,849 | ) | | (2,849 | ) | ||||||||||||
Coastal Sunbelt Real Estate, Inc. |
Real Estate Investments | Non-affiliate | | (2,784 | ) | | (2,784 | ) | ||||||||||||
Xpressdocs Holdings, Inc. |
Business Services | Non-affiliate | | (2,558 | ) | | (2,558 | ) | ||||||||||||
Stratford School Holdings, Inc. |
Education | Affiliate | | (2,538 | ) | | (2,538 | ) | ||||||||||||
Intran Media, LLC |
Other Media | Control | | (1,545 | ) | | (1,545 | ) | ||||||||||||
Construction Trailer Specialists, Inc. |
Auto Parts | Non-affiliate | | (1,481 | ) | | (1,481 | ) | ||||||||||||
Cleartel Communications, Inc. |
Communications | Control | | (1,352 | ) | | (1,352 | ) | ||||||||||||
CEI Holdings Inc. |
Cosmetics | Non-affiliate | (3,190 | ) | (926 | ) | 3,179 | (937 | ) | |||||||||||
Flexsol Packaging Corp. |
Plastic Products | Non-affiliate | (2,821 | ) | (847 | ) | 2,772 | (896 | ) | |||||||||||
Orbitel Holdings, LLC |
Cable | Control | | 2,066 | | 2,066 | ||||||||||||||
Cyrus Networks, LLC |
Business Services | Non-affiliate | | 1,406 | | 1,406 | ||||||||||||||
LMS Intellibound Investors, LLC |
Logistics | Control | 16,257 | | (15,065 | ) | 1,192 | |||||||||||||
JetBroadband Holdings, LLC |
Cable | Control | | 1,149 | | 1,149 | ||||||||||||||
XFone, Inc. |
Communications | Affiliate | (1,969 | ) | | 1,969 | | |||||||||||||
Other |
128 | 1,420 | 97 | 1,645 | ||||||||||||||||
Total |
$ | (29,872 | ) | $ | (88,254 | ) | $ | 31,415 | $ | (86,711 | ) | |||||||||
As shown in the above table, we recorded $23.7 million of unrealized depreciation on Total Sleep Holdings, Inc., primarily resulting from company performance. In addition, we recorded a $36.7 million realized loss on TNR and $15.8 million unrealized depreciation, which was partially offset by the reversal of $36.9 million of unrealized depreciation resulting in a $15.6 million net loss on this investment. Also, we realized a $16.3 million gain on LMS, which was partially offset by the reversal of $15.1 million of unrealized appreciation, which resulted in a $1.2 million net gain. These changes and the remaining unrealized depreciation shown in the above table resulted predominantly from a change in the performance of certain of the portfolio companies, and, to a lesser extent, the comparable multiples that we used to estimate the fair value of the investments.
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The following table summarizes our realized gain and (loss) on investments and changes in our unrealized appreciation and depreciation on investments for the nine months ended September 30, 2008:
(in thousands) | Nine months Ended September 30, 2008 | |||||||||||||||||||
Portfolio Company |
Industry |
Type |
Realized (Loss)/Gain |
Unrealized Appreciation/ (Depreciation) |
Reversal of Unrealized (Appreciation)/ Depreciation |
Net Gain/ (Loss) |
||||||||||||||
Broadview Networks Holdings, Inc. |
Communications | Control | $ | | $ | (52,242 | ) | $ | | $ | (52,242 | ) | ||||||||
Jet Plastica Investors, LLC |
Plastic Products | Control | | (36,300 | ) | | (36,300 | ) | ||||||||||||
Cleartel Communications, Inc. |
Communications | Control | | (33,243 | ) | | (33,243 | ) | ||||||||||||
Working Mother Media, Inc. |
Publishing | Control | (20,750 | ) | (7,089 | ) | 15,404 | (12,435 | ) | |||||||||||
GMC Television Broadcasting, LLC |
Broadcasting | Control | | (12,309 | ) | | (12,309 | ) | ||||||||||||
CWP/RMK Acquisition Corp. |
Home Furnishings | Non-affiliate | | (8,053 | ) | | (8,053 | ) | ||||||||||||
Intran Media, LLC |
Other Media | Control | | (6,843 | ) | | (6,843 | ) | ||||||||||||
National Product Services, Inc. |
Business Services | Control | | (6,111 | ) | | (6,111 | ) | ||||||||||||
JetBroadband Holdings, LLC |
Cable | Control | | (5,232 | ) | | (5,232 | ) | ||||||||||||
RadioPharmacy Investors, LLC |
Healthcare | Control | | (4,668 | ) | | (4,668 | ) | ||||||||||||
Philadelphia Newspapers, LLC |
Newspaper | Non-affiliate | | (4,228 | ) | | (4,228 | ) | ||||||||||||
Coastal Sunbelt, LLC |
Food Services | Control | | (4,127 | ) | | (4,127 | ) | ||||||||||||
Active Brands International, Inc. |
Consumer Products | Non-affiliate | | (3,708 | ) | | (3,708 | ) | ||||||||||||
PremierGarage Holdings, LLC |
Home Furnishings | Control | | (3,210 | ) | | (3,210 | ) | ||||||||||||
Orbitel Holdings, LLC |
Cable | Control | | (2,533 | ) | | (2,533 | ) | ||||||||||||
Cruz Bay Publishing, Inc. |
Publishing | Non-affiliate | | (1,497 | ) | | (1,497 | ) | ||||||||||||
Marietta Intermediate Holding Corporation |
Cosmetics | Non-affiliate | | (1,481 | ) | | (1,481 | ) | ||||||||||||
Home Interiors & Gifts, Inc. |
Home Furnishings | Non-affiliate | | (1,240 | ) | | (1,240 | ) | ||||||||||||
Teleguam Holdings, LLC |
Communications | Non-affiliate | | (1,232 | ) | | (1,232 | ) | ||||||||||||
G&L Investment Holdings, LLC |
Insurance | Non-affiliate | | (1,205 | ) | | (1,205 | ) | ||||||||||||
Golden Knight II CLO, Ltd. |
Diversified Financial Services | Non-affiliate | | (1,017 | ) | | (1,017 | ) | ||||||||||||
Sunshine Media Delaware, LLC |
Publishing | Affiliate | | (1,003 | ) | | (1,003 | ) | ||||||||||||
Stratford School Holdings, Inc. |
Education | Affiliate | | 7,356 | | 7,356 | ||||||||||||||
Avenue Broadband LLC |
Cable | Control | | 6,128 | | 6,128 | ||||||||||||||
LMS Intellibound Investors, LLC |
Logistics | Control | | 4,894 | | 4,894 | ||||||||||||||
MCI Holdings LLC |
Healthcare | Non-affiliate | | 4,162 | | 4,162 | ||||||||||||||
Jenzabar, Inc. |
Technology | Non-affiliate | | 3,729 | | 3,729 | ||||||||||||||
Wiesner Publishing Company, LLC |
Publishing | Non-affiliate | 5,344 | 2,169 | (5,503 | ) | 2,010 | |||||||||||||
JUPR Holdings, Inc. |
Information Services | Control | 5,994 | 1,714 | (5,958 | ) | 1,750 | |||||||||||||
Other |
284 | (6,759 | ) | (247 | ) | (6,722 | ) | |||||||||||||
Total |
$ | (9,128 | ) | $ | (175,178 | ) | $ | 3,696 | $ | (180,610 | ) | |||||||||
As shown in the preceding table, we recorded $52.2 million of unrealized depreciation on Broadview during the nine months ended September 30, 2008, primarily attributable to of a reduction in the comparable multiples used in the estimate of the fair value of Broadview. We also took a $36.3 million unrealized loss on Jet Plastica Investors, LLC, or Jet Plastica, during the nine months ended September 30, 2008. This loss on Jet Plastica is related primarily to substantial increases in Jet Plasticas raw materials cost, which was caused by significant increases in oil prices. We believe we may recover part, or all of this loss, if Jet Plastica is able to recover cost increases and improve its financial performance. We recorded a $33.2 million unrealized loss on Cleartel, which brings the fair value of our investment in Cleartel to zero. The remaining net unrealized depreciation changes predominantly resulted from a reduction in the comparable multiples used to estimate the fair value of the investments and, to a lesser extent, the performance of some portfolio companies.
GAIN ON EXTINGUISHMENT OF DEBT
In January 2009, we repurchased $7.5 million of collateralized loan obligations for $2.1 million that previously had been issued by our wholly owned subsidiary, Commercial Loan Trust 2006-1. As a result of this purchase, we recognized a $5.4 million gain on extinguishment of debt during the nine months ending September 30, 2009. Partially offsetting this gain was $0.4 million of premiums we incurred when we repurchased $18.5 million of our private placement notes.
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INCOME TAX (BENEFIT) PROVISION
During the nine months ended September 30, 2009, we recorded a $0.3 million income tax benefit compared to a $0.6 million income tax provision during the nine months ended September 30, 2008. Our income taxes primarily relate to unrealized gains and losses on our investments and the performance of certain of our investments that are held in taxable subsidiaries.
NET LOSS
During the nine months ended September 30, 2009, we incurred a $52.6 million net loss, compared to a $133.9 million net loss during the nine months ended September 30, 2008. The decrease in net loss is attributable to the items discussed above.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
CASH AND CASH EQUIVALENTS, CASH, SECURITIZATION ACCOUNTS, AND CASH, RESTRICTED
Our Consolidated Balance Sheets and our Consolidated Statements of Cash Flows reflect three categories of cash: cash and cash equivalents; cash securitization accounts; and cash, restricted. Each of these categories is described more fully below:
| Cash and cash equivalents represents unrestricted cash including checking accounts, interest bearing deposits collateralized by marketable debt securities and highly liquid investments with maturities of 90 days or less. As of September 30, 2009 and December 31, 2008, we had $47.2 million and $46.1 million, respectively, in cash and cash equivalents. By October 29, 2009, this balance rose to $49.9 million. During 2008 and in January 2009, we invested cash on hand in interest bearing deposit accounts. However, beginning in February 2009, we maintained our cash on hand in non-interest bearing accounts, which are fully insured by the U.S. Federal Deposit Insurance Corporation, or FDIC, through December 31, 2009 under the FDICs Temporary Liquidity Guarantee Program. |
| Cash, securitization accounts include principal and interest payments received on securitized loans, which in certain cases, are held in designated bank accounts until monthly or quarterly disbursements are made from the securitization trusts. In certain cases, we are required to use a portion of these amounts to pay interest expense, reduce borrowings or pay other amounts in accordance with the related securitization agreements. In other cases, we are permitted to use these amounts to acquire new loans into the securitization trusts. Cash in securitization accounts has a negative impact on our earnings since the interest we pay on borrowings typically exceeds the rate of return that we are able to earn on temporary cash investments. Our objective is to maintain sufficient cash on hand and availability under our debt facilities to cover current funding requirements and operational needs. As of September 30, 2009 and December 31, 2008, we had $68.4 million and $37.5 million, respectively, in cash, securitization accounts. By October 29, 2009, this balance had decreased to $57.2 million. |
| Cash, restricted includes cash held for regulatory purposes and cash that we have received that is earmarked for transfer into our cash securitization accounts. The largest component of restricted cash is represented by cash held by Solutions Capital I, LP, our SBIC, which generally is restricted to the origination of new loans from our SBIC. As of September 30, 2009 and December 31, 2008, we had $20.8 million and $1.0 million of restricted cash, respectively. As of October 29, 2009, this balance was $20.8 million. |
For the nine months ended September 30, 2009, our operating activities provided $120.6 million of cash and cash equivalents, compared to $122.6 million during the same period in 2008, which represents a $2.0 million decrease. For the nine months ended September 30, 2009, our financing activities used $119.5 million of cash, compared to $126.6 million during the same period in 2008. This $7.1 million decrease in cash used by financing activities was due primarily to a $48.3 million net increase in cash held in securitization and restricted cash accounts and a $78.1 million decrease in distributions paid. These amounts were partially offset by a $35.0 million decrease in net payments on borrowings and $57.1 million decrease in issuance of common stock, net of costs.
We believe our current liquidity, combined with our future cash flows from operations and expected monetizations should provide sufficient liquidity to meet our operating expenses during the upcoming year.
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CURRENT MARKET CONDITIONS
The United States has been in a recession since 2007, which has had a severe adverse impact on many companies. Banks and others in the financial services industry have continued to report significant write-downs in the fair value of their assets. During the nine months ended September 30, 2009, consumer confidence continued to deteriorate and unemployment figures increased. However, in recent months, certain economic indicators have shown modest improvements and our financial performance has improved compared to previous quarters.
Consistent with other companies in the financial services sector, we have been affected adversely by many of these events. The availability of debt and equity capital continues to be constrained. While the price of our stock rose from $0.71 as of December 31, 2008 to $4.19 as of September 30, 2009, our stock was trading at 52.0% of our NAV as of September 30, 2009, thereby making it undesirable to issue new equity. In addition, the deterioration in consumer confidence and a general reduction in spending by both consumers and businesses have had an adverse effect on a number of the industries in which some of our portfolio companies operate and has led to an overall reduction in many of the comparable multiples that we use to estimate the fair value of certain companies in our investment portfolio. Consequently, during the nine months ended September 30, 2009, we recorded $118.1 million of net realized and unrealized losses, resulting from the performance of certain portfolio companies and a reduction in comparable multiples and market pricing used to estimate the fair value of our investments. The $118.1 million of net realized and unrealized losses includes a $36.7 million realized loss and $15.8 million unrealized depreciation on TNR and $23.7 million unrealized depreciation on Total Sleep. These net realized and unrealized losses were partially offset by $31.4 million reversal of unrealized depreciation, including $36.9 million on the sale of our investment in TNR in April 2009.
During 2009, we continued to monitor evolving economic events and execute measures instituted in 2008 to retain liquidity, meet the requirements of BDC regulations and debt agreements, and reduce expenditures. We recognize that many of these measures have been difficult for our stockholders, our employees and our portfolio companies. Nonetheless, we believe these actions continue to be necessary actions to preserve capital and liquidity during this turbulent economic period. If we are able to meet our goals with respect to leverage levels, unrestricted cash balances and credit agreement limitations, we will evaluate on a quarterly basis the potential repurchase of equity and additional debt securities at a discount, if available, and the resumption of stockholder distributions.
LIQUIDITY AND CAPITAL RESOURCES
The current capital markets continue to be challenging for most companies in the financial services sector, including MCG. Despite these challenges, we have been successful during the nine months ended September 30, 2009 in maintaining reasonable levels of unrestricted cash, while reducing our outstanding borrowings by $68.1 million. We achieved these results largely because of a number of initiatives that we initiated beginning in 2008. Once we meet our liquidity and capital objectives, we may consider debt and equity repurchases, subject to the limitations set forth in the 1940 Act and our borrowing facilities, and we expect to evaluate the resumption of dividends in the future.
Beginning in the third quarter of fiscal 2008, we announced that we were implementing a strategic plan that was aimed at preserving our capital base and building our liquidity during one of the most tumultuous periods in the nations economic history. To achieve these goals, the 2008 plan set forth a number of major initiatives including the suspension of new loan activities to preserve our liquidity; opportunistic monetizations of certain debt and equity investments to build our cash reserve and deleverage our balance sheet; renegotiation of our borrowing agreements to provide continuing financing and relief from certain restrictive covenants; repurchase of certain of our collateralized loan obligations whose fair value was well below par; and significant reductions in general and administrative expenses, including a 27% reduction in workforce, the closure of nonessential facilities and base salary freezes for essentially all employees. To further preserve capital, our 2008 plan included the suspension of dividend distributions for the third and fourth quarters of 2008 and provided that we would pay the statutory minimum dividend to maintain our RIC status during 2009. Due to anticipated loss transactions in the fourth quarter of 2009, we do not expect there will be any required distributions.
We believe that our execution of the actions set forth in the 2008 strategic plan has helped us to begin to rebuild value for our stockholders. The balance of cash in our securitization and restricted accounts has increased from $38.5 million as of December 31, 2008 to $89.2 million as of September 30, 2009 and we maintained a $47.2 million unrestricted cash and cash equivalents as of September 30, 2009. In February 2009, we successfully renegotiated three of our borrowing facilities to provide us with continuing debt financing, relief from
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key covenants and repayment provisions that were tied to our monetization of assets. Subsequently, in October 2009, we were able to renegotiate with holders of our unsecuritized Series 2005-A and Series 2007-A privately-placed notes to, among other things, extend the maturity of the Series 2005-A notes from October 2010 to October 2011. In effect, other than repayments that we must make when we monetize assets, our next maturity is August 2011. These efforts, combined with the monetization of $216.1 million of portfolio investments at close to their carrying value, have reduced our leverage and improved our BDC asset coverage ratio from 201% as of December 31, 2008 to 214% as of October 29, 2009.
While the execution of our 2008 strategic plan, combined with modest improvements in certain economic indicators, have produced these positive results, we continue to be cautious about the stability of the economy and the potential for further near-term economic growth. As such, in the third quarter of 2009 we undertook a comprehensive strategic study to review our historical performance and to develop a multi-year strategic plan. While management continues to be cautious about the state of the economy we believe that we can increase stockholder value by converting lower-yielding equity investments and deploying cash in securitization and restricted accounts into yield-oriented new investment opportunities. As we execute this plan over the next several years, we plan to continue to monetize our equity portfolio, which has an average annual earnings yield of 1.9%, and redeploy that capital and cash held in securitization and restricted accounts into debt securities with interest yields that are expected to increase our operating income and support the reinstitution and future growth of distributions to our stockholders. As we execute on this monetization strategy, we will continue to focus on preserving our NAV and enhancing the overall return profile on our investment capital. We estimate this component of our strategy will reduce our investment in equity securities to no more than 20% of the fair value of our total portfolio over the next few years. We generally expect to limit our future investing activities to debt investments until such time that we have closed the valuation gap between our stock price and our NAV and can validate the performance returns of our existing equity portfolio. We do not intend to make significant investments in control companies beyond those that are currently in our portfolio for the foreseeable future. When making new investments we expect to underwrite credit in a manner consistent with our expectation that macro economic conditions will be under pressure for extended period of time. Over time, if we can meet our goals with respect to leverage levels and unrestricted cash balances, we will seek to potentially repurchase equity and additional debt securities, subject to the limitations set forth in our private placement borrowing agreements. To help provide sustainable stockholder value, we expect to make future distributions to stockholders based upon a quarterly assessment of cash earnings, liquidity, statutory distribution requirements, asset coverage ratio and our borrowing agreements.
The following described below is a detailed discussion of the major initiatives that we undertook to implement our 2008 strategic plan and how we will redirect each of these initiatives as we implement the 2009 strategic plan:
| Investment OpportunitiesBeginning in 2008, we suspended new loan and equity origination activities, however, during the third quarter of 2009, we completed a strategic review and concluded that we will begin to evaluate opportunities for new investments. We expect to focus on new debt investment opportunities, and do not expect to make significant investments in control companies beyond those that currently are in our investment portfolio for the foreseeable future. |
| MonetizationsSince the second half of 2008, we have focused on the monetization of certain debt and equity investments in our portfolio to deleverage our balance sheet and build cash reserves. During the nine months ended September 30, 2009, we successfully monetized $124.0 million of our portfolio investments (at close to our carrying value). These monetizations include the sale of our equity investment in LMS in February 2009 for $40.5 million, or $16.3 million and $4.1 million above the most recently reported cost and fair value; respectively, as well as the $10.2 million prepayment of our subordinated debt investment in LMS at par in June 2009. Other monetizations completed during the first three quarters of 2009, include the February 2009 repayment of our $21.5 million second-lien debt investment in Dayton Parts Holding, LLC at par and $0.9 million above its most previously reported fair value; and the June 2009 repayment of our $18.7 million senior debt investment in Cervalis, LLC at par and $0.4 million above the most recently reported fair value. In April 2009, we monetized our senior debt and equity investment in TNR for $11.6 million in April 2009. Our monetization of TNR represents a distressed sale, which was completed at 23.8% and 42.3% of our most recently reported cost and fair value, respectively, which we exited after three major customers notified TNR that they did not intend to renew their contracts. In addition, in August 2009, we sold our equity investment in Coastal Sunbelt Holdings, Inc., for $15.2 million, or 98% of its most recently reported cost and fair value. A comprehensive list of 2009 monetization activity is included in the Portfolio Composition and Investment Activity section of this Managements Discussion and Analysis of Financial Conditions and Results of Operations. |
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In 2008, we successfully monetized $155.6 million of our portfolio assets, including $92.1 million of monetizations (at close to our carrying value) during the second half of the year. Since initiating our deleveraging initiatives in July 2008, we have completed a total of $216.1 million of investment monetizations, including 22 monetizations that were completed at 105.8% and 99.5% of their most recently reported cost and fair value, respectively, as well as the TNR distressed sale at 23.8% and 42.3% of its most recently reported cost and fair value, respectively.
Under our strategic plan, we plan to identify opportunities to monetize lower-yielding equity investments and redeploy the proceeds to higher-yielding debt investments intended to improve our operating income. The timing of such monetizations depends largely upon future market conditions. We are under no contractual or other obligation to monetize assets at specified times, levels or prices.
| Renegotiation of AgreementsIn February 2009, we successfully amended the agreements for our revolving credit facility, our secured warehouse facility and our private placement notes. Most significantly, these amendments relaxed key covenant requirements under the borrowing facilities. The minimum net worth requirement in the secured warehouse facility was reduced from $654.0 million to $525.0 million, plus 50% of the proceeds from post-amendment date equity issuances, and to $500.0 million for the private placement notes. In addition, cross-default provisions in the agreement for our private placement notes were modified so that defaults under other non-recourse credit facilities would not be an event of default for the private placement notes. In addition, in February 2009, the lender for our secured warehouse facility provided its annual renewal of its liquidity facility that supports our secured warehouse credit facility, which resulted in a final legal maturity for this facility of August 2011. |
In exchange for these concessions, we agreed to increase the interest rates paid for borrowings under these facilities and to apply a portion of the proceeds from future monetizations to reduce the outstanding borrowings and the borrowing capacity under these facilities. In addition, our borrowing commitment under the secured warehouse facility was reduced from $250.0 million to $190.0 million. As of September 30, 2009, we had $164.6 million outstanding under this facility. These amendments will provide us with continuing debt financing and the repayment terms that we established for these facilities, which are generally tied to future monetizations, provide a contingency-based mechanism for us to repay a portion of these obligations as liquidity becomes available. On May 4, 2009, we elected to repay our unsecured revolving line of credit prior to the May 29, 2009 maturity of this facility.
In October 2009, the terms of our Series 2005-A and Series 2007-A unsecured privately-placed notes were amended, which, in part, included an extension of the scheduled maturity of the Series 2005-A notes by one year to October 11, 2011. The interest rate for the Series 2005-A notes was also increased by 100 basis points to 9.98%. The percentage of net cash proceeds of any monetization of unencumbered investment assets to be swept to reduce amounts outstanding under the Unsecured Notes was increased by 5% to 45% after the secured warehouse facility receives $7.5 million of net proceeds pursuant to its required 7.5% sweep. The interest rate and maturity of the Series 2007-A notes remains unchanged.
The amendments provided for a prepayment totaling $5.0 million to the holders of the Series 2005-A notes and the Series 2007-A notes that was prorated based upon their respective outstanding principal balances. Immediately following this payment, the principal balances of the Series 2005-A notes and the Series 2007-A notes was $34.3 million and $17.2 million, respectively.
| Corporate RestructuringIn August 2008, we announced the implementation of a corporate restructuring that resulted in lower incentive compensation for our executives, a 27% reduction in our workforce and the closure of certain facilities. Subsequent to the August 2008 reduction in force, ten employees have left MCG, whom we do not expect to replace. As of November 4, 2009, including our reduction in force and voluntary terminations, we have reduced the workforce from 101 to 66, or 35%, since we began our cost reduction initiatives. To further control our employee compensation expense, we implemented a salary freeze for virtually all personnel for 2009. We expect to pursue additional cost-saving measures and we plan to manage our expense base relative to our asset size as the portfolio decreases through monetizations. |
| Dividend SuspensionWe did not declare dividends during the nine months ended September 30, 2009. Currently, we expect to apply certain losses for tax purposes in 2009 that we recognized for book |
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purposes during 2008, which could result in a significant reduction to our statutorily required dividend payment in 2009. In order to preserve capital, we have committed to pay the statutory minimum dividend for 2009 to maintain our RIC status. Due to anticipated loss transactions in the fourth quarter of 2009, we do not expect there will be any required distributions. We will make our decisions with respect to the actual level of 2010 dividends on a quarter-by-quarter basis during 2010, after taking into account the minimum statutorily required level of distributions, gains and losses recognized for tax purposes, portfolio transactional events, our liquidity, cash earnings and our asset coverage ratio at the time of such decision. Variables that could affect dividend levels for 2010 to meet our RIC requirements include the actual timing of gains and losses for tax purposes, equity investment monetizations and net operating income. |
| Repurchases of Collateralized Loan ObligationsIn January 2009, we repurchased $7.5 million of collateralized loan obligations for $2.1 million that had previously been issued by our wholly owned subsidiary, Commercial Loan Trust 2006-1. As a result of this purchase, we recognized a $5.4 million gain on extinguishment of debt for the quarter ended March 31, 2009. In total, since December 2008, we have repurchased a total of $22.6 million of collateralized loan obligations for approximately 27% of par. |
In addition to being able to extinguish this debt for less than 27% of the principal amount of the associated notes, our interest expense will be reduced by approximately $0.6 million of annual interest expense, based on the LIBOR in effect as of September 30, 2009, over the remaining life of the Commercial Loan Trust 2006-1 facility.
In order to reduce future cash interest payments, as well as future amounts due at maturity or upon redemption, we may, from time to time, purchase such debt for cash in open market purchases and/or privately negotiated transactions, if attractive pricing can be identified. We will evaluate any such transactions in light of then-existing market conditions, taking into account our current liquidity and prospects for future access to capital. The amounts involved in any such transactions, individually or in the aggregate, may be material.
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LIQUIDITY AND CAPITAL RESOURCESBORROWINGS
The following table summarizes our borrowing facilities and the potential borrowing capacity of those facilities and contingent borrowing eligibility of Solutions Capital I, LP, an SBIC.
September 30, 2009 | December 31, 2008 | |||||||||||||||
(dollars in thousands) |
Maturity Date | Potential Maximum Borrowing |
Amount Outstanding |
Potential Maximum Borrowing |
Amount Outstanding | |||||||||||
Unsecured Notes |
||||||||||||||||
Series 2005-A |
October 2010 | (a) | $ | 37,641 | $ | 37,641 | $ | 50,000 | $ | 50,000 | ||||||
Series 2007-A |
October 2012 | 18,820 | 18,820 | 25,000 | 25,000 | |||||||||||
Commercial Loan Funding Trust Facility |
||||||||||||||||
Class A Variable Funding Certificate |
August 2011 | (b) | 175,648 | 164,566 | 218,750 | 162,219 | ||||||||||
Class B Variable Funding Certificate |
August 2011 | (b) | | | 31,250 | 24,950 | ||||||||||
Term Securitizations |
||||||||||||||||
Series 2006-1 Class A-1 Notes |
April 2018 | 106,250 | 106,250 | 106,250 | 106,250 | |||||||||||
Series 2006-1 Class A-2 Notes |
April 2018 | 50,000 | | 50,000 | | |||||||||||
Series 2006-1 Class A-3 Notes |
April 2018 | 85,000 | 85,000 | 85,000 | 85,000 | |||||||||||
Series 2006-1 Class B Notes |
April 2018 | 58,750 | 58,750 | 58,750 | 58,750 | |||||||||||
Series 2006-1 Class C Notes(c) |
April 2018 | 45,000 | 40,000 | 45,000 | 40,000 | |||||||||||
Series 2006-1 Class D Notes(d) |
April 2018 | 47,500 | 29,880 | 47,500 | 37,380 | |||||||||||
Unsecured Revolving Line of Credit(e) |
May 2009 | | | 70,000 | 44,500 | |||||||||||
SBIC (Maximum borrowing potential)(f) |
(g) | 130,000 | 27,600 | 130,000 | 2,600 | |||||||||||
Total borrowings |
$ | 754,609 | $ | 568,507 | $ | 917,500 | $ | 636,649 | ||||||||
(a) | On October 28, 2009, the Series 2005-A and Series 2007-A Unsecured Notes were amended, which, in part, extended the maturity date of the Series 2005-A Unsecured Notes to October 2011. |
(b) | Renewable each February at the lenders discretion. The lender provided this renewal in February 2009. At that time, the final legal maturity became August 2011. In conjunction with additional collateral transferred to this facility in February 2009, the Class B advances were retired. |
(c) | Amount outstanding excludes $5.0 million of notes that we repurchased in December 2008 for $1.6 million. The notes that MCG, the parent company, purchased are eliminated from this schedule as part of the consolidation process. |
(d) | Amount outstanding excludes $10.1 million of notes that we repurchased in December 2008 for $2.4 million and $7.5 million of notes that we repurchased in January 2009 for $2.1 million. The notes that MCG, the parent company, purchased are eliminated from this schedule as part of the consolidation process. |
(e) | On May 4, 2009, we repaid the balance of this facility. |
(f) | As of September 30, 2009, we had the potential to borrow up to $130.0 million of SBA-guaranteed debentures under the SBIC program. The SBA has approved and committed up to $130.0 million in borrowings to the SBIC. To realize the full $130.0 million borrowing potential approved and committed by the SBIC under this program, we must fund a total of $65.0 million to the SBIC, of which we have funded $18.6 million as of September 30, 2009. Based on our funded capital, Solutions Capital I, LP may, subject to the SBAs approval, borrow up to an additional $28.3 million to originate investments. To access the entire $130.0 million that has been approved and committed by the SBA, we would have to fund an additional $46.4 million. In February 2009, the American Recovery and Reinvestment Act of 2009 was passed into law which, among other things, included a provision that increased the maximum amount of outstanding leverage available to SBIC companies up to $150.0 million. |
(g) | Currently, we may originate new borrowings through September 2012 at which time we can apply for a new commitment. We must repay borrowings under the SBIC program within ten years after the borrowing date, which will occur between September 2018 and September 2022. |
Each of our credit facilities has certain collateral requirements and/or financial covenants. As of December 31, 2008, the net worth covenant on the warehouse facility requires that we maintain a minimum stockholders equity of not less than $525.0 million, plus 50% of any equity raised after February 26, 2009. The terms of this facility include a step-down provision that allows us to reduce the minimum stockholders equity requirement to $500.0 million, plus 50% of the proceeds from any equity issuances after February 26, 2009, if we reduce the effective advance rate for the advances outstanding to less than 60% of eligible collateral and we provide formal notice to the lender. Under these covenants, we must also maintain an asset coverage ratio of at least 180%.
Our asset coverage ratio increased to 212% as of September 30, 2009 and had increased to 214% as of October 29, 2009. We have $28.3 million of unused, previously funded borrowing capacity remaining in our SBIC subsidiary subject to the SBAs approval that is exempt from the asset coverage ratio requirements.
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As of September 30, 2009, we were in compliance with all key financial covenants under each of our borrowing facilities, although there can be no assurance regarding compliance in future periods. On our website, we have provided a list of hyperlinks to each of our borrowing agreements where these covenant requirements can be reviewed. You may view this list at http://www.mcgcapital.com/. We are not including the information contained on our website as a part of, or incorporating it by reference into, this Quarterly Report on Form 10-Q.
We fund all of our current debt facilities, except the unsecured notes through our bankruptcy remote, special-purpose, wholly owned subsidiaries. Therefore, these subsidiaries assets may not be available to our creditors. In some cases, advances under our debt facilities are subject to certain collateral levels, collateral quality, leverage and other restrictive covenants. We continue to service the portfolio investments that are used as collateral in our secured borrowing facilities. Additional information about these facilities is provided below.
Unsecured Notes. In October 2005, we issued $50.0 million of Series 2005-A unsecured notes, at a fixed interest rate of 6.73% per annum. In October 2007, we issued an additional $25.0 million of Series 2007-A unsecured notes at a fixed interest rate of 6.71% per annum. Both of these tranches are five-year notes that require semi-annual interest payments. We issued these notes through private placements with Bayerische Hypo-Und Vereinsbank, AG, New York Branch, or HVB, acting as the placement agent. In February 2009, these notes were amended. In connection with these amendments, MCG and the noteholders agreed to a number of modifications to the terms of the notes, including certain financial covenants. The minimum asset coverage ratio that we are required to maintain has been lowered from 200% to 180% effective as of December 31, 2008. The minimum consolidated stockholders equity requirement was reduced from $642.9 million prior to December 31, 2008 to $500.0 million effective as of and after December 31, 2008. The cross-default provisions were modified so that defaults of indebtedness by certain direct and indirect subsidiaries, including Solutions Capital I, L.P. and the special purpose subsidiaries relating to the 2006-1 term securitization and our secured warehouse credit facility, would not constitute defaults under the unsecured notes, as long as we (the parent company) or any other subsidiary that is not a non-recourse financing subsidiary are not liable for the repayment of such indebtedness. The amendments also require us to offer to repurchase the unsecured notes with a portion of certain monetization proceeds at a purchase price of 102% of the principal amount to be purchased. The interest rate for the Series 2005-A unsecured notes, increased from 6.73% to 8.98%. The interest rate for the Series 2007-A unsecured notes, increased from 6.71% to 8.96%. Subsequently, on October 28, 2009, the terms of our Series 2005-A and Series 2007-A unsecured privately-placed notes were amended. In connection with this amendment, MCG and the noteholders agreed to a number of modifications, including an extension of the maturity date for the Series 2005-A notes by one year to October 11, 2011. The interest rate for these notes was also increased 100 basis points to 9.98%. The 8.96% interest rate and October 2012 maturity on the Series 2007-A notes remains unchanged.
On May 4, 2009, we repaid our revolving line of credit. Prior to that repayment, we were required to use 60% of the cash net proceeds of any sale of unencumbered assets to reduce amounts outstanding under the unsecured notes and the revolving line of credit on a pro rata basis, based on then-outstanding amounts. After such repayment, we agreed to direct 40% of such net monetization proceeds from unencumbered asset sales as and when such sales occur to the repurchase of the notes, unless an event of default under one of the financing subsidiary debt facilities has occurred and is continuing, in which case the percentage of net proceeds increases to 60%. The previously mentioned October 2009 amendments increased the percentage of net cash proceeds that we receive from any sale of unencumbered assets that we must use to reduce amounts outstanding on the unsecured notes by 5% to 45% after the secured warehouse facility receives $7.5 million of net proceeds pursuant to its 7.5% sweep requirement. This amendment did not make any changes to the percentage of proceeds that must be used to reduce outstanding borrowings in the case of a default in respect to non-recourse subsidiary debt.
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The following table summarizes the reductions in the borrowing capacity from monetization proceeds during the nine months ended September 30, 2009:
(in thousands) |
Quarter Ended |
Monetization Payment |
Maximum Borrowing Capacity After Monetization Payment | |||||
Unsecured Note Series |
||||||||
2005-A |
March 31, 2009 | $ | 5,314 | $ | 44,686 | |||
June 30, 2009 | 3,128 | 41,558 | ||||||
September 30, 2009 | 3,917 | 37,641 | ||||||
2007-A |
March 31, 2009 | 2,658 | 22,342 | |||||
June 30, 2009 | 1,564 | 20,778 | ||||||
September 30, 2009 | 1,958 | 18,820 |
As of September 30, 2009, the outstanding balances under the Series 2005-A and Series 2007-A unsecured notes were $37.6 million and $18.8 million, respectively. The October 2009 amendment provided that we would make a payment totaling $5.0 million to the holders of the Series 2005-A notes and the Series 2007-A notes that would be prorated based upon their respective outstanding principal balances. Immediately following this payment, the principal balances of the Series 2005-A notes and the Series 2007-A notes were $34.4 million and $17.2 million, respectively. In connection with the February 2009 amendments to the unsecured notes we also agreed to limit the amount of debt from the 2006-1 term securitization and our common stock that we may repurchase. For every $5.0 million of unsecured notes we offer to purchase, we may repurchase $2.5 million of debt from the 2006-1 term securitization. Once we have offered to purchase $35.0 million in unsecured notes, then we may also repurchase $1.0 million in shares of our common stock for every $5.0 million increment of unsecured notes offered to be repurchased, provided that the amount of permitted 2006-1 debt repurchases shall be reduced by the amount of any MCG common stock repurchases made. We paid to the holders of the unsecured notes an amendment fee of $375,000, or 0.50%.
MCG Commercial Loan Funding Trust. We established, through MCG Commercial Loan Funding Trust, a $250.0 million warehouse financing facility funded through Three Pillars Funding LLC, an asset-backed commercial paper conduit administered by SunTrust. The warehouse financing facility, which operates like a revolving credit facility, is secured primarily by MCG Commercial Loan Funding Trusts assets, including commercial loans that we sold to the trust. The pool of commercial loans in the trust must meet certain requirements, such as term, average life, investment rating, agency rating and industry diversity requirements. We must also meet certain requirements related to portfolio performance, including required minimum portfolio yield and limitations on delinquencies and charge-offs. We funded this facility through two separate Variable Funding Certificates, or VFCs, including a $218.75 million Class A VFC and a $31.25 million Class B VFC.
In February 2009, SunTrust renewed its annual liquidity commitment for this facility. We paid a $2.4 million, or 1.25%, facility fee for this renewal. In connection with this renewal, a number of modifications were made to the warehouse facility terms, including a reduction in the facility borrowing commitment from $250.0 million to $190.0 million. In conjunction with this reduction, the Class B VFC was retired. The legal final maturity date is now August 2011, subject to contractual terms and conditions. The amendment also eliminated the requirement for a six-month standstill upon non-liquidity renewal. If a new agreement or extension is not executed by February 2010, the warehouse facility enters an 18-month amortization period during which principal under the facility is paid down through orderly monetizations of portfolio company assets that are financed through the facility. The facility is funded by third parties through the commercial paper market with SunTrust providing a liquidity backstop, subject to SunTrusts annual liquidity commitment.
Advances under the Class A VFC may be up to 64% of eligible collateral. The warehouse facility is non-recourse to us; therefore, in the event of a termination event or upon the legal final maturity date, the lenders under the warehouse facility may only look to the collateral to satisfy the outstanding obligations under this facility. The following table summarizes the collateral under the MCG Commercial Loan Funding Trust as of September 30, 2009 and December 31, 2008.
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(dollars in thousands) |
September 30, 2009 | December 31, 2008 | ||||||||||
Amount | % | Amount | % | |||||||||
Securitized assets |
||||||||||||
Senior secured debt |
$ | 162,070 | 60.1 | % | $ | 164,188 | 64.3 | % | ||||
Subordinated secured debt |
107,428 | 39.9 | 91,347 | 35.7 | ||||||||
Total securitized assets |
$ | 269,498 | 100.0 | % | $ | 255,535 | 100.0 | % | ||||
The interest rate for Class A advances has been increased to the commercial paper rate plus 2.50%. Class A advances previously bore interest at the commercial paper rate plus 1.50%. The minimum asset coverage ratio that we are required to maintain was reduced from 200% to 180% effective as of December 31, 2008, and the minimum consolidated stockholders equity requirement was reduced from $654.0 million prior to December 31, 2008 to $525.0 million as of and after December 31, 2008, plus 50% of any equity raised after February 26, 2009. The terms of this facility include a step-down provision that allows us to reduce the minimum stockholders equity requirement to $500.0 million plus 50% of the proceeds from any equity issuances after February 26, 2009, if we reduce the effective advance rate for the advances outstanding to less than 60% of eligible collateral and we formally notify the lender.
Prior to the commencement of any amortization period, we will contribute 80% of net proceeds from monetizations of collateral financed in the warehouse facility to reduce the facility borrowing limit, until such limit is reduced to $150.0 million. In addition, 7.5% of the sale of the first $100.0 million of unencumbered investment assets by us will be used to repay the warehouse facility.
The following table summarizes the reductions in the facility borrowing limit from monetization proceeds:
(in thousands) |
Monetization Payment |
Maximum Borrowing Capacity After Monetization Payment | ||||
Quarter ended |
||||||
March 31, 2009 |
$ | 1,491 | $ | 188,509 | ||
June 30, 2009 |
2,894 | 185,615 | ||||
September 30, 2009 |
9,967 | 175,648 |
MCG Commercial Loan Trust 2006-1. In April 2006, we completed a $500.0 million debt securitization through MCG Commercial Loan Trust 2006-1, a wholly owned subsidiary. The 2006-1 Trust issued $106.25 million of Class A-1 Notes, $50.0 million of Class A-2 Notes, $85.0 million of Class A-3 Notes, $58.75 million of Class B Notes, $45.0 million of Class C Notes and $47.5 million of Class D Notes. The respective classes of notes bear interest at LIBOR plus 0.33%, 0.35%, 0.33%, 0.58%, 1.05% and 2.25%.
All of the notes are secured by the assets of MCG Commercial Loan Trust 2006-1. The following table summarizes the assets securitization under this facility as of September 30, 2009 and December 31, 2008:
(dollars in thousands) |
September 30, 2009 | December 31, 2008 | ||||||||||
Amount | % | Amount | % | |||||||||
Securitized assets |
||||||||||||
Senior secured debt |
$ | 210,196 | 58.6 | % | $ | 224,661 | 56.7 | % | ||||
Subordinated secured debt |
148,335 | 41.4 | 171,914 | 43.3 | ||||||||
Total securitized assets |
$ | 358,531 | 100.0 | % | $ | 396,575 | 100.0 | % | ||||
We retain all of the equity in the securitization. The securitization includes a five-year reinvestment period ending in April 2011, unless we terminate this facility earlier, during which the trust may use principal collections received on the underlying collateral to purchase new collateral from us. Up to 55% of the collateral may be non-senior secured, and in certain instances, unsecured commercial loans. The remaining 45% must be senior secured commercial loans.
The Class A-1, Class B, Class C and Class D Notes are term notes. The Class A-2 Notes are a revolving class of secured notes and have a five-year revolving period. The Class A-3 Notes are a delayed draw class of secured notes, which were drawn in full during April 2007. From time to time, the trust purchases additional commercial loans from us, primarily using the proceeds from the Class A-2 revolving notes. The pool of commercial loans in the trust must meet certain requirements, such as asset mix and concentration, collateral coverage, term, agency rating, minimum coupon, minimum spread and sector diversity requirements.
In December 2008, we repurchased $15.1 million of collateralized loan obligations for $4.0 million that previously had been issued by Commercial Loan Trust 2006-1. In January 2009, we purchased an additional $7.5 million of these notes for $2.1 million, which resulted in a $5.4 million gain on extinguishment of debt during the quarter ending March 31, 2009.
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Unsecured Revolving Line of Credit. In June 2008, we entered into an agreement, effective May 30, 2008, for a one-year unsecured revolving line of credit facility with a $70.0 million commitment. SunTrust Bank acted as the agent for this facility and SunTrust Robinson Humphrey, Inc. acted as arranger for this facility. Originally, SunTrust Bank committed $25.0 million to this facility, while Chevy Chase Bank, F.S.B.; Sovereign Bank; and BMO Capital Markets, Inc., each committed $15.0 million. Advances under this facility bore interest at LIBOR plus 2.75%, prime plus 1.25% or the Federal Funds rate plus 4.00% (reduced to the Federal Funds rate plus 3.00%, if the Federal Funds rate was less than 0.25% below LIBOR), with a commitment fee of 0.25% per annum on undrawn amounts. We used this facility for: the origination of loans to, and investments in, primarily middle-market companies; repayment of indebtedness; working capital; and other general corporate purposes. In February 2009, the unsecured revolving line of credit agreement was amended to reduce the maximum borrowing limit from $70.0 million to $35.0 million and increase the interest rate on borrowings under this facility to LIBOR plus 400 basis points from LIBOR plus 275 basis points. The amendment also reduced the minimum stockholders equity requirements from $650.0 million prior to December 31, 2008 to $500.0 million plus 50% of the proceeds from post-amendment date equity issuances for the periods ending as of and after December 31, 2008. In addition, we agreed to maintain minimum cash and cash equivalents of $12.5 million at all times and a quarterly cash coverage ratio of not less than 1.25 to 1.00. We were required to direct a portion of any monetization proceeds to pay down debt. Up to 60% of the net proceeds of any sale by us or unencumbered investment assets were used to reduce amounts outstanding under the revolving line of credit and our unsecured notes on a pro rata basis, based on then-outstanding amounts. All asset monetizations were at our sole discretion based upon the economic merits of any proposed transaction. Dividends payable in cash with a declared payment date prior to July 1, 2009 were limited to the minimum amount required for us to maintain our status as a RIC. On May 4, 2009, we repaid this facility in full in advance of its May 29, 2009 maturity.
SBIC Debentures. In December 2004, we formed a wholly owned subsidiary, Solutions Capital I, LP. Solutions Capital I, LP has a license from the SBA to operate as an SBIC under the Small Business Investment Act of 1958, as amended. As of September 30, 2009, the license gave Solutions Capital I, LP the potential to borrow up to $130.0 million. The SBA has approved and committed $130.0 million in borrowings to the SBIC, subject to certain capital requirements and customary procedures and approvals. These funds can be used to provide debt and equity capital to qualifying small businesses. We may use the borrowings from the SBA to fund new originations; however, we may not use these borrowings to originate debt to companies that are currently in our portfolio without SBA approval. In addition, we may not use these funds for MCGs, the parent companys, working capital.
To realize the full $130.0 million potential borrowing for which we have been approved under this program, we must fund a total of $65.0 million to the SBIC, of which we have funded $18.6 million as of September 30, 2009. Based on our current funded capital, Solutions Capital I, LP may, subject to the SBAs approval, borrow up to an additional $28.3 million to originate new investments. To access the entire $130.0 million that the SBA has approved and committed, we would have to fund an additional $46.4 million.
The American Recovery and Reinvestment Act of 2009, which was passed into law in February 2009, included a provision that increased the maximum amount of outstanding leverage to available SBIC companies to up to $150.0 million, which represents a $12.9 million increase over the $137.1 million limit as of December 31, 2008. Solutions Capital I, LP would require the SBAs approval and commitment in order to access this incremental borrowing capacity. To access the entire $150.0 million, we would have to fund a total of $56.4 million, in addition to the $18.6 million that we had funded through September 30, 2009. As of September 30, 2009 and December 31, 2008, we had $30.6 million and $27.8 million, respectively, of investments and we had $20.8 million and $0.8 million, respectively, of restricted cash to be used for investments in our SBIC.
Once drawn, the SBIC debt bears an interim interest rate of LIBOR plus 30 basis points. The rate becomes fixed at the time of SBA pooling, which is within nine months of funding, and is set to the then-current 10-year treasury rate plus a spread and an annual SBA charge. As of September 30, 2009, the SBIC had $27.6 million outstanding summarized in the following table:
Amount Outstanding | ||||||||||||||||
(dollars in thousands) |
September 30, 2009 |
December 31, 2008 |
Rate | Treasury Rate at Pooling Date |
Spread in basis points | |||||||||||
Tranche |
||||||||||||||||
2008-10B |
$ | 2,600 | $ | 2,600 | 6.44 | % | Fixed | 3.80 | % | 264 | ||||||
2009-10A |
12,000 | | 5.34 | % | Fixed | 2.81 | % | 253 | ||||||||
2009-10B |
13,000 | | 4.95 | % | Fixed | 3.44 | % | 151 | ||||||||
Total |
$ | 27,600 | $ | 2,600 | 5.19 | % | 3.16 | % | 203 | |||||||
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In October 2008, we received exemptive relief from the SEC, which effectively allows us to exclude debt issued by Solutions I, L.P. from the calculation of our consolidated BDC asset coverage ratio.
The following table shows our weighted-average borrowings, the weighted-average interest rate on all of our borrowings, including amortization of deferred debt issuance costs and commitment fees, the average LIBOR, and the average spread to LIBOR for the nine months ended September 30, 2009 and 2008:
(dollars in thousands) |
Nine months ended | |||||||
September 30, 2009 | September 30, 2008 | |||||||
Weighted average borrowings |
$ | 602,893 | $ | 707,344 | ||||
Average LIBOR |
0.83 | % | 2.98 | % | ||||
Average spread to LIBOR, excluding amortization of deferred debt issuance costs |
2.50 | 1.68 | ||||||
Impact of amortization of deferred debt issuance costs |
0.69 | 0.32 | ||||||
Total cost of funds |
4.02 | % | 4.98 | % | ||||
The 4.0% weighted-average cost of funds for the nine months ended September 30, 2009 was 96 basis points less than the same period in 2008. This decrease resulted from a 215 basis point decrease in average LIBOR, partially offset by an 82 basis point increase in the average spread to LIBOR and a 37 basis point increase in the impact of amortization of deferred debt issuance costs.
LIQUIDITY AND CAPITAL RESOURCESCOMMON STOCK
We are a closed-end investment company that has elected to be regulated as a BDC under the 1940 Act. The 1940 Act prohibits us from selling shares of our common stock at a price below the current NAV of such stock unless our stockholders approve such a sale and our board of directors makes certain determinations. On June 17, 2009, our stockholders approved a proposal to authorize us to issue securities to subscribe to, convert to, or purchase shares of our common stock in one or more offerings up to an aggregate of 10 million shares. This proposal permits us to issue securities that may be converted into or exercised for shares of our common stock at a conversion or exercise price per share not less than our current market price at the date such securities are issued. This conversion or exercise price may, however, be less than our NAV per share at the date such securities are issued or the date such securities are converted into or exercised for shares of our common stock. The approval expires on the earlier of June 17, 2010 or the date of our 2010 Annual Meeting of Stockholders.
On March 28, 2008, we issued to our stockholders of record transferable rights to subscribe for up to 9.5 million shares of our common stock. Stockholders received one right for every seven outstanding shares of common stock owned on the record date. The rights offering expired on April 18, 2008. At the time of expiration, the rights offering, which was oversubscribed by 67%, resulted in the issuance of 9.5 million shares of our common stock. Net proceeds after payment of dealer-manager fees and before other offering-related expenses were $57.7 million that we used to make investments primarily in middle-market companies, repayment of indebtedness, working capital, and other general corporate purposes. The subscription price for the rights offering was $6.36, or 88% of the volume-weighted average sales prices, or VWAP, of our common stock on the NASDAQ Global Select market during the five trading days ending on the expiration date. The VWAP was $7.23 per share of common stock.
During the nine months ended September 30, 2009, we awarded zero and 22,500 shares of restricted stock to employees and non-employee directors, respectively. During the nine months ended September 30, 2009, the forfeiture provision lapsed on 324,000 shares of restricted stock pursuant to the Amended and Restated 2006 Employee Restricted Stock Plans, or the 2006 Plans, time and service requirements.
On July 23, 2009, our board of directors approved the LTIP. The LTIP is a three-year incentive compensation plan that provides our executive officers and certain key non-executive employees the opportunity to receive a
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total of up to an aggregate of 865,000 shares of our restricted common stock and up to $5.2 million of cash awards upon, among other things, achievement of specified MCG share price thresholds for our common stock within the LTIPs 36-month performance period.
OFF-BALANCE SHEET ARRANGEMENTS
We are party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our customers. These instruments include commitments to extend credit and involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. We attempt to limit our credit risk by conducting extensive due diligence and obtaining collateral where appropriate.
Commitments to extend credit include the unused portions of commitments that obligate us to extend credit in the form of loans, participations in loans or similar transactions. Commitments to extend credit would also include loan proceeds we are obligated to advance, such as loan draws, rotating or revolving credit arrangements, or similar transactions. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee by the counterparty. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
As of September 30, 2009, we had unused commitments to extend credit to our portfolio companies of $38.7 million, which are not reflected on our balance sheet, as shown in the table below. We believe that our operations, monetizations and unrestricted cash will liquidity sufficient to fund, as necessary, requests to draw on these unfunded commitments.
(in thousands) | As of September 30, 2009 | |||||||||||
Unused commitments to portfolio companies |
Non- Affiliate Investments |
Affiliate Investments |
Control Investments |
Total | ||||||||
Revolving credit facilities |
$ | 23,047 | $ | 11,650 | $ | 2,469 | $ | 37,166 | ||||
Other |
108 | | 1,394 | 1,502 | ||||||||
Total unused commitments to portfolio companies |
$ | 23,155 | $ | 11,650 | $ | 3,863 | $ | 38,668 | ||||
From time to time, we provide guarantees or standby letters of credit on behalf of our portfolio companies. As of September 30, 2009, we had $2.0 million of guarantees.
CONTRACTUAL OBLIGATIONS
The following table shows our contractual obligations as of September 30, 2009:
(in thousands) | Payments Due by Period | ||||||||||||||
Contractual Obligations(a) |
Total | Less than 1 year |
1-3 years | 4-5 years | After 5 years | ||||||||||
Borrowings |
|||||||||||||||
Term securitizations |
$ | 319,880 | $ | | $ | | $ | | $ | 319,880 | |||||
Commercial loan funding trust facility(b) |
164,566 | 2,036 | 162,530 | | | ||||||||||
Unsecured notes |
56,461 | | 37,641 | 18,820 | | ||||||||||
SBIC |
27,600 | | | | 27,600 | ||||||||||
Total borrowings |
568,507 | 2,036 | 200,171 | 18,820 | 347,480 | ||||||||||
Operating Leases |
7,539 | 2,350 | 4,402 | 787 | | ||||||||||
Total contractual obligations |
$ | 576,046 | $ | 4,386 | $ | 204,573 | $ | 19,607 | $ | 347,480 | |||||
(a) | Excludes the unused commitments to extend credit to our customers of $38.7 million as discussed above. |
(b) | Borrowings under the MCG Commercial Loan Funding Trust Facility are listed based on the contractual maturity due to the revolving nature of the facility. |
FINANCIAL INSTRUMENTS
During the normal course of business, we are party to certain financial instruments, including loans, participations in loans, guarantees, letters of credit and other financial commitments. We conduct extensive due diligence and, when appropriate, obtain collateral to limit our credit risk. Generally, these commitments have fixed expiration dates or other termination clauses, which may require payment of a fee by the counterparty. We expect many of these commitments will not be fully used before they expire; therefore, the total commitment amounts do not necessarily represent future cash requirements.
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In accordance with GAAP, the unused portions of these commitments are not recorded on our Condensed Consolidated Balance Sheets. The following table summarizes the nominal dollar balance and the fair value of unused commercial loan commitments, guarantees and standby letters of credit as of September 30, 2009 and December 31, 2008:
(in thousands) |
September 30, 2009 | December 31, 2008 | ||||
Unused loan commitments(a) |
$ | 38,668 | $ | 43,393 | ||
Guarantees |
2,000 | 5,833 | ||||
Standby letters of credit |
| 97 | ||||
| ||||||
(a) Estimated fair value of unused loan commitments as of both September 30, 2009 and December 31, 2008 was $0.2 million, based on the fees that we currently charge to enter into similar arrangements, taking into account the creditworthiness of the counterparties. |
DISTRIBUTIONS
As a BDC that has elected to be treated as a RIC, we generally must: 1) distribute at least 90% of our investment company taxable income and 90% of any ordinary pre-RIC built-in gains that we recognize in order to deduct distributions made (or deemed made) to our stockholders; and 2) distribute (actually or on a deemed basis) at least 98% of our income (both ordinary income and net capital gains) in order to avoid an excise tax.
We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions. In addition, we may be limited in our ability to make distributions due to the BDC asset coverage test for borrowings applicable to us as a BDC under the 1940 Act and due to provisions in our credit facilities. If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including possible loss of favorable RIC tax treatment. We cannot assure stockholders that they will receive any distributions or distributions at a particular level. We may make distributions to our stockholders of certain net capital gains.
Since December 2001, we have declared distributions of $11.78 per share. The following table summarizes our distributions declared since January 1, 2008:
Date Declared |
Record Date |
Payment Date |
Amount | ||||
May 6, 2008 |
June 30, 2008 | July 30, 2008 | $ | 0.27 | |||
February 22, 2008 |
March 12, 2008 | April 29, 2008 | 0.44 |
We met our distribution requirements as a RIC for 2008 and will monitor distribution requirements for 2009 in order to ensure compliance under Subchapter M of the Internal Revenue Code. Currently, we expect to apply certain losses for tax purposes in 2009 that we recognized for book purposes during 2008, which will significantly reduce our statutorily required dividend payment in 2009. In order to preserve capital, we intend to pay the statutory minimum dividend for 2009. Due to anticipated loss transactions in the fourth quarter of 2009, we do not expect there will be any required distributions. We will make decisions with respect to the actual level of 2010 dividends on a quarter-by-quarter basis during 2010, after taking into account the minimum statutorily required level of distributions, gains and losses recognized for tax purposes, monetizations, our liquidity and our BDC asset coverage ratio at the time of such decision.
Each year, we mail statements on Form 1099-DIV to our stockholders, which identify the source of the distribution, such as paid from ordinary income, paid from net capital gains on the sale of securities and/or a return of paid-in-capital surplus, which is a nontaxable distribution. To the extent our taxable earnings fall below the total amount of our distributions for that fiscal year, a portion of those distributions may be deemed a tax return of capital to our stockholders. For the fiscal years ended December 31, 2008, 2006, 2005, 2004, and 2003 a portion of the distributions to our stockholders was deemed a return of capital. None of the distributions to stockholders during the fiscal year ended December 31, 2007 was deemed a return of capital. We did not declare a dividend during the nine months ended September 30, 2009. We determine the tax attributes of our distributions as of the end of our fiscal year based upon our taxable income for the full year and distributions paid during the full year. Therefore, a determination of tax attributes made on a quarterly basis may not be representative of the actual tax attributes of distributions for a full year.
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The following table reconciles GAAP net loss to taxable net income (loss) for the nine months ended September 30, 2009 and the year ended December 31, 2008:
(in thousands) |
Nine months ended September 30, 2009 |
Year ended December 31, 2008 |
||||||||
Net loss |
$ | (52,624 | ) | $ | (191,245 | ) | ||||
Difference between book and tax losses on investments(a) |
(14,784 | ) | (73,272 | ) | ||||||
Net change in unrealized depreciation on investments not taxable until realized |
56,839 | 248,218 | ||||||||
Capital losses in excess of capital gains |
34,985 | | ||||||||
Timing difference related to deductibility of long-term incentive compensation |
4,399 | 6,642 | ||||||||
Taxable interest income on non-accrual loans(b) |
18,307 | 2,051 | ||||||||
Dividend income accrued for GAAP purposes that is not yet taxable |
(4,815 | ) | (19,972 | ) | ||||||
Distributions from taxable subsidiaries |
74 | 483 | ||||||||
Federal tax (benefit) provision |
(293 | ) | 789 | |||||||
Other, net |
292 | 4,181 | ||||||||
Taxable income (loss) before deductions for distributions |
$ | 42,380 | $ | (22,125 | ) | |||||
(a) | Results for the year ended December 31, 2008, primarily reflect the write-off, for tax purposes, of the common stock of Cleartel. |
(b) | Results for the year ended December 31, 2008, reflect the reversal of interest that we previously recognized on non-accrual loans of a portfolio investment that we liquidated. We applied the proceeds from the liquidation to the portfolio companys outstanding principal balance on the debt obligation to us. |
CRITICAL ACCOUNTING POLICIES
These Condensed Consolidated Financial Statements are based on the selection and application of critical accounting policies, which require management to make significant estimates and assumptions. The following section describes our accounting policies associated with the valuation of our portfolio of investments. For a full discussion of our other critical accounting policies and estimates, see Managements and Discussion of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2008.
VALUATION OF INVESTMENTS
We determine the value of each investment in our portfolio on a quarterly basis. Value, as defined in Section 2(a)(41) of the 1940 Act, is: (i) the market price for those securities for which a market quotation is readily available; and (ii) for all other securities and assets, fair value is as determined in good faith by the board of directors. As of September 30, 2009, investments in portfolio companies comprised 86.8% of our total assets, of which 99.5% are valued at fair value and 0.5% are valued at market value based on readily ascertainable public market quotes.
ADOPTION OF ASC 820FAIR VALUE MEASUREMENTS AND DISCLOSURES
As of January 1, 2008, we adopted Statement of Financial Accounting Standards No. 157Fair Value Measurements, which was subsequently included in Accounting Standard Codification Topic 820Fair Value Measurements and Disclosures, or ASC 820. ASC 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about assets and liabilities measured at fair value. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This fair value definition focuses on exit price in the principal, or most advantageous, market and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs.
DETERMINATION OF FAIR VALUE IN GOOD FAITH
As a BDC, we invest primarily in illiquid securities, including debt and equity securities of private companies. To protect our investments and maximize our returns, we negotiate the structure of each debt and equity security in our investment portfolio. Our contracts with those portfolio companies generally include many terms governing interest rate, repayment terms, prepayment penalties, financial covenants, operating covenants, ownership and corporate governance parameters, dilution parameters, liquidation preferences, voting rights, and put or call rights. In some cases, our loan agreements also allow for increases in the spread to the base index rate, if the portfolio companys financial or operational performance deteriorates or shows negative variances from its business plan and, in some cases, allow for decreases in the spread if financial or operational performance improves or exceeds the portfolio companys plan. Generally, our investments are subject to some restrictions on
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resale and have no established trading market. Because of the type of investments that we make and the nature of our business, our valuation processes require analyses of numerous market, industry and company-specific factors, including the performance of the underlying investment, the financial condition of the portfolio company, changing market events and other factors relevant to the individual security.
There is no single approach for determining fair value in good faith. Unlike banks, we are not permitted to provide a general reserve for anticipated loan losses. As a result, for portfolio investments that do not have an active market, we must apply judgment to the specific facts and circumstances associated with each security to determine fair value.
We use several valuation methodologies to estimate the fair value of our investment portfolio, which generally results in a range of fair values from which we derive a single estimate of the portfolio companys fair value. To determine a portfolio companys fair value, we analyze its historical and projected financial results, as well as key market value factors. In determining a securitys fair value, we assume we would exchange it in an orderly transaction at the measurement date. We use the following methods to determine the fair value of investments in our portfolio that are not traded actively:
| Majority-Owned Control InvestmentsMajority-owned control investments comprise 38.5% of our investment portfolio. Market quotations are not readily available for these investments; therefore, we use a combination of market and income approaches to determine their fair value. Typically, private companies are bought and sold based on multiples of EBITDA, cash flows, net income, revenues or, in limited cases, book value. Generally, we apply multiples that we observe for other comparable companies to relevant financial data for the portfolio company. Also, in a limited number of cases, we use income approaches to determine the fair value of these securities, based on our projections of the discounted future free cash flows that the portfolio company will likely generate, as well as industry derived capital costs. Our valuation approaches for majority-owned investments estimate the value were we to sell or exit the investment. These valuation approaches assume the highest and best use of the investment by market participants and consider the value of our ability to control the portfolio companys capital structure and the timing of a potential exit. |
| Non-Majority-Owned Control InvestmentsNon-majority owned investments comprise 0.5% of our investment portfolio. For our non-majority owned equity investments, we use the same market and income valuation approaches used to value our majority-owned control investments. For non-majority-owned control debt investments, we estimate fair value using the market yield approach based on the expected future cash flows discounted at the loans effective interest rates, based on our estimate of current market rates. We may adjust discounted cash flow calculations to reflect other market conditions or the perceived credit risk of the borrower. |
| Non-Control InvestmentsNon-control investments comprise 61.0% of our investment portfolio. Quoted prices are not available for 99.2% of our non-control investments, which represent 60.5% of our investment portfolio. For our non-control equity investments, we use the same market and income approaches used to value our control investments. For non-control debt investments, we estimate fair value using a market yield approach based on the expected future cash flows discounted at the loans effective interest rates, based on our estimate of current market rates. We may adjust discounted cash flow calculations to reflect other market conditions or the perceived credit risk of the borrower. |
| Thinly Traded and Over-the-Counter SecuritiesGenerally, we value securities that are traded in the over-the-counter market or on a stock exchange at the average of the prevailing bid and ask prices on the date of the relevant period end. However, we may apply a discount to the market value of restricted or thinly traded public securities to reflect the impact that these restrictions have on the value of these securities. We review factors including the trading volume, total securities outstanding and our percentage ownership of securities to determine whether the trading levels are active (Level 1) or inactive (Level 2). As of September 30, 2009, these securities represented 0.5% of our investment portfolio. |
Our valuation analyses incorporate the impact that key events could have on the securities values, including private mergers and acquisitions, purchase transactions, public offerings, letters of intent and subsequent debt or equity sales. Our valuation analyses consider key external data, such as market changes and industry valuation benchmarks. We also use independent valuation firms to provide additional data points for our quarterly valuation analyses. Our general practice is to obtain an independent valuation or review of valuation once per year for each portfolio investment that had a fair value in excess of $5.0 million, unless the fair value has otherwise been validated
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through a sale of some or all of our investment in the portfolio company. Valuation firms performed independent valuations or reviewed valuations of 45 portfolio companies over the last four quarters, representing $979.4 million, or 94.4%, of the fair value of our total portfolio investments and $295.5 million, or 99.1%, of the fair value of our equity portfolio investments. In addition, the fair value of $50.6 million of our debt investments, representing 6.9% of the fair value of our debt portfolio and 4.9% of the fair value of our total portfolio, was validated with sales transactions involving the portfolio company. In total, either we obtained an independent valuation or review or we considered recent sales transactions for 99.3% of the fair value of our investment portfolio.
As of September 30, 2009 | ||||||||||||||||||||
Investments at Fair Value | Percent of | |||||||||||||||||||
(dollars in thousands) |
Debt | Equity | Total | Debt Portfolio |
Equity Portfolio |
Total Portfolio |
||||||||||||||
Quarter independent valuation/review prepared(a) |
||||||||||||||||||||
Third quarter 2009 |
$ | 129,385 | $ | 149,915 | $ | 279,300 | 17.5 | % | 50.3 | % | 26.9 | % | ||||||||
Second quarter 2009 |
145,662 | 12,529 | 158,191 | 19.7 | 4.2 | 15.3 | ||||||||||||||
First quarter 2009 |
269,275 | 103,855 | 373,130 | 36.4 | 34.8 | 35.9 | ||||||||||||||
Fourth quarter 2008 |
139,508 | 29,225 | 168,733 | 18.9 | 9.8 | 16.3 | ||||||||||||||
Total independent valuation/review |
683,830 | 295,524 | 979,354 | 92.5 | 99.1 | 94.4 | ||||||||||||||
Quarter fair value validated with sales transaction |
||||||||||||||||||||
Third quarter 2009 |
50,621 | | 50,621 | 6.9 | | 4.9 | ||||||||||||||
Total validated with sales transaction |
50,621 | | 50,621 | 6.9 | | 4.9 | ||||||||||||||
Not evaluated during the 12 months ended September 30, 2009 |
4,471 | 2,798 | 7,269 | 0.6 | 0.9 | 0.7 | ||||||||||||||
Total investment portfolio |
$ | 738,922 | $ | 298,322 | $ | 1,037,244 | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
(a) | Independent valuations/reviews prepared more than one time during the twelve months ended September 30, 2009 have that investments fair value reflected in the most recent quarter for which an independent valuation/review was prepared. |
The majority of the valuations used by the independent valuation firms utilize proprietary models and inputs. We intend to continue to use independent valuation firms to provide additional support for our internal analyses. Our board of directors considers our valuations, as well the independent valuations and reviews in its determination of the fair value of our investments. The fair value of our interest rate swap is based on a binding broker quote, based on the estimated net present value of the future cash flows using a forward interest rate yield-curve in effect as of the measurement period.
Due to the uncertainty inherent in the valuation process, such fair value estimates may differ significantly from the values that would have been used had a ready market for the securities existed, and the differences could be material. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses that we ultimately realize on these investments to be different from the valuations currently assigned.
RECENT ACCOUNTING PRONOUNCEMENTS
CODIFICATION OF ACCOUNTING STANDARDS
In June 2009, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards No.168The FASB Accounting Standards Codification and Hierarchy of Generally Accepted Accounting Principles, or SFAS 168. SFAS 168 introduced a new Accounting Standard Codification, or ASC, which organized current and future accounting standards into a single codified system. SFAS 168, which is now referred to as ASC Topic 105Generally Accepted Accounting Principles, or ASC 105, under the new codification, superseded, but did not significantly change, all previously existing accounting standards. ASC 105 was effective for interim periods ending after September 15, 2009. We adopted ASC 105 beginning with our Quarterly Report on Form 10-Q for the quarter ended September 30, 2009.
As part of our adoption of this standard, our discussions about specific accounting standards must now reference the standards as set forth in the new codification. To assist readers of our financial statements, we have included the new ASC reference, as well as the reference to the standard as it was originally issued.
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STANDARD ON SUBSEQUENT EVENTS
In May 2009, FASB issued SFAS 165Subsequent Events, which was subsequently included in ASC Topic 855Subsequent Events, or ASC 855. ASC 855 provides guidance on managements assessment of subsequent events and requires additional disclosure about the timing of managements assessment of subsequent events. ASC 855 did not significantly change the accounting requirements for the reporting of subsequent events. ASC 855 was effective for interim or annual financial periods ending after June 15, 2009 and we adopted this standard as of June 30, 2009. Our adoption of this standard did not affect our financial position or results of operations.
FAIR VALUE MEASUREMENTS
FASB set forth most of the accounting guidance associated with the measurement and disclosure of fair value in ASC Topic 820Fair Value Measurements and Disclosures. Prior to its adoption of the new codification, FASB issued a number of standards that either affected the measurement and disclosure of fair value or provided additional guidance or clarification. All such amendments have been incorporated into ASC 820, including the following:
| In February 2008, FASB issued FASB Staff Position No. FAS 157-2Effective Date of FASB No. 157, which deferred the date for which ASC 820 was required to be adopted for nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008, with early adoption permitted in certain cases. Our adoption of this standard as of January 1, 2009 did not affect our financial position or results of operations. |
| In October 2008, FASB issued FASB Staff Position No. FAS 157-3Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active, which provided an illustrative example of how to determine the fair value of a financial asset in an inactive market. This standard did not change the fair value measurement principles previously set forth by FASB. We adopted this modification in January 2009. Our practice for determining the fair value of our investment portfolio has been, and continues to be, consistent with the guidance provided in the example included in the October 2008 guidance. Therefore, our adoption of this standard did not affect our practices for determining the fair value of our investment portfolio and did not have a material effect on our financial position or results of operations. |
| In April 2009, FASB issued FASB Staff Position No. FAS 157-4Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Indentifying Transactions That Are Not Orderly, which established standards for determining whether normal market activity exists for Level 2 assets and liabilities. In addition, the standard expands disclosure requirements for fair value reporting and requires a categorization of investments consistent with that required for ASC 320InvestmentsDebt and Equity Securities. We adopted this standard for the period ended June 30, 2009. Since our Level 2 investments comprise less than 0.5% of our investment portfolio, our adoption of this standard, did not have a material effect on our financial position or results of operations. |
In April 2009, FASB issued FASB Staff Position No. FAS 107-1 and APB 28-1Interim Disclosures about Fair Value of Financial Instruments, which was subsequently incorporated into ASC Topic 825Financial Instruments. The April 2009 guidance requires disclosures about financial instruments, including fair value, carrying amount, and method and significant assumptions used to estimate the fair value. We adopted this standard as of June 30, 2009. Our adoption of this standard did not affect our financial position or results of operations.
In August 2009, FASB issued Accounting Standard Update No. 2009-05Measuring Liabilities at Fair Value, or ASU 2009-05. The August 2009 update provides clarification to ASC 820 for the valuation techniques required to measure the fair value of liabilities. ASU 2009-05 also provides clarification around required inputs to the fair value measurement of a liability and definition of a Level 1 liability. ASU 2009-05 is effective for interim and annual periods beginning after August 28, 2009. We will adopt this standard beginning with our financial statements ending December 31, 2009. We do not anticipate that our adoption of this standard will have a material effect on our financial position and results of operations.
TWO-CLASS METHOD OF PRESENTING EARNINGS PER SHARE
In June 2008, FASB issued FASB Staff Position EITF 03-06-1Determining Whether Instruments Granted in Share-based Payment Transactions are Participating Securities, which was subsequently incorporated into ASC
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Topic 260Earnings Per Share. The June 2008 guidance requires companies to include unvested share-based payment awards that contain non-forfeitable rights to dividends in the computation of earnings per share pursuant to the two-class method. In effect, this standard requires companies to report basic and diluted earnings per share in two broad categories. First, companies must report basic and diluted earnings per share associated with the unvested share-based payments with non-forfeitable dividend rights. Second, companies must report separately basic and diluted earnings per share for their remaining common stock. This standard was effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. We adopted this standard beginning with our financial statements ended March 31, 2009. As required, we applied this standard retroactively to all reported periods. Our adoption of this standard did not have a material impact on our financial position or results of operations. See Note 9Earnings (Loss) Per Share for additional information about our adoption of this standard.
DISCLOSURES ABOUT DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In March 2008, FASB issued SFAS No. 161Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133, which was subsequently incorporated into ASC Topic 815Derivatives and Hedging, or ASC 815. The March 2008 guidance requires qualitative disclosures about: objectives and strategies for using derivatives; quantitative disclosures about fair value amounts of, and gains and losses on, derivative instruments; and disclosures about credit-risk-related contingent features in derivative agreements. This standard was effective for fiscal years beginning after November 15, 2008 and interim periods within those fiscal years. We adopted this standard as of January 1, 2009. We have reflected the disclosure requirements for ASC 815 in Note 2Investment Portfolio.
ACCOUNTING FOR TRANSFERS OF FINANCIAL ASSETS
In June 2009, FASB issued SFAS 166Accounting for Transfers of Financial Assets. This statement amends SFAS 140Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, which was subsequently incorporated into ASC Topic 860Transfers and Servicing, or ASC 860. The June 2009 guidance removed the concept of a qualifying special-purpose entity from ASC 860. The June 2009 guidance also established specific conditions for reporting the transfer of a portion of a financial asset as a sale. This June 2009 guidance must be applied as of the beginning of each reporting entitys first annual reporting period that begins after November 15, 2009 and early application is prohibited. We will adopt this standard as of January 1, 2010. We do not anticipate that our adoption of this standard will have a material effect on our financial position and results of operations.
INCOME TAXES
In September 2009, FASB issued ASU 2009-06Implementation Guidance on Accounting for Uncertainty in Income Taxes and Disclosure Amendments for Nonpublic Entities, or ASU 2009-06. The September 2009 update did not change existing GAAP but provides implementation guidance to ASC 740Income Taxes, or ASC 740. In addition, ASU 2009-06 eliminates certain disclosures required by ASC 740 for nonpublic companies, but does not alter the disclosure requirements for public companies. ASU 2009-06 is effective for interim and annual periods ending after September 15, 2009. We adopted this standard as of September 30, 2009. Our adoption of this standard did not affect our financial position or results of operations.
ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Beginning in late 2007, the United States entered a recession. As the economy continued to deteriorate in 2008, spending by both consumers and businesses declined significantly, which has impacted the broader financial and credit markets and has reduced the availability of debt and equity capital for the market as a whole and financial firms in particular. This reduction in spending has had an adverse effect on a number of the industries in which some of our portfolio companies operate. Historically, MCG and other commercial finance companies have utilized the collateralized loan obligation, or CLO, market to finance some of their investment activities. Due to the current dislocation of the CLO market, which we believe may continue for an extended period of time, we and other companies in the commercial finance sector will have to either curtail originations or obtain access to alternative debt markets. During 2008 and continuing into 2009, the availability of debt capital was extremely constrained. While we have been successful in renegotiating certain of our borrowing agreements in early 2009, these agreements are at higher cost and include less favorable terms than our historical borrowing agreements.
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In the event that the current recession continues for a significant time or the economy deteriorates further, the financial position and results of operations of certain of the middle-market companies in our portfolio could be affected adversely, which ultimately could lead to difficulty in meeting debt service requirements and an increase in defaults. During the nine months ended September 30, 2009, we experienced write-downs across the portfolio, most of which were due to a reduction in the performance of certain portfolio companies and a reduction in comparable multiples and market pricing used to estimate the fair value of our investments. There can be no assurance that the performance of our portfolio companies will not be further impacted by economic conditions, which could have a negative impact on our future results.
Interest rate sensitivity refers to the change in earnings that may result from changes in the level of interest rates. Our net interest income is affected by changes in various interest rates, including LIBOR, prime rates and commercial paper rates. As of September 30, 2009, approximately 58.8% of our loan portfolio, at fair value, bears interest at a spread to LIBOR or prime rate, and 41.2% at a fixed interest rate. As of September 30, 2009, approximately 41.1% of our loan portfolio, at fair value, had LIBOR floors between 1.5% and 4.0% on the LIBOR base index and prime floors between 3.0% and 6.0%. These floors minimize our exposure to significant decreases in interest rates.
We regularly measure exposure to interest rate risk. We assess interest rate risk and we manage our interest rate exposure on an ongoing basis by comparing our interest rate sensitive assets to our interest rate sensitive liabilities. Based on this review, we determine whether or not any hedging transactions are necessary to mitigate exposure to changes in interest rates. We also will enter derivative transactions in connection with our financing vehicles. During the first quarter ended March 31, 2009, we entered into two interest rate swaps expiring in August 2011 for notional amounts of $8.7 million and $12.5 million at interest rates of 9.0% and 13.0%, respectively. During 2008, we entered into two interest rate swaps expiring in November 2010 for notional amounts of $16.0 million and $8.0 million at interest rates of 10.0% and 14.0%, respectively.
The following table compares the interest rate base for our commercial loans and our outstanding borrowings as of September 30, 2009 and December 31, 2008:
September 30, 2009 | December 31, 2008 | |||||||||||||
(in thousands) |
Commercial Loans |
Borrowings | Interest Bearing Cash and Commercial Loans |
Borrowings | ||||||||||
Money Market Rate |
$ | | $ | | $ | 156 | $ | | ||||||
Prime Rate |
76,122 | | 63,346 | | ||||||||||
LIBOR |
||||||||||||||
30-Day |
43,422 | | 16,825 | | ||||||||||
60-Day |
| | | | ||||||||||
90-Day |
389,935 | 319,880 | 459,012 | 371,880 | ||||||||||
180-Day |
3,780 | | 7,923 | | ||||||||||
Commercial Paper |
| 164,566 | | 187,169 | ||||||||||
Fixed Rate |
367,960 | 84,061 | 372,226 | 77,600 | ||||||||||
Total |
$ | 881,219 | $ | 568,507 | $ | 919,488 | $ | 636,649 | ||||||
Based on our September 30, 2009 balance sheet, the following table shows the impact to net income of base rate changes in interest rates assuming no changes in our investment and borrowing structure:
(dollars in thousands) Basis Point Change |
Interest Income |
Interest Expense |
Unrealized Appreciation |
Net Loss | |||||
100 |
1,475 | 4,844 | 714 | (2,655 | ) | ||||
200 |
3,262 | 9,689 | 1,416 | (5,011 | ) | ||||
300 |
6,846 | 14,533 | 2,107 | (5,580 | ) |
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ITEM 4. | CONTROLS AND PROCEDURES |
DISCLOSURE CONTROLS AND PROCEDURES
Our management, with the participation of our Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2009. The term disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SECs rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the companys management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the foregoing evaluation of our disclosure controls and procedures as of September 30, 2009, our Chief Executive Officer, our Chief Financial Officer and our Chief Accounting Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
INTERNAL CONTROL OVER FINANCIAL REPORTING
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act), occurred during the fiscal quarter ended September 30, 2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 1. | LEGAL PROCEEDINGS. |
From time to time, we are a party to certain legal proceedings incidental to the normal course of our business, including the enforcement of our rights under contracts with our portfolio companies. While we cannot predict the outcome of these legal proceedings with certainty, we do not expect that these proceedings will have a material effect on our financial condition or results of operations. During the quarter ended September 30, 2009 there were no new or material developments in legal proceedings.
ITEM 1A. | RISK FACTORS. |
Investing in our common stock involves a high degree of risk. You should consider carefully the risks described below and all other information contained in this Quarterly Report on Form 10-Q, including our financial statements and the related notes and the schedules and exhibits to this Quarterly Report on Form 10-Q.
Set forth below and elsewhere in this Quarterly Report on Form 10-Q and in other documents that we file with the SEC are descriptions of the risks and uncertainties that could cause our actual results to differ materially from the results contemplated by the forward-looking statements contained in this Quarterly Report on Form 10-Q. The description below includes any material changes to, and supersedes the description of, the risk factors affecting our business previously disclosed in Part I, Item 1A. Risk Factors of our Annual Report on Form 10-K for the fiscal year ended December 31, 2008.
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Many of our portfolio investments are not publicly-traded and, as a result, there is uncertainty as to the value of our portfolio investments. If our determinations regarding the fair value of our investments were materially higher than the values that we ultimately realize upon the disposition of such investments, our net asset value could be affected adversely.
In accordance with the 1940 Act and accounting principles generally accepted in the United States, we carry substantially all of our portfolio investments at fair value as determined in good faith by our board of directors. Whenever possible, we value securities at market value; however, only a small percentage of our investment portfolio is traded publicly. We value the investments that are not publicly traded pursuant to a valuation process utilizing the input of our investment and valuation committee. The types of factors that may be considered in fair value pricing of these investments include private mergers and acquisitions transactions, comparisons to publicly traded comparable companies, third-party assessments of valuation, discounted cash flow analyses, the nature and realizable value of any collateral, the portfolio companys earnings and its ability to make payments, the markets in which the portfolio company does business, market-based pricing and other relevant factors. In determining fair value in good faith, we generally obtain financial and other information from portfolio companies, which may include unaudited, projected or pro forma financial information. Our board of directors also uses several independent valuation firms to aid it in determining the fair value of these investments. Because our valuations, and particularly the valuations of private securities and private companies, are inherently uncertain, they may fluctuate over short periods of time and may be based on estimates. Our determinations of fair value may differ materially from the values that would have been used if a readily available market for these investments existed and from the amounts we may realize on any disposition of such investments. If our determinations regarding the fair value of our investments were materially higher than the values that we ultimately realize upon the disposition of such investments, our NAV could be affected adversely.
Economic downturns or recessions could impair our portfolio companies financial position and operating results, which could, in turn, harm our operating results.
Since 2007, the U.S. and most other global markets have been in a protracted period of recession. Many of the companies in which we have made, or may make investments are, and may continue to be, susceptible to economic downturns or recessions. Since the nation entered this recession, the stock market has declined, a number of financial institutions have failed, the availability of debt and equity capital became severely constrained, unemployment rose and consumer confidence eroded significantly, all of which led to a decline in consumer spending. The U.S. government has acted to restore liquidity and stability to the financial system, but there can be no assurances these regulatory programs and proposals will have a beneficial impact. Current adverse economic conditions have decreased the value of some of our loans and equity investments and a prolonged recession or depression and the after-effects of these conditions may further decrease such value. These conditions are contributing to, and if prolonged, could lead to further losses of value in our portfolio and decrease in our revenues, net income and net assets. If prolonged, unfavorable or uncertain economic and market conditions may affect the ability of our portfolio companies to repay our loans or engage in a liquidity event, such as a sale, merger, recapitalization or initial public offering. Therefore, the number of non-performing assets may increase and the value of our portfolio may decrease during these periods. A portfolio companys failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, an acceleration of its loans and foreclosure on its secured assets, which could trigger cross-defaults under other agreements and jeopardize our portfolio companys ability to meet its obligations under the debt securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms with a defaulting portfolio company. In addition, if one of our portfolio companies were to go bankrupt, even though we, or one of our affiliates, may have structured our interest as senior debt, depending on the facts and circumstances, including the extent to which we actually provided managerial assistance to that portfolio company, a bankruptcy court might re-characterize our debt holding as equity and subordinate all, or a portion, of our claim to that of other creditors.
Investing in middle-market businesses involves a high degree of risk and our financial results may be affected adversely if one or more of our significant portfolio investments defaults on its loans or fails to perform as we expect.
Our portfolio consists primarily of debt and equity investments in privately owned middle-market businesses. Investment in middle-market companies involves a number of significant risks. Typically, the debt in which we invest is not initially rated by any rating agency; however, we believe that if such investments were rated, they would be below investment grade. Compared to larger publicly-owned companies, these middle-market companies may be in a weaker financial position and experience wider variations in their operating results, which may make them more vulnerable to economic downturns. Typically, these companies need more capital to
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compete; however, their access to capital is limited and their cost of capital is often higher than that of their competitors. Our portfolio companies face intense competition from larger companies with greater financial, technical and marketing resources and their success typically depends on the management talents and efforts of an individual or a small group of persons. Therefore, the loss of any of their key employees could affect their ability to compete effectively and harm their financial condition. Further, some of these companies conduct business in regulated industries that are susceptible to regulatory changes. These factors could impair the cash flow of our portfolio companies and result in other events, such as bankruptcy. These events could limit a portfolio companys ability to repay their obligations to us, which may have an adverse affect on the return on, or the recovery of, our investment in these businesses. Deterioration in a borrowers financial condition and prospects may be accompanied by deterioration in the value of the loans collateral.
Some of these companies cannot obtain financing from public capital markets or from traditional credit sources, such as commercial banks. Accordingly, loans made to these types of companies pose a higher default risk than loans made to companies who have access to traditional credit sources.
Generally, little, if any, public information is available about such companies. Therefore, we must rely on our employees diligence to obtain the information needed to make well-informed investment decisions. If we do not uncover material information about these companies, we may not make a fully informed investment decision, which could, in turn cause us to lose money on our investments.
Our financial position and results of operations could be affected adversely if a significant portion of our portfolio is invested in industries that experience adverse economic or business conditions.
From time to time, we target specific industries in which to invest on a recurring basis. This practice could concentrate a significant portion of our portfolio in a specific industry. As of September 30, 2009, our investments in communications companies represented 18.2% of the fair value of our portfolio. Of the 18.2% investment, 16.5% represented investments in CLECs and 1.7% represented investments in other communications companies. In addition, as of September 30, 2009, our investments in cable and healthcare portfolio companies represented 12.3% and 9.5%, respectively, of the fair value of our portfolio. If an industry in which we have significant investments suffers from adverse business or economic conditions, as these industries have to varying degrees, a material portion of our investment portfolio could be affected adversely, which, in turn, could adversely affect our financial position and results of operations.
Our financial results could be affected adversely if a significant portfolio investment fails to perform as expected.
Our total investment in companies may be significant individually or in the aggregate. As a result, if a significant investment in one or more companies fails to perform as expected, our financial results could be affected adversely and the magnitude of the loss could be more significant than if we had made smaller investments in a greater number of companies.
Broadview, a CLEC serving primarily business customers, is our largest portfolio investment. As of September 30, 2009, we held preferred stock in Broadview with a $138.8 million fair value. As of September 30, 2009 and December 31, 2008, our investment in Broadview represented 13.4% and 11.6%, respectively, of the fair value of our investment portfolio. During the nine months ended September 30, 2009, we did not recognize any unrealized depreciation on our investment in Broadview. If Broadviews performance deteriorates in future periods, we may be required to recognize additional unrealized depreciation on this investment.
In November 2007, Broadview filed a registration statement on Form S-1 to register shares of its common stock for an initial public offering, or IPO, of equity securities. Since early 2008, however, the IPO markets have been inaccessible due to market conditions. Broadview continues to perform in accordance with our expectations; however, we currently do not expect to accrue any further dividends on our Broadview investment. Our ability to recognize income from our preferred stock investment in Broadview in future periods depends on the performance and value of Broadview.
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We have been in a period of capital markets disruption and recession and we do not expect these conditions to improve in the near future. This disruption in the capital markets has contributed to the decrease in our net asset value and stock price, and could have an adverse impact on our business and operations.
Since late 2007, and particularly since mid-2008, the financial services industry and the securities markets generally were materially and adversely affected by significant declines in the values of nearly all asset classes and by a lack of liquidity. These market conditions were initially triggered by declines in home prices and the values of subprime mortgages, but spread to all mortgage and real estate asset classes, to leveraged bank loans and to nearly all asset classes, including equities. For nearly two years, the global markets have been characterized by substantially increased volatility, short-selling and an overall loss of investor confidence, initially in financial institutions, but more recently in companies in a number of other industries and in the broader markets. The U.S. economy has been in a period of recession and forecasts for 2009 generally call for continued instability in the economy. As of September 30, 2009, our common stock was trading at $4.19 per share, or at 52.0% of net asset value.
We may be unable to monetize assets in a difficult market environment that precludes our target buyers from making investments at the fair values established by our board of directors. We are susceptible to the risk of significant loss if we are forced to discount the value of our investments in order to monetize assets to provide liquidity to fund operations, meet our liability maturities and to maintain compliance with our debt covenants. In addition, if the fair value of our assets declines substantially, we may fail to maintain the BDC asset coverage ratios stipulated by the 1940 Act. Any such failure would affect our ability to issue senior securities, including borrowings, pay dividends and could cause us to breach certain covenants in our credit facilities, which could materially impair our business operations. Further asset value degradation may result from circumstances that we may be unable to control, such as a severe decline in the value of the U.S. dollar, a protracted economic downturn or an operational problem that affects third parties or us. Ongoing disruptive conditions could cause our stock price and net asset value to decline, restrict our business operations and could adversely impact our results of operations and financial condition.
If we are not successful in our appeal to the Internal Revenue Service, we could be subject to up to $20.5 million of additional taxes, interest and penalties, and could be required to make up to $25.1 million of additional cash and/or stock distributions. This event could have an adverse effect on our liquidity.
In December 2007, we received an examination report from the Internal Revenue Service related to its audit of our tax returns for the 2004 and 2005 tax years. The Internal Revenue Service proposed changes to certain deductions made by us for those years, primarily associated with the timing of certain realized losses in our portfolio. We are appealing the proposed changes and believe it is more likely than not that our appeal will be successful. In the event that our appeal is unsuccessful, we also could be required to make up to $25.1 million of additional cash and/or stock distributions to our stockholders, although alternative options may be available to us in lieu of such distributions.
If market constraints further prevent us from obtaining additional debt or equity capital, our liquidity could be affected adversely, our business prospects could be impacted negatively, we could lose key employees and our operating results could be affected negatively.
The current economic and capital market conditions in the U.S. have resulted in a severe reduction in the availability of debt and equity capital for the market as a whole, and financial services firms in particular. These conditions have constrained us and other companies in the financial services sector, limiting or completely preventing access to markets for debt and equity capital needed to maintain operations, continue investment originations and to grow. If these conditions continue for a prolonged period of time, or worsen in the future, we could lose key employees and access to leverage and our business prospects could be impacted negatively. In addition, the debt capital that will be available, if at all, may be at a higher cost and/or less favorable terms and conditions. Equity capital is, and may continue to be, difficult to raise because, subject to some limited exceptions, we generally are not able to issue and sell our common stock at a price below net asset value per share. In addition, issuing equity at depressed stock prices is dilutive to our stockholders, uneconomical and would impair our ability to grow. These events and inability to raise capital have had a negative effect on our origination process, curtailed our ability to grow and had a negative impact on our liquidity and operating results. The continued inability to raise additional capital could further constrain our liquidity, negatively impact our business prospects, cause the departure of key employees and have an adverse impact our operating results.
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If we fail to qualify as a regulated investment company, we will have to pay corporate-level taxes on our income and our income available for distribution would be reduced significantly or eliminated.
We have elected to be taxed for federal income tax purposes as a RIC, under Subchapter M of the Internal Revenue Code. To qualify as a RIC under the Internal Revenue Code, we must meet certain source-of-income, asset diversification and annual distribution requirements. The annual distribution requirement for a RIC is satisfied if we distribute to our stockholders at least 90% of our ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, on an annual basis. If we do not distribute at least 98% of our annual taxable income, we generally will be required to pay an excise tax on amounts carried over and distributed to stockholders in the next year equal to 4% of the amount by which 98% of our annual taxable income exceeds the distributions from such income for the current year. We met our distribution requirements as a RIC for 2008 and the nine-months ended September 30, 2009. Covenants and provisions in our credit facilities limit the ability of our subsidiaries and our securitization trusts to make distributions to us, which could affect our ability to make distributions to our stockholders and to maintain our status as a RIC. In addition, we may have difficulty meeting the requirement to make distributions to our stockholders because in certain cases we may recognize income before or without receiving cash representing such income. Consequently, if we are unable to obtain cash from other sources to satisfy our distributions to our stockholders, we may fail to qualify as a RIC and, thus, may be subject to corporate-level income tax.
The Internal Revenue Service recently issued a Revenue Procedure that provides temporary cash flow relief to RICs, including BDCs, by allowing them to satisfy their federal tax income distribution requirements through the use of substantial amounts of their own stock, rather than solely cash or other RIC assets. Although there has been some guidance that suggests that distributions of stock consistent with the Revenue Procedure will not be viewed as violating the provisions of the 1940 Act relating to sales of shares below net asset value and do not need to be registered under the Securities Act of 1933, any such distributions require complicated compliance procedures and would be dilutive to existing stockholders. To qualify as a RIC, we must also meet certain asset diversification requirements at the end of each calendar quarter. Failure to meet these tests may, in certain instances, result in our having to dispose of certain investments quickly in order to prevent the loss of RIC status. Because most of our investments are in private companies, any such dispositions could be made at disadvantageous prices and may result in substantial losses. If we fail to qualify as a RIC for any reason and become subject to corporate-level income tax, the resulting corporate-level taxes could substantially reduce our net assets, the amount of income available for distribution and the amount of our distributions. Such a failure would have a material adverse effect on our stockholders and us.
We have substantial indebtedness and, if we do not service our debt arrangements adequately, our business could be harmed materially.
As of September 30, 2009, we had $568.5 million of outstanding borrowings under our debt facilities. As of September 30, 2009, the weighted-average annual interest rate on all of our outstanding borrowings was 3.3%, excluding the amortization of deferred debt issuance costs. In order for us to make our annual interest payments on indebtedness, we must achieve annual returns on our September 30, 2009 total assets of at least 1.5%. Our ability to service our debt arrangements depends largely on our financial performance and will be subject to prevailing economic conditions and competitive pressures.
Under our warehouse financing facility funded through Three Pillars Funding LLC, an asset-backed commercial paper conduit administered by SunTrust, and under our debt securitization through MCG Commercial Loan Trust 2006-1, we are subject to financial and operating covenants that restrict our business activities, including limitations that could hinder our ability to finance additional loans and investments or to make the distributions required to maintain our status as a RIC under Subchapter M of the Internal Revenue Code and impact our liquidity. In addition, these facilities include various affirmative and negative covenants, as well as certain cross-default provisions, whereby a payment default or acceleration under one of our debt facilities could, in certain circumstances, constitute a default under other debt facilities. In the event that there is a breach of one of the covenants contained in one of our debt facilities that has not been cured within any applicable cure period, if any, the lenders thereunder would have the ability to, in certain circumstances, accelerate the maturity of the indebtedness outstanding under that facility and exercise certain other remedies. In addition, our subsidiaries have sold some of our loans to trusts that serve as the vehicles for our securitization facilities, and these trusts, which are bankruptcy remote, hold legal title to these assets. However, in the event of a default on these loans held by the trusts, we bear losses to the extent our collateral exceeds our borrowings, which was $234.8 million as of September 30, 2009.
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Under the terms of our unsecured notes, or the Private Placement Notes, we are also subject to financial and operating covenants that restrict our business activities, including our ability to incur certain additional indebtedness, effect debt and stock repurchases in specified circumstances or through the use of borrowings or unrestricted cash, or pay dividends above certain levels.
We record decreases in the fair values of our portfolio company investments as unrealized depreciation, which could affect certain covenants in our credit facilities. Our SunTrust Warehouse requires that we maintain a minimum stockholders equity of not less than $525.0 million as of December 31, 2008 plus 50% of the proceeds from any post-amendment date equity issuances. The Private Placement Notes require that we maintain a consolidated stockholders equity of $500.0 million for the periods ending as of and after December 31, 2008. As of September 30, 2009, our stockholders equity was $612.0 million. In the event that we experience a significant amount of unrealized depreciation, we could breach one or more of the covenants in our credit facilities pursuant to which our lenders might, among other things, require full and immediate payment.
As a BDC, we are not permitted to incur indebtedness or issue senior securities, including preferred stock, unless immediately after such borrowing we have an asset coverage for total borrowings (excluding borrowings by our SBIC facility) of at least 200%. In addition, we may not be permitted to declare any cash dividend or other distribution on our outstanding common shares, or purchase any such shares, unless, at the time of such declaration or purchase, we have an asset coverage of at least 200% after deducting the amount of such dividend, distribution or purchase price. If we are unable to meet this asset coverage requirement, we may not be able to incur additional debt and may need to sell a portion of our investments to repay some debt when it is disadvantageous to do so, and we may not be able to make distributions until we are in compliance with the 200% threshold requirement.
In addition, because a significant portion of our assets and liabilities are priced using various short-term rate indices, including one-month to three-month LIBOR, commercial paper rates and the prime rate, the timing of changes in market interest rates or in the relationship between interest rate indices could affect the interest rates earned on interest-earning assets differently than the interest rates paid on interest-bearing liabilities, which could result in a decrease in net income.
If we are not able to refinance or renew our debt or able to do so on favorable terms, our operations could be affected adversely.
As of September 30, 2009, we had $568.5 million of borrowings. In February 2009, we entered into amendments related to our SunTrust Warehouse and Private Placement Notes, pursuant to which the facility limits on the SunTrust Warehouse was reduced to $190.0 million. This facility has been further reduced by monetization prepayments. As of September 30, 2009, the facility limits for the SunTrust Warehouse and Private Placement notes are $175.6 million and $56.5 million, respectively.
Absent any acceleration events, the SunTrust Warehouse matures in August 2011 and the Private Placement Notes mature in October 2011 (with respect to the $34.3 million in notes remaining as of October 30, 2009) and October 2012 (with respect to the $17.2 million in notes remaining as of October 30, 2009). We cannot be certain that we will be able to renew our credit facilities as they mature or to consummate new borrowing facilities to provide capital for normal operations, including new originations. Reflecting concern about the stability of the financial markets, many lenders and institutional investors have reduced or ceased providing funding to borrowers. This market turmoil and tightening of credit has led to increased market volatility and widespread reduction of business activity generally. If we are unable to renew or replace such facilities and consummate new facilities, at a reasonable size, our liquidity will be reduced significantly. Even if we are able to renew or refinance these facilities or consummate new borrowing facilities, we may not be able to do so on favorable terms. If we are unable to repay amounts outstanding under such facilities and are declared in default or are unable to renew or refinance these facilities, our operations could be affected adversely.
When we are a debt or minority equity investor in a portfolio company, we may not be in a position to control the entity, and management of the portfolio company may make decisions that could decrease the value of our portfolio holdings.
We make both debt and minority equity investments. For these investments, we are subject to the risk that a portfolio company may make business decisions with which we disagree, and the stockholders and management of that company may take risks or otherwise act in ways that do not serve our interests. As a result, a portfolio company may make decisions that could decrease the value of our portfolio holdings and have an adverse effect on our performance.
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Investments in equity securities involve a substantial degree of risk.
We may purchase common stock and other equity securities, including warrants. Although equity securities have historically generated higher average total returns than debt securities over the long term, equity securities may experience more volatility in those returns than debt securities. The equity securities we acquire may fail to appreciate, decline in value or lose all value; and, our ability to recover our investment will depend on our portfolio companys success. Investments in equity securities involve a number of significant risks, including the risk of further dilution as a result of additional issuances. Investments in preferred securities involve special risks, such as the risk of deferred distributions, illiquidity and limited voting rights.
You may not receive future distributions.
In the event that our asset coverage ratio falls below 200%, which it did during the quarter ended March 31, 2009, we will be unable to make distributions until our asset coverage ratio improves. If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including the possible loss of our status as a RIC for the applicable period. We cannot assure you that you will receive any distributions or distributions at a particular level. As of September 30, 2009, our asset coverage ratio was 212%. On August 6, 2008, we announced that we had met our estimated distribution requirements for 2008. Subsequently, we did not make additional distributions during 2008. Currently, we expect to apply certain losses for tax purposes in 2009 that we recognized for book purposes during 2008, which could result in a significant reduction to our statutorily required dividend payment in 2009. In order to preserve capital, we intend to pay the statutory minimum dividend for 2009. Due to anticipated loss transactions in the fourth quarter of 2009, we do not expect there will be any required distributions. We may not be able to achieve operating results or our business may not perform in a manner that will allow us to make any distributions in 2010. During 2010, we will make decisions with respect to dividends on a quarter-by-quarter basis after taking into account the minimum statutorily required level of distributions, including gains and losses recognized for tax purposes, portfolio transactional events, our liquidity and our BDC asset coverage ratio. In addition, we may not be able to make distributions at a specific level or to increase the amount of these distributions from time to time. Due to the BDC asset coverage test applicable to us as a BDC, we may be limited in our ability to make distributions.
We may have difficulty paying our required distributions if we recognize income before or without receiving cash representing such income.
In accordance with generally accepted accounting principles and tax regulations, we include in taxable income certain amounts that we have not yet received in cash, such as contractual payment-in-kind interest, which represents contractual interest added to the loan balance and due at the end of the loan term. The increases in loan balances as a result of contracted payment-in-kind arrangements are included in taxable income in advance of receiving cash payment. Since we may recognize income before or without receiving cash representing such income, we may have difficulty meeting the requirement to distribute at least 90% of our investment company taxable income to maintain tax benefits as a RIC.
If we need to sell any of our investments, we may not be able to do so at a favorable price and, as a result, we may suffer losses.
Our investments usually are subject to contractual or legal restrictions on resale or are otherwise illiquid because there is usually no established trading market for such investments. The illiquidity of most of our investments may make it difficult for us to dispose of them at a favorable price, and, as a result, we may suffer losses. In addition, if we were forced to liquidate some or all of the investments in our portfolio immediately, the proceeds of such liquidation could be significantly less than the current value of such investments. We may be required to liquidate some or all of our portfolio to meet our debt service obligations or to maintain our qualification as a business development company and as a RIC if we do not satisfy one or more of the applicable criteria under the respective regulatory frameworks.
Our business depends on our key personnel.
We depend on the continued services of our executive officers and other key management personnel. The loss of any of our executive officers or key management personnel could result in inefficiencies in our operations and lost business opportunities, which could have a negative impact on our business. In addition, under our SunTrust Warehouse, if either Steven F. Tunney, our CEO, or B. Hagen Saville, our Executive Vice President, Business Development, ceases to be involved actively in the management of MCG and is not replaced by a
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person reasonably acceptable to SunTrust within 90 consecutive calendar days of such occurrence, we would be in default under such facility. If we lose the services of Mr. Tunney or Mr. Saville and are unable to identify and hire suitably qualified replacements, it could trigger a covenant default under our SunTrust Warehouse, which could accelerate the termination date of that facility.
Fluctuations in interest rates could affect our income adversely.
Because we sometimes borrow to make investments, our net income is dependent upon the difference between the rate at which we borrow funds and the rate at which we invest these funds. A significant increase in market interest rates could harm our ability to attract new portfolio companies and originate new loans and investments, our non-performing assets could increase and the value of our portfolio could decrease because our floating-rate loan portfolio companies may be unable to meet higher payment obligations. Due to the nature of the portfolio companies to which we provide fixed rate financing, fluctuations in market rates have a limited impact on rates charged. As a result, an increase in market interest rates generally would not have a material effect on the existing fixed rate loans in our portfolio. In addition, a significant decrease in interest rates could reduce our net income, all other things being equal. A decrease in interest rates may reduce net income, despite the increased demand for our capital that the decrease in interest rates may produce. As of September 30, 2009, approximately 58.8% of the fair value of our loan portfolio, was at variable rates based on a LIBOR benchmark or prime rate and approximately 41.2% of the fair value of our loan portfolio was at fixed rates. As of September 30, 2009, approximately 41.1% of our loan portfolio, at fair value, had LIBOR floors between 1.5% and 4.0% on the LIBOR base index and prime floors between 3.0% and 6.0%. These floors minimize our exposure to significant decreases in interest rates.
Regulations governing our operation as a business development company will affect our ability to, and the way in which we, raise additional capital.
We have issued debt securities and may issue debt securities and/or borrow money from banks or other financial institutions, which we refer to collectively as senior securities, up to the maximum amount permitted by the 1940 Act. Under the provisions of the 1940 Act, as a BDC, we are permitted to issue senior securities only in amounts such that our BDC asset coverage, as defined in the 1940 Act, equals at least 200% after each issuance of senior securities. If the value of our assets declines, we may be unable to satisfy this test. If that happens, we would be precluded from issuing senior securities, could not pay dividends and may be required to sell a portion of our investments and, depending on the nature of our leverage, may be required to repay a portion of our indebtedness at a time when such sales may be disadvantageous. In addition, the 1940 Act prohibits us from selling shares of our common stock at a price below the current net asset value unless our stockholders approve such a sale and our board of directors makes certain determinations.
Any change in the regulation of our business could have a negative effect on the profitability of our operations.
Changes in the laws, regulations or interpretations of the laws and regulations that govern business development companies, RICs, SBICs or non-depository commercial lenders could have a significant effect on our operations and our cost of doing business. We are subject to federal, state and local laws and regulations and are subject to judicial and administrative decisions that affect our operations. If these laws, regulations or decisions change, or if we expand our business into jurisdictions that have adopted more stringent requirements than those in which we currently conduct business, we may have to incur significant expenses in order to comply or we may have to restrict our operations.
One of our wholly owned subsidiaries is licensed by the SBA, and, as a result, we will be subject to SBA regulations.
Our wholly owned subsidiary, Solutions Capital I, LP, is licensed to operate as an SBIC and is regulated by the SBA. The SBA regulations require that a licensed SBIC be examined periodically and audited by an independent auditor to determine the SBICs compliance with the relevant SBA regulations. If Solutions Capital I, LP fails to comply with applicable SBA regulations, the SBA could, depending on the severity of the violation, limit or prohibit the Solutions Capital I, LPs use of debentures, declare outstanding debentures immediately due and payable, and/or limit Solutions Capital I, LP from making new investments. The SBA also imposes a limit on the maximum amount that may be borrowed by any single SBIC. The SBA prohibits, without prior SBA approval, a change of control of an SBIC or transfers that would result in any person (or a group of persons acting in concert) owning 10% or more of a class of capital stock of a licensed SBIC.
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The SBA also places certain limitations on the financing terms of investments by SBICs in portfolio companies and prohibits SBICs from providing funds for certain purposes or to businesses in a few prohibited industries. Compliance with SBA requirements may cause the SBIC to forego attractive investment opportunities that are not permitted under SBA regulations.
The SBA can revoke or suspend a license for willful or repeated violation of, or willful or repeated failure to observe, any provision of the Small Business Investment Act of 1958 or any rule or regulation promulgated thereunder.
Current levels of market volatility are unprecedented. Our stock price has been, and continues to be, volatile and purchasers of our common stock could incur substantial losses.
Since 2007, the capital and credit markets have been experiencing extreme volatility and disruption. In recent quarters, the volatility and disruption have reached unprecedented levels, and we have experienced greater than usual stock price volatility. In addition, the stock market in general and the market prices for securities of financial services companies and business development companies in particular have experienced extreme volatility that often have been unrelated or disproportionate to the operating performance of these companies. If current levels of market volatility continue or worsen, there can be no assurance that we will not continue to experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations.
In addition, the trading price of our common stock following an offering may fluctuate substantially. The price of the common stock that will prevail in the market after an offering may be higher or lower than the price you paid and the liquidity of our common stock may be limited, in each case depending on many factors, some of which are beyond our control and may not be related directly to our operating performance. These factors include, but are not limited to, the following:
| our quarterly results of operations; |
| price and volume fluctuations in the overall stock market from time to time; |
| investors general perception of our company, the economy and general market conditions; |
| actual or anticipated changes in our earnings or fluctuations in our operating results or changes in the expectations of securities analysts; |
| the financial performance of the specific industries in which we invest on a recurring basis, including without limitation, our investments in communications companies; |
| significant transactions or capital commitments by us or our competitors; |
| significant volatility in the market price and trading volume of securities of BDCs or other financial services companies; |
| volatility resulting from trading in derivative securities related to our common stock including puts, calls or short trading positions; |
| changes in laws or regulatory policies or tax guidelines with respect to BDCs or RICs; |
| the loss of a major funding source, including one of our lenders; |
| announcements of strategic developments, acquisitions and other material events by us or our competitors; or |
| departures of key personnel. |
If any of these factors causes an adverse effect on our business, our results of operations or our financial condition, the price of our common stock could fall and investors may not be able to sell their common stock at or above their respective purchase prices.
ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS. |
None.
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ITEM 3. | DEFAULTS UPON SENIOR SECURITIES. |
Not Applicable.
ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. |
Not Applicable.
ITEM 5. | OTHER INFORMATION. |
Not Applicable.
ITEM 6. | EXHIBITS. |
The following table lists exhibits filed as part of this report, according to the number assigned to them in Item 601 of Regulation S-K. All exhibits listed in the following table are incorporated by reference except for those exhibits denoted in the last column.
Incorporated by Reference | ||||||||||
Exhibit No. |
Description |
Form and SEC File No. |
Filing Date with SEC |
Exhibit No. | Filed with this 10-Q | |||||
10.1 | MCG Capital Corporation 2009 Annual Incentive Cash Bonus Plan | 8-K (0-33377) |
July 24, 2009 | 10.1 | ||||||
10.2 | MCG Capital Corporation 2009 Long-Term Incentive Program | 8-K (0-33377) |
July 24, 2009 | 10.2 | ||||||
15.1 | Letter regarding unaudited interim financial information from Ernst & Young LLP, independent registered public accounting firm | * | ||||||||
31.1 | Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | * | ||||||||
31.2 | Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | * | ||||||||
31.3 | Certification of Chief Accounting Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | * | ||||||||
32.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | | ||||||||
32.2 | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | | ||||||||
32.3 | Certification of Chief Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
* | Filed herewith. |
| Furnished herewith. |
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Table of Contents
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
MCG Capital Corporation | ||||
Date: November 4, 2009 | By: | /S/ STEVEN F. TUNNEY | ||
Steven F. Tunney | ||||
Chief Executive Officer | ||||
Date: November 4, 2009 | By: | /S/ STEPHEN J. BACICA | ||
Stephen J. Bacica | ||||
Chief Financial Officer | ||||
Date: November 4, 2009 | By: | /S/ LINDA A. NIMMONS | ||
Linda A. Nimmons | ||||
Chief Accounting Officer |
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